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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K


ý

 

Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2008

o

 

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                             to                            

Commission file number: 0-25923

Eagle Bancorp, Inc.
(Exact Name of Registrant as Specified in its Charter)

Maryland
(State or other jurisdiction of
incorporation or organization)
  52-2061461
(I.R.S. Employer Identification Number)

7815 Woodmont Avenue, Bethesda, Maryland
(Address of Principal Executive Offices)

 

20814
(Zip Code)

        Registrant's Telephone Number, including area code: (301) 986-1800

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

Title of each class   Name of each exchange on which registered
Common Stock, $0.01 par value   The Nasdaq Stock Market

        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 Section 405 of the Securities Act. Yes o    No ý

        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 o    No ý

        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 ý    No o

        Indicate by check mark if disclosure of delinquent filers in 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. o

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

Large accelerated filer o   Accelerated filer ý   Non-accelerated filer o   Smaller reporting company o

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

        The aggregate market value of the outstanding Common Stock held by nonaffiliates as of June 30, 2008 was approximately $76 million.

        As of March 11, 2009, the number of outstanding shares of the Common Stock, $.01 par value, of Eagle Bancorp, Inc. was 12,745,118.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 21, 2009 are incorporated by reference in part III hereof.


Form 10-K Cross Reference Sheet

        The following shows the location in this Annual Report on Form 10-K or the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on May 21, 2009, of the information required to be disclosed by the United States Securities and Exchange Commission Form 10-K. References to pages are only to pages in this report.

PART I   Item 1.   Business. See "Business" at Pages 84 through 90.
    Item 1A.   Risk Factors. See "Risk Factors" at Pages 90 through 96.
    Item 1B.   Unresolved Staff Comments. None
    Item 2.   Properties. See "Properties" at Pages 104 through 105.
    Item 3.   Legal Proceedings. From time to time the Company is a participant in various legal proceedings incidental to its business. In the opinion of management, the liabilities (if any) resulting from such legal proceedings will not have a material effect on the financial position of the Company.
    Item 4.   Submission of Matters to a Vote of Security Holders. No matter was submitted to a vote of the security holders of the Company during the fourth quarter of 2008.
PART II   Item 5.   Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. See "Market for Common Stock and Dividends" at Pages 40 though 42.
    Item 6.   Selected Financial Data. See "Six Year Summary of Financial Information" at Page 3.
    Item 7.   Management's Discussion and Analysis of Financial Condition and Results of Operation. See "Management's Discussion and Analysis of Financial Condition and Results of Operation" at Pages 4 through 39.
    Item 7A.   Quantitative and Qualitative Disclosures about Market Risk. See "Interest Rate Risk Management—Asset/Liability Management and Quantitative and Qualitative Disclosures About Market Risk" at Page 33 through Page 37.
    Item 8.   Financial Statements and Supplementary Data. See Consolidated Financial Statements and Notes thereto at Pages 44 through 83.
    Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None.
    Item 9A.   Controls and Procedures. See "Disclosure Controls and Procedures" at Page 106 and "Management Report on Internal Control Over Financial Reporting" at Page 107.
    Item 9B.   Other Information. None.
PART III   Item 10.   Directors, Executive Officers and Corporate Governance. The information required by this Item is incorporated by reference to the material appearing under the captions "Election of Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Proxy Statement.
        The Company has adopted a code of ethics that applies to its Chief Executive Officer and Chief Financial Officer. A copy of the code of ethics will be provided to any person, without charge, upon written request directed to Jane Cornett, Corporate Secretary, Eagle Bancorp, Inc., 7815 Woodmont Avenue, Bethesda, Maryland 20814.
        There have been no material changes in the procedures previously disclosed by which shareholders may recommend nominees to the Company's Board of Directors.
    Item 11.   Executive Compensation. The information required by this Item is incorporated by reference to the material appearing under the captions "Election of Directors—Director's Compensation" and "Executive Compensation" in the Proxy Statement.
    Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. See "Market for Common Stock and Dividends—Securities Authorized for Issuance Under Equity Compensation Plans" on page 41. The remainder of the information required by this Item is incorporated by reference to the material appearing under the caption "Voting Securities and Principal Shareholders" in the Proxy Statement.
    Item 13.   Certain Relationships and Related Transactions and Director Independence. The information required by this Item is incorporated by reference to the material appearing under the captions "Election of Directors" and "Certain Relationships and Related Transactions" in the Proxy Statement.
    Item 14.   Principal Accountant Fees and Services. The information required by this Item is incorporated by reference to the material appearing under the caption "Independent Registered Public Accounting Firm—Fees Paid to Independent Accounting Firm" in the Proxy Statement.
PART IV   Item 15.   Exhibits, Financial Statement Schedules. See "Exhibits and Financial Statements" at Page 109.

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Six Year Summary of Selected Financial Data

        The following table shows selected historical consolidated financial data for Eagle Bancorp, Inc. (the "Company"). It should be read in conjunction with the Company's audited consolidated financial statements appearing elsewhere in this report.

 
  Year Ended December 31,    
 
 
  5 Year Compound
Growth Rate
 
(dollars in thousands except per common share data)
  2008   2007   2006   2005   2004   2003  

Selected Balances—Period End

                                           

Total assets

  $ 1,496,827   $ 846,400   $ 773,451   $ 672,252   $ 553,453   $ 442,997     28 %

Total stockholders' equity

    142,371     81,166     72,916     64,964     58,534     53,012     22 %

Total loans

    1,265,640     716,677     625,773     549,212     415,509     317,533     32 %

Total deposits

    1,129,380     630,936     628,515     568,893     462,287     335,514     27 %

Selected Balances—Averages

                                           

Total assets

  $ 1,076,201   $ 800,437   $ 712,297   $ 610,245   $ 487,853   $ 375,802     23 %

Total stockholders' equity

    92,892     76,760     68,973     61,563     55,507     34,028     22 %

Total loans

    911,329     659,204     575,854     479,311     353,537     266,811     28 %

Total deposits

    839,568     634,332     585,621     512,416     397,788     292,953     23 %

Results of Operations

                                           

Interest income

  $ 65,657   $ 57,077   $ 50,318   $ 36,726   $ 24,195   $ 18,403     29 %

Interest expense

    23,676     23,729     17,880     8,008     4,328     3,953     43 %

Net interest income

    41,981     33,348     32,438     28,718     19,867     14,450     24 %

Provision for credit losses

    3,979     1,643     1,745     1,843     675     1,175     28 %

Net interest income after provision for credit losses

    38,002     31,705     30,693     26,875     19,192     13,275     23 %

Noninterest income

    4,366     5,186     3,846     3,998     3,753     2,850     9 %

Noninterest expense

    30,817     24,921     21,824     18,960     14,952     11,007     23 %

Income before taxes

    11,551     11,970     12,715     11,913     7,993     5,118     18 %

Income tax expense

    4,123     4,269     4,690     4,369     2,906     1,903     17 %

Net income

    7,428     7,701     8,025     7,544     5,087     3,215     18 %

Dividends paid, common shareholders

    1,178     2,302     2,147     1,994                

Per Share Data(1)

                                           

Earnings per weighted average common share, basic(2)

  $ 0.63   $ 0.73   $ 0.77   $ 0.74   $ 0.51   $ 0.44     7 %

Earnings per weighted average common share, diluted(2)

    0.62     0.71     0.74     0.70     0.48     0.41     9 %

Book value per common share

    8.19     7.59     6.99     6.32     5.80     5.32     9 %

Dividends declared per common share

    0.11     0.22     0.21     0.20                

Dividend payout ratio per common share(3)

    15.86 %   29.89 %   27.06 %   26.42 %              

Financial Ratios

                                           

Return on average assets

    0.69 %   0.96 %   1.13 %   1.24 %   1.04 %   0.86 %      

Return on average common equity

    8.05 %   10.03 %   11.63 %   12.25 %   9.16 %   9.45 %      

Average common equity to average assets

    8.37 %   9.59 %   9.68 %   10.09 %   11.38 %   9.05 %      

Net interest margin

    4.05 %   4.37 %   4.81 %   4.99 %   4.35 %   4.14 %      

Efficiency ratio(4)

    66.49 %   64.67 %   60.15 %   57.95 %   63.30 %   63.62 %      

Nonperforming loans to total loans

    2.01 %   0.74 %   0.32 %   0.09 %   0.04 %   0.21 %      

Net charge-offs to average loans

    0.12 %   0.15 %   0.06 %   0.02 %   0.03 %   0.10 %      

(1)
Presented giving retroactive effect to the 10% stock dividend paid on the common stock on October 1, 2008 and the stock splits in the form of 30% dividends on the common stock paid on July 5, 2006 and February 28, 2005. In July 2008, the Company discontinued the payment of its quarterly cash dividend.

(2)
Earnings per weighted average common share, basic and diluted, for the twelve months ended December 31, 2008 reflects the reduction to net income for the accrued dividends of $177 thousand on the preferred stock issued on December 5, 2008 pursuant to the Capital Purchase Program.

(3)
Computed by dividing dividends declared per common share by net income.

(4)
Computed by dividing noninterest expense by the sum of net interest income and noninterest income.

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

        The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of Eagle Bancorp, Inc. (the "Company"). The Company's primary subsidiaries are EagleBank (the "Bank") and Eagle Commercial Ventures ("ECV"). This discussion and analysis should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this report.

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

GENERAL

        The Company is a growth oriented, one-bank holding company headquartered in Bethesda, Maryland. The Company provides general commercial and consumer banking services through the Bank, its wholly owned banking subsidiary, a Maryland chartered bank which is a member of the Federal Reserve System. The Company was organized in October 1997, to be the holding company for the Bank. The Bank was organized as an independent, community oriented, full service banking alternative to the super regional financial institutions, which dominate the primary market area. The Company's philosophy is to provide superior, personalized service to its customers. The Company focuses on relationship banking, providing each customer with a number of services, becoming familiar with and addressing customer needs in a proactive, personalized fashion. The Bank currently has seven offices serving Montgomery County, five offices in the District of Columbia and one office in Fairfax County, Virginia.

        The Company offers a broad range of commercial banking services to its business and professional clients as well as full service consumer banking services to individuals living and/or working primarily in the service area. The Company emphasizes providing commercial banking services to sole proprietors, small and medium-sized businesses, partnerships, corporations, non-profit organizations and associations, and investors living and working in and near the primary service area. A full range of retail banking services are offered to accommodate the individual needs of both corporate customers as well as the community the Company serves. These services include the usual deposit functions of commercial banks, including business and personal checking accounts, "NOW" accounts and money market and savings accounts, business, construction, and commercial loans, residential mortgages and consumer loans and cash management services. The Company has developed significant expertise and commitment as an SBA lender, and has been designated a Preferred Lender by the Small Business Administration ("SBA").

        During 2008, the financial industry encountered significant volatility and stress as economic conditions worsened, unemployment increased and the effects of the "mortgage crisis" became more widespread. The Company did not make subprime residential mortgage loans to retail customers, and did not invest in private label mortgage backed securities or securities backed by subprime or Alt A mortgages or the preferred stock of Freddie Mac and Fannie Mae.

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        The slowing economy, declines in housing construction and the related impact on contractors and other small and medium sized businesses, has impacted the Company's business. There can be no assurance that the steps taken to stimulate the economy and stabilize the financial system will prove successful, or that they will improve the financial condition of the Company's customers or the Company.

ACQUISITION COMPLETED

        The Company completed as of August 31, 2008, the acquisition of Fidelity & Trust Financial Corporation ("Fidelity") and its subsidiary Fidelity & Trust Bank ("F&T Bank") which added approximately $360 million in loans, $100 million in investments, $385 million in deposits, $47 million in customer repurchase agreements and $13 million in equity capital. Fidelity operated six branches in Montgomery County, Maryland, Washington D.C. and Fairfax County, Virginia. For further information about the acquisition, please refer to "Note 18 of Notes to Consolidated Financial Statements" and to "Business—Acquisition" at page 84.

CAPITAL PURCHASE PROGRAM

        On December 5, 2008, the Company entered into and consummated a Letter Agreement (the "Purchase Agreement") with the United States Department of the Treasury (the "Treasury"), pursuant to which the Company issued 38,235 shares of the Company's Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the "Series A Preferred Stock"), having a liquidation amount per share equal to $1,000, for a total purchase price of $38,235,000. The Series A Preferred Stock pays cumulative dividends at a rate of 5% per year for the first five years and thereafter at a rate of 9% per year. For additional information see "Capital Resources and Adequacy" on page 37.

CRITICAL ACCOUNTING POLICIES

        The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, the consolidated financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility.

        The fair values and the information used to record valuation adjustments for investment securities available for sale are based either on quoted market prices or are provided by other third-party sources, when available. The Company's investment portfolio is categorized as available for sale with unrealized gains and losses net of tax being a component of stockholders' equity and comprehensive income. Refer to the fair value disclosures on page 18 and Note 19 of Notes to Consolidated Financial Statements for further discussion of the carrying value of the investment portfolio.

        The allowance for credit losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two principles of accounting: (a) Statement of Financial Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies", which requires that losses be accrued when they are probable of occurring and are estimable and (b) SFAS No. 114, "Accounting by Creditors for Impairment of

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a Loan" ("SFAS 114"), which requires that losses be accrued when it is probable that the Company will not collect all principal and interest payments according to the contractual terms of the loan. The loss, if any, can be determined by the difference between the loan balance and the value of collateral, the present value of expected future cash flows, or values observable in the secondary markets.

        Three components comprise our allowance for credit losses: a specific allowance, a formula allowance and a nonspecific or environmental factors allowance. Each component is determined based on estimates that can and do change when actual events occur.

        The specific allowance allocates a reserve to identified impaired loans. Loans identified in the risk rating evaluation as substandard, doubtful and loss, (classified loans) are segregated from non-classified loans. Classified loans are assigned specific reserves based on an impairment analysis. Under SFAS 114, a loan for which reserves are individually allocated may show deficiencies in the borrower's overall financial condition, payment record, support available from financial guarantors and for the fair market value of collateral. When a loan is identified as impaired, a specific reserve is established based on the Company's assessment of the loss that may be associated with the individual loan.

        The formula allowance is used to estimate the loss on internally risk rated loans, exclusive of those identified as requiring specific reserves. The portfolio of unimpaired loans is stratified by loan type and risk assessment. Allowance factors relate to the type of loan and level of the internal risk rating, with loans exhibiting higher risk and loss experience receiving a higher allowance factor.

        The environmental allowance is also used to estimate the loss associated with pools of non-classified loans. These unclassified loans are also stratified by loan type, and environmental allowance factors are assigned by management based upon a number of conditions, including delinquencies, loss history, changes in lending policy and procedures, changes in business and economic conditions, changes in the nature and volume of the portfolio, management expertise, concentrations within the portfolio, quality of internal and external loan review systems, competition, and legal and regulatory requirements.

        The allowance captures losses inherent in the portfolio which have not yet been recognized. Allowance factors and the overall size of the allowance may change from period to period based upon management's assessment of the above described factors, the relative weights given to each factor, and portfolio composition.

        Management has significant discretion in making the judgments inherent in the determination of the provision and allowance for credit losses, including, in connection with the valuation of collateral, a borrower's prospects of repayment, and in establishing allowance factors on the formula allowance and environmental allowance components of the allowance. The establishment of allowance factors involves a continuing evaluation, based on management's ongoing assessment of the global factors discussed above and their impact on the portfolio. The allowance factors may change from period to period, resulting in an increase or decrease in the amount of the provision or allowance, based upon the same volume and classification of loans. Changes in allowance factors can have a direct impact on the amount of the provision, and a related after tax effect on net income. Errors in management's perception and assessment of the global factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs. Alternatively, errors in management's perception and assessment of the global factors and their impact on the portfolio could result in the allowance being in excess of amounts necessary to cover losses in the portfolio, and may result in lower provisions in the future. For additional information regarding the allowance for credit losses, refer to the discussion under the caption "Allowance for Credit Losses" on page 21.

        The Company follows the provisions of SFAS No. 123R, "Share-Based Payment", which requires the expense recognition for the fair value of share based compensation awards, such as stock options, restricted stock units, and performance based shares. This standard allows management to establish modeling assumptions as to expected stock price volatility, option terms, forfeiture rates and dividend rates

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which directly impact estimated fair value. The accounting standard also allows for the use of alternative option pricing models which may impact fair value as determined. The Company's practice is to utilize reasonable and supportable assumptions which are reviewed with the appropriate Board Committee.

        In accounting for the acquisition of Fidelity, the Company followed the provisions of SFAS No. 141 "Business Combinations", which mandates the use of the purchase method of accounting and AICPA Statement of Position 03-3 ("SOP 03-3"), "Accounting for Certain Loans or Debt Securities Acquired in a Transfer". Accordingly, the tangible assets and liabilities and identifiable intangibles acquired were recorded at their respective fair values on the date of acquisition, with any impaired loans acquired being recorded at fair value outside the allowance for loan losses. The valuation of the loan and time deposit portfolios acquired were made by independent analysis for the difference between the instruments stated interest rates and the instruments current origination interest rate, with premiums and discounts being amortized to interest income and interest expense to achieve an effective market interest rate. An identified intangible asset related to core deposits was recorded based on independent valuation. Deferred tax assets were recorded for the future value of a net operating loss and for the tax effect of timing differences between the accounting and tax basis of assets and liabilities. The Company recorded an unidentified intangible (goodwill) for the excess of the purchase price of the acquisition (including direct acquisition costs) over the fair value of net tangible and identifiable intangible assets acquired. See discussion of "Allowance for Credit Losses" on page 21, discussion of "Nonperforming Asserts" on page 24, discussion of "Intangible Assets" on page 26, and Note 4 "Loans and Allowance for Credit Losses"; Note 18 "Acquisition" of Notes to Consolidated Financial Statements, and "Business-Acquisition" on page 84, for further information on the acquisition of Fidelity.


RESULTS OF OPERATIONS

Overview

        The results of operation of the Company include the results of operation of Fidelity, acquired on August 31, 2008, for the period September 1, 2008 through December 31, 2008 only.

        The Company reported net income of $7.4 million for the year ended December 31, 2008, a 4% decrease from net income of $7.7 million for the year ended December 31, 2007, as compared to $8.0 million for the year ended December 31, 2006.

        The decrease in net income for the twelve months ended December 31, 2008 can be attributed substantially to an increase in the provision for credit losses of 142% and a 24% increase in noninterest expense while interest income increased by only 15% as compared to the same period in 2007. Net interest income showed an increase of 26% on growth in average earning assets of 36%. For the twelve months ended December 31, 2008, the Company has experienced a 32 basis point decline in its net interest margin from 4.37% in 2007 to 4.05% in 2008. This change was primarily due to reliance on more expensive sources of funds (i.e. funding mix) which has increased interest expense at a faster rate than increases in interest income. Also contributing to the lower net interest margin was a lesser value of noninterest funding sources as interest rates declined significantly during 2008. Additionally, a small portion of the decline was due to lower margins on the assets and liabilities acquired in the Fidelity acquisition.

        Earnings per basic common share were $0.63 for the year ended December 31, 2008, as compared to $0.73 for 2007 and $0.77 for 2006. Earnings per diluted common share were $0.62 for the year ended December 31, 2008, as compared to $0.71 for 2007 and $0.74 for 2006. Per common share amounts and the number of shares have been adjusted to give effect to the 10% stock dividend paid on October 1, 2008.

