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

FORM 10-Q

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

For the Quarterly Period Ended September 30, 2010

OR

(   )     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
52-2061461
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
   
7815 Woodmont Avenue, Bethesda, Maryland
20814
(Address of principal executive offices)
(Zip Code)
         
(301) 986-1800
(Registrant's telephone number, including area code)
 
N/A
(Former name, former address and former fiscal year, if changed since last report)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer [ ]
Accelerated filer [x]
Non-accelerated filer [ ]
Smaller Reporting Company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act
Yes [ ]  No [x]

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

As of October 29, 2010, the registrant had 19,678,372 shares of Common Stock outstanding.

 
1

 
EAGLE BANCORP, INC.
TABLE OF CONTENTS

PART I.
FINANCIAL INFORMATION
   
       
   
     
     
     
     
       
     
       
   
     
     
     
       
   
       
   
       
PART II.
OTHER INFORMATION
   
       
   
       
   
       
   
       
   
       
   
       
   
       
   
       
     
 
 
2

 
Item 1 – Financial Statements

EAGLE BANCORP, INC.
Consolidated Balance Sheets
September 30, 2010 and December 31, 2009
(dollars in thousands, except per share data)
 
   
September 30,
   
December 31,
 
   
2010
   
2009
 
Assets
 
(Unaudited)
   
(Audited)
 
Cash and due from banks
  $ 19,734     $ 21,955  
Federal funds sold
    72,101       88,248  
Interest bearing deposits with banks and other short-term investments
    7,577       7,484  
Investment securities available for sale, at fair value
    258,902       235,227  
Federal Reserve and Federal Home Loan Bank stock
    9,774       10,417  
Loans held for sale
    70,889       1,550  
Loans
    1,530,946       1,399,311  
Less allowance for credit losses
    (22,240 )     (20,619 )
Loans, net
    1,508,706       1,378,692  
Premises and equipment, net
    8,658       9,253  
Deferred income taxes
    12,350       12,455  
Bank owned life insurance
    13,237       12,912  
Intangible assets, net
    4,242       4,379  
Other real estate owned
    4,581       5,106  
Other assets
    15,395       17,826  
           Total Assets
  $ 2,006,146     $ 1,805,504  
                 
Liabilities
               
Deposits:
               
Noninterest bearing demand
  $ 380,167     $ 307,959  
Interest bearing transaction
    62,722       59,720  
Savings and money market
    693,381       582,854  
Time, $100,000 or more
    324,399       296,199  
Other time
    185,422       213,542  
Total deposits
    1,646,091       1,460,274  
Customer repurchase agreements
               
and federal funds purchased
    99,147       90,790  
Other short-term borrowings
    -       10,000  
Long-term borrowings
    49,300       49,300  
Other liabilities
    9,307       6,819  
Total liabilities
    1,803,845       1,617,183  
                 
Shareholders' 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 23,235 at each period
               
discount of $645 and $570, respectively, net
    22,537       22,612  
Common stock, par value $.01per share; shares authorized 50,000,000, shares
               
issued and outstanding 19,671,797 and 19,534,226, respectively
    197       195  
Warrants
    946       946  
Additional paid in capital
    129,958       129,211  
Retained earnings
    43,833       33,024  
Accumulated other comprehensive income
    4,830       2,333  
Total shareholders' equity
    202,301       188,321  
Total Liabilities and Shareholders' Equity
  $ 2,006,146     $ 1,805,504  
                 
See notes to consolidated financial statements.
 
 
3

 
EAGLE BANCORP, INC.
Consolidated Statements of Operations
For the Nine and Three Month Periods Ended September 30, 2010 and 2009 (Unaudited)
 (dollars in thousands, except per share data)
 
   
Nine Months Ended
   
Three Months Ended
 
   
September 30,
   
September 30,
 
Interest Income
 
2010
   
2009
   
2010
   
2009
 
Interest and fees on loans
  $ 64,995     $ 56,427     $ 22,655     $ 19,744  
Interest and dividends on investment securities
    5,412       5,391       1,697       1,623  
Interest on balances with other banks and short-term investments
    83       56       24       19  
Interest on federal funds sold
    128       51       45       40  
Total interest income
    70,618       61,925       24,421       21,426  
Interest Expense
                               
Interest on deposits
    12,860       16,090       4,005       5,481  
Interest on customer repurchase agreements
                               
and federal funds purchased
    545       774       167       200  
Interest on short-term borrowings
    27       428       -       270  
Interest on long-term borrowings
    1,647       1,832       550       457  
Total interest expense
    15,079       19,124       4,722       6,408  
Net Interest Income
    55,539       42,801       19,699       15,018  
Provision for Credit Losses
    5,752       5,141       1,962       1,857  
Net Interest Income After Provision For Credit Losses
    49,787       37,660       17,737       13,161  
                                 
Noninterest Income
                               
Service charges on deposits
    2,300       2,182       814       727  
Gain on sale of loans
    990       950       739       292  
Gain on sale of investment securities
    833       1,537       260       -  
Increase in the cash surrender value of  bank owned life insurance
    325       348       108       118  
Other income
    1,117       1,004       412       349  
Total noninterest income
    5,565       6,021       2,333       1,486  
Noninterest Expense
                               
Salaries and employee benefits
    18,193       15,477       6,549       5,128  
Premises and equipment expenses
    6,725       5,500       2,021       1,798  
Marketing and advertising
    919       785       391       228  
Data processing
    1,955       1,780       697       658  
Legal, accounting and professional fees
    2,181       2,041       655       664  
FDIC insurance
    2,027       2,465       692       550  
Other expenses
    5,529       4,098       1,924       1,254  
Total noninterest expense
    37,529       32,146       12,929       10,280  
Income Before Income Tax Expense
    17,823       11,535       7,141       4,367  
Income Tax Expense
    6,219       4,067       2,375       1,625  
Net Income
    11,604       7,468       4,766       2,742  
Preferred Stock Dividends and Discount Accretion
    971       1,767       327       595  
Net Income Available to Common Shareholders
  $ 10,633     $ 5,701     $ 4,439     $ 2,147  
                                 
Earnings Per Common Share
                               
Basic
  $ 0.54     $ 0.44     $ 0.22     $ 0.16  
Diluted
  $ 0.53     $ 0.43     $ 0.22     $ 0.15  
                                 
See notes to consolidated financial statements.
               