        For the three months ended December 31, 2008, the Company reported net income of $1.7 million as compared to $2.3 million for the same period in 2007. Earnings per basic and diluted common shares were $0.12 for the three months ended December 31, 2008, as compared to $0.22 per basic common share and $0.21 per diluted common share for the same period in 2007.

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        The Company had a return on average assets of 0.69% and a return on average common equity of 8.05% for the year of 2008, as compared to returns on average assets and average equity of 0.96% and 10.03%, respectively, for the year of 2007 and 1.13% and 11.63%, respectively, for the year of 2006.

        For the twelve months ended December 31, 2008, average interest bearing liabilities funding average earning assets increased to 78% as compared to 77% for the year of 2007. Additionally, while the average rate on earning assets for the twelve month period ended December 31, 2008, as compared to 2007 decreased by 115 basis points from 7.48% to 6.33%, the cost of interest bearing liabilities also decreased by 115 basis points from 4.06% to 2.91%, resulting in a net interest spread of 3.42% for both the twelve months ended December 31, 2008 and 2007. The 32 basis point decline in the net interest margin from 4.37% for the twelve months ended December 31, 2007 to 4.05% for the twelve months ended December 31, 2008, despite the stable interest spread, reflects the effects of a steep decline in market interest rates that reduced the benefit of noninterest funding sources from 95 basis points in 2007 to 63 basis points for 2008. For the twelve months ended December 31, 2008, average noninterest sources funding earning assets were $225 million as compared to $179 million for the same period in 2007.

        Market interest rates (as evidenced by the U.S. Treasury yield curve), declined sharply in the fourth quarter of 2008 due to a deepening financial crisis emanating from defaults in the residential mortgage markets and spreading quickly to all leveraged investments. During the fourth quarter of 2008, the Company's net interest spread was 3.18% as compared to 3.52% for the third quarter of 2008 and 3.69% for the second quarter of 2008. The Company believes that the change in the net interest spread has been consistent with its risk analysis. Furthermore, as market interest rates are currently very low, the lower rates tend to create floors (given a shock of -100 and -200 basis points) on various deposit interest rate products, as interest rates cannot be reduced below zero. This effect further serves to compress net interest income and net interest spreads and margins.

        Due to the need to meet loan funding objectives in excess of deposit growth, the Bank (during 2008) has relied to a larger extent on alternative funding sources, such as Federal Home Loan Bank of Atlanta ("FHLB") advances and brokered time deposits, which sources provided favorable funding costs. If significant reliance on alternative funding sources continues, the Company's earnings could be adversely impacted, although use of such funds during 2008 had a favorable earnings impact.

        Loans, which generally have higher yields than securities and other earning assets, increased to 88% of average earning assets in 2008 from 86% of average earning assets for 2007. Investment securities accounted for 11% of average earning assets for both 2008 and 2007. Federal funds sold averaged 1% and 2% of average earning assets for 2008 and 2007, respectively.

        For the quarter ended December 31, 2008, average interest bearing liabilities funding average earning assets increased to 79% as compared to 77% for the same period in 2007. Additionally, while the average rate on earning assets for the quarter ended December 31, 2008, as compared to the same period in 2007, has declined by 132 basis points from 7.23% to 5.91%, the cost of interest bearing liabilities has decreased by 110 basis points from 3.83% to 2.73%, resulting in a decline in the net interest spread of 22 basis points from 3.40% for the quarter ended December 31, 2007 to 3.18% for the quarter ended December 31, 2008. The net interest margin decreased 56 basis points from 4.30% for the quarter ended December 31, 2007 to 3.74% for the quarter ended December 31, 2008, a higher decline than the net interest spread as the benefit of average noninterest sources funding earning assets declined from 90 basis points for the quarter ended December 31, 2007 to 56 basis points for the quarter ended December 31, 2008. This decline was due to the lower value of noninterest funding sources in a much lower market interest rate environment during 2008 as compared to 2007.

        For the quarter ended December 31, 2008 average loans increased 77% over the same period in 2007, due substantially to the acquisition of Fidelity, and increased to 87% of average earning assets as compared to 84% of average earning assets for 2007. For the quarter ended December 31, 2008, investment securities amounted to 12% of average earning assets, a decrease of 1% from 13% of average earning assets for the

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same period in 2007. Federal funds sold averaged 1% and 3% of average earning assets for the quarters ended December 31, 2008 and 2007, respectively. This mix change toward a higher level of average loans as a percentage of assets reflects the Company's efforts to meet the demand for credit.

        The provision for credit losses was $4.0 million for the year ended December 31, 2008 as compared to $1.6 million in 2007. The higher provision for the year ended December 31, 2008 as compared to 2007 is attributable to substantially higher levels of loan growth, migration of loans to higher risk assessments within the portfolio and increases in reserve allocations on classified loans. For the full year 2008, the Company recorded net charge-offs of $1.1 million, as compared to $979 thousand for the same period in 2007. The ratio of net-charge offs to average loans was 0.12% for 2008 and 0.15% for 2007. The increase in the amount of net charge-offs in 2008 over 2007 was attributable to charge-offs in commercial construction and land development loans ($446 thousand versus $0), the un-guaranteed portion of SBA loans ($337 thousand versus $0), non-real estate commercial business loans ($100 thousand versus $968 thousand), consumer loans ($210 thousand versus $11 thousand), and commercial real estate investment property loans ($29 thousand versus $0).

        At December 31, 2008, the allowance for credit losses was $18.4 million (including the assumed balance of the Fidelity allowance for credit losses of $7.5 million) or 1.45% of total loans, as compared to $8.0 million or 1.12% of total loans at December 31, 2007. The primary factor in the increase of the balance of the allowance was the acquisition of Fidelity and the assumption of its allowance related to unimpaired loans. The increase in the allowance as a percentage of total loans reflects a higher risk profile of the loans acquired from Fidelity, as well as a change in the mix of loans as a result of the acquisition of Fidelity.

        The provision for credit losses was $1.4 million for the three months ended December 31, 2008 as compared to $883 thousand for the same period in 2007, the increase being primarily attributable to changes in the composition of the loan portfolio among loan classes and risk grades. For the fourth quarter of 2008, the Company recorded net charge-offs of $166 thousand, as compared to $252 thousand net charge-offs for the fourth quarter of 2007. The charge-offs in the fourth quarter of 2008 related principally to two problem loan relationships identified several quarters ago and for which specific reserves had been established.

        Total noninterest income was $4.4 million for the year 2008 as compared to $5.2 million for 2007, a decrease of 16%. These amounts include net investment gains of $2 thousand for the year of 2008 and $6 thousand in 2007. The decrease was attributable primarily to $1.3 million of income in 2007 from the settlement of a subordinated financing transaction. Excluding this transaction, noninterest income increased 10%, which includes the impact of the Fidelity acquisition. Other factors were higher service charges on deposit accounts of $919 thousand ($2.4 million in 2008 versus $1.5 million in 2007), partially offset by lower volume of SBA and residential mortgage loan sales activity ($426 thousand in 2008 versus $1.0 million in 2007). Income from subordinated financing activities can fluctuate greatly between periods, as it is based on the progress of a limited number of development projects. Refer to "Loan Portfolio" section below for further discussion of subordinated financing activities.

        Total noninterest income for the fourth quarter of 2008 was $1.3 million as compared to $2.0 million for the three months ended December 31, 2007, a 36% decrease. This decrease was due primarily to $1.0 million recorded in the fourth quarter of 2007 from settlement of a subordinated financing transaction. Excluding this transaction, noninterest income increased 30% over the same period in 2007, in part due to the Fidelity acquisition. Other major contributors were higher service charges on deposit accounts and loan fees, partially offset by a lower volume of SBA and residential mortgage loan sales activity which is subject to significant quarterly variances.

        Total noninterest expenses were $30.8 million for the full year of 2008, as compared to $24.9 million for 2007, a 24% increase, which reflects the larger organization subsequent to the Fidelity acquisition. The other primary reasons for this increase were merit increases, higher personnel costs, increased broker fees,

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higher internet and license agreement fees, increased legal, accounting and professional fees, including loan collection costs, and acquisition related expenses. In addition, higher costs were incurred for marketing, sponsorship, and professional services associated with the EagleBank Bowl, a new NCAA Bowl in 2008 played in Washington, D.C. on December 20, 2008. The efficiency ratio, which measures the level of noninterest expense to total revenue, was 66.49% for the year of 2008 as compared to 64.67% for 2007.

        The efficiency ratio was 72.54% for the three months ended December 31, 2008, as compared to 59.87% for the three months ended December 31, 2007. Noninterest expenses were $10.5 million for the fourth quarter of 2008, as compared to $6.5 million for 2007, a 62% increase, due substantially to the Fidelity acquisition. Other reasons for this increase were merit increases and related personnel costs, increased broker fees, higher internet and license agreement fees, increased legal, accounting and professional fees, including loan collection costs, and acquisition related expenses. In addition, higher costs were incurred in the fourth quarter for marketing, sponsorship, and professional services associated with the EagleBank Bowl.

Net Interest Income and Net Interest Margin

        Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans and investment securities. The cost of funds represents interest expense on deposits, customer repurchase agreements and other borrowings, which comprise federal funds purchased and other borrowings. Noninterest bearing deposits and capital are other components representing funding sources. Changes in the volume and mix of assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income. Net interest income in 2008 was $42.0 million compared to $33.3 million in 2007 and $32.4 million in 2006. For the three months ended December 31, 2008, net interest income was $13.2 million as compared to $8.8 million for the same period in 2007, a 50% increase, due in part to the Fidelity acquisition.

        The tables below labeled "Average Balances, Interest Yields and Rates and Net Interest Margin" present the average balances and rates of the various categories of the Company's assets and liabilities for the years ended 2008, 2007 and 2006 and the three months ended December 31, 2008 and 2007. Included in the tables are measurements of interest rate spread and margin. Interest spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest expense on interest bearing liabilities. While net interest spread provides a quick comparison of earnings rates versus cost of funds, management believes that margin provides a better measurement of performance. Margin includes the effect of noninterest bearing sources in its calculation and is net interest income expressed as a percentage of average earning assets.

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Average Balances, Interest Yields and Rates, and Net Interest Margin

 
  Year Ended December 31,  
 
  2008   2007   2006  
(dollars in thousands)
  Average
Balance
  Interest   Average
Yield/Rate
  Average
Balance
  Interest   Average
Yield/Rate
  Average
Balance
  Interest   Average
Yield/Rate
 

ASSETS:

                                                       

Interest earning assets:

                                                       

Interest bearing deposits with other banks and other short-term investments

  $ 3,750   $ 98     2.61 % $ 4,565   $ 293     6.42 % $ 3,379   $ 212     6.27 %

Loans(1)(2)(3)

    911,329     59,901     6.57 %   659,204     51,931     7.88 %   575,854     45,814     7.96 %

Investment securities available for sale(3)

    111,398     5,459     4.90 %   85,177     4,177     4.90 %   75,181     3,277     4.36 %

Federal funds sold

    11,255     199     1.77 %   13,682     676     4.94 %   20,271     1,015     5.01 %
                                             
 

Total interest earning assets

    1,037,732     65,657     6.33 %   762,628     57,077     7.48 %   674,685     50,318     7.46 %
                                             

Noninterest earning assets

    50,050                 45,217                 44,090              

Less: allowance for credit losses

    11,581                 7,408                 6,478              
                                                   
 

Total noninterest earning assets

    38,469                 37,809                 37,612              
                                                   
 

TOTAL ASSETS

  $ 1,076,201               $ 800,437               $ 712,297              
                                                   

LIABILITIES AND STOCKHOLDERS' EQUITY

                                                       

Interest bearing liabilities:

                                                       

Interest bearing transaction

  $ 48,094   $ 306     0.64 % $ 51,465   $ 305     0.59 % $ 58,675   $ 204     0.35 %

Savings and money market

    225,126     4,212     1.87 %   177,312     6,044     3.41 %   152,162     5,174     3.40 %

Time deposits

    402,232     15,025     3.74 %   270,480     13,461     4.98 %   229,719     10,225     4.45 %
                                             
 

Total interest bearing deposits

    675,452     19,543     2.89 %   499,257     19,810     3.97 %   440,556     15,603     3.54 %

Customer repurchase agreements and federal funds purchased

    68,696     1,406     2.05 %   44,992     1,887     4.19 %   32,968     1,199     3.64 %

Other short-term borrowings

    15,577     399     2.56 %   11,093     611     5.51 %   12,596     639     5.07 %

Long term borrowings

    53,750     2,328     4.33 %   29,033     1,421     4.89 %   7,888     439     5.57 %
                                             
 

Total interest bearing liabilities

    813,475     23,676     2.91 %   584,375     23,729     4.06 %   494,008     17,880     3.62 %
                                             

Noninterest bearing liabilities:

                                                       

Noninterest bearing demand

    164,116                 135,075                 145,065              

Other liabilities

    5,718                 4,227                 4,251              
                                                   
 

Total noninterest bearing liabilities

    169,834                 139,302                 149,316              
                                                   

Stockholders' equity

    92,892                 76,760                 68,973              
                                                   
   

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

  $ 1,076,201               $ 800,437               $ 712,297              
                                                   

Net interest income

        $ 41,981               $ 33,348               $ 32,438        
                                                   

Net interest spread

                3.42 %               3.42 %               3.84 %

Net interest margin

                4.05 %               4.37 %               4.81 %

(1)
Includes loans held for sale.

(2)
Loans placed on nonaccrual status are included in average balances. Net loan fees and late charges included in interest income on loans totaled $1.6 million, $1 million and $2 million for 2008, 2007 and 2006 respectively.

(3)
Interest and fees on loans and investment securities available for sale exclude tax equivalent adjustments.

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Average Balances, Interest Yields and Rates, and Net Interest Margin

 
  Three Months Ended December 31,  
 
  2008   2007  
(dollars in thousands)
  Average
Balance
  Interest   Average
Yield/Rate
  Average
Balance
  Interest   Average
Yield/Rate
 

ASSETS:

                                     

Interest earning assets:

                                     

Interest bearing deposits with other banks and other short-term investments

  $ 6,648   $ 24     1.44 % $ 4,675   $ 112     9.50 %

Loans(1)(2)(3)

    1,218,067     18,803     6.14 %   687,032     13,299     7.68 %

Investment securities available for sale(3)

    166,803     2,040     4.87 %   102,643     1,218     4.71 %

Federal funds sold

    14,903     36     0.96 %   21,839     250     4.54 %
                               
 

Total interest earning assets

    1,406,421     20,903     5.91 %   816,189     14,879     7.23 %
                               

Total noninterest earning assets

    62,433                 43,556              

Less: allowance for credit losses

    17,559                 7,503              
                                   
 

Total noninterest earning assets

    44,874                 36,053              
                                   
 

TOTAL ASSETS

  $ 1,451,295               $ 852,242              
                                   

LIABILITIES AND STOCKHOLDERS' EQUITY

                                     

Interest bearing liabilities:

                                     

Interest bearing transaction

  $ 51,536   $ 53     0.41 % $ 47,809     92     0.76 %

Savings and money market

    282,534     1,232     1.73 %   196,283     1,490     3.01 %

Time deposits

    605,022     5,127     3.37 %   274,035     3,341     4.84 %
                               
 

Total interest bearing deposits

    939,092     6,412     2.72 %   518,127     4,923     3.77 %

Customer repurchase agreements and federal funds purchased

    99,071     388     1.56 %   55,698     511     3.64 %

Other short-term borrowings

    6,522     18     1.10 %   21,752     302     5.51 %

Long-term borrowings

    72,362     861     4.73 %   30,249     300     3.93 %
                               
 

Total interest bearing liabilities

    1,117,047     7,679     2.73 %   625,826     6,036     3.83 %
                               

Noninterest bearing liabilities:

                                     

Noninterest bearing demand

    213,284                 141,229              

Other liabilities

    7,719                 5,130              
                                   
 

Total noninterest bearing liabilities

    221,003                 146,359              
                                   

Stockholders' equity

    113,245                 80,057              
                                   
 

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

  $ 1,451,295               $ 852,242              
                                   

Net interest income

        $ 13,224               $ 8,843        
                                   

Net interest spread

                3.18 %               3.40 %

Net interest margin

                3.74 %               4.30 %

(1)
Includes loans held for sale.

(2)
Loans placed on nonaccrual status are included in average balances. Net loan fees and late charges included in interest income on loans totaled $514 thousand and $263 thousand for the three months ended December 31, 2008 and 2007 respectively.

(3)
Interest and fees on investments exclude tax equivalent adjustments.

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        The rate/volume table below presents the composition of the change in net interest income for the periods indicated, as allocated between the change in net interest income due to changes in the volume of average earning assets and interest bearing liabilities, and the changes in net interest income due to changes in interest rates. As the table shows, the increase in net interest income in 2008 as compared to 2007 was a function of significant increase in the volume of earning assets partially offset by a decrease in the net interest margin on earning assets, due to the lower value of noninterest funding sources in 2008 as compared to 2007. For 2007 over 2006, the change is due to growth in the volume of earning assets offset by a decrease in the net interest margin on earning assets.

Rate/Volume Analysis of Net Interest Income

 
  2008 compared with 2007   2007 compared with 2006  
(dollars in thousands)
  Change Due
to Volume
  Change Due
to Rate
  Total Increase
(Decrease)
  Change Due
to Volume
  Change Due
to Rate
  Total Increase
(Decrease)
 

Interest earned on:

                                     
 

Loans

  $ 19,862   $ (11,892 ) $ 7,970   $ 6,631   $ (514 ) $ 6,117  
 

Investment securities

    1,286     (4 )   1,282     436     464     900  
 

Interest bearing bank deposits

    (52 )   (143 )   (195 )   74     7     81  
 

Federal funds sold

    (120 )   (357 )   (477 )   (330 )   (9 )   (339 )
                           
   

Total interest income

    20,976     (12,396 )   8,580     6,811     (52 )   6,759  
                           

Interest paid on:

                                     
 

Interest bearing transaction

    (20 )   21     1     (25 )   126     101  
 

Savings and money market

    1,630     (3,462 )   (1,832 )   855     15     870  
 

Time deposits

    6,557     (4,993 )   1,564     1,814     1,422     3,236  
 

Customer repurchase agreements

    994     (1,475 )   (481 )   437     251     688  
 

Other borrowings

    1,457     (762 )   695     1,101     (147 )   954  
                           
   

Total interest expense

    10,618     (10,671 )   (53 )   4,182     1,667     5,849  
                           

Net interest income

  $ 10,358   $ (1,725 ) $ 8,633   $ 2,629   $ (1,719 ) $ 910  
                           

Provision for Credit Losses

        The provision for credit losses represents the amount of expense charged to current earnings to fund the allowance for credit losses. The amount of the allowance for credit losses is based on many factors which reflect management's assessment of the risk in the loan portfolio. Those factors include economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company and Bank.

        Management has developed a comprehensive analytical process to monitor the adequacy of the allowance for credit losses. This process and guidelines were developed utilizing among other factors, the guidance from federal banking regulatory agencies. The results of this process, in combination with conclusions of the Bank's outside loan review consultant, support management's assessment as to the adequacy of the allowance at the balance sheet date. Please refer to the discussion under the caption "Critical Accounting Policies" for an overview of the methodology management employs on a quarterly basis to assess the adequacy of the allowance and the provisions charged to expense. Also, refer to the table in the section titled "Allowance for Credit Losses" which reflects the comparative charge-offs and recoveries on page 23.