 
 
4

 
EAGLE BANCORP, INC.
Consolidated Statements of Changes in Shareholders’ Equity
For the Nine Month Periods Ended September 30, 2010 and 2009 (Unaudited)
 (dollars in thousands, except per share data)
 
                                 
Accumulated
       
                                 
Other
   
Total
 
   
Preferred
 
Common
         
Additional Paid
   
Retained
   
Comprehensive
   
Stockholders'
 
   
Stock
 
Stock
   
Warrants
 
in Capital
   
Earnings
   
Income
   
Equity
 
Balance, January 1, 2010
  $ 22,612     $ 195     $ 946     $ 129,211     $ 33,024     $ 2,333     $ 188,321  
Comprehensive Income
                                                       
Net Income
                                    11,604               11,604  
Other comprehensive income:
                                                       
Unrealized gain on securities available for sale (net of taxes)
                              2,997       2,997  
Less: reclassification adjustment for gains net of taxes of $333 included in net income
              (500 )     (500 )
Total Comprehensive Income
                                                    14,101  
Stock-based compensation
                            447                       447  
Exercise of options for 71,918 shares of common stock
      2               229                       231  
Tax benefit on non-qualified options exercise
                            124                       124  
Capital raise issuance cost
                            (53 )                     (53 )
Preferred stock:
                                                       
Preferred stock dividends
                                    (870 )             (870 )
Discount accretion
    (75 )                             75               -  
Balance, September 30, 2010
  $ 22,537     $ 197     $ 946     $ 129,958     $ 43,833     $ 4,830     $ 202,301  
                                                         
Balance, January 1, 2009
  $ 36,312     $ 127     $ 1,892     $ 76,822     $ 24,866     $ 2,352     $ 142,371  
Comprehensive Income
                                                       
Net Income
                                    7,468               7,468  
Other comprehensive income:
                                                       
Unrealized gain on securities available for sale (net of taxes)
                              1,787       1,787  
Less: reclassification adjustment for gains net of taxes of $553 included in net income
              (984 )     (984 )
Total Comprehensive Income
                         
`
                      8,271  
Preferred stock dividends  ($34.73 per share)
                                    (1,328 )             (1,328 )
Stock-based compensation
                            427                       427  
Shares issued under the capital offering -
                                                       
6,731,640 shares, net of issuance costs of $3,457
      68               51,674                       51,742  
Exercise of options for 9,759 shares of common stock
                      30                       30  
Tax benefit on non-qualified options exercise
                            24                       24  
Preferred stock:
                                                       
     Warrants reduced by 385,434 warrants
    946               (946 )                             -  
     Issuance costs
    (21 )                                             (21 )
     Discount accretion
    250                               (250 )             -  
Balance, September 30, 2009
  $ 37,487     $ 195     $ 946     $ 128,977     $ 30,756     $ 3,155     $ 201,516  
                                                         
See notes to consolidated financial statements.
 
 
 
5

 
EAGLE BANCORP, INC.
Consolidated Statements of Cash Flows
For the Nine Month Periods Ended September 30, 2010 and 2009 (Unaudited)
 (dollars in thousands, except per share data)
 
   
2010
   
2009
 
Cash Flows From Operating Activities:
           
Net income
  $ 11,604     $ 7,468  
Adjustments to reconcile net income to net cash
               
 (used in) provided by operating activities:
               
Provision for credit losses
    5,752       5,141  
Depreciation and amortization
    2,105       1,706  
Gains on sale of loans
    (990 )     (950 )
Origination of loans held for sale
    (212,790 )     (78,827 )
Proceeds from sale of loans held for sale
    144,441       81,427  
Net increase in cash surrender value of BOLI
    (325 )     (348 )
Decrease deferred income taxes
    105       95  
Net loss (gain) on sale of other real estate owned
    256       (64 )
Net gain on sale of investment securities
    (833 )     (1,537 )
Stock-based compensation expense
    447       427  
Excess tax benefit from stock-based compensation
    (124 )     (24 )
Increase (decrease) in other assets
    4,999       (5,616 )
Increase in other liabilities
    2,488       1,554  
Net cash (used in) provided by operating activities
    (42,865 )     10,452  
Cash Flows From Investing Activities:
               
Decrease in interest bearing deposits with other banks
               
 and short term investments
    (93 )     (4,944 )
Purchases of available for sale investment securities
    (106,219 )     (141,272 )
Proceeds from maturities of available for sale securities
    46,339       45,169  
Proceeds from sale/call of available for sale securities
    37,038       47,520  
Purchases of Federal Reserve and Federal Home Loan Bank stock
    (4 )     (2,253 )
Proceeds from repurchase of Federal Reserve and Federal Home Loan Bank stock
    647       1,800  
Net increase in loans
    (137,356 )     (55,064 )
Proceeds from sale of other real estate owned
    1,859       907  
Bank premises and equipment acquired
    (1,371 )     (1,147 )
Net cash used in investing activities
    (159,160 )     (109,284 )
Cash Flows From Financing Activities:
               
Increase in deposits
    185,817       202,622  
Increase (decrease) in customer repurchase agreements and
               
 federal funds purchased
    8,357       (19,501 )
Decrease in other short-term borrowings
    (10,000 )     (25,000 )
Decrease in long-term borrowings
    -       (32,850 )
Payment of dividends on preferred stock
    (870 )     (1,328 )
Issuance of common stock
    -       51,772  
Proceeds from exercise of stock options
    229       -  
Excess tax benefit from stock-based compensation
    124       24  
Net cash provided by  financing activities
    183,657       175,739  
Net (Decrease) Increase In Cash and Cash Equivalents
    (18,368 )     76,907  
Cash and Cash Equivalents at Beginning of Period
    110,203       27,348  
Cash and Cash Equivalents at End of Period
  $ 91,835     $ 104,255  
Supplemental Cash Flows Information:
               
Interest paid
  $ 15,754     $ 20,037  
Income taxes paid
  $ 6,469     $ 5,515  
Non-Cash Investing Activities
               
Transfers from loans to other real estate owned
  $ 1,590     $ 6,122  
                 
See notes to consolidated financial statements.
 
 
 
6

 
 EAGLE BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Nine Months Ended September 30, 2010 and 2009 (Unaudited)


1. BASIS OF PRESENTATION

The Consolidated Financial Statements include the accounts of Eagle Bancorp, Inc. and its subsidiaries (the “Company”), EagleBank (the “Bank”), Eagle Commercial Ventures, LLC (“ECV”), Eagle Insurance Services, LLC, and Bethesda Leasing, LLC, with all significant intercompany transactions eliminated.

The consolidated financial statements of the Company included herein are unaudited.  The consolidated financial statements reflect all adjustments, consisting only of normal recurring accruals that in the opinion of management, are necessary to present fairly the results for the periods presented. The amounts as of and for the year ended December 31, 2009 were derived from audited consolidated financial statements. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. There have been no significant changes to the Company’s Accounting Policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. The Company believes that the disclosures are adequate to make the information presented not misleading. Certain reclassifications have been made to amounts previously reported to conform to the current period presentation.

These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. Operating results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results of operations to be expected for the remainder of the year, or for any other period.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes.  Actual results may differ from those estimates and such differences could be material to the financial statements.

2. NATURE OF OPERATIONS

The Company, through the Bank, conducts a full service community banking business, primarily in Montgomery County, Maryland, Washington, D.C. and Fairfax County Northern Virginia.  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 residential mortgage loans are originated for sale to third-party investors, generally large mortgage companies, under commitments by the investors to purchase the loans subject to compliance with pre-established investor criteria. 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 through twelve banking offices and various electronic capabilities, including remote deposit services. Bethesda Leasing, LLC, a direct subsidiary of the Company holds title to and manages Other Real Estate Owned (“OREO”) assets.  Eagle Insurance Services, a direct subsidiary of the Company markets insurance products and services through an arrangement with a third party insurance broker.  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.  This lending involves higher levels of risk, together with commensurate returns. Refer to Note 4 – Higher Risk Lending – Revenue Recognition below.

3. 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).
 
 
7

 
4. 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 Standards 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 2010 and 2009 (although normal interest income was recorded) and had one higher risk lending transaction outstanding as of September 30, 2010 and December 31, 2009, amounting to $1.3 million and $1.6 million, respectively.

5. 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 noninterest 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.

6. 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.  The Company’s testing of potential impairment of intangible assets at December 31, 2009, resulted in no impairment being recorded.

7. CUSTOMER REPURCHASE AGREEMENTS

The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same securities.  Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets.  As a result, securities sold under agreements to repurchase are accounted for as collateralized financing arrangements and not as a sale and subsequent repurchase of securities.  The agreements are entered into primarily as accommodations for large commercial deposit customers.  The obligation to repurchase the securities is reflected as a liability in the Company’s Consolidated Balance Sheets, while the securities underlying the securities sold under agreements to repurchase remain in the respective assets accounts and are delivered to and held as collateral in segregated accounts by third parties.
 
 
8

 
8. INVESTMENT SECURITIES AVAILABLE FOR SALE

Amortized cost and estimated fair value of securities available for sale are summarized as follows:
         
Gross
   
Gross
   
Estimated
 
 
 
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
September 30, 2010
 
Cost
   
Gains
   
Losses
   
Value
 
(dollars in thousands)
                       
U. S. Government agency securities
  $ 85,263     $ 1,768     $ -     $ 87,031  
Mortgage backed securities
    117,621       3,618       125       121,114  
Municipal bonds
    47,523       2,891       34       50,380  
Other equity investments
    445       -       68       377  
    $ 250,852     $ 8,277     $ 227     $ 258,902  
                                 
                                 
           
Gross
   
Gross
   
Estimated
 
 
 
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
December 31, 2009
 
Cost
   
Gains
   
Losses
   
Value
 
(dollars in thousands)
                               
U. S. Government agency securities
  $ 75,980     $ 412     $ 285     $ 76,107  
Mortgage backed securities
    122,076       3,501       181       125,396  
Municipal bonds
    32,845       717       237       33,325  
Other equity investments
    436       -       37       399  
    $ 231,337     $ 4,630     $ 740     $ 235,227  
 
Gross unrealized losses and fair value by length of time that the individual available for sale securities have been in a continuous unrealized loss position are as follows:
 
   
Less than
   
12 Months
             
   
12 Months
   
or Greater
   
Total
 
   
Estimated
         
Estimated
         
Estimated
       
 
 
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
September 30, 2010
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
(dollars in thousands)
                                   
U. S. Government agency securities
  $ -     $ -     $ -     $ -     $ -     $ -  
Mortgage backed securities
    26,756       125       -       -       26,756       125  
Municipal bonds
    1,916       34       -       -       1,916       34  
Other equity investments
    -       -       110       68       110       68  
    $ 28,672     $ 159     $ 110     $ 68     $ 28,782     $ 227  
                                                 
                                                 
   
Less than
   
12 Months
                 
   
12 Months
   
or Greater
   
Total
 
   
Estimated
           
Estimated
           
Estimated
         
 
 
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
December 31, 2009
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
(dollars in thousands)
                                               
U. S. Government agency securities
  $ 37,357     $ 285     $ -     $ -     $ 37,357     $ 285  
Mortgage backed securities
    11,681       181       -       -       11,681       181  
Municipal bonds
    13,850       237       -       -       13,850       237  
Other equity investments
    140       37       -       -       140       37  
    $ 63,028     $ 740     $ -     $ -     $ 63,028     $ 740  
 
 
9

 
The unrealized losses that exist are generally the result of changes in market interest rates and spread relationships since original purchases. The weighted average duration of debt securities, which comprise 99.8% of total investment securities, is relatively short at 3.2 years. The gross unrealized loss on other equity investments represents common stock of one local banking company owned by the Company, and traded on a broker “bulletin board” exchange. The estimated fair value is determined by broker quoted prices. The unrealized loss is deemed a result of generally weak valuations for many smaller community bank stocks. The individual banking company is profitable and has a satisfactory capital position. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. The Company does not believe that the investment securities that were in an unrealized loss position as of September 30, 2010 represent an other-than-temporary impairment for the reasons noted. The Company does not intend to sell the investments and it is more likely than not that the Company will not have to sell the securities before recovery of its amortized cost basis, which may be maturity. In addition, at September 30, 2010, the Company held $9.8 million in equity securities in a combination of Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) stocks which are required to be held for regulatory purposes and are not marketable.

The amortized cost and estimated fair value of investments available for sale by contractual maturity are shown in the table below.  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.