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        During the year of 2008, the provision for credit losses was $4.0 million and the allowance for credit losses increased $10.4 million, including the impact of net charge-offs of $1.1 million during the period and the assumption of Fidelity's $7.5 million allowance in respect of unimpaired loans. During the year of 2007, the provision for credit losses was $1.6 million and the allowance for credit losses increased $664 thousand, including the impact of net charge-offs of $979 thousand during the period. The higher provisioning for the year ended December 31, 2008 as compared to 2007 is attributable to substantially higher levels of loan growth, migration of loans within the portfolio to higher risk assessments and increases in reserve allocations on classified loans. The provision for credit losses of $1.6 million for the year 2007 was similar to the provision for credit losses of $1.7 million for the year 2006, as the overall portfolio mix of loans at year end 2007 and 2006 was similar and the amount of loan growth was also similar.

        For the three months ended December 31, 2008, a provision for credit losses was made in the amount of $1.4 million, as compared to $883 thousand for the same period in 2007. The higher provision for the fourth quarter of 2008 is primarily attributable to higher levels of loan growth in the fourth quarter of 2008 versus 2007, migration within the portfolio to higher risk assessments, and increases in specific reserves for problem loans. For the fourth quarter of 2008, net charge-offs amounted to $166 thousand as compared to $252 thousand of net charge-offs for the same period in 2007. The charge-offs in the fourth quarter of 2007 related to one problem loan relationship identified several quarters ago for which specific reserves had been established.

        The maintenance of a high quality loan portfolio, with an adequate allowance for credit losses will continue to be a primary objective of the Company.

Noninterest Income

        Total noninterest income includes service charges on deposits, gain on sale of loans, gain on sale of investments, income from bank owned life insurance ("BOLI"), income from subordinated financing and other income.

        Total noninterest income for the full year of 2008 was $4.4 million compared to $5.2 million for the same period in 2007, a decrease of 16%. The decrease was attributed primarily to $1.3 million of income in 2007 from the settlement of a subordinated financing transaction. Excluding this transaction, noninterest income increased 10%, which includes the impact of the Fidelity acquisition. Other factors were higher service charges on deposit accounts of $919 thousand ($2.4 million in 2008 versus $1.5 million in 2007), partially offset by a lower volume of SBA and residential mortgage loan gain on sale activity ($426 thousand in 2008 versus $1.0 million in 2007). Income from subordinated financing activities can fluctuate greatly between periods, as it is based on the progress of a limited number of development projects. Refer to the discussion under Loan Portfolio for further information on the Company's higher risk lending activities.

        Total noninterest income for the fourth quarter of 2008 was $1.3 million as compared to $2.0 million for the three months ended December 31, 2007, a 36% decrease. This decrease was due primarily to $1.0 million recorded in the fourth quarter of 2007 from settlement of a subordinated financing transaction. Excluding this non-recurring transaction, noninterest income increased 30% over the same period in 2007, in part due to the Fidelity acquisition. Other major contributors were higher service charges on deposit accounts and loan fees, offset by a lower volume of SBA and residential mortgage loan sales activity which is subject to significant quarterly variances.

        For the year ended December 31, 2008 service charges on deposit accounts increased to $2.4 million from $1.5 million, an increase of 61%. The increase in service charges for the year was primarily related to the Fidelity acquisition, to fee increases due in part to the impact of lower interest rates on customer earnings credits and to new relationships. For the three months ended December 31, 2008 service charges on deposit accounts increased from $429 thousand to $876 thousand compared to the same period in 2007,

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an increase of 104%. This increase relates in part to the impact of lower interest rates in fourth quarter of 2008 as compared to 2007 on commercial deposit account fees.

        Gain on sale of loans consists of SBA and residential mortgage loans. For the year ended December 31, 2008 gain on sale of loans decreased from $1.0 million to $426 thousand compared to the same period in 2007 or 59%. For the three months ended December 31, 2008 gain on loan sales decreased from $220 thousand to $20 thousand compared to the same period in 2007. These declines were due to lower volumes of activity due to weaker economic conditions and to a lowering of the profit margin afforded on SBA guaranteed loan sales.

        The Company is an originator of SBA loans and its current practice is to sell the insured portion of those loans at a premium. Income from this source was $212 thousand for the year ended December 31, 2008 compared to $620 thousand for the year ended December 31, 2007. For the three months ended December 31, 2008, gains on the sale of SBA loans amounted to $0 as compared to $140 thousand for the same period in 2007. Activity in SBA loan sales to secondary markets can vary widely from quarter to quarter. As noted above, weaker economic activity and lower fee margins established by the SBA were the reasons for the decline in this source of revenue.

        The Company originates residential mortgage loans on a pre-sold basis, servicing released. Sales of these mortgage loans yielded gains of $214 thousand for the year of 2008 compared to $416 thousand in the same period in 2007. For the three months ended December 31, 2008, gains on the sale of residential mortgage loans were $26 thousand as compared to $80 thousand for the same three months of 2007. The Company continues its efforts to originate residential mortgages and associated sale of these assets on a servicing released basis. Loans sold are subject to repurchase in circumstances where documentation is deficient or the underlying loan becomes delinquent within a specified period following sale and loan funding. The Bank considers these potential recourse provisions to be a minimal risk and to date has not been required to repurchase any loans. The Bank does not originate so called "sub-prime" loans and has no exposure to this market segment. A weaker general economy and a slowdown in housing activity in 2008 as compared to 2007 was the reason for the decline in this source of revenue.

        Other income totaled $1.1 million for the year ended 2008 as compared to $2.2 million for the same period in 2007, a decrease of 52%. The decrease is attributable primarily to the $1.3 million of income from the settlement of a subordinated financing transaction in 2007. The Company provides subordinated financing for the acquisition, development and construction of real estate projects. These subordinated financings which are held by its wholly owned subsidiary ECV, generally entail a higher risk profile (including lower priority and higher loan to value ratios) than loans made by the Bank. A portion of the amount which the Company expects to receive for such loans will be payments based on the success, sale or completion of the underlying project, and as such the income from these loans may be volatile from period to period, based on the status of such projects. For the year ended December 31, 2008 the Company recognized no income from the settlement of its remaining interest in a subordinated financing transaction compared to $1.3 million for the same period in 2007. Income from subordinated financing activities is subject to wide variances, as it is based on the sales progress of a limited number of development projects. Refer to "Loan Portfolio" below for additional information on outstanding subordinated financing transactions. The decline in other income for 2008 was partially offset by increases in loan commitment fees on terminated transactions, and loan prepayment fees.

        Other income totaled $303 thousand for the fourth quarter of 2008 down from $1.2 million for the fourth quarter of 2007, a decrease of approximately $900 thousand. This decrease was due primarily to the $1.0 million recorded in the fourth quarter of 2007 from settlement of a subordinated financing transaction discussed above.

        Net investment gains amounted to $2 thousand and a loss of $53 thousand for the year and quarter ended December 31, 2008, respectively, as compared to net investment gains of $6 thousand and a loss of $1 thousand for the year and quarter ended December 31, 2007, respectively. Investment gains and losses

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are typically recognized as part of the Company's asset and liability management to meet loan demand or to better manage the Bank's interest rate risk position.

Noninterest Expense

        Total noninterest expense consists of salaries and employee benefits, premises and equipment expenses, marketing and advertising, outside data processing, legal, accounting and professional fees and other expenses.

        Total noninterest expenses were $30.8 million for the full year of 2008, as compared to $24.9 million for 2007, a 24% increase, which reflects the larger organization subsequent to the Fidelity acquisition. For the three months ended December 31, 2008, total noninterest expenses were $10.5 million for the fourth quarter of 2008, as compared to $6.5 million for 2007, a 62% increase, due substantially to the Fidelity acquisition and in part due to higher costs for marketing, sponsorship, and professional services associated with the EagleBank Bowl.

        Salaries and employee benefits were $16.7 million for the year ended 2008, as compared to $14.2 million for 2007, an 18% increase. For the three months ended December 31, 2008, salaries and employee benefits amounted to $5.3 million versus $3.8 million for the same period in 2007, a 39% increase. This increase for both periods was due primarily to the Fidelity acquisition and to staff additions and related personnel costs, merit increases and increased benefit costs, and to higher levels of incentive based compensation. At December 31, 2008, the Company's staff numbered 235, as compared to 175 and 171 at December 31, 2007 and 2006, respectively.

        Premises and equipment expenses amounted to $5.4 million for the year ended December 31, 2008 versus $4.8 million for the same period in 2007. This increase of 12% was due primarily to new banking offices acquired from the Fidelity acquisition. Additionally, ongoing operating expense increases associated with the Company's facilities, all of which are leased, and increased equipment costs contributed to the overall increase in expense. For the three months ended December 31, 2008, premises and equipment expenses amounted to $1.9 million versus $1.2 million for the same period in 2007. The reason for the increase in expense for the three month period is the same as mentioned above for the full year.

        Advertising costs increased from $465 thousand in the year ended December 31, 2007 to $1.1 million in the same period in 2008, an increase of 127%. For the three months ended December 31, 2008, advertising expenses amounted to $734 thousand versus $109 thousand for the same period in 2007, an increase of 573%. The primary reasons for the significant increase were higher costs incurred in the fourth quarter for marketing, sponsorship, and professional services associated with the EagleBank Bowl. This increase was partially offset by declines in time deposit advertising in 2008 as compared to 2007.

        Data processing costs were $1.6 million for the year ended 2008, as compared to $1.2 million in 2007, an increase of 32%. For the three months ended December 31, 2008, data processing costs amounted to $469 thousand versus $269 thousand for the same period in 2007, an increase of 74%. This increase in the three months and year ended December 31, 2008 as compared to 2007 was due initially to the addition of six new bank offices and an increase in the volume of data processing activity following the Fidelity acquisition.

        Legal, accounting and professional fees were $1.1 million for the year ended 2008, as compared to $611 thousand for 2007, a 73% increase. This increase was due in part to higher legal and consulting engagement work in 2008 related to the larger organization subsequent to the Fidelity acquisition and to higher loan collection fees. For the three months ended December 31, 2008, legal, accounting and professional fees amounted to $398 thousand versus $151 thousand for the same period in 2007, a 164% increase. The increase in the fourth quarter costs related to legal and professional services for a larger organization and to costs associated with loan collection and the EagleBank Bowl.

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        FDIC insurance and regulatory assessments were $718 thousand for the year ended 2008, as compared to $508 thousand in 2007, an increase of 41%. For the three months ended December 31, 2008, FDIC insurance and regulatory assessments amounted to $268 thousand versus $154 thousand for the same period in 2007, an increase of 75%. The primary reasons for the increase in the three months and year ended December 31, 2008 as compared to 2007 were an increase in the FDIC premium rates charged on deposits and increased deposits following the Fidelity acquisition.

        Other expenses increased to $4.2 million in the year ended 2008 from $3.1 million for the year ended December 31, 2007, or an increase of 36%. For the three months ended December 31, 2008, other expenses amounted to $1.5 million versus $820 thousand for the same period in 2007, an increase of 84%. The major components of costs in this category include ATM expenses, broker fees, telephone, courier, printing, business development, office supplies, charitable contributions, dues, and director fees. For the year ended of 2008, as compared to 2007, the significant increases in this category were primarily broker fees, correspondent bank fees, and merger expense. The same factors which contributed to an increase in other expenses for 2008 over 2007 mentioned above also contributed substantially to the increase in other expenses for the three months ended December 31, 2008, as compared to the same period in 2007. These increases were also impacted by the Fidelity acquisition consummated as of August 31, 2008.

Income Tax Expense

        The Company recorded income tax expense of $4.1 million in 2008 compared to $4.3 million in 2007, resulting in an effective tax rate of 35.7% and 35.7%, respectively. The lower effective tax rate for 2008 and 2007 relates in part to a higher level of state tax exempt income.

BALANCE SHEET ANALYSIS

Overview

        At December 31, 2008, the Company's total assets were $1.5 billion, loans were $1.3 billion, deposits were $1.1 billion, other borrowings, including customer repurchase agreements were $216.0 million and stockholders' equity was $142.4 million. As compared to December 31, 2007, assets grew in 2008 by $651.2 million (77%), loans by $549.0 million (77%), deposits by $498.4 million (79%), borrowings by $87.5 million (68%) and stockholders' equity by $61.2 million (75%).

        A substantial portion of the growth in all categories in 2008 was due to the Fidelity acquisition. A significant portion of the growth in stockholders' equity was due to participation in the Capital Purchase Program established under the Emergency Economic Stimulation Act of 2008 ("EESA") pursuant to which $38.235 million of preferred stock was sold to the United States Department of the Treasury (the "Treasury") in December 2008. In connection with the purchase, the Treasury also received warrants to purchase 770,236 shares of common stock, which are exercisable for a term of ten years. For additional information regarding the Company's participation in the Capital Purchase Program please refer to page 37 and Note 9 of Notes to Consolidated Financial Statements.

        The Company paid a cash dividend of $0.0545 per common share for each of the first and second quarters of 2008 and $0.0545 per common share for each quarter of 2007. In July 2008, the Company, in an action to conserve capital, discontinued the payment of its quarterly cash dividend. On October 1, 2008, the Company paid a 10% stock dividend on the common stock.

Investment Securities Available-for-Sale ("AFS") and Short-Term Investments

        The AFS portfolio is comprised largely of U.S. Government agency securities (44% of AFS) with an average duration of 1.0 years. The remaining AFS securities consists of seasoned mortgage backed securities that are 100% agency issued (47% of AFS) which have an average expected lives of 2.1 years with contractual maturities of the underlying mortgages of up to thirty years, municipal bonds ($4.7 million or 3% of AFS) and equity investments (6% of AFS), most of which are required by regulatory mandates (Federal Reserve and Federal Home Loan Bank stocks). The remaining portion of equity investments are either preferred or common stocks of three community-based banking companies which amount to

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$1.0 million fair value. Ninety seven percent (97%) of the bonds (the debt instruments) are rated AAA. The remaining three percent (3%) of the bonds represent municipal bonds which have a rating of AA. Both ratings represent high investment grade issues.

        At December 31, 2008, the investment portfolio amounted to $169.1 million as compared to a balance of $87.1 million at December 31, 2007, an increase of 94%, most of the growth being associated with the Fidelity acquisition consummated as of August 31, 2008. The investment portfolio is managed to achieve goals related to income, liquidity, interest rate risk management and providing collateral for customer repurchase agreements and other borrowing relationships.

        The Company also has a portfolio of short-term investments utilized for asset liability management needs which consists from time-to-time of discount notes, money market investments, and other bank certificates of deposit This portfolio amounted to $2.5 million at December 31, 2008 as compared to $4.5 million at December 31, 2007.

        Federal funds sold amounted to $191 thousand at December 31, 2008 as compared to $244 thousand at December 31, 2007. These funds represent excess daily liquidity which is invested on an unsecured basis with well capitalized banks, in amounts generally limited both in the aggregate and to any one bank.

        The tables below and Note 3 of Notes to Consolidated Financial Statements provide additional information regarding the Company's investment securities available for sale. The Company classifies all its investment securities as AFS. This classification requires that investment securities be recorded at their fair value with any difference between the fair value and amortized cost (the purchase price adjusted by any accretion or amortization) reported as a component of stockholders' equity (accumulated other comprehensive income), net of deferred income taxes. At December 31, 2008, the Company had a net unrealized gain in AFS securities of $3.9 million as compared to a net unrealized gain in AFS securities of $966 thousand at December 31, 2007. The deferred income tax liability/benefit at December 31, 2008 and 2007 of these unrealized gains and losses was $1.5 million and $382 thousand, respectively.

        The following table provides information regarding the composition of the Company's investment securities portfolio at the dates indicated. Amounts are reported at estimated fair value. The change in composition of the portfolio at December 31, 2008 as compared to 2007 was due principally to the acquisition of Fidelity which had a larger portion of its portfolio invested in mortgaged backed securities. The Company also expanded its investment in municipal bonds during 2008 as they represented high quality issues and attractive yields.

 
  December 31,  
 
  2008   2007   2006  
(dollars in thousands)
  Balance   Percent
of Total
  Balance   Percent
of Total
  Balance   Percent
of Total
 

U. S. Government agency securities

  $ 74,029     43.8 % $ 51,295     58.9 % $ 58,584     64.3 %

Mortgage backed securities—GSEs

    79,770     47.2 %   29,303     33.6 %   27,333     30.0 %

Municipal bonds

    4,708     2.8 %   351     0.4 %        

Federal Reserve and Federal Home Loan Bank stock

    9,599     5.7 %   4,870     5.6 %   3,829     4.2 %

Other equity investments

    973     0.6 %   1,298     1.5 %   1,394     1.5 %
                           

  $ 169,079     100 % $ 87,117     100 % $ 91,140     100 %
                           

        The following table provides information, on an amortized cost basis, regarding the contractual maturity and weighted average yield of the investment portfolio at December 31, 2008. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Yields on tax exempt securities have not been calculated on a tax equivalent basis.

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        At December 31, 2008, there were no issuers, other than the U.S. Government and its agencies, whose securities owned by the Company had a book or fair value exceeding 10% of the Company's stockholders' equity.

 
  One Year or Less   After One Year
Through Five Years
  After Five Years
Through Ten Years
  After Ten Years   Total  
(dollars in thousands)
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
 

U. S. Government agency securities

  $ 2,014     4.50 % $ 34,805     4.72 % $ 35,018     5.16 % $       $ 71,837     4.85 %

Mortgage backed securities—GSEs

            9,670     4.15 %   9,282     5.68 %   58,290     5.84 %   77,242     5.67 %

Muncipal bonds

                            5,061     3.61 %   5,061     3.61 %

Federal Reserve and Federal Home Loan Bank stock

                                    9,599     4.21 %

Other equity investments

                                    1,396     5.36 %
                                           

  $ 2,014     4.50 % $ 44,475     4.60 % $ 44,300     5.27 % $ 63,351     5.66 % $ 165,135     5.16 %
                                           

Loan Portfolio

        In its lending activities, the Company seeks to develop sound relationships with clients whose businesses and individual banking needs will grow with the Bank. There has been a significant effort to grow the loan portfolio and to be responsive to the lending needs in the markets served, while maintaining sound asset quality.

        Loan growth over the past year has been favorable, with loans outstanding reaching $1.3 billion at December 31, 2008, an increase of $549.0 million or 77% as compared to $716.7 million at December 31, 2007, and were $625.8 million at December 31, 2006, an increase of $90.9 million or 15% in 2007 over 2006. For the fourth quarter of 2008, the loan portfolio increased $95.1 million or 8.1% over $1.2 billion at September 30, 2008.

        The Company had strong loan growth throughout the year. In August, $360 million of loans were added from the acquisition of Fidelity. Approximately 50% of the Company's organic growth was recorded in the fourth quarter of 2008. The fourth quarter experienced growth in investment real estate lending which is attributable to various factors including the Company having the opportunity to lend on local income producing commercial real estate which was typically financed in the Commercial Mortgage-Backed Securities ("CMBS") market. The commercial portfolio growth is also attributable to various factors including increasing SBA guaranteed loans made for business acquisition; recording new commercial term loans to assist local business in various financing needs including equipment financing and providing ESOP financing so that the employees of a local company could acquire their company. New commercial lines of credit booked grew providing local businesses working capital; and new owner occupied commercial real estate loans grew allowing business owners to purchase and/or refinance the real estate in which their company operates.

        The Bank is primarily commercial oriented and as can be seen in the chart below, has a large proportion of its loan portfolio related to real estate (66%) consisting of real estate commercial, real estate residential mortgage and construction commercial and residential loans. Real estate also serves as collateral for loans made for other purposes, resulting in 74% of loans being secured by real estate.