   
September 30, 2010
   
December 31, 2009
 
   
Amortized
   
Estimated
   
Amortized
   
Estimated
 
(dollars in thousands)
 
Cost
   
Fair Value
   
Cost
   
Fair Value
 
U. S. Government agency securities maturing:
                   
   One year or less
  $ 23,330     $ 23,413     $ 8,095     $ 8,186  
   After one year through five years
    61,933       63,618       67,885       67,921  
Mortgage backed securities
    117,621       121,114       122,076       125,396  
Municipal bonds maturing:
                               
   Five years through ten years
    7,267       7,632       3,023       3,072  
   After ten years
    40,256       42,748       29,822       30,253  
Other equity investments
    445       377       436       399  
    $ 250,852     $ 258,902     $ 231,337     $ 235,227  
 
The carrying value of securities pledged as collateral for certain government deposits, securities sold under agreements to repurchase, and certain lines of credit with correspondent banks at September 30, 2010 was $186.4 million. As of September 30, 2010 and December 31, 2009, there were no holdings of securities of any one issuer, other than the U.S. Government and U.S. Government agency securities that exceeded ten percent of shareholders’ equity.

9. ACCOUNTING STANDARDS UPDATE

Accounting Standards Update (ASU) No. 2010-20, “Receivables” (Topic 830) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a rollforward of the allowance for credit losses as well as information about modified, impaired, non-accrual and past due loans and credit quality indicators. ASU 2010-20 will be effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period will be required for the Company’s financial statements that include periods beginning on or after January 1, 2011.

 
10

 
10. EARNINGS PER SHARE

The calculation of net income per common share for the nine and three months ended September 30 was as follows:
 
   
Nine Months Ended
   
Three Months Ended
 
   
September 30,
   
September 30,
 
(dollars and shares in thousands)
 
2010
 
2009
   
2010
 
2009
 
Basic:
                       
Net income available to common shareholders
  $ 10,633     $ 5,701     $ 4,439     $ 2,147  
Average common shares outstanding
    19,637       12,999       19,875       13,505  
Basic net income per common  share
  $ 0.54     $ 0.44     $ 0.22     $ 0.16  
                                 
Diluted:
                               
Net income available to common shareholders
  $ 10,633     $ 5,701     $ 4,439     $ 2,147  
Average common shares outstanding
    19,637       12,999       19,875       13,505  
Adjustment for common share equivalents
    373       113       355       290  
Average common shares outstanding-diluted
    20,010       13,112       20,230       13,795  
Diluted net income per common share
  $ 0.53     $ 0.43     $ 0.22     $ 0.15  
                                 
Anti-dilutive shares
    413,848       778,022       413,848       742,325  
 
11. STOCK-BASED COMPENSATION
 
The Company maintains the 1998 Stock Option Plan (“1998 Plan”) and the 2006 Stock Plan (“2006 Plan”), and, in connection with the acquisition of Fidelity & Trust Financial Corporation (“Fidelity”) and its subsidiary Fidelity & Trust Bank (F&T Bank”), assumed the Fidelity 2004 Long Term Incentive Plan and 2005 Long Term Incentive Plan (the “Fidelity Plans”). No additional options may be granted under the 1998 Plan or the Fidelity Plans.

The 2006 Plan provides for the issuance of awards of incentive options, nonqualifying options, restricted stock and stock appreciation rights to selected key employees and members of the Board. As amended, 1,215,000 shares of common stock are subject to issuance pursuant to awards under the 2006 Plan.  Option awards are made with an exercise price equal to the average of the high and low price of the Company’s shares at the date of grant.

For awards that are service based, compensation expense is being recognized over the service (vesting) period based on fair value, which for stock option grants is computed using the Black Scholes model, and for restricted stock awards is based on the average of the high and low stock price of the Company’s shares at the date of grant. For awards that are performance based, compensation expense is recorded based on the probability of achievement of the goals underlying the grant. No performance based awards are outstanding at September 30, 2010.

In January 2010, the Company awarded 81,600 shares of restricted stock to employees, senior officers and to a Director.  Of the total restricted stock awarded, 17,464 shares vest in five substantially equal installments beginning on the date of grant. The Company awarded 31,247 shares that vest 100% upon the later of the date of repayment in full of all financial assistance received by the Company under the Troubled Asset Relief Program Capital Purchase Program (the “Capital Purchase Program”) or on January 21, 2012. The remaining 32,889 shares vest 60% upon the second anniversary of the date of grant and 20% on the third and fourth anniversaries of the date of grant or upon the later date of repayment in full of all financial assistance received by the Company under the Capital Purchase Program.

 
11

 
In April 2010, the Company awarded two employees options to purchase a total of 5,000 shares under the 2006 Plan which have ten-year terms and vest in ten substantially equal installments on the first through ten anniversaries of the date of grant.

Below is a summary of changes in shares under option pursuant to our equity compensation plans for the nine months ended September 30, 2010, and 2009. The information excludes restricted stock units and awards.

   
Nine Months Ended September 30,
 
   
2010
   
2009
 
   
Shares
 
Weighted-Average
Grant Date
Fair Value
   
Shares
 
Weighted-Average
Grant Date
Fair Value
 
                         
Beginning Balance
    1,234,181     $ 2.56       1,036,994     $ 2.58  
Issued
    5,000       5.52       324,937       2.04  
Exercised
    (52,144 )     1.76       (9,759 )     1.36  
Forfeited
    (53,950 )     0.07       (37,538 )     2.12  
Expired
    (32,277 )     2.67       (40,017 )     1.07  
Ending Balance
    1,100,810       2.73       1,274,617       2.52  
 
The following summarizes information about stock options outstanding at September 30, 2010. The information excludes restricted stock units and awards.

Outstanding:
             
Weighted-Average
 
Range of
 
Stock Options
   
Weighted-Average
   
Remaining
 
Exercise Prices
Outstanding
 
Exercise Price
 
Contractual Life
 
$2.98 - $8.10     434,094     $ 6.29       5.95  
$8.11 - $11.07     259,368       10.18       3.68  
$11.08 - $15.43     219,661       12.75       3.27  
$15.44 - $26.86     187,687       21.15       3.73  
      1,100,810       11.03       4.50  
                         
Exercisable:
                       
Range of
 
Stock Options
   
Weighted-Average
         
Exercise Prices
Exercisable
 
Exercise Price
         
$2.98 - $8.10     194,752     $ 6.22          
$8.11 - $11.07     253,117       10.19          
$11.08 - $15.43     187,161       12.89          
$15.44 - $26.86     173,252       21.50          
      808,282       12.28          

The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the assumptions as shown in the table below used for grants during the nine months ended September 30, 2010 and the years ended December 31, 2009, and 2008.

 
12

 
   
Nine Months Ended
   
Year Ended
   
Year Ended
 
   
September 30, 2010
 
2009
 
2008
 
Expected Volatility
    51.2% - 51.2 %     25.9% - 58.0 %     23.7% - 43.6 %
Weighted-Average Volatility
    51.19 %     26.74 %     30.28 %
Expected Dividends
    0.0 %     0.0 %     0.9 %
Expected Term (In years)
    5.0 - 5.0       3.5 - 8.5       3.0 - 9.0  
Risk-Free Rate
    1.01 %     0.84 %     2.55 %
Weighted-Average Fair Value (Grant date)
  $ 5.52     $ 2.06     $ 1.30  
 
 The expected lives are based on the “simplified” method allowed by ASC Topic 718“Compensation”, whereby the expected term is equal to the midpoint between the vesting period and the contractual term of the award.

The total intrinsic value of outstanding stock options was $2.6 million at September 30, 2010. The total intrinsic value of stock options exercised during the nine months ended September 30, 2010 and 2009 was $295 thousand and $58 thousand, respectively. The total fair value of stock options vested was $377 thousand and $232 thousand for the nine months ended September 30, 2010 and 2009, respectively.

The Company recognized $447 thousand and $427 thousand in stock-based compensation expense for the nine months ended September 30, 2010 and 2009, respectively which is included in salaries and employee benefits. Stock-based compensation expense is recognized ratably over the requisite service period for all awards. Unrecognized stock based compensation expense related to all stock-based awards totaled $1.4 million at September 30, 2010. At such date, the weighted-average period over which this unrecognized expense is expected to be recognized was 2.79 years.

The Company has outstanding restricted stock award grants of 115,172 shares from the 2006 Plan at September 30, 2010.  Unrecognized stock based compensation expense related to restricted stock awards totaled $833 thousand at September 30, 2010. At such date, the weighted-average period over which this unrecognized expense was expected to be recognized was 1.63 years.  The following table summarizes the unvested restricted stock awards outstanding at September 30, 2010 and 2009 and the restricted stock units at September 30, 2009, which were performance based, and which were not outstanding at September 30, 2010:
 
 
13

 
   
September 30, 2010
 
   
Restricted Stock Units
   
Restricted Stock Awards
 
   
Shares
   
Weighted-Average
Grant Date
Fair Value
 
Shares
   
Weighted-Average
Grant Date
Fair Value
 
                         
Unvested at Beginning
    7,642     $ 15.21       49,585     $ 6.88  
Issued
    -       -       81,600       10.35  
Forfeited
    (3,817 )     15.21       (116 )     10.35  
Vested
    (3,825 )     15.21       (15,897 )     7.77  
Unvested at End
    -     $ -       115,172     $ 9.21  
                                 
                                 
   
September 30, 2009
 
   
Restricted Stock Units
   
Restricted Stock Awards
 
   
Shares
   
Weighted-Average
Grant Date
Fair Value
 
Shares
   
Weighted-Average
Grant Date
Fair Value
 
                                 
Unvested at Beginning
    7,642     $ 15.21       -     $ -  
Issued
    -       -       49,585       6.88  
Forfeited
    -       -       -       -  
Vested
    -       -       -       -  
Unvested at End
    7,642     $ 15.21       49,585     $ 6.88  
 
12. FAIR VALUE MEASUREMENTS

The measurement of fair value under GAAP uses a hierarchy intended to maximize the use of observable inputs and minimize the use of unobservable inputs.  This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:

Level 1:
Quoted prices in active exchange markets for identical assets or liabilities; also includes certain U.S. Treasury and other U.S. government and agency securities actively traded in over-the-counter markets.
 
Level 2:
Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data; also includes derivative contracts whose value is determined using a pricing model with observable market inputs or can be derived principally from or corroborated by observable market data.  This category generally includes certain U.S. government and agency securities, corporate debt securities, derivative instruments, and residential mortgage loans held for sale.
 
Level 3:
Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs for single dealer nonbinding quotes not corroborated by observable market data. This category generally includes certain private equity investments, retained interests from securitizations, and certain collateralized debt obligations.

 
14

 
Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Assets measured at fair value on a recurring basis comprised the following at September 30, 2010:
 
(dollars in thousands)
 
Quoted Prices
(Level 1)
   
Significant
Other
Observable
Inputs (Level 2)
   
Significant
Other
Unobservable
Inputs (Level 3)
   
Total
(Fair Value)
 
                         
Investment securities available for sale:
                       
U. S. Government agency securities
  $ -     $ 87,031     $ -     $ 87,031  
Mortgage backed securities
    -       121,114       -       121,114  
Municipal bonds
    -       50,380       -       50,380  
Other equity investments
    110       -       267       377  
Residential mortgage loans held for sale
    -       70,889       -       70,889  

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include US government agency debt securities, mortgage backed securities issued by government sponsored entities and municipal bonds. Securities classified as Level 3 include securities in less liquid markets.

The Company’s residential loans held for sale are reported on an aggregate basis at the lower of cost or fair value.

The following is a reconciliation of activity for assets measured at fair value based on significant unobservable (non-market) information:

(dollars in thousands)
 
Available
For Sale
Securities
 
Balance, January 1, 2010
  $ 258  
    Total realized and unrealized gains and losses:
       
         Included in net income
    -  
         Included in other comprehensive income
    1  
    Purchases, issuances and settlements
    8  
    Transfers in and/or out of Level 3
    -  
Balance, September 30, 2010
  $ 267  


Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. There are no liabilities which the Company measures at fair value on a nonrecurring basis.  Assets measured at fair value on a nonrecurring basis are included in the table below:

 
15

 
(dollars in thousands)
 
Quoted Prices
(Level 1)
   
Significant
Other
Observable
Inputs (Level 2)
   
Significant
Other
Unobservable
Inputs (Level 3)
   
Total
(Fair Value)
 
                         
Impaired loans:
                       
Commercial
  $ -     $ 1,769     $ 2,092     $ 3,861  
Investment - commercial real estate
    -       1,767       2,821       4,588  
Owner occupied - commercial real estate
            5,753       -       5,753  
Real estate mortgage - residential
            -       247       247  
Construction - commercial and residential
    -       9,215       982       10,197  
Home equity
    -       -       15       15  
Other real estate owned
    -       3,931       650       4,581  
 
Loans

The Company does not record loans at fair value on a recurring basis; however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. The fair value of impaired loans is estimated using one of several methods, including the collateral value, the market value of similar debt, the enterprise value, the liquidation value and the discounted cash flow value. Those impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. When the fair value of the collateral is based on an observable market price or a current appraised value, which includes the cost to sell, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value or adjusts the third party appraisal for cost to sell and there is no observable market price, the Company records the loan as nonrecurring Level 3.