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        The following table shows the trends in the composition of the loan portfolio over the past five years.

 
  December 31,  
 
  2008   2007   2006   2005   2004  
(dollars in thousands)
  Amount   %   Amount   %   Amount   %   Amount   %   Amount   %  

Commercial

  $ 334,999     27 % $ 149,332     21 % $ 132,981     21 % $ 118,928     22 % $ 101,911     25 %

Real estate—commercial(1)

    549,069     43 %   392,757     55 %   349,044     56 %   284,667     52 %   189,708     47 %

Real estate—residential

    9,757     1 %   2,160         1,523         1,130         9,230     2 %

Construction—commercial and residential(1)

    283,020     22 %   110,115     15 %   86,524     14 %   90,035     16 %   62,745     14 %

Home equity

    80,295     6 %   57,515     8 %   50,572     8 %   50,776     9 %   49,632     11 %

Other consumer

    8,500     1 %   4,798     1 %   5,129     1 %   3,676     1 %   2,283     1 %
                                           
 

Total loans

    1,265,640     100 %   716,677     100 %   625,773     100 %   549,212     100 %   415,509     100 %
                                                     

Less: Allowance for credit losses

    (18,403 )         (8,037 )         (7,373 )         (5,985 )         (4,240 )      
                                                     
 

Net loans

  $ 1,247,237         $ 708,640         $ 618,400         $ 543,227         $ 411,269        
                                                     

(1)
Includes loans for land acquisition and development.

        As discussed under the captions "Business" and "Risk Factors", the Company has directly made higher risk loans that entail higher risks than loans made following normal underwriting practices ("subordinated financing transactions"). These higher risk loan transactions, representing financing subordinated to loans made by the Bank, and occasionally referred to in this report as "subordinated financings" are currently made through the Company's subsidiary, ECV. This activity is limited as to individual transaction amount and total exposure amounts based on capital levels and is carefully monitored. Transactions are structured to provide ECV with returns commensurate to the risk through the requirement of additional interest following payoff of all loans:

        Although the Company carefully underwrites each higher risk loan transaction and expects these transactions to provide additional revenues, there can be no assurance that any higher risk loan transaction, or the related loans made by the Bank, will prove profitable for the Company and Bank, that the Company will be able to receive any additional interest payments in respect of these loans, that any additional interest payments will be significant, or that the Company and Bank will not incur losses in respect of these transactions.

        As noted above, a significant portion of the loan portfolio consists of commercial, construction and commercial real estate loans, primarily made in the Washington, D.C. metropolitan area and secured by real estate or other collateral in that market. Although these loans are made to a diversified pool of unrelated borrowers across numerous businesses, adverse developments in the Washington D.C. metropolitan real estate market could have an adverse impact on this portfolio of loans and the Company's income and financial position. While our basic trading area is the Washington, D.C. metropolitan area, the Bank has made loans outside that market area where the nature and quality of such loans was consistent with the Bank's lending policies.

        The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions

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which have (1) total reported loans for construction, land development, and other land which represent in total 100% or more of an institutions total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institutions total risk-based capital and the institution's commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened portfolio monitoring and reporting, and strong underwriting criteria with respect to its commercial real estate portfolio. The Company is well capitalized. Nevertheless, the Company could be required to maintain higher levels of capital as a result of our commercial real estate concentration, which could require us to obtain additional capital, and may adversely affect shareholder returns.

        At December 31, 2008, the Company had no other concentrations of loans in any one industry exceeding 10% of its total loan portfolio. An industry for this purpose is defined as a group of businesses that are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions.

Loan Maturity

        The following table sets forth the time to contractual maturity of the loan portfolio as of December 31, 2008.

 
  Due In  
(dollars in thousands)
  Total   One Year or
Less
  Over One to
Five Years
  Over Five to
Ten Years
  Over Ten
Years
 

Commercial

  $ 334,999   $ 149,242   $ 124,218   $ 55,710   $ 5,829  

Real estate—commercial

    549,069     55,347     182,895     283,703     27,124  

Real estate—residential mortgage

    9,757     1,757     1,641     2,048     4,311  

Construction—commercial and residential

    283,020     176,377     56,095     47,123     3,425  

Home equity

    80,295     876     2,015     2,224     75,180  

Other consumer

    8,500     3,056     4,390     88     966  
                       

Total loans

  $ 1,265,640   $ 386,655   $ 371,254   $ 390,896   $ 116,835  
                       

Loans with:

                               

Predetermined fixed interest rate

  $ 369,323   $ 54,937   $ 205,836   $ 83,474   $ 25,076  

Floating interest rate

    896,317     331,718     165,418     307,422     91,759  
                       

Total loans

  $ 1,265,640   $ 386,655   $ 371,254   $ 390,896   $ 116,835  
                       

        Loans are shown in the period based on final contractual maturity. Demand loans, having no contractual maturity and overdrafts, are reported as due in one year or less.

Allowance for Credit Losses

        The provision for credit losses represents the amount of expense charged to current earnings to fund the allowance for credit losses. The amount of the allowance for credit losses is based on many factors which reflect management's assessment of the risk in the loan portfolio. Those factors include economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company and Bank.

        Management has developed a comprehensive analytical process to monitor the adequacy of the allowance for credit losses. This process and guidelines were developed utilizing among other factors, the guidance from federal banking regulatory agencies. The results of this process, in combination with conclusions of the Bank's outside loan review consultant, support management's assessment as to the

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adequacy of the allowance at the balance sheet date. During 2008, a provision for credit losses was made in the amount of $4.0 million before net charge-offs of $1.1 million. A full discussion of the accounting for allowance for credit losses is contained in Note 1 of Notes to Consolidated Financial Statements; activity in the allowance for credit losses is contained in Note 4 of Notes to Consolidated Financial Statements. Also, please refer to the discussion under the caption, "Critical Accounting Policies" within Management's Discussion and Analysis of Financial Condition and Results of Operation for further discussion of the methodology which management employs to maintain an adequate allowance for credit losses, and the discussion under the caption "Provision for Credit Losses".

        The allowance for credit losses represented 1.45% of total loans at December 31, 2008 as compared to 1.12% at December 31, 2007. This increase in the ratio of the allowance for credit losses was due substantially to the acquisition of Fidelity whose allowance for credit losses was approximately $7.5 million or 2.10% of Fidelity loans outstanding at August 31, 2008.

        At December 31, 2008, the allowance represented 72% of nonperforming loans as compared to 151% at December 31, 2007. The decline in the coverage ratio was due substantially to the acquisition of nonperforming loans in connection with the acquisition of Fidelity. Under generally accepted accounting principles, specific reserves associated with impaired loans acquired in a merger are to be charged off (or shown as an unaccretable discount) resulting in the acquiring entity (the Company) carrying the nonperforming loans at the resulting net fair value. The impact of this adjustment was to increase nonperforming loans without the corresponding specific reserves previously assigned by the non surviving entity, thus lowering the coverage ratio. The Company has also experienced an increase in its nonperforming loans (excluding acquired loans from the acquisition) at December 31, 2008 as compared to December 31, 2007. Subsequent downward adjustments to the valuation of impaired loans acquired will result in additional loan loss provisions. Subsequent upward adjustments to the valuation of impaired loans acquired will result in accretable discount. No adjustments have been made to the fair value amounts recorded at the date of acquisition.

        As part of its comprehensive loan review process, the Company's Board of Directors and the Bank Director's Loan Committee and or Board of Director's Credit Review Committees carefully evaluate loans which are past-due 30 days or more. The Committee(s) make a thorough assessment of the conditions and circumstances surrounding each delinquent loan. The Bank's loan policy requires that loans be placed on nonaccrual if they are ninety days past-due, unless they are well secured and in the process of collection. Additionally, Credit Administration specifically analyzes the status of development and construction projects, sales activities and utilization of interest reserves in order to carefully and prudently assess potential increased levels of risk requiring additional reserves.

        At December 31, 2008, the Company had $25.5 million of loans classified as nonperforming, and $3.6 million of potential problem loans, as compared to $5.3 million of nonperforming loans and $1.9 million of potential problem loans at December 31, 2007. Please refer to Note 1 of Notes to Consolidated Financial Statements under the caption "Loans" for a discussion of the Company's policy regarding impairment of loans. Please refer to "Nonperforming Assets" on page 24 for a discussion of problem and potential problem assets.

        As the loan portfolio and allowance for credit losses review process continues to evolve, there may be changes to elements of the allowance and this may have an effect on the overall level of the allowance maintained. Historically, the Bank has enjoyed a high quality loan portfolio with relatively low levels of net charge-offs and low delinquency rates. The maintenance of a high quality portfolio will continue to be a high priority for both management and the Board of Directors.

        Management, being aware of the significant loan growth experienced by the Company, is intent on maintaining a strong credit review system and risk rating process. The Company has an internal Credit Department to provide independent analysis of credit requests and to manage problem credits. The area was further enhanced as part of the Fidelity acquisition. The Credit Department has developed and implemented analytical procedures for evaluating credit requests, has refined the Company's risk rating system, and has adopted enhanced monitoring of the loan portfolio (and in particular the construction loan portfolio) and the allowance for credit losses. The loan portfolio analysis process is ongoing and proactive in order to maintain a portfolio of quality credits and to quickly identify any weaknesses before they become more severe.

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        The following table sets forth activity in the allowance for credit losses for the past five years.

 
  Year Ended December 31,  
(dollars in thousands)
  2008   2007   2006   2005   2004  

Balance at beginning of year

  $ 8,037   $ 7,373   $ 5,985   $ 4,240   $ 3,680  

Charge-offs:

                               
 

Commercial(1)

    481     1,005     369     122     257  
 

Real estate—commercial(2)

    29                  
 

Real estate—residential

                     
 

Construction—commercial and residential(2)

    497                  
 

Home equity

    124         15          
 

Other consumer

    86     26     5     17     35  
                       

Total charge-offs

    1,217     1,031     389     139     292  
                       

Recoveries:

                               
 

Commercial(1)

    44     37     27     41     175  
 

Real estate—commercial(2)

                     
 

Real estate—residential

                     
 

Construction—commercial and residential(2)

    50                  
 

Home equity

                     
 

Other consumer

        15     5         2  
                       

Total recoveries

    94     52     32     41     177  
                       

Net charge-offs

    1,123     979     357     98     115  
                       

Additions charged to operations

    3,979     1,643     1,745     1,843     675  

Acquired allowance—Fidelity

    7,510                  
                       

Balance at end of year

  $ 18,403   $ 8,037   $ 7,373   $ 5,985   $ 4,240  
                       

Ratio of allowance for credit losses to total loans outstanding at year end

    1.45 %   1.12 %   1.18 %   1.09 %   1.02 %

Ratio of net charge-offs during the year to average loans outstanding during the year

    0.12 %   0.15 %   0.06 %   0.02 %   0.03 %

(1)
Includes SBA loans.

(2)
Includes loans for land acquisition and development.

        The following table presents the allocation of the allowance by loan category and the percent of loans each category bears to total loans. The allocation of the allowance at December 31, 2008 includes specific reserves of $1.2 million against impaired loans of $25.5 million as compared to specific reserves of $220 thousand against impaired loans of $5.3 million at December 31, 2007. The allocation of the allowance to each category is not necessarily indicative of future losses or charge-offs and does not restrict the usage of the allowance for any specific loan or category. The larger allowance at December 31, 2008

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reflects in part the allowance acquired in the Fidelity acquisition consummated as of August 31, 2008 of $7.5 million.

 
  Year Ended December 31,  
 
  2008   2007   2006   2005   2004  
(dollars in thousands)
  Amount   %(1)   Amount   %(1)   Amount   %(1)   Amount   %(1)   Amount   %(1)  

Commercial

  $ 8,923     27 % $ 3,300     21 % $ 3,379     21 % $ 2,594     22 % $ 1,963     25 %

Real estate—commercial(2)

    4,849     43 %   3,053     55 %   2,800     56 %   2,395     52 %   1,426     47 %

Real estate—residential

    58     1 %   21         40         48         105     2 %

Construction—commercial and residential(2)

    3,972     22 %   1,314     15 %   854     14 %   602     16 %   431     14 %

Home equity

    394     6 %   233     8 %   176     8 %   176     9 %   223     11 %

Other consumer

    207     1 %   116     1 %   124     1 %   84     1 %   58     1 %

Unallocated

                            86         34      
                                           
 

Total loans

  $ 18,403     100 % $ 8,037     100 % $ 7,373     100 % $ 5,985     100 % $ 4,240     100 %
                                           

(1)
Represents the percent of loans in each category to total loans.

(2)
Includes loans for land acquisition and development.

Nonperforming Assets

        As shown in the table below, the Company's nonperforming assets, which are comprised of loans delinquent 90 days or more, nonaccrual loans, restructured loans and other real estate owned, totaled $26.4 million at December 31, 2008 compared to $5.3 million at December 31, 2007. The percentage of nonperforming assets to total assets was 1.76% at December 31, 2008 compared to 0.63% at December 31, 2007. Included in nonperforming assets is other real estate owned (OREO) of $909 thousand and $0 at December 31, 2008 and December 31, 2007, respectively.

        Excluding OREO from nonperforming assets, total nonperforming loans amounted to $25.5 million at December 31, 2008 (2.01% of total loans) as compared to $5.3 million (0.74% of total loans) at December 31, 2007.

        The increase in nonperforming loans at December 31, 2008 as compared to December 31, 2007 relates primarily to nonperforming loans acquired from Fidelity of $10.7 million and to two commercial loan relationships (approximately $4.4 million) which include commercial real estate loans secured by residential properties which have experienced cost overruns and/or delays in the development and construction processes.

        Nonaccrual loans in the table below at December 31, 2008 include approximately $17.6 million in nonperforming commercial real estate construction loans. This increase as compared to December 31, 2007 is principally due to the acquisition of nonperforming loans in connection with the acquisition of Fidelity. Under generally accepted accounting principles, specific reserves associated with impaired loans acquired in a merger are to be charged off (or shown as an unaccretable discount) resulting in the acquiring entity (the Company) carrying the nonperforming loans at the resulting net fair value. The impact of this adjustment was to increase nonperforming loans without the corresponding specific reserves previously assigned by the non surviving entity, thus lowering the allowance coverage ratio, as shown in the table below. Additionally, slowing absorption in commercial construction projects has caused delays in project sell out and loan repayment according to contractual terms. Where appropriate, as with all nonperforming loans, specific reserves have been established for these nonperforming construction loans.

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        Refer to Note 4 "Loans and Allowance for Credit Losses" of Notes to Consolidated Financial Statements for further discussion of the accounting treatment of nonperforming loans acquired from Fidelity.

        The following table shows the amounts of nonperforming assets at December 31 for the past five years:

 
   
   
   
   
   
 

(dollars in thousands)

  2008    2007    2006    2005    2004   

Nonaccrual Loans:

                               
 

Commercial

  $ 3,506   $ 1,174   $ 1,976   $ 362   $ 156  
 

Other consumer

                129      
 

Home equity

    196     123              
 

Construction—commercial and residential

    17,588     3,386              
 

Real estate—commercial

    4,167     641              

Accrual loans-past due 90 days:

                               
 

Commercial

            37          
 

Other consumer

                     
 

Real estate—commercial

                     

Restructured loans

                     
                       
   

Total nonperforming loans

    25,457     5,324     2,013     491     156  
                       

Other real estate owned

    909                  
                       
   

Total nonperforming assets

  $ 26,366   $ 5,324   $ 2,013   $ 491   $ 156  
                       

Coverage ratio, allowance for credit losses to total nonperforming loans(2)

   
72.29

%
 
150.96

%
 
366.27

%
 
1218.94

%
 
2717.95

%

Ratio of nonperforming loans to total loans

    2.01 %   0.74 %   0.32 %   0.09 %   0.04 %

Ratio of nonperforming assets to total assets

    1.76 %   0.63 %   0.26 %   0.07 %   0.03 %

(1)
Gross interest income that would have been recorded in 2008 if nonaccrual loans and leases shown above had been current and in accordance with their original terms was $1.6 million, while interest actually recorded on such loans was $406 thousand. See Note 1 of Notes to Consolidated Financial Statements for a description of the Company's policy for placing loans on nonaccrual status.

(2)
The decline in the coverage ratio was due primarily to the acquisition of nonperforming loans as a result of the Fidelity acquisition.

        Significant variation in the amount of nonperforming loans may occur from period to period because the amount of nonperforming loans depends largely on the condition of a relatively small number of individual credits and borrowers relative to the total loan portfolio.

        The Company had no troubled debt restructured loans at either December 31, 2008 or 2007. Impaired loans consisted of $25.5 million of nonaccrual loans at December 31, 2008, with $1.2 million of specific reserves, compared to $5.3 million of impaired loans at December 31, 2007 with $220 thousand of specific reserves.

        At December 31, 2008, there were $3.6 million of performing loans considered potential problem loans, defined as loans which are not included in the 90 day past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms which may in the future result in disclosure in the past due, nonaccrual or restructured loan categories.

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Other Earning Assets

        Residential mortgage loans held for sale amounted to $2.7 million at December 31, 2008 compared to $2.2 million at December 31, 2007. Origination and sales of these loans on a servicing released basis is emphasized by the Company in order to enhance noninterest income, which emphasis is expected to continue in 2009. The Bank did not engage in the origination of subprime or "exotic" mortgage loans. See "Business" at page 84 for a description of the Bank's mortgage lending and brokerage activities.

        Bank owned life insurance is utilized by the Company in accordance with tax regulations as part of the Company's financing of its benefit programs. At December 31, 2008 this asset amounted to $12.4 million as compared to $12.0 million at December 31, 2007, which reflected an increase in cash surrender values, and not new investments.

Intangible Assets

        The Company recognizes a servicing asset for the computed value of servicing fees on the sale of the guaranteed portion of SBA loans, which is in excess of a normal servicing fee. Assumptions related to loan term and amortization are made to arrive at the initial recorded value, which is included in other assets.

        For 2008, excess servicing fees of $54 thousand were recorded, and $105 thousand was amortized as a reduction of actual service fees collected, which is a component of other income. At December 31, 2008, the balance of excess servicing fees was $185 thousand. For 2007, excess servicing fees of $122 thousand were recorded, of which $141 thousand was amortized as a reduction of actual service fees collected, which is a component of other income. At December 31, 2007, the balance of excess servicing fees was $236 thousand.

        In connection with the Fidelity acquisition, the Company made an allocation of the purchase price to a core deposit intangible which was determined by independent evaluation and is included in accrued interest, taxes and other assets on the consolidated balance sheet. The initial amount was $2.3 million, which is being amortized over its economic life of 6.44 years as a component of other noninterest expenses. The amount amortized in 2008 was $62 thousand and the unamortized amount at December 31, 2008 was $2.2 million.

        The Company recorded an initial amount of unidentified intangible (goodwill) incident to the acquisition of Fidelity of approximately $360 thousand. Based on allowable adjustments through December 31, 2008, the unidentifiable intangible (goodwill) amounted to approximately $105 thousand. These intangible assets are subject to impairment testing annually.

Deposits and Other Borrowings

        The principal sources of funds for the Bank are core deposits, consisting of demand deposits, NOW accounts, money market accounts, savings accounts and certificates of deposits from the local market areas surrounding the Bank's offices. The deposit base includes transaction accounts, time and savings accounts and accounts which customers use for cash management and which provide the Bank with a source of fee income and cross-marketing opportunities, as well as an attractive source of lower cost funds. To meet funding needs during periods of high loan demand and seasonal variations in core deposits, the Bank utilizes alternative funding sources such as secured borrowings from the FHLB; federal funds purchased lines of credit from correspondent banks and brokered deposits from a regional brokerage firm.