The fair value of the Company’s other real estate owned when determined using current appraisals, within the last twelve months, and which includes estimated costs to sell is recorded as nonrecurring Level 2.  When the appraisal is older than twelve months or management determines the fair value of the real estate owned is further impaired below the appraised value and there is no observable market price, the Company records the real estate owned as nonrecurring Level 3.

The following table presents the estimated fair values of financial assets and liabilities on the Company’s consolidated balance sheet, including those financial assets and liabilities that are not measured and reported at fair value on a recurring or non-recurring basis:

 
16

 
   
September 30, 2010
   
December 31, 2009
 
(dollars in thousands)
 
Carrying
Value
 
Fair
Value
   
Carrying
Value
 
Fair
Value
 
Assets:
                       
Cash and due from banks
  $ 19,734     $ 19,734     $ 21,955     $ 21,955  
Interest bearing deposits with other banks
    7,577       7,577       7,484       7,484  
Federal funds sold
    72,101       72,101       88,248       88,248  
Investment securities
    258,902       258,902       235,227       235,227  
Federal Reserve and Federal Home Loan Bank stock
    9,774       9,774       10,417       10,417  
Loans held for sale
    70,889       70,889       1,550       1,550  
Loans
    1,530,946       1,525,644       1,399,311       1,398,043  
Other earning assets
    13,237       13,237       12,912       12,912  
                                 
Liabilities:
                               
Noninterest bearing deposits
    380,167       380,167       307,959       307,959  
Interest bearing deposits
    1,265,924       1,267,970       1,152,315       1,155,583  
Customer repurchase agreements and federal funds purchased
    99,147       99,147       90,790       90,790  
Borrowings
    49,300       51,366       59,300       63,690  

The Company discloses fair value information about financial instruments for which it is practicable to estimate the value, whether or not such financial instruments are recognized on the balance sheet. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by quoted market price, if one exists.

Quoted market prices, if available, are shown as estimates of fair value. Because no quoted market prices exist for a portion of the Company’s financial instruments, the fair value of such instruments has been derived based on management’s assumptions with respect to future economic conditions, the amount and timing of future cash flows and estimated discount rates. Different assumptions could significantly affect these estimates. Accordingly, the net realizable value could be materially different from the estimates presented above. In addition, the estimates are only indicative of individual financial instrument values and should not be considered an indication of the fair value of the Company taken as a whole.

The following methods and assumptions were used to estimate the fair value of each category of financial instrument for which it is practicable to estimate value:

Cash due from banks and federal funds sold: For cash and due from banks, and federal funds sold the carrying amount approximates fair value.

Interest bearing deposits with other banks: Values are estimated by discounting the future cash flows using the current rates at which similar deposits would be earning.

Investment securities: For these instruments, fair values are based upon quoted prices, if available. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.

Federal Reserve and Federal Home Loan Bank stock: The carrying amount approximate the fair values at the reporting date.

Loans held for sale: Fair values are at the carrying value (lower of cost or market) since such loans are typically committed to be sold (servicing released) at a profit.

 
17

 
Loans: For variable rate loans that re-price on a scheduled basis, fair values are based on carrying values.  The fair value of the remaining loans are estimated by discounting the estimated future cash flows using the current interest rate at which similar loans would be made to borrowers with similar credit ratings and for the same remaining term.

Other earning assets: The fair value of bank owned life insurance is the current cash surrender value which is the carrying value.

Noninterest bearing deposits: The fair value of these deposits is the amount payable on demand at the reporting date, since generally accepted accounting standards do not permit an assumption of core deposit value.

Interest bearing deposits: The fair value of interest bearing transaction, savings, and money market deposits with no defined maturity is the amount payable on demand at the reporting date, since generally accepted accounting standards do not permit an assumption of core deposit value.

The fair value of certificates of deposit is estimated by discounting the future cash flows using the current rates at which similar deposits would be accepted.

Customer repurchase agreements and federal funds purchased: The carrying amount approximate the fair values at the reporting date.

Borrowings: The carrying amount for variable rate borrowings approximate the fair values at the reporting date. The fair value of fixed rate Federal Home Loan Bank advances and the subordinated debentures are estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms. The fair value of variable rate Federal Home Loan Bank advances is estimated to be carrying value since these liabilities are based on a spread to a current pricing index.

13. SHAREHOLDERS’ EQUITY

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. On December 23, 2009, the Company redeemed 15,000 shares of Series A Preferred Stock for an aggregate redemption price of $15,079,166, including accrued but unpaid dividends on the shares.  Following the repurchase, 23,235 shares of Series A Preferred Stock remain outstanding, held by the Treasury. The Company accrued dividends on the preferred stock and recognized the discount accretion totaling $327 thousand and $971 thousand for the three and nine months ended September 30, 2010 reducing net income available to common shareholders to $4.4 million ($0.22 per basic and diluted common share) and $10.6 million ($0.54 per basic common share and $0.53 diluted common share) for the three and nine months ended September 30, 2010, respectively.

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information about the results of operations, and financial condition, liquidity, and capital resources of the Company and its subsidiaries as of the dates and periods indicated. This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this report and the Management Discussion and Analysis in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

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”,

 
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“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. For details on factors that could affect these expectations, see the risk factors and other cautionary language included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and in other periodic and current reports filed by the Company with the Securities and Exchange Commission. 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 EagleBank, its wholly owned banking subsidiary, a Maryland-chartered bank which is a member of the Federal Reserve System (the “Bank”). 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, Maryland, four offices in the District of Columbia, and one office in Fairfax County, Virginia. In September, 2010 the Company announced the acquisition, subject to regulatory approval, of a branch office in Washington, D.C. in the Penn Quarter / Chinatown area to be completed early in 2011. In October 2010, the Company announced the signing of a lease on space for a second northern Virginia office in Rosslyn, expected to open in April 2011 subject to regulatory approval.

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, savings, and time deposit accounts; business, construction, and commercial loans; residential mortgages and consumer loans; insurance services; 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”).

CRITICAL ACCOUNTING POLICIES


The Company’s consolidated financial statements are prepared in accordance with 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.

 
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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 income tax being a component of shareholders’ equity and accumulated other comprehensive income.