        For the twelve months ended December 31, 2008, noninterest bearing deposits increased $81.1 million as compared to December 31, 2007, while interest bearing deposits increased by $417.3 million during the same period, due substantially to deposits acquired in the acquisition of Fidelity.

        For the year ended December 31, 2008, total deposits increased $498.4 million, from $630.9 million to $1.1 billion or 79%. Approximately 51% of the Bank's deposits at December 31, 2008 ($579.2 million) are

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made up of time deposits, which are generally the most expensive form of deposit because of their fixed rate and term, as compared to 41% at December 31, 2007 ($257.3 million). This increase in the time deposit category at December 31, 2008 as compared to December 31, 2007 was due to both the acquisition of Fidelity, which had a higher proportion of its deposits in time deposits, and to customer preferences toward higher interest FDIC insured products in the fourth quarter of 2008 as economic conditions worsened. Average time deposits amounted to $402.2 million in 2008, (48% of average total deposits) compared to $270.5 million in 2007 (43% of average total deposits), an increase of $131.7 million or 49%.

        The following table sets forth the maturities of time deposits with balances of $100,000 or more, which represent 22% of total deposits as of December 31, 2008, compared to 28% at December 31, 2007. See Note 7 of Notes to Consolidated Financial Statements and the Average Balances Table above for additional information regarding the maturities of time deposits and average rates paid on interest-bearing deposits. Time deposits of $100 thousand or more can be more volatile and more expensive than time deposits of less than $100 thousand. However, because the Bank focuses on relationship banking, and its marketplace demographics are favorable, its historical experience has been that large time deposits have not been more volatile or significantly more expensive than smaller denomination certificates.

 
  December 31,  
(dollars in thousands)
  2008   2007   2006  

Three months or less

  $ 109,283   $ 52,570   $ 39,730  

More than three months through six months

    115,280     56,540     59,731  

More than six months through twelve months

    23,911     61,117     54,234  

Over twelve months

    1,042     3,359     4,800  
               

Total

  $ 249,516   $ 173,586   $ 158,495  
               

        From time to time, when appropriate in order to fund strong loan demand, the Bank accepts time deposits, generally in denominations of less than $100 thousand from bank and credit union subscribers to a wholesale deposit rate line and also acquires brokered deposits from a regional brokerage firm. Additionally, the Bank participates in the Certificates of Deposit Account Registry Service ("CDARS"), which provides for reciprocal transactions among banks facilitated by the Promontory Interfinancial Network, LLC for the purpose of maximizing FDIC insurance. These funds are currently classified as brokered deposits for regulatory reporting, but are deemed more core related. At December 31, 2008, total time deposits included $192.7 million of brokered deposits which represented 17% of total deposits. The CDARS component represented $81.1million or 7% of total deposits. These sources are deemed reliable and cost efficient as an alternative funding source for the Company. At December 31, 2007, total brokered deposits amounted to $14.6 million or 2% of total deposits, of which CDARS represented $ 4.6 million or 1% of total deposits.

        At December 31, 2008, the Company had approximately $223.6 million in noninterest bearing demand deposits, representing 20% of total deposits. This compared to approximately $142.5 million of these deposits at December 31, 2007 or 23% of total deposits. These deposits are primarily business checking accounts on which the payment of interest is prohibited by regulations of the Federal Reserve. Proposed legislation has been introduced in past Congresses which would permit banks to pay interest on checking and demand deposit accounts established by businesses. If legislation effectively permitting the payment of interest on business demand deposits is enacted, of which there can be no assurance, it is likely that we may be required to pay interest on some portion of our noninterest bearing deposits in order to compete with other banks. Payment of interest on these deposits could have a significant negative impact on our net interest income and net interest margin, net income, and the return on assets and equity.

        As an enhancement to the basic noninterest bearing demand deposit account, the Company offers a sweep account, or "customer repurchase agreement", allowing qualifying businesses to earn interest on short-term excess funds which are not suited for either a certificate of deposit or a money market account.

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The balances in these accounts were $93.9 million at December 31, 2008 compared to $52.9 million at December 31, 2007, the increase being attributed primarily to the acquisition of Fidelity. Customer repurchase agreements are not deposits and are not insured by the FDIC, but are collateralized by U.S. government agency securities. These accounts are particularly suitable to businesses with significant fluctuation in the levels of cash flows. Attorney and title company escrow accounts are an example of accounts which can benefit from this product, as are customers who may require collateral for deposits in excess of FDIC insurance limits but do not qualify for other pledging arrangements. This program requires the Company to maintain a sufficient investment securities level to accommodate the fluctuations in balances which may occur in these accounts.

        At December 31, 2008 the Company had $5.0 million outstanding balances under its federal funds lines of credit provided by correspondent banks, as compared to $23.5 million outstanding at December 31, 2007. This decrease was due to changes in the funding mix to the less expensive funding provided by the FHLB. At December 31, 2008, The Bank had $105 million borrowings outstanding under its credit facility from the FHLB, as compared to $52 million at December 31, 2007. Outstanding advances are secured by collateral consisting of a blanket lien on qualifying loans in the Bank's commercial mortgage loan portfolio. Please refer to Note 8 of Notes to Consolidated Financial Statements for additional information regarding the Company's short and long-term borrowings.

        On August 11, 2008, the Company entered into a Loan Agreement and related Stock Security Agreement and Promissory Note (the "credit facility") with United Bank, pursuant to which the Company may borrow, on a revolving basis, up to $20 million for working capital purposes, to finance capital contributions to the Bank and ECV. The credit facility is secured by a first lien on all of the stock of the Bank, and bears interest at a floating rate equal to the Wall Street Journal Prime Rate minus 0.25%. Interest is payable on a monthly basis. The term of the credit facility expires on August 31, 2010. At any time, provided no event of default exists, the Company may term out repayment of the outstanding principal balance of the credit facility over a five year term, based on a ten year straight line amortization. At December 31, 2008, there were no amounts outstanding under this United Bank credit facility. At December 31, 2007, the Company had a similar loan facility with another correspondent which had no amounts outstanding.

        On August 28, 2008 the Company accepted subscriptions for and sold an aggregate of $12.15 million of subordinated notes (the "Notes"), on a private placement basis, to seven parties, all of whom are current directors of the Company or the Bank. The capital treatment of the Notes will be phased out during the last 5 years of the Notes' term, at a rate of 20% of the original principal amount per year commencing in October 2009. The Notes bear interest, payable on the first day of each month, commencing in October 2008, at a fixed rate of 10.0% per year. The Notes have a term of approximately six years, and have a maturity on September 30, 2014.

COMPARISON OF 2007 VERSUS 2006

        The Company reported net income of $7.7 million for the year ended December 31, 2007, a 4% decrease from net income of $8.0 million for the year ended December 31, 2006.

        The decrease in net income for the twelve months ended December 31, 2007 can be attributed substantially to an increase in interest expense of 33% while interest income increased by 13% as compared to the same period in 2006. Net interest income showed an increase of 3% on growth in average earning assets of 13%. For the twelve months ended December 31, 2007, the Company has experienced a 44 basis point decline in its net interest margin from 4.81% in 2006 to 4.37% in 2007. This change was primarily due to reliance on more expensive sources of funds which has increased interest expense at a faster rate than increases in interest income.

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        Earnings per basic common share were $0.73 for the year ended December 31, 2007, as compared to $0.77 for 2006. Earnings per diluted common share were $0.71 for the year ended December 31, 2007, as compared to $0.74 for 2006.

        The Company had a return on average assets of 0.96% and a return on average common equity of 10.03% for 2007, as compared to returns on average assets and average common equity of 1.13% and 11.63%, respectively, for 2006.

        For the twelve months ended December 31, 2007, average interest bearing liabilities funding average earning assets increased to 77% as compared to 73% for the first twelve months of 2006. Additionally, while the average rate on earning assets for the twelve month period ended December 31, 2007, as compared to 2006 has increased by 2 basis points from 7.46% to 7.48%, the cost of interest bearing liabilities has increased by 44 basis points from 3.62% to 4.06%, resulting in a decline in the net interest spread of 42 basis points from 3.84% for the twelve months ended December 31, 2006 to 3.42% for the twelve months ended December 31, 2007. The 44 basis point decline in the net interest margin (from 4.81% for the twelve months ended December 31, 2006 to 4.37% for the twelve months ended December 31, 2007) has been slightly greater than the decline in the net interest spread as the Company's benefit from average noninterest bearing funding sources in 2007 declined modestly as compared to 2006. For the twelve months ended December 31, 2007, average noninterest sources funding earning assets were $178 million as compared to $181 million for the same period in 2006. The slight decline in noninterest funding sources has resulted in a slight decrease in the value of noninterest sources funding earning assets from 97 basis points in 2006 to 95 basis points in 2007.

        Net interest income in 2007 was $33.3 million compared to $32.4 million in 2006. The increase in net interest income in 2007 as compared to 2006 is due to growth in the volume of earning assets offset substantially by a decrease in the net interest margin on earning assets.

        Loans, which generally have higher yields than securities and other earning assets, increased to 86% of average earning assets in 2007 from 85% of average earning assets for 2006. Investment securities accounted for 11% of average earning assets for both 2007 and 2006. Federal funds sold averaged 2% and 3% of average earning assets for 2007 and 2006, respectively. This decline was directly related to average loan growth over the past twelve month period exceeding the growth of average deposits and other funding sources.

        The provision for credit losses was $1.6 million for the year ended December 31, 2007 as compared to $1.7 million in 2006. For the full year 2007, the Company recorded net charge-offs of $979 thousand, as compared to $357 thousand for the same period in 2006. The ratio of net-charge offs to average loans was 0.15% for 2007 and 0.06% for 2006. The increase in net charge-offs in 2007 is associated with one large commercial loan relationship identified in prior periods.

        Total noninterest income was $5.2 million for the year 2007 as compared to $3.8 million for 2006, an increase of 35%. These amounts include net investment gains of $6 thousand for the year of 2007 and $124 thousand in 2006. Excluding securities gains, total noninterest income increased by 39%. The increase was attributed primarily to higher amounts of gains on the sale of residential mortgage loans ($416 thousand versus $301 thousand); higher deposit account activity fees ($1.5 million versus $1.4 million) and income from subordinated financing of a real estate project ($1.3 million versus $0). Income from subordinated financing activities can fluctuate greatly between periods, as it is based on the progress of a limited number of development projects. Refer to the discussion under "Loan Portfolio" above for further discussion of subordinated financing activity.

        Total noninterest expense increased from $21.8 million for 2006 to $24.9 million for 2007, an increase of 14%. The primary reasons for this increase were increases in staff levels over the past twelve months and related personnel cost, occupancy cost (due in part to a new banking office and an expanded lending center facility), higher software licensing costs and expense associated with a reinstated FDIC deposit insurance

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assessment. The efficiency ratio which measures the level of noninterest expense to total revenue was 64.67% for 2007 as compared to 60.15% for 2006. The higher efficiency ratio relates in part to a lower net interest margin in 2007 as compared to 2006.

        The Company recorded income tax expense of $4.3 million in 2007 compared to $4.7 million in 2006, resulting in an effective tax rate of 35.7% and 36.9%, respectively. The lower effective tax rate for 2007 relates in part to a higher level of state tax exempt income.

        At December 31, 2007, the Company's total assets were $846.4 million, loans were $716.7 million, deposits were $630.9 million, other borrowings, including customer repurchase agreements were $128.4 million and stockholders' equity was $81.2 million. As compared to December 31, 2006, assets grew in 2007 by $72.9 million (9%), loans by $90.9 million (15%), deposits by $2.4 million (0.4%), borrowings by $60.3 million (89%) and stockholders' equity by $8.3 million (11%).

        The Company declared cash dividends of $0.22 per share for 2007 and $0.21 per share for 2006.

        At December 31, 2007, the investment portfolio amounted to $87.1 million as compared to a balance of $91.1 million at December 31, 2006, a decrease of 4%. The investment portfolio is managed to achieve goals related to income, liquidity, interest rate risk management and providing collateral for customer repurchase agreements and other borrowing relationships.

        The Company also has a portfolio of short-term investments utilized for asset liability management needs which consists from time-to-time of discount notes, money market investments, and other bank certificates of deposit. This portfolio amounted to $4.5 million at December 31, 2007 as compared to $4.9 million at December 31, 2006.

        Federal funds sold amounted to $244 thousand at December 31, 2007 as compared to $9.7 million at December 31, 2006. These funds represent excess daily liquidity which is invested on an unsecured basis with well capitalized banks, in amounts generally limited both in the aggregate and to any one bank.

        Loan growth during 2007 was favorable, with loans outstanding reaching $716.7 million at December 31, 2007, an increase of $90.9 million or 15% as compared to $625.8 million at December 31, 2006.

        The allowance for credit losses represented 1.12% of total loans at December 31, 2007 as compared to 1.18% at December 31, 2006. This decrease in the ratio of the allowance for credit losses was due to the charge-off of a large commercial loan relationship during 2007 that had been partially reserved at December 31, 2006.

        At December 31, 2007, the Company had $5.3 million of loans classified as nonperforming, and $1.9 million of potential problem loans, as compared to $2.0 million of nonperforming assets and $4.3 million of potential problem loans at December 31, 2006. The percentage of nonperforming assets to total assets was 0.63% at December 31, 2007 compared to 0.26% at December 31, 2006. Nonaccrual loans at December 31, 2007, included two related loans totaling $4.0 million, which were placed on nonaccrual in the third quarter of 2007. Interest on these two related loans is being recorded on a cash basis. Nonaccrual loans at December 31, 2006 consisted primarily of one large commercial relationship amounting to $1.9 million which had a specific reserve of $678 thousand at December 31, 2006 and which had been charged-off as of December 31, 2007 to an amount expected to be realized. The Company had no Other Real Estate Owned (OREO) or restructured loans at either December 31, 2007 or 2006. The balance of impaired loans, consisting of all nonaccrual loans only, was $5.3 million at December 31, 2007, with $220 thousand of specific reserves compared to $2.0 million of impaired loans at December 31, 2006 with $678 thousand of specific reserves.

        Residential mortgage loans held for sale amounted to $2.2 million at both December 31, 2007 and December 31, 2006. Origination and sales of these loans during 2007 was emphasized by the Company in order to enhance noninterest income. The Bank did not engage in the origination of subprime or "exotic"

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mortgage loans. See "Business" at page 84 for a description of the Bank's mortgage lending and brokerage activities.

        Bank owned life insurance is utilized by the Company as part of the Company's financing of its benefit programs. At December 31, 2007 this asset amounted to $12.0 million as compared to $11.5 million at December 31, 2006, which reflected an increase in cash surrender values, and not new investments.

        For the year ended December 31, 2007, deposits grew just $2.4 million, from $628.5 million to $630.9 million or 0.4%. Approximately 41% of the Bank's deposits at December 31, 2007 are made up of time deposits, which are generally the most expensive form of deposit because of their fixed rate and term, as compared to 42% at December 31, 2006. These deposits increased modestly, by $4.9 million, at December 31, 2007 as compared to December 31, 2006 as the Bank utilized alternative funding sources due to lower cost. Average time deposits amounted to $270.5 million in 2007, compared to $229.7 million in 2006, an increase of $40.8 million or 17%. Time deposits in denominations of $100 thousand or more increased $15.1 million, or 9.5% to $173.6 million, or 28% of total deposits at December 31, 2007, as compared to 25% at December 31, 2006.

        Wholesale deposits amounted to approximately $10.2 million or 2% of total deposits at December 31, 2007, as compared to approximately $18.3 million or 3% of total deposits at December 31, 2006. On an average basis, wholesale deposits amounted to $25.9 million for 2007 (4% of average deposits) as compared to $9.1 million in 2006 (2% of average deposits).

        At December 31, 2007, the Company had approximately $142.5 million in noninterest bearing demand deposits, representing 23% of total deposits. This compared to approximately $139.9 million of these deposits at December 31, 2006 or 22% of total deposits. These deposits are primarily business checking accounts on which the payment of interest is prohibited by regulations of the Federal Reserve.

        As an enhancement to the basic noninterest bearing demand deposit account, the Company offers a sweep account, or "customer repurchase agreement", allowing qualifying businesses to earn interest on short-term excess funds which are not suited for either a certificate of deposit or a money market account. The balances in these accounts were $52.9 million at December 31, 2007 compared to $38.1 million at December 31, 2006. Customer repurchase agreements are not deposits and are not insured but are collateralized by U.S. government agency securities.

        At December 31, 2007 the Company had $23.5 million outstanding balances under its federal funds lines of credit provided by correspondent banks, as compared to no outstandings at December 31, 2006. This increase was due to funding loan growth late in 2007. The Bank had $52 million borrowings outstanding under its credit facility from the FHLB at December 31, 2007, as compared to $30 million outstandings at December 31, 2006.

CONTRACTUAL OBLIGATIONS

        The Company has various financial obligations, including contractual obligations and commitments that may require future cash payments. Except for its loan commitments, as shown in Note 15 of Notes to Consolidated Financial Statements—Financial Instruments with Off-Balance Sheet Risk, the following

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table shows details on these fixed and determinable obligations as of December 31, 2008 in the time period indicated.

(dollars in thousands)
  Within One
Year
  One to
Three Years
  Three to
Five Years
  Over Five
Years
  Total  

Deposits without a stated maturity(1)

  $ 550,172   $   $   $   $ 550,172  

Time deposits(1)

    530,370     47,364     1,474         579,208  

Borrowed funds(2)

    153,802     30,000     10,000     22,150     215,952  

Operating lease obligations

    3,933     7,887     6,566     8,473     26,859  

Outside data processing(3)

    908     1,376     1,376         3,660  
                       
 

Total

  $ 1,239,185   $ 86,627   $ 19,416   $ 30,623   $ 1,375,851  
                       

(1)
Excludes accrued interest payable at December 31, 2008.

(2)
Borrowed funds include customer repurchase agreements, federal funds purchased and other short-term and long-term borrowings.

(3)
The Bank has outstanding significant obligations under its current core data processing contract that expires in May 2013 and one other significant vendor arrangement that relates to data communications and data software that expires in December 2009.

OFF-BALANCE SHEET ARRANGEMENTS

        The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

        The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. See Note 15 of Notes to Consolidated Financial Statements for a summary list of loan commitments at December 31, 2008 and 2007.

        Loan commitments represent agreements to lend to a customer as long as there is no violation of any condition established in the contract and which have been accepted in writing by the borrower. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained is based on management's credit evaluation of the borrower. Collateral obtained varies, and may include certificates of deposit, accounts receivable, inventory, property and equipment, residential and commercial real estate.

        Standby letters of credit are conditional commitments issued by the Company which guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Company deems necessary. At December 31, 2008, approximately 95% of the dollar amount of standby letters of credit was collateralized.

        With the exception of these off-balance sheet arrangements, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's

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financial condition, changes in financial condition, revenues or expenses, results of operations, capital expenditures or capital resources, that is material to investors.

LIQUIDITY MANAGEMENT

        Liquidity is a measure of the Company and Bank's ability to meet loan demand and to satisfy depositor withdrawal requirements in an orderly manner. The Bank's primary sources of liquidity consist of cash and cash balances due from correspondent banks, loan repayments, federal funds sold and other short-term investments, maturities and sales of investment securities and income from operations. The Bank's investment portfolio of debt securities is held in an available-for-sale status and has a substantial unrealized gain position, which allows for flexibility, subject to holdings held as collateral for customer repurchase agreements; to generate cash from sales as needed to meet ongoing loan demand. These sources of liquidity are considered primary and are supplemented by the ability of the Company and Bank to borrow funds, which are termed secondary sources and which are substantial. The Company's secondary sources of liquidity, includes a $20 million line of credit with a regional bank, secured by the stock of the Bank, against which there were no amounts outstanding at December 31, 2008. Additionally, the Bank can purchase up to $65.5 million in federal funds on an unsecured basis and $5.5 million on a secured basis from its correspondents, against which there were $4.9 million outstanding at December 31, 2008. At December 31, 2008, the Bank was also eligible to make advances from the FHLB up to $130.0 million based on collateral at the FHLB, of which it had $105.0 million of advances outstanding at December 31, 2008. Also, the Bank may enter into repurchase agreements as well as obtaining additional borrowing capabilities from the FHLB provided adequate collateral exists to secure these lending relationships. The substantial use of the FHLB facility as of December 31, 2008 was based on it providing the most cost effective means to fund substantial loan growth in the fourth quarter of 2008.

        The loss of deposits, through disintermediation, is one of the greater risks to liquidity. Disintermediation occurs most commonly when rates rise and depositors withdraw deposits seeking higher rates in alternative savings and investment sources than the Bank may offer. The Bank was founded under a philosophy of relationship banking and, therefore, believes that it has less of an exposure to disintermediation and resultant liquidity concerns than do many banks. There is, however, a risk that some deposits would be lost if rates were to increase and the Bank elected not to remain competitive with its deposit rates. Under those conditions, the Bank believes that it is well positioned to use other sources of funds such as FHLB borrowings, repurchase agreements and Bank lines of credit to offset a decline in deposits in the short run. Over the long-term, an adjustment in assets and change in business emphasis could compensate for a potential loss of deposits. The Bank also maintains a marketable investment portfolio to provide flexibility in the event of significant liquidity needs. The Bank's Asset Liability Committee has adopted policy guidelines which emphasize the importance of core deposits and their continued growth.

        At December 31, 2008, under the Bank's liquidity formula, it had $336.4 million of primary and secondary liquidity sources, which was deemed adequate to meet current and projected funding needs.

INTEREST RATE RISK MANAGEMENT

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

        A fundamental risk in banking is exposure to market risk, or interest rate risk, since a bank's net income is largely dependent on net interest income. The Bank's Asset Liability Committee ("ALCO") of the Board of Directors formulates and monitors the management of interest rate risk through policies and guidelines established by it and the full Board of Directors. In its consideration of risk limits, the ALCO considers the impact on earnings and capital, the level and direction of interest rates, liquidity, local economic conditions, outside threats and other factors. Banking is generally a business of managing the

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maturity and re-pricing mismatch inherent in its asset and liability cash flows and to provide net interest income growth consistent with the Company's profit objectives.

        The Company, through its ALCO, monitors the interest rate environment in which it operates and adjusts the rates and maturities of its assets and liabilities to remain competitive and to achieve its overall financial objectives subject to established risk limits. The Company does not presently utilize any derivative market products to manage its interest rate risk.

        In the current very low interest rate environment, the Company has continued its emphasis on funding loans in its marketplace and has been partially funding loan growth with cash flow from calls in its investment portfolio. Call risk has increased in the fourth quarter of 2008 as market interest rates declined significantly. Earlier in 2008, the Company made investment portfolio purchases of tax exempt municipal bonds and GNMA guaranteed mortgage backed securities in an effort to extend maturities and benefit from what was perceived as favorable spreads. Taken together, these factors resulted in the duration of the investment portfolio declining to 1.5 years at December 31, 2008, as compared to 2.4 years at September 30, 2008 and 2.2 years at December 31, 2007. In the loan portfolio, the largest portion of the portfolio is variable or adjustable rate (70%) with 30% being fixed rate at December 31, 2008. As compared to December 31, 2007, the fixed rate component at December 31, 2008 decreased from 34% to 30% and the variable and adjustable rate component increased from 66% to 70%. As compared to September 30, 2008, the fixed rate component at December 31, 2008 increased from 28% to 30% and the variable and adjustable rate component decreased from 72% to 70%. A significant factor in the change in the loan portfolio repricing mix during 2008 was the composition of the loans acquired in the acquisition of Fidelity. The Bank has also established interest rate floors in a significant portion of its prime based loans which has the effect of mitigating interest rate risk as market interest rates decline. Finally, from a liability management standpoint, the Bank has been acquiring more variable and short-term liabilities, so as to maintain a reasonable repricing match with its earning assets and to mitigate the risk to earnings and capital should interest rates decline from current levels. There can be no assurance that the Company will be able to successfully achieve its optimal asset liability mix, as a result of competitive pressures, customer preferences and the inability to perfectly forecast future interest rates.

        One of the tools used by the Company to manage its interest rate risk is a static GAP analysis presented below. The Company also uses an earnings simulation model (simulation analysis) on a quarterly basis to monitor its interest rate sensitivity and risk and to model its balance sheet cash flows and its income statement effects in different interest rate scenarios. The model utilizes current balance sheet data and attributes and is adjusted for assumptions as to investment maturities (calls), loan prepayments, interest rates, the level of noninterest income and noninterest expense. The data is then subjected to a "shock test" which assumes a simultaneous change in interest rate up 100 and 200 basis points or down 100 and 200 basis points, along the entire yield curve, but not below zero. The results are analyzed as to the impact on net interest income, and net income over the next twelve and twenty-four month periods and to the market value of equity impact.

        As noted above, the acquisition of Fidelity's assets and liabilities had the effect of significantly increasing the Company's short-term asset sensitivity position (0 to 180 days) primarily as a result of a large prime based (variable rate) loan portfolio. This increased asset sensitivity position has the effect of increasing the Company's exposure to declining interest rates, as compared to prior periods.

        For the analysis presented below, at December 31, 2008, the Bank utilizes an assumption for the re-pricing of money market deposit accounts to reflect a change of 50 basis points in money market account interest rates for each 100 basis points in market interest rates in both a decreasing and increasing interest rate shock scenario.

        As quantified in the table below, the Company's analysis at December 31, 2008 shows a moderate effect on net interest income (over the next 12 months) as well as to the economic value of equity when interest rates are shocked both down 100 and 200 basis points and up 100 and 200 basis points due to the

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significant level of variable rate and repriceable assets and liabilities. The re-pricing duration of the investment portfolio at December 31, 2008 is 1.5 years, the loan portfolio 1.0 years; the interest bearing deposit portfolio 1.4 years and the borrowed funds portfolio 0.6 years.

        The following table reflects the result of simulation analysis on the December 31, 2008 asset and liabilities balances:

Change in interest
rates (basis points)
  Percentage change in net
interest income
  Percentage change in
net income
  Percentage change in
market value of portfolio
equity
 
  +200     -5.0 %   -14.3 %   -3.2 %
  +100     -2.5 %   -7.3 %   -0.4 %
  0              
  -100     +0.9 %   +2.7 %   -2.8 %
  -200     -1.3 %   -3.8 %   -7.5 %

        The results of simulation are within the policy limits adopted by the Company. For net interest income, the Company has adopted a policy limit of 15% for a 100 basis point change and 20% for a 200 basis point change. For the market value of equity, the Company has adopted a policy limit of 20% for a 100 basis point change and 25% for a 200 basis point change. The change in the economic value of equity in a lower interest rate shock scenario at December 31, 2008 is due primarily to call risk in the investment portfolio and to the lower value of noninterest deposits.

        Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or repricing periods, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that limit changes in interest rates on a short-term basis and over the life of the loan. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase.

        Market interest rates (as evidenced by the U.S. Treasury yield curve), declined sharply in the fourth quarter of 2008 due to a deepening financial crisis emanating from defaults in the residential mortgage markets and spreading quickly to all leveraged investments. During the fourth quarter of 2008, the Company's net interest spread was 3.18% as compared to 3.52% for the third quarter of 2008 and 3.69% for the second quarter of 2008. The Company believes that the change in the net interest spread has been consistent with its risk analysis. Furthermore, as market interest rates are currently very low, the lower rates tend to create floors (given a shock of -100 and -200 basis points) on various deposit interest rate products, as interest rates cannot be reduced below zero. This effect further serves to compress net interest income and net interest spreads and margins.

GAP Analysis

        Banks and other financial institutions earnings are significantly dependent upon net interest income, which is the difference between interest earned on earning assets and interest expense on interest bearing liabilities.

        In falling interest rate environments, net interest income is maximized with longer term, higher yielding assets being funded by lower yielding short-term funds, or what is referred to as a negative mismatch or GAP. Conversely, in a rising interest rate environment, net interest income is maximized with shorter term, higher yielding assets being funded by longer-term liabilities or what is referred to as a positive mismatch or GAP.

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        Based on the current economic environment, management has generally been endeavoring to maintain the duration of the investment portfolio in the face of increased call risk (see above discussion of municipal bonds and GNMA guaranteed mortgaged backed securities purchases); to acquire more fixed rate loans, where available, and has been emphasizing the acquisition of shorter-term time deposits, including brokered CD's and shorter-term FHLB borrowings. These additional brokered deposits and non-deposit sources have been required to fund loan growth in excess of core deposit growth. This strategy had mitigated the Company's exposure to lower interest rates through June 30, 2008. As noted above, the acquisition of Fidelity added significant amounts of variable rate loans which are subject to immediate repricing should market rates change as compared to a funding source consisting largely of interest bearing time deposits which generally mature and reprice within periods up to 12 months. This asset sensitive position, resulting from the acquisition, placed added risk to net interest income and the net interest spread and margin as market interest rates continued to decline in the fourth quarter of 2008.

        While management believes that this overall position creates a reasonable balance in managing its interest rate risk and maximizing its net interest margin within plan objectives, there can be no assurance as to actual results. Management has carefully considered its strategy to maximize interest income by reviewing interest rate levels, economic indicators and call features within its investment portfolio. These factors have been discussed with the ALCO and management believes that current strategies are appropriate to current economic and interest rate trends.

        The GAP position, which is a measure of the difference in maturity and re-pricing volume between assets and liabilities, is a means of monitoring the sensitivity of a financial institution to changes in interest rates. The chart below provides an indication of the sensitivity of the Company to changes in interest rates. A negative GAP indicates the degree to which the volume of repriceable liabilities exceeds repriceable assets in given time periods.

        At December 31, 2008, the Company had a positive GAP position of approximately 13% of total assets out to three months and a positive cumulative GAP position of 2% out to 12 months; as compared to a positive GAP position of 2% out to three months and a negative cumulative GAP position of 6% out to 12 months at December 31, 2007, and a positive GAP position of 14% out to three months and a negative cumulative GAP position of 2% out to 12 months at September 30, 2008. The increase in the three month and 12 month asset sensitive position during 2008 was due primarily to the acquisition of Fidelity.

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GAP Analysis
December 31, 2008
(dollars in thousands)

 
  0–3 mos   4–12 mos   13–36 mos   37–60 mos   over 60 mos   Total Rate
Sensitive
  Non-
sensitive
  Total Assets  

Repriceable in:

                                                 

RATE SENSITIVE ASSETS:

                                                 
 

Investments securities

  $ 35,858   $ 61,523   $ 48,288   $ 9,524   $ 13,886   $ 169,079              
 

Loans(1)(2)

    695,377     124,127     233,421     174,558     40,875     1,268,358              
 

Fed funds and other short-term investments

    2,680                     2,680              
 

Other earning assets

        12,450                 12,450              
                                       
   

Total

  $ 733,915   $ 198,100   $ 281,709   $ 184,082   $ 54,761   $ 1,452,567   $ 44,260   $ 1,496,827  
                                       

RATE SENSITIVE LIABILITIES:

                                                 
 

Noninterest bearing demand

  $ 7,244   $ 22,848   $ 57,394   $ 57,394   $ 78,700   $ 223,580              
 

Interest bearing transaction

    27,401         10,960     10,960     5,480     54,801              
 

Savings and money market

    135,896         54,357     54,358     27,180     271,791              
 

Time deposits

    184,945     347,238     42,902     3,240     883     579,208              
 

Customer repurchase agreements and fed funds purchased

    98,802                     98,802              
 

Other borrowings

    85,000             10,000     22,150     117,150              
                                       
   

Total

  $ 539,288   $ 370,086   $ 165,613   $ 135,952   $ 134,393   $ 1,345,332   $ 9,124   $ 1,354,456  
                                       

GAP

  $ 194,627   $ (171,986 ) $ 116,096   $ 48,130   $ (79,632 ) $ 107,235              

Cumulative GAP

  $ 194,627   $ 22,641   $ 138,737   $ 186,867   $ 107,235                    

Cumulative gap as percent of total assets

    13.00 %   1.51 %   9.27 %   12.48 %   7.16 %                  

(1)
Includes loans held for sale

(2)
Non-accrual loans are included in the over 60 months category

        Over the next twelve months, as reflected in the GAP table above, the Company has a slight excess of rate sensitive assets over rate sensitive liabilities of 2% out to 12 months. During 2008, the Company has recognized the probability of lower market interest rates and has kept its time deposit maturities short-term and its money market accounts at as low a rate as possible without incurring substantial deposit runoff. On the asset side, the duration of the loan portfolio shortened due primarily to the acquisition of Fidelity. Additionally, during 2008, in anticipation of lower market interest rates, investment purchases were made with longer durations to mitigate the higher call risk embedded in the investment portfolio.

        Although NOW and MMA accounts are subject to immediate repricing, the Bank's GAP model has incorporated a repricing schedule to account for a lag in rate changes based on our experience, as measured by the amount of those deposit rate changes relative to the amount of rate change in assets.

CAPITAL RESOURCES AND ADEQUACY

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

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        The year ended December 31, 2008 was an especially difficult economic year in which to raise capital for all public companies. The Company's need for capital in the latter half of 2008 was associated with growth in loans and other assets from both organic growth and growth from the acquisition of Fidelity as opposed to capital needs arising from operating losses. During 2008, a series of substantial market events and credit defaults all but eliminated access to capital markets for the Company. This substantial contraction in the availability of additional capital during 2008 caused the Company to rely in the latter half of 2008 on the only two sources of new capital then available, the sale of subordinated debt to current insiders late in the third quarter of 2008 and the sale of preferred stock to the Treasury as part of the Capital Purchase Program.

        At December 31, 2008, the capital position of the Company's wholly-owned subsidiary, the Bank, continues to meet regulatory requirements as a well-capitalized institution. The primary indicators relied on by bank regulators in measuring the capital position are the Tier 1 risk-based capital, total risk-based capital, and leverage ratios. Tier 1 capital consists of common and qualifying preferred stockholders' equity (including without limit the preferred stock issued to the Treasury) less goodwill and other intangibles, and for the Company a limited amount of certain other restricted core capital elements, such as qualifying trust preferred securities and minority interests in consolidated subsidiaries. Total risk-based capital consists of Tier 1 capital, qualifying subordinated debt, and the qualifying portion of the allowance for credit losses, 91% and 100% respectively of which qualifies at December 31, 2008 and 2007 and for the Company to a limited extent excess amounts of restricted core capital elements. Risk-based capital ratios are calculated with reference to risk-weighted assets, which are prescribed by regulation. The Tier 1 capital to average assets ratio is often referred to as the leverage ratio.

        The Company's capital ratios were all in excess of guidelines established by the Federal Reserve and the Bank's capital ratios as earlier mentioned were in excess of those required to be classified as a "well capitalized" institution under the prompt corrective action provisions of the Federal Deposit Insurance Act. The Company and Bank's capital ratios at December 31, 2008 and 2007 are shown in Note 17 of Notes to Consolidated Financial Statements.

        On August 28, 2008 the Company accepted subscriptions for and sold an aggregate of $12.15 million of subordinated notes (the "Notes"), on a private placement basis, to seven parties, all of whom are directors of the Company or the Bank. The Notes, which qualify as Tier 2 capital for regulatory purposes, to the extent permitted, were issued in connection with an effort to meet regulatory requirements for the consummation of the acquisition of Fidelity. The qualifying capital treatment of the Notes will be phased out during the last 5 years of the Notes' term (commencing in October 2009), at a rate of 20% of the original principal amount per year. The Notes bear interest, payable on the first day of each month, commencing in October 2008, at a fixed rate of 10.0% per year. The Notes have a term of approximately six years, and have a maturity of September 30, 2014.

        On December 5, 2008, the Company entered into and consummated the "Purchase Agreement" with the Treasury, pursuant to which the Company issued 38,235 shares of the Company's Series A Preferred Stock', having a liquidation amount per share equal to $1,000, for a total purchase price of $38,235,000. The Series A Preferred Stock pays cumulative dividends at a rate of 5% per year for the first five years and thereafter at a rate of 9% per year. As a result of legislative changes during 2009, and subject to the issuance of implementing regulations and consultation with the Company's and Bank's federal regulators, the Company may, at its option redeem the Series A Preferred Stock at the liquidation amount plus accrued and unpaid dividends. The Series A Preferred Stock is non-voting, except in limited circumstances. Prior to the third anniversary of issuance, unless the Company has redeemed all of the Series A Preferred Stock or the Treasury has transferred all of the Series A Preferred Stock to a third party, the consent of the Treasury will be required for the Company to increase its common stock dividend or repurchase its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.

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        In connection with the purchase of the Series A Preferred Stock, the Treasury was issued a warrant (the "Warrant") to purchase 770,867 shares of the Company's common stock at an initial exercise price of $7.44 per share. The Warrant provides for the adjustment of the exercise price and the number of shares of the common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the common stock, and upon certain issuances of the common stock (or securities exercisable or exchangeable for, or convertible into, common stock) at or below 90% of the market price of the common stock on the trading day prior to the date of the agreement on pricing such securities. The Warrants expires ten years from the date of issuance. The number of shares of common stock issuable pursuant to the Warrant will be reduced by one-half if, on or prior to December 31, 2009, the Company receives aggregate gross cash proceeds of not less than $38,235,000 from "qualified equity offerings" announced after October 13, 2008. If the Company redeems the Series A Preferred Stock in full prior to exercise of the Warrant, the Warrant will be liquidated based upon the then current fair market value of the common stock. The Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.

        The ability of the Company to continue to grow is dependent on its earnings and those of the Bank, the ability to obtain additional funds for contribution to the Bank's capital, through additional borrowings, through the sale of additional common stock or preferred stock, or through the issuance of additional qualifying equity equivalents, such as subordinated debt or trust preferred securities. The capital levels required to be maintained by the Company and Bank may be impacted as a result of the Bank's concentrations in commercial real estate loans. See "Risk Factors" at page 90 and "Regulation" at page 98.

IMPACT OF INFLATION AND CHANGING PRICES

        The Consolidated Financial Statements and Notes thereto have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations. Unlike most industrial companies, nearly all of our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods or services.

NEW ACCOUNTING STANDARDS

        Refer to Note 1 of Notes to Consolidated Financial Statements for statements on New Accounting Standards.