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) ASC Topic 450, “Contingencies”, which requires that losses be accrued when they are probable of occurring and are estimable and (b) ASC Topic 310, “Receivables”, 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.  Impaired loans are assigned specific reserves based on an impairment analysis. Under ASC Topic 310, “Receivables”, 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 non-classified 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 and environmental 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 provision for credit losses, refer to the discussion under the caption “Provision for Credit Losses” below.

 
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The Company follows the provisions of ASC Topic 718, “Compensation”, which requires the expense recognition for the fair value of share based compensation awards, such as stock options, restricted stock, 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 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.

In accounting for the acquisition of Fidelity & Trust Financial Corporation (“Fidelity”) and Fidelity & Trust Bank (“F&T Bank”), the Company followed the provisions of ASC Topic 805 “Business Combinations”, which mandates the use of the purchase method of accounting and ASC Topic - 310, “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 credit 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.

RESULTS OF OPERATIONS

Earnings Summary


For the nine months ended September 30, 2010, the Company reported net income of $11.6 million, a 55% increase over the $7.5 million for the nine months ended September 30, 2009. Net income available to common shareholders (which is after accrual of preferred stock dividends and discount accretion) increased 87% to $10.6 million ($0.54 per basic common share and $0.53 per diluted common share), as compared to $5.7 million ($0.44 per basic common share and $0.43 per diluted common share) for the same nine month period in 2009.
 
For the three months ended September 30, 2010 the Company’s net income was $4.8 million, a 74% increase over the $2.7 million for the same three months in 2009. Net income available to common shareholders increased 107% to $4.4 million ($0.22 per basic and diluted common share) for the quarter ended September 30, 2010, compared to $2.1 million ($0.16 per basic common share and $0.15 per diluted common share) for the quarter ended September 30, 2009.

The increase in net income for the nine and three months ended September 30, 2010 can be attributed primarily to an increase in net interest income of 30% and 31%, respectively, as compared to the same period in 2009.  Net interest income growth was due to both growth in average earning assets of 22% and 21% for the nine and three months ended September 30, 2010, respectively, as compared to 2009, and to expansion of the net interest margin.

The Company had an annualized return on average assets of 0.82% and an annualized return on average common equity of 8.24% for the first nine months of 2010, as compared to annualized returns on average assets and average common equity of 0.64% and 7.02%, respectively, for the same nine month period in 2009.

For the three months ended September 30, 2010, the Company had an annualized return on average assets of 0.96% and an annualized return on average common equity of 9.93%, as compared to annualized returns on average assets and average common equity of 0.67% and 7.85%, respectively,  for the same period in 2009.
 
The Company’s earnings are largely dependent on net interest income, which represented 91% of total revenue (i.e. net interest income plus noninterest income) for the nine months ended September 30, 2010 compared to 88% for the same period in 2009.

 
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The net interest margin, which measures the difference between interest income and interest expense (i.e. net interest income) as a percentage of earning assets increased from 3.81% for the nine months ended September 30, 2009 to 4.06% for the nine months ended September 30, 2010. The higher margin in the first nine months of 2010 as compared to the same period of 2009 was due to lower funding costs for both deposits and borrowings more than offsetting declines in earning asset yields. Substantially higher average federal funds sold during the nine months ended September 30, 2010, as compared to the same period ended in 2009, contributed to the lower earning asset yields, as did lower yields on investment securities, due to lower market interest rates. The benefit of noninterest sources funding earning assets declined by 11 basis points to 37 basis points for the nine months ended September 30, 2010 as compared to 48 basis points for the same period in 2009, which effect was due to lower market interest rates in the current period as compared to 2009. Additionally, while the average rate on earning assets for the nine months ended September 30, 2010, as compared to the same period in 2009 decreased by 36 basis points from 5.52% to 5.16%, the cost of interest bearing liabilities decreased by 72 basis points from 2.19% to 1.47%, resulting in a net interest spread of 3.69% for the nine months ended September 30, 2010, as compared to 3.33% for the same period in 2009, an increase of 36 basis points. The combination of a 36 basis point increase in the net interest spread and an 11 basis point decline in the value of noninterest sources resulted in the 25 basis point increase in the net interest margin.

For the three months ended September 30, 2010 and 2009, average interest bearing liabilities were 74% and 78%, respectively, of average earning assets.  Additionally, while the average rate on earning assets for the three months ended September 30, 2010 declined by 30 basis points from 5.38% to 5.08%, as compared to 2009, the cost of interest bearing liabilities decreased by 73 basis points from 2.06% to 1.33%, resulting in a increase in the net interest spread of 43 basis points from 3.32% for the quarter ended September 30, 2009 to 3.75% for the three months ended September 30, 2010. The net interest margin increased 33 basis points from 3.77% for the three months ended September 30, 2009 to 4.10% for the three months ended September 30, 2010. The 10 basis point difference between the net interest spread improvement of 43 basis points and the net interest margin improvement of 33 basis points was due to lower market interest rates in the current period reducing the benefit of noninterest funding sources from 45 basis points to 35 basis points.

The Company believes it has effectively managed its net interest margin and net interest income over the past twelve months as market interest rates have declined. This factor has been significant to overall earnings performance over the past twelve months as net interest income represents the most significant component of the Company’s revenues.

Due to favorable core deposit growth over the past twelve months, the need to meet loan funding objectives has not required the use of alternative funding sources, such as Federal Home Loan Bank (“FHLB”) advances, correspondent bank lines of credit and brokered time deposits, the balances of which have declined since September 30, 2009.  The major component of the growth in core deposits has been growth in a special money market account originally promoted through advertisements, but which is currently being promoted primarily through direct sales effort by the business development staff.

In terms of the average balance sheet composition or mix, loans, which generally have higher yields than securities and other earning assets, decreased from 87% of average earning assets in the first nine months of 2009 to 81% of average earning assets for the same period of 2010. The decrease in average loans as a percentage of other earning assets is due to the growth in the securities portfolio and other earning assets resulting from higher levels of growth in deposits as compared to loans over the past twelve months. In the first nine months of 2010, average loans, including loans held for sale, increased $184 million, a 14% increase, and average deposits increased by $323 million, a 27% increase as compared to the same period in 2009.  The increase in average loans in 2010 as compared to 2009 is primarily attributable to growth in loans on income-producing commercial real estate and commercial loans. The increase in average deposits in 2010 as compared to 2009 is primarily attributable to noninterest bearing demand deposits and money market deposits. Investment securities for the first nine months of 2010 amounted to 14% of average earning assets, an increase of 3% from an average of 11% for the same period in 2009. Federal funds sold averaged 4.0% of average earning assets in the first nine months of 2010 as compared to 2.0% for the same period in 2009.

For the three months ended September 30, 2010, average loans were 81% of average earning assets as compared to 83% for the same period in 2009.
 
 
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Average loans, which include loans held for sale, increased $64 million (4%) and average deposits increased $81 million (5%) during the three months ended September 30, 2010 as compared to the second quarter of 2010. The increase in average loans in the third quarter of 2010 as compared to the second quarter of 2010 is primarily attributable to growth in loans on income-producing commercial real estate, commercial loans, and loans held for sale, as the Company significantly expanded its residential mortgage origination division late in the second quarter of 2010. Increases in average deposits in the third quarter of 2010, as compared to the second quarter of 2010, is attributable to growth in both noninterest bearing demand deposits and money market accounts.  Average investment securities for the three months ended September 30, 2010 amounted to 14% of average earning assets, an increase of 2% from an average of 12% for the same period in 2009. Average federal funds sold averaged 4.2% of average earning assets for the three months ended September 30, 2010 as compared to 4.6% for the same period in 2009.

The provision for credit losses was $5.8 million for the first nine months of 2010 as compared to $5.1 million in 2009. The higher provisioning in 2010 as compared to 2009 is attributable to both higher amounts of loan growth in the first nine months of 2010 compared to 2009, and to slightly higher net charge-offs in 2010 as compared to 2009, offset by a change in the reserve calculation to include the heavier weighting of our consistently low levels of historical losses in the reserve methodology, beginning in the second quarter of 2010. For the nine months ended September 30, 2010, net charge-offs totaled $4.1 million (0.38% of average loans) compared to $3.6 million (0.37% of average loans) for the nine months ended September 30, 2009. Net charge-offs in the nine months ended September 30, 2010 were attributable to charge-offs in consumer loans ($21 thousand), investment commercial real estate loans - income producing ($49 thousand), investment commercial real estate loans ($177 thousand), commercial real estate loans - owner occupied ($322 thousand), commercial loans ($1.2 million), construction loans ($1.7 million), and the unguaranteed portion of SBA loans ($659 thousand).

The provision for credit losses was $2.0 million for the three months ended September 30, 2010 as compared to $1.9 million for the three months ended September 30, 2009.  The slightly higher provisioning in the third quarter of 2010, as compared to the third quarter of 2009, is primarily attributable to loan growth.  Net charge-offs of $1.5 million represented 0.39% of average loans  in the third quarter of 2010, as compared to  $1.6 million or  0.48%  of average loans  in the third quarter of 2009. Net charge-offs in the third quarter of 2010 were attributable to charge-offs in consumer loans ($11 thousand), investment commercial real estate loans ($177 thousand), commercial loans ($254 thousand), commercial real estate loans - owner occupied ($322 thousand), construction loans ($693 thousand), and the unguaranteed portion of SBA loans ($7 thousand).

At September 30, 2010, the allowance for credit losses represented 1.45% of loans outstanding, as compared to 1.51% at September 30, 2009, 1.47% at December 31, 2009, and 1.45% at June 30, 2010. The allowance for credit losses was 90% of nonperforming loans at September 30, 2010, as compared to 88% at September 30, 2009, 94% at December 31, 2009, and 86% at June 30, 2010.

Total noninterest income for the nine months of 2010 was $5.6 million compared to $6.0 million in 2009, a decrease of 8%. This decrease was due primarily to a $704 thousand decline in gains on the sale of investment securities. Investment gains realized in both the first nine months of 2010 and 2009 were the result of asset/liability management decisions to reduce call risk in the portfolio of U.S. Agency securities, to mitigate potential extension risk in longer-term mortgage backed securities and to mitigate prepayment risk in mortgage backed bonds. Excluding investment securities gains, total noninterest income was $4.7 million for the first nine months of 2010 as compared to $4.5 million for the same period in 2009, the increase being attributed to increases in service charges and to increased loan fees.

Total noninterest income for the three months ended September 30, 2010 increased 57% to $2.3 million from $1.5 million for the three months ended September 30, 2009. This increase was due primarily to $260 thousand in gains realized on the sale of investment securities and an increase of $447 thousand in gains realized on the sale of SBA and residential mortgage loans. Gains on the sale of SBA loans decreased $62 thousand while gains on the sales of residential mortgages increased $509 thousand. With the late second quarter expansion of the residential mortgage origination division, the Company realized higher amounts of noninterest income from the sale of residential mortgage loans for the three months ended September 30, 2010. Investment gains realized in the third quarter of 2010 were the result of asset/liability management decisions to sell a portion of the mortgage backed
 
 
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securities that exhibited substantial prepayment risk. Also contributing to the increase in noninterest income in 2010 compared to 2009 was an increase of $87 thousand in service fees and a $63 thousand increase in other income.
 
The efficiency ratio, which measures the ratio of noninterest expense to total revenue, was 61.42% for the first nine months of 2010, as compared to 65.84% for the nine months ended September 30, 2009, as the Company has enhanced its productivity. Cost control remains a key operating objective of the Company. Total noninterest expenses were $37.5 million for the first nine months of 2010, as compared to $32.1 million for 2009, a 17% increase primarily comprised of salaries and benefits expense of $2.7 million, reflecting in part the expansion of the residential mortgage banking division, premises and equipment expenses of $1.2 million, other expenses of $1.4 million, data processing costs of $175 thousand; legal, accounting and professional fees of $140 thousand, and marketing and advertising of 134 thousand. Premises and equipment expenses include approximately $595 thousand due to the acceleration of the remaining lease term for the closure of the Sligo branch in Silver Spring, Maryland in April 2010 and approximately $232 thousand due to the acceleration of the remaining leasehold amortization for the closure of the 1725 Eye Street, NW branch in Washington, DC in September, 2010. The decrease in the FDIC insurance of $438 thousand is a result of the absence during 2010 of the one-time special assessment of approximately $723 thousand recorded in the second quarter of 2009.

Total noninterest expenses were $12.9 million for the three months ended September 30, 2010, as compared to $10.3 million for the three months ended September 30, 2009, a 26% increase.  Higher costs were incurred for salaries and benefits of $1.4 million, reflecting in large part the expansion of the residential mortgage banking division, premises and equipment expenses of $223 thousand, reflecting in part additional leased space to house the expanded residential mortgage banking division, other expenses of $670 thousand, marketing and advertising of $163 thousand, FDIC insurance of $142 thousand, and data pro