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MARKET FOR COMMON STOCK AND DIVIDENDS

        Market for Common Stock.    The Company's common stock is listed for trading on the NASDAQ Capital Market under the symbol "EGBN". Over the twelve month period ended December 31, 2008, the average daily trading amounted to approximately 5,600 shares. No assurance can be given that a very active trading market will develop in the foreseeable future or can be maintained. The following table sets forth the high and low sale prices for the common stock during each calendar quarter during the last two fiscal years, and dividends declared during such periods, as adjusted for the 10% stock dividend paid on October 1, 2008. As of March 11, 2009, there were 12,745,118 shares of common stock outstanding, held by approximately 1,940 beneficial shareholders, including approximately 1,100 shareholders of record.

 
  2008   2007  
Quarter
  High   Low   Dividends
Declared
per Share
  High   Low   Dividends
Declared
per Share
 

First

  $ 11.97   $ 9.30   $ 0.0545   $ 15.85   $ 14.32   $ 0.0545  

Second

  $ 11.09   $ 7.15   $ 0.0545   $ 15.45   $ 14.77   $ 0.0545  

Third

  $ 10.44   $ 6.37   $ 0.00   $ 15.45   $ 11.59   $ 0.0545  

Fourth

  $ 9.00   $ 5.35   $ 0.00   $ 12.68   $ 10.24   $ 0.0545  

        Dividends.    The Company commenced paying a quarterly cash dividend in January 2005. The Company paid a cash dividend of $0.0545 per share for each of the first and second quarters of 2008 and $0.0545 per share (as adjusted) for each of the quarters of 2007. In July 2008, the Company, in an action to conserve capital, discontinued the payment of its quarterly cash dividend on common stock. It further announced at the same time a 10% stock dividend paid on the common stock on October 1, 2008.

        The resumption of payment of a cash dividend on common stock is prohibited for the first three years that the preferred stock issued to the Treasury is outstanding or the earlier event of redeeming the preferred stock. This resumption may also depend upon the ability of the Bank, the Company's principal operating business, to declare and pay dividends to the Company. Resumption of future dividends on the Company's common stock will also depend upon the Bank's earnings, financial condition, and need for funds, as well as governmental policies and regulations applicable to the Company and the Bank.

        In January 2007, the Company established a Dividend Reinvestment Plan, pursuant to which stockholders may have dividends paid on their common stock automatically reinvested in additional shares of common stock. The price at which shares are reinvested may be at a discount of 5% from the market price, where the shares are newly issued shares purchased directly from the Company. For the year 2008 and 2007, respectively, 76,246 shares and 47,000 shares were issued under this Plan. As a result of the termination of the cash dividends and the restrictions on the resumption of cash dividends, it is not expected that any shares will be issued under this plan in the near future.

        Regulations of the Federal Reserve Board and Maryland law place limits on the amount of dividends the Bank may pay to the Company without prior approval. Prior regulatory approval is required to pay dividends which exceed the Bank's net profits for the current year plus its retained net profits for the preceding two calendar years, less required transfers to surplus. Under Maryland law, dividends may only be paid out of retained earnings. State and federal bank regulatory agencies also have authority to prohibit a bank from paying dividends if such payment is deemed to be an unsafe or unsound practice, and the Federal Reserve Board has the same authority over bank holding companies. At December 31, 2008, subject to prior approval by the Maryland Commissioner of Financial Regulation, the Bank could pay dividends to the parent to the extent of its earnings so long as it maintained required capital ratios.

        The Federal Reserve Board has established guidelines with respect to the maintenance of appropriate levels of capital by registered bank holding companies. Compliance with such standards, as presently in effect, or as they may be amended from time to time, could possibly limit the amount of dividends that the

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Company may pay in the future. In 1985, the Federal Reserve Board issued a policy statement on the payment of cash dividends by bank holding companies. In the statement, the Federal Reserve Board expressed its view that a holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income, or which could only be funded in ways that weaken the holding company's financial health, such as by borrowing. As a depository institution, the deposits of which are insured by the FDIC, the Bank may not pay dividends or distribute any of its capital assets while it remains in default on any assessment due the FDIC. The Bank currently is not in default under any of its obligations to the FDIC. Refer to above discussion on conditions precedent to resuming the payment of the cash common stock dividend.

        Issuer Repurchase of Common Stock.    No shares of the Company's Common Stock were repurchased by or on behalf of the Company during 2008 or 2007.

        Internet Access To Company Documents.    The Company provides access to its SEC filings through its web site at www.eaglebankcorp.com by linking to the SEC's web site. After accessing the web site, the filings are available upon selecting "Investor Relations SEC Filings." Reports available include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after the reports are electronically filed or furnished to the SEC.

        Securities Authorized for Issuance Under Equity Compensation Plans.    The following table sets forth information regarding outstanding options and other rights to purchase or acquire common stock granted under the Company's compensation plans as of December 31, 2008:


Equity Compensation Plan Information

Plan category
  Number of securities to
be issued upon exercise
of outstanding
options, warrants and
rights
  Weighted average
exercise price of
outstanding options,
warrants and rights
  Number of securities
remaining available for
future issuance under
equity compensation
plans excluding securities
reflected in column (a)
 
 
  (a)
  (b)
  (c)
 

Equity compensation plans approved by security holders(1)(2)

    1,029,067   $ 13.01     497,080 (3)

Equity compensation plans not approved by security holders

    0     0     0  
               
 

Total

    1,029,067   $ 13.01     497,080  

(1)
Consists of the Company's 1998 Stock Option Plan, 2006 Stock Plan and the 2004 Employee Stock Purchase Plan. Outstanding options, warrants and rights includes nominal number of shares subject to awards of SARS and shares subject to unvested performance based restricted stock awards. For additional information, see Note 13 to the Consolidated Financial Statements.

(2)
The 2004 Employee Stock Purcahse Plan expired on December 31, 2008. As such, no further awards may be granted under that plan.

(3)
Shares include 359,335 available for issuance under the 2006 Stock Option Plan and 137,745 under the Employee Stock Purchase Plan.

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        Stock Price Performance.    The following table compares the cumulative total return on a hypothetical investment of $100 in the Company's common stock on December 31, 2003 through December 31, 2008, with the hypothetical cumulative total return on the NASDAQ Stock Market Index (U.S. Companies) and the NASDAQ Bank Index for the comparable period, including reinvestment of dividends.


Total Return Performance

GRAPHIC

 
  December 31,  
 
  2003   2004   2005   2006   2007   2008  

Eagle Bancorp, Inc. 

  $ 100.00   $ 116.02   $ 172.36   $ 170.54   $ 120.53   $ 63.69  

Nasdaq Stock Market Index—(U.S. Companies)

  $ 100.00   $ 108.59   $ 110.08   $ 120.56   $ 132.39   $ 78.72  

Nasdaq Bank Index

  $ 100.00   $ 110.99   $ 106.18   $ 117.87   $ 91.85   $ 69.88  

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REPORT OF STEGMAN & COMPANY
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and
Stockholders of Eagle Bancorp, Inc.

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

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

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Eagle Bancorp Inc. as of December 31, 2008 and 2007, and the results of its operations and cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Eagle Bancorp Inc.'s. internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 12, 2009 expressed an unqualified opinion.

/s/ Stegman & Company

Stegman & Company
Baltimore, Maryland
March 12, 2009

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EAGLE BANCORP, INC.

Consolidated Balance Sheets

(dollars in thousands)

 
  December 31, 2008   December 31, 2007  

Assets

             

Cash and due from banks

  $ 27,157   $ 15,408  

Federal funds sold

    191     244  

Interest bearing deposits with banks and other short-term investments

    2,489     4,490  

Investment securities available for sale, at fair value

    169,079     87,117  

Loans held for sale

    2,718     2,177  

Loans

    1,265,640     716,677  

Less allowance for credit losses

    (18,403 )   (8,037 )
           
 

Loans, net

    1,247,237     708,640  

Premises and equipment, net

    9,666     6,701  

Deferred income taxes

    11,106     3,597  

Bank owned life insurance

    12,450     11,984  

Accrued interest, taxes and other assets

    14,734     6,042  
           
     

Total Assets

  $ 1,496,827   $ 846,400  
           

Liabilities and Stockholders' Equity Liabilities

             

Deposits:

             
 

Noninterest bearing demand

  $ 223,580   $ 142,477  
 

Interest bearing transaction

    54,801     54,090  
 

Savings and money market

    271,791     177,081  
 

Time, $100,000 or more

    249,516     173,586  
 

Other time

    329,692     83,702  
           
   

Total deposits

    1,129,380     630,936  

Customer repurchase agreements and federal funds purchased

    98,802     76,408  

Other short-term borrowings

    55,000     22,000  

Long-term borrowings

    62,150     30,000  

Other liabilities

    9,124     5,890  
           
   

Total liabilities

    1,354,456     765,234  
           

Stockholders' Equity

             

Preferred stock, par value $.01 per share, shares authorized 1,000,000, Series A, $1,000 per share liquidation preference, shares issued and outstanding 38,235 and 0, respectively, discount of $1,892 and $0, respectively, net

    36,312      

Common stock, par value $.01; shares authorized 50,000,000, shares issued and outstanding 12,714,355 and 9,721,315, respectively

    127     97  

Warrants

    1,892      

Additional paid in capital

    76,822     52,290  

Retained earnings

    24,866     28,195  

Accumulated other comprehensive income

    2,352     584  
           
   

Total stockholders' equity

    142,371     81,166  
           
   

Total Liabilities and Stockholders' Equity

  $ 1,496,827   $ 846,400  
           

See notes to consolidated financial statements.

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EAGLE BANCORP, INC.

Consolidated Statements of Operations

Years Ended December 31,

(dollars in thousands, except per share data)

 
  2008   2007   2006  

Interest Income

                   
 

Interest and fees on loans

  $ 59,901   $ 51,931   $ 45,814  
 

Taxable interest and dividends on investment securities

    5,459     4,177     3,277  
 

Interest on balances with other banks and short-term investments

    98     293     212  
 

Interest on federal funds sold

    199     676     1,015  
               
     

Total interest income

    65,657     57,077     50,318  
               

Interest Expense

                   
 

Interest on deposits

    19,543     19,810     15,603  
 

Interest on customer repurchase agreements and federal funds purchased

    1,406     1,887     1,199  
 

Interest on short-term borrowings

    399     611     639  
 

Interest on long-term borrowings

    2,328     1,421     439  
               
     

Total interest expense

    23,676     23,729     17,880  
               

Net Interest Income

    41,981     33,348     32,438  

Provision for Credit Losses

    3,979     1,643     1,745  
               

Net Interest Income After Provision For Credit Losses

    38,002     31,705     30,693  
               

Noninterest Income

                   
 

Service charges on deposits

    2,410     1,491     1,386  
 

Gain on sale of loans

    426     1,036     1,114  
 

Gain on sale of investment securities

    2     6     124  
 

Increase in the cash surrender value of bank owned life insurance

    466     455     406  
 

Income from subordinated financing

        1,252      
 

Other income

    1,062     946     816  
               
     

Total noninterest income

    4,366     5,186     3,846  
               

Noninterest Expense

                   
 

Salaries and employee benefits

    16,728     14,167     12,230  
 

Premises and equipment expenses

    5,424     4,829     3,835  
 

Marketing and advertising

    1,054     465     587  
 

Data processing

    1,622     1,231     1,236  
 

Legal, accounting and professional fees

    1,054     611     801  
 

FDIC insurance and regulatory assessments

    718     508     128  
 

Other expenses

    4,217     3,110     3,007  
               
     

Total noninterest expense

    30,817     24,921     21,824  
               

Income Before Income Tax Expense

    11,551     11,970     12,715  

Income Tax Expense

    4,123     4,269     4,690  
               

Net Income

    7,428     7,701     8,025  

Preferred Stock Dividends and Discount Accretion

    177          
               

Net Income Available to Common Shareholders

  $ 7,251   $ 7,701   $ 8,025  
               

Earnings Per Common Share

                   
 

Basic

  $ 0.63   $ 0.73   $ 0.77  
 

Diluted

  $ 0.62   $ 0.71   $ 0.74  

Dividends Declared Per Common Share

  $ 0.11   $ 0.22   $ 0.21  

See notes to consolidated financial statements.

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EAGLE BANCORP, INC.

Consolidated Statements of Changes in Stockholders' Equity

For The Years Ended December 31, 2008, 2007 and 2006

(dollars in thousands)

 
  Preferred
Stock
  Warrants   Common
Stock
  Additional Paid
in Capital
  Retained
Earnings
  Accumulated
Other
Comprehensive
Income (Loss)
  Total
Stockholders'
Equity
 

Balance January 1, 2006

  $   $   $ 72   $ 48,594   $ 16,918   $ (620 ) $ 64,964  

Comprehensive Income

                                           
 

Net Income

                            8,025           8,025  
 

Other comprehensive income:

                                           
   

Unrealized gain on securities available for sale (net of taxes)

                                  442     442  
   

Less: reclassification adjustment for gains net of taxes of $49 included in net income

                                  (75 )   (75 )
                                         

Total Comprehensive Income

                                  367     8,392  

Cash Dividends ($0.21 per share)

                            (2,147 )         (2,147 )

Stock-based compensation

                      345                 345  

1.3 to one stock split in the form of a 30% common stock dividend

                22     (22 )                

Cash paid in lieu of fractional shares

                      (5 )               (5 )

Exercise of options for 137,999 shares of common stock

                1     935                 936  

Tax benefit on non-qualified options exercise

                      431                 431  
                               
   

Balance December 31, 2006

            95     50,278     22,796     (253 )   72,916  

Comprehensive Income

                                           
 

Net Income

                            7,701           7,701  
 

Other comprehensive income:

                                           
   

Unrealized gain on securities available for sale (net of taxes)

                                  841     841  
   

Less: reclassification adjustment for gains net of taxes of $2 included in net income

                                  (4 )   (4 )
                                         
 

Total Comprehensive Income

                                  837     8,538  

Cash Dividends ($0.22 per share)

                            (2,302 )         (2,302 )

Stock-based compensation

                      224                 224  

Shares issued under dividend reinvestment plan—47,000 shares

                    689                 689  

Exercise of options for 196,251 shares of common stock

                2     1,080                 1,082  

Tax benefit on non-qualified options exercise

                      19                 19  
                               
   

Balance December 31, 2007

            97     52,290     28,195     584     81,166  

Comprehensive Income

                                           
 

Net Income

                            7,428           7,428  
 

Other comprehensive income:

                                           
   

Unrealized gain on securities available for sale (net of taxes)

                                  1,769     1,769  
   

Less: reclassification adjustment for gains net of taxes of $1 included in net income

                                  (1 )   (1 )
                                         
 

Total Comprehensive Income

                                  1,768     9,196  

Shares issued to effect merger with Fidelity 1,638,031 shares, net of issuance costs of $96

                16     13,037                 13,053  

Net tangible asset value of Fidelity & Trust assets acquired

                      181                 181  

Cash Dividends ($0.11 per share)

                            (1,178 )         (1,178 )

Preferred shares and warrants issued, net of issuance costs

    36,312     1,892                             38,204  

Shares issued under dividend reinvestment plan—76,246 shares

                1     806                 807  

10% common stock dividend

                12     9,567     (9,579 )          

Cash paid in lieu of fractional shares

                      (6 )               (6 )

Stock-based compensation

                      311                 311  

Exercise of options for 126,827 shares of common stock

                1     441                 442  

Tax benefit on non-qualified options exercise

                      195                 195  
                               
   

Balance December 31, 2008

  $ 36,312   $ 1,892   $ 127   $ 76,822   $ 24,866   $ 2,352   $ 142,371  
                               

See notes to consolidated financial statements.

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EAGLE BANCORP, INC.

Consolidated Statements of Cash Flows

Years Ended December 31,

(dollars in thousands)

 
  2008   2007   2006  

Cash Flows From Operating Activities:

                   
 

Net income

  $ 7,428   $ 7,701   $ 8,025  
   

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

                   
       

Decrease in deferred income taxes

    (1,643 )   (868 )   (647 )
       

Provision for credit losses

    3,979     1,643     1,745  
       

Depreciation and amortization

    1,613     1,347     1,196  
       

Gains on sale of loans

    (426 )   (1,036 )   (1,114 )
       

Origination of loans held for sale

    (29,071 )   (52,455 )   (59,966 )
       

Proceeds from sale of loans held for sale

    28,956     53,471     61,847  
       

Gain on sale of investment securities

    (2 )   (6 )   (124 )
       

Net increase in surrender value of Bank-owned life insurance

    (466 )   (455 )   (406 )
       

Stock-based compensation expense

    311     224     345  
       

Excess tax benefit from stock-based compensation

    (195 )   (19 )   (431 )
 

(Increase) decrease in other assets

    (19,579 )   119     (1,857 )
 

Increase (decrease) in other liabilities

    2,163     1,953     (1,869 )
               
       

Net cash (used in) provided by operating activities

    (6,932 )   11,619     6,744  
               

Cash Flows From Investing Activities:

                   
 

Decrease in interest bearing deposits—other banks

    2,001     365     6,376  
 

Purchases of available for sale investment securities

    (67,785 )   (33,696 )   (48,632 )
 

Proceeds from maturities of available for sale securities

    20,399     9,784     20,979  
 

Proceeds from sale / call of available for sale securities

    64,830     29,326     5,277  
 

Net increase in loans

    (191,577 )   (91,882 )   (76,918 )
 

Net cash received in acquisition

    10,885          
 

Bank premises and equipment acquired

    (1,422 )   (1,094 )   (2,376 )
               
       

Net cash used in investing activities

    (162,669 )   (87,197 )   (95,294 )
               

Cash Flows From Financing Activities:

                   
 

Increase in deposits

    111,708     2,421     59,622  
 

(Decrease) increase in customer repurchase agreements and Fed Funds

    (29,878 )   38,344     5,925  
 

Increase in other short-term borrowings

    28,847     14,000     8,000  
 

Increase in long-term borrowings

    32,150     8,000     22,000  
 

Issuance of preferred stock and warrants

    38,204          
 

Issuance of common stock

    1,249     1,771     936  
 

Excess tax benefit from stock-based compensation

    195     19     431  
 

Payment of dividends and payment in lieu of fractional shares

    (1,178 )   (2,302 )   (2,152 )
               
       

Net cash provided by financing activities

    181,297     62,253     94,762  
               

Net Increase (Decrease) in Cash

   
11,696
   
(13,325

)
 
6,212
 

Cash and Cash Equivalents at Beginning of Year

    15,652     28,977     22,765  
               

Cash and Cash Equivalents at End of Year

  $ 27,348   $ 15,652   $ 28,977  
               

Supplemental Cash Flows Information:

                   
 

Interest paid

  $ 22,380   $ 23,640   $ 16,906  
               
 

Income taxes paid

  $ 6,088   $ 4,052   $ 4,751  
               
 

Stock issued for acquisition of Fidelity

  $ 13,330   $   $  
               

Non-Cash Financing Activities

                   
 

Reclassification of borrowings from long-term to short-term

  $   $ 22,000   $  

Non-Cash Investing Activities

                   
 

Transfers from loans to other real estate owned

  $ 909   $   $ 257  

See notes to consolidated financial statements.

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Eagle Bancorp, Inc.

Notes to Consolidated Financial Statements
for the Years Ended December 31, 2008, 2007 and 2006:

Note 1—Significant Accounting Policies

        The consolidated financial statements include the accounts of Eagle Bancorp, Inc. (the "Company") and its subsidiaries, EagleBank (the "Bank") and Eagle Commercial Ventures LLC ("ECV") with all significant intercompany transactions eliminated. The investment in subsidiaries is recorded on the Company's books (Parent Only) on the basis of its equity in the net assets of the subsidiary. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices in the banking industry. Certain reclassifications have been made to amounts previously reported to conform to the classification made in 2008. The following is a summary of the more significant accounting policies.

Nature of Operations

        The Company, through EagleBank, its bank subsidiary (the "Bank"), conducts a full service community banking business, primarily in Montgomery County, Maryland, Washington, D.C. and Fairfax County in Northern Virginia. On August 31, 2008, the Company completed the acquisition of Fidelity & Trust Financial Corporation ("Fidelity") and Fidelity & Trust Bank ("F&T Bank"). Refer to Note 18 for a full description of this transaction. The primary financial services offered by the Bank include real estate, commercial and consumer lending, as well as traditional deposit and repurchase agreement products. The Bank is also active in the origination and sale of residential mortgage loans and the origination of small business loans. The guaranteed portion of small business loans is typically sold through the Small Business Administration, in a transaction apart from the loan's origination. The Bank offers its products and services (following completion of the merger) through thirteen banking offices and various electronic capabilities, including remote deposit services introduced in 2006. Eagle Commercial Ventures, LLC ("ECV"), a direct subsidiary of the Company provides subordinated financing for the acquisition, development and construction of real estate projects, where the primary financing is provided by the Bank. Prior to the formation of ECV, the Company engaged directly in occasional subordinated financing transactions, which involve higher levels of risk, together with commensurate returns. Refer to—Higher Risk Lending—Revenue Recognition below.

Use of Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

Cash Flows

        For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, and federal funds sold (items with an original maturity of three months or less).

Loans Held for Sale

        The Company engages in sales of residential mortgage loans and the guaranteed portion of Small Business Administration ("SBA") loans originated by the Bank. Loans held for sale are carried at the lower of aggregate cost or fair value. Fair value is derived from secondary market quotations for similar

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Eagle Bancorp, Inc.

Notes to Consolidated Financial Statements
for the Years Ended December 31, 2008, 2007 and 2006: (Continued)

Note 1—Significant Accounting Policies (Continued)


instruments. Gains and losses on sales of these loans are recorded as a component of noninterest income in the Consolidated Statements of Operations.

        The Company's current practice is to sell residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing as of December 31, 2008 or 2007. The sale of the guaranteed portion of SBA loans on a servicing retained basis gives rise to an Excess Servicing Asset, which is computed on a loan by loan basis and which unamortized amount is included in other assets. This asset is being amortized on a straight line basis (with adjustment for prepayments) as an offset of servicing fees collected and is included in other noninterest income. Also, please refer to the discussion under the caption, "Intangible Assets" within Management's Discussion and Analysis of Financial Condition and Results of Operation for further discussion.

        The Company enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitments). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 15 to 60 days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. As a result, the Company is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates.

        The market values of rate lock commitments and best efforts contracts are not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss occurs on the rate lock commitments.

Investment Securities

        The Company has no securities classified as trading, nor are any investment securities classified as held-to-maturity. Marketable equity securities and debt securities not classified as held-to-maturity or trading are classified as available-for-sale. Securities available-for-sale are acquired as part of the Company's asset/liability management strategy and may be sold in response to changes in interest rates, loan demand, changes in prepayment risk and other factors. Securities available-for-sale are carried at fair value, with unrealized gains or losses being reported as accumulated other comprehensive income, a separate component of stockholders' equity, net of deferred tax. Realized gains and losses, using the specific identification method, are included as a separate component of noninterest income. Declines in the fair value of individual available-for-sale securities below their cost that are other than temporary in nature result in write-downs of the individual securities to their fair value. Factors affecting the determination of whether other-than-temporary impairment has occurred include a downgrading of the security by a rating agency, a significant deterioration in the financial condition of the issuer, or a change in management's intent and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value.

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Eagle Bancorp, Inc.

Notes to Consolidated Financial Statements
for the Years Ended December 31, 2008, 2007 and 2006: (Continued)

Note 1—Significant Accounting Policies (Continued)

Loans

        Loans are stated at the principal amount outstanding, net of unamortized deferred costs and fees. Interest income on loans is accrued at the contractual rate on the principal amount outstanding. It is the Company's policy to discontinue the accrual of interest when circumstances indicate that collection is doubtful. Deferred fees and costs on loans originated through October 2005 are being amortized on the straight line method over the term of the loan. Deferred fees and costs on loans originated subsequent to October 2005 are being amortized on the interest method over the term of the loan. The difference between the straight line method and the interest method was considered immaterial.

        Management considers loans impaired when, based on current information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Loans are evaluated for impairment in accordance with the Company's portfolio monitoring and ongoing risk assessment procedures. Management considers the financial condition of the borrower, cash flow of the borrower, payment status of the loan, and the value of the collateral, if any, securing the loan. Generally, impaired loans do not include large groups of smaller balance homogeneous loans such as residential real estate and consumer type loans which loans are evaluated collectively for impairment and are generally placed on non-accrual when the loan becomes 90 days past due as to principal or interest. Loans specifically reviewed for impairment are not considered impaired during periods of "minimal delay" in payment (ninety days or less) provided eventual collection of all amounts due is expected. The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if repayment is expected to be provided solely by the collateral. In appropriate circumstances, interest income on impaired loans may be recognized on the cash basis.

Higher Risk Lending—Revenue Recognition

        The Company has occasionally made higher risk acquisition, development, and construction (ADC) loans that entail higher risks than ADC loans made following normal underwriting practices ("higher risk loan transactions"). These higher risk loan transactions are currently made through the Company's subsidiary, ECV. This activity is limited as to individual transaction amount and total exposure amounts based on capital levels and is carefully monitored. The loans are carried on the balance sheet at amounts outstanding and meet the loan classification requirements of the Accounting Standard Executive Committee ("AcSEC") guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No. 1). Additional interest earned on these higher risk loan transactions (as defined in the individual loan agreements) is recognized as realized under the provisions contained in AcSEC's guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No.1) and Staff Accounting Bulletin No. 101 (Revenue Recognition in Financial Statements). The additional interest is included as a component of noninterest income. ECV recorded no additional interest on higher risk transactions during 2008 (although normal interest income was recorded) and has one higher risk lending transaction outstanding as of December 31, 2008 amounting to $1.8 million and $1.9 million as of December 31, 2007.

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Eagle Bancorp, Inc.

Notes to Consolidated Financial Statements
for the Years Ended December 31, 2008, 2007 and 2006: (Continued)

Note 1—Significant Accounting Policies (Continued)

Allowance for Credit Losses

        The allowance for credit losses represents an amount which, in management's judgment, is adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The adequacy of the allowance for credit losses is determined through careful and continuous review and evaluation of the loan portfolio and involves the balancing of a number of factors to establish a prudent level of allowance. Among the factors considered in evaluating the adequacy of the allowance for credit losses are lending risks associated with growth and entry into new markets, loss allocations for specific credits, the level of the allowance to nonperforming loans, historical loss experience, economic conditions, portfolio trends and credit concentrations, changes in the size and character of the loan portfolio, and management's judgment with respect to current and expected economic conditions and their impact on the existing loan portfolio. Allowances for impaired loans are generally determined based on collateral values. Loans or any portion thereof deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for credit losses, which is recorded as a current period operating expense. The allowance for credit losses consists of allocated and unallocated components.

        The components of the allowance for credit losses represent an estimation done pursuant to either Statement of Financial Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies," or SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." Specific allowances are established in cases where management has identified significant conditions or circumstances related to a specific credit that management believes indicate the probability that a loss may be incurred. For potential problem credits for which specific allowance amounts have not been determined, the Company establishes allowances according to the application of credit risk factors. These factors are set by management and approved by the appropriate Board Committee to reflect its assessment of the relative level of risk inherent in each risk grade. A third component of the allowance computation, termed a nonspecific or environmental factors allowance, is based upon management's evaluation of various environmental conditions that are not directly measured in the determination of either the specific allowance or formula allowance. Such conditions include general economic and business conditions affecting key lending areas, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, specific industry conditions within portfolio categories, recent loss experience in particular loan categories, duration of the current business cycle, bank regulatory examination results, findings of outside review consultants, and management's judgment with respect to various other conditions including credit administration and management and the quality of risk identification systems. Executive management reviews these environmental conditions quarterly, and documents the rationale for all changes.

        Management believes that the allowance for credit losses is adequate; however, determination of the allowance is inherently subjective and requires significant estimates. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Evaluation of the potential effects of these factors on estimated losses involves a high degree of uncertainty, including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Bank periodically review the Bank's loan portfolio and allowance for credit losses. Such review may result

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Eagle Bancorp, Inc.

Notes to Consolidated Financial Statements
for the Years Ended December 31, 2008, 2007 and 2006: (Continued)

Note 1—Significant Accounting Policies (Continued)


in recognition of additions to the allowance based on their judgments of information available to them at the time of their examination.

Premises and Equipment

        Premises and equipment are stated at cost less accumulated depreciation and amortization computed using the straight-line method for financial reporting purposes. Premises and equipment are depreciated over the useful lives of the assets, which generally range from seven years for furniture, fixtures and equipment, three to five years for computer software and hardware, and ten to forty years for buildings and building improvements. Leasehold improvements are amortized over the terms of the respective leases, which may include renewal options where management has the positive intent to exercise such options, or the estimated useful lives of the improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary maintenance and repairs are expensed as incurred. These costs are included as a component of premises and equipment expenses on the Consolidated Statement of Operations.

Other Real Estate Owned (OREO)

        Assets acquired through loan foreclosure are held for sale and are initially recorded at the lower of cost or fair value less estimated selling costs when acquired, establishing a new cost basis. The new basis is supported by recent appraisals. Costs after acquisition are generally expensed. If the fair value of the asset declines, a write-down is recorded through expense. The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in economic conditions or review by regulatory examiners. OREO is included in accrued interest, taxes and other assets in the accompanying Consolidated Balance Sheets and totaled $909 thousand and $0 at December 31, 2008 and 2007, respectively.

Goodwill and Other Intangible Assets

        Goodwill and other intangible assets are subject to impairment testing at least annually, or when events or changes in circumstances indicate the assets might be impaired. Intangible assets (other than goodwill) are amortized to expense using accelerated or straight-line methods over their respective estimated useful lives.

Marketing and Advertising

        Marketing and advertising costs are generally expensed as incurred.

Income Taxes

        The Company employs the liability method of accounting for income taxes as required by Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under the liability method, deferred-tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse. The Company adopted the provisions of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" in the first quarter of 2007. The Company utilizes statutory requirements for its income tax accounting, and

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Eagle Bancorp, Inc.

Notes to Consolidated Financial Statements
for the Years Ended December 31, 2008, 2007 and 2006: (Continued)

Note 1—Significant Accounting Policies (Continued)


avoids risks associated with potentially problematic tax positions that may incur challenge upon audit, where an adverse outcome is more likely than not. Therefore, no provisions are made for either uncertain tax positions nor accompanying potential tax penalties and interest for underpayments of income taxes in the Company's tax reserves. In accordance with SFAS No.109, the Company may establish a reserve against deferred tax assets in those cases where realization is less than certain.

Transfer 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 obtain the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. In certain cases, the recourse to the Bank to repurchase assets may exist but be deemed immaterial based on the specific facts and circumstances.

Earnings per Common Share

        Basic net income per common share is derived by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period measured. Diluted earnings per common share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period measured including the potential dilutive effects of common stock equivalents. Earnings per common share has been adjusted to give retroactive reflect to all stock splits.

Stock-Based Compensation

        Effective January 2006, in accordance with a new accounting standard (SFAS 123R), the Company records as compensation expense an amount equal to the amortization (over the remaining service period) of the fair value (computed at the date of option grant) of any outstanding fixed stock option grants which vest subsequent to December 31, 2005. Compensation expense on variable stock option grants (i.e. performance based grants) is recorded based on the probability of achievement of the goals underlying the performance grant. Refer to Note 13 for a description of stock-based compensation expense for the years ended December 31, 2008, 2007 and 2006.

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Eagle Bancorp, Inc.

Notes to Consolidated Financial Statements
for the Years Ended December 31, 2008, 2007 and 2006: (Continued)

Note 1—Significant Accounting Policies (Continued)

New Accounting Pronouncements

Recent Accounting Pronouncements Adopted

        In September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"). This statement provides a single definition of fair value, a framework for measuring fair value, and expanded disclosures concerning fair value. Previously, different definitions of fair value were contained in various accounting pronouncements creating inconsistencies in measurement and disclosures. SFAS 157 applies under those previously issued pronouncements that prescribe fair value as the relevant measure of value, except SFAS 123R and related interpretations and pronouncements that require or permit measurement similar to fair value but are not intended to measure fair value. This pronouncement is effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 157 as of January 1, 2008 and the adoption did not have a material impact on the consolidated financial statements or results of operations of the Company.

        In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument by instrument basis, is typically irrevocable once elected. Statement 159 is effective for fiscal years beginning after November 15, 2007. The Company adopted the provisions of SFAS 159 on January 1, 2008 and the adoption did not have a material impact on the consolidated financial statements or results of operations of the Company.

        In December 2007, the SEC issued Staff Accounting Bulletin No. 110 ("SAB No. 110"), Certain Assumptions Used in Valuation Methods, which extends the use of the "simplified" method, under certain circumstances, in developing an estimate of expected term of "plain vanilla" share options in accordance with SFAS No. 123R. Prior to SAB No. 110, SAB No. 107 stated that the simplified method was only available for grants made up to December 31, 2007. The Company continues to use the simplified method in developing an estimate of the expected term of stock options.

        In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). This Statement identifies the sources for generally accepted accounting principles (GAAP) in the U.S. and lists the categories in descending order. An entity should follow the highest category of GAAP applicable for each of its accounting transactions. The adoption did not have a material effect on the Company's consolidated financial statements.

Accounting Pronouncements Issued But Not Yet Effective

        In December 2007, the FASB issued SFAS 141(R), "Business Combinations (Revised 2007) ("SFAS 141R"). SFAS 141R replaces SFAS 141, "Business Combinations," and applies to all transactions and other events in which one entity obtains control over one or more other businesses. SFAS 141R requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process required under SFAS 141 whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their

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Eagle Bancorp, Inc.

Notes to Consolidated Financial Statements
for the Years Ended December 31, 2008, 2007 and 2006: (Continued)

Note 1—Significant Accounting Policies (Continued)


estimated fair value. SFAS 141R requires acquirers to expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed, as was previously the case under SFAS 141. Under SFAS 141R, the requirements of SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities," would have to be met in order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting and, instead, that contingency would be subject to the probable and estimable recognition criteria of SFAS 5, "Accounting for Contingencies." SFAS 141R is expected to have a significant impact on the Company's accounting for business combinations closing on or after January 1, 2009.

        In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB Statement No. 51. ("SFAS 160"). SFAS 160 amends Accounting Research Bulletin (ARB) No. 51, "Consolidated Financial Statements," to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies that a non-controlling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. SFAS 160 is effective for the Company on January 1, 2009 and is not expected to have a significant impact on the Company's financial statements.

        In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133" ("SFAS 161"). SFAS 161 is intended to enhance the current disclosure framework previously required for derivative instruments and hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" to include how and why an entity uses derivative instruments, how derivative instruments and related hedge items are accounted for and their impact on an entity's financial positions, results of operations, and cash flows. This standard is effective for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged. While the Company does not currently utilize derivative instruments, it is currently evaluating the impact of this new standard on its financial position, results of operations and cash flows.

        In May 2008, the FASB issued Statement of Financial Accounting Standards No. 163, "Accounting for Financial Guarantee Insurance Contracts—an interpretation of FASB Statement No. 60" ("SFAS 163"). SFAS 163 clarifies how Statement of Financial Accounting Standards No. 60, "Accounting and Reporting by Insurance Enterprises," applies to financial guarantee insurance contracts, including the recognition and measurement of premium revenue and claim liabilities. SFAS 163 also requires expanded disclosers about financial guarantee insurance contracts. SFAS 163 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. The Company does not have any guarantee insurance contracts, and therefore, we do not expect that SFAS 163 will have a material impact on our consolidated financial positions, results of operations or cash flows.

        In June 2008, the FASB issued FASB Staff Position Emerging Issues Task Force 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transaction Are Participating Securities" (FSP-EITF 03-6-1"). Under FASP-EITF 03-6-1, unvested share-based payment awards that contain

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Eagle Bancorp, Inc.

Notes to Consolidated Financial Statements
for the Years Ended December 31, 2008, 2007 and 2006: (Continued)

Note 1—Significant Accounting Policies (Continued)


non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP-EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years and requires retrospective application. We are currently evaluating the impact, if any, that FSP-EITF 03-6-1 may have on our consolidation financial positions, results of operations or cash flows.

        In December 2008, the FASB issued FASB Staff Position ("FSP") FAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities, The document increases disclosure requirements for public companies and is effective for reporting periods (interim and annual) that end after December 15, 2008. The purpose of this FSP is to promptly improve disclosers by public entities and enterprises until the pending amendments to FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, are finalized and approved by the Board. The FSP amends Statement 140 to require public entities to provide additional disclosures about transferors' continuing involvement with transferred financial assets. It also amends Interpretation 46(R) to require public enterprises, including sponsors that have a variable interest in a variable interest entity, to provide additional disclosures about their involvement with variable interest entities. This pronouncement is related to disclosures only and will not have an impact on our consolidated financial position, results of operations or cash flows.

Note 2—Cash and Due from Banks

        Regulation D of the Federal Reserve Act requires that banks maintain noninterest reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. During 2008, the Bank maintained balances at the Federal Reserve (in addition to vault cash) to meet the reserve requirements as well as balances to partially compensate for services. Late in 2008, the Federal Reserve in connection with the Emergency Economic Stabilization Act of 2008 began paying a nominal amount of interest on balances held. Additionally, the Bank maintained interest bearing balances with the Federal Home Loan Bank and noninterest bearing balances with nine domestic correspondents as compensation for services they provide to the Bank.

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Eagle Bancorp, Inc.

Notes to Consolidated Financial Statements
for the Years Ended December 31, 2008, 2007 and 2006: (Continued)

Note 3—Investment Securities Available-for-Sale

        The amortized cost and estimated fair values of investments available for sale at December 31, 2008 and 2007 are as follows:

December 31, 2008
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Estimated
Fair Value
 
(dollars in thousands)
   
   
   
   
 

U. S. Government agency securities

  $ 71,837   $ 2,197   $ 5   $ 74,029  

Mortgage backed securities—GSEs

    77,242     2,559     31     79,770  

Municipal bonds

    5,061         353     4,708  

Federal Reserve and Federal Home Loan Bank stock

    9,599             9,599  

Other equity investments

    1,396         423     973  
                   

  $ 165,135   $ 4,756   $ 812   $ 169,079  
                   

 

December 31, 2007
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Estimated
Fair Value
 
(dollars in thousands)
   
   
   
   
 

U. S. Government agency securities

  $ 50,428   $ 885   $ 18   $ 51,295  

Mortgage backed securities—GSEs

    29,218     220     135     29,303  

Municipal bonds

    357         6     351  

Federal Reserve and Federal Home Loan Bank stock

    4,870             4,870  

Other equity investments

    1,278     20         1,298  
                   

  $ 86,151   $ 1,125   $ 159   $ 87,117  
                   

        The acquisitions of Fidelity consummated as of August 31, 2008 contributed approximately $100 million of balances to the investment portfolio.

        Ninety seven percent (97%) of the bonds reflected in the above table (the debt instruments) are rated AAA. The remaining three percent (3%) of the bonds represent municipal bonds which have a rating of AA;