Republic First 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended: September 30, 2006

Commission File Number: 000-17007

Republic First Bancorp, Inc.
(Exact name of business issuer as specified in its charter)

Pennsylvania
23-2486815
(State or other jurisdiction of
IRS Employer Identification
incorporation or organization)
Number

1608 Walnut Street, Philadelphia, Pennsylvania  19103
(Address of principal executive offices)   (Zip code)

215-735-4422
(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 filing requirements for the past 90 days.
 
YES  X
NO____

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ____
Accelerated Filer   X
Non-accelerated filer ____

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
 
YES____
NO  X
APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the Issuer's classes of common stock, as of the latest  practicable date.
9,743,204 shares of Issuer's Common Stock, par value
$0.01 per share, issued and outstanding as of November 3, 2006

Page 1
Exhibit index appears on page 38
 



TABLE OF CONTENTS
   
Part I: Financial Information
Page
   
   
 
   
   
   
Part II: Other Information
 
   
   
   
   
   
   
   



2


 
PART I - FINANCIAL INFORMATION



ITEM 1: FINANCIAL STATEMENTS

 
Page
   
   
   
 
   
 
   
 
   
   




3


Republic First Bancorp, Inc. and Subsidiary
Consolidated Balance Sheets
As of September 30, 2006 and December 31, 2005
Dollars in thousands, except share data
(Unaudited)


ASSETS:
 
September 30, 2006
 
December 31, 2005
 
   
 
     
Cash and due from banks
 
$
12,752
 
$
19,985
 
Interest bearing deposits with banks
   
500
   
768
 
Federal funds sold
   
97,822
   
86,221
 
Total cash and cash equivalents
   
111,074
   
106,974
 
               
Investment securities available for sale, at fair value
   
76,638
   
37,283
 
Investment securities held to maturity at amortized cost
             
(Fair value of $512 and $570 respectively)
   
505
   
559
 
Federal Home Loan Bank stock, at cost
   
6,094
   
6,319
 
Loans receivable (net of allowance for loan losses of
             
 $7,934 and $7,617, respectively)
   
753,869
   
670,469
 
Premises and equipment, net
   
5,778
   
3,598
 
Other real estate owned
   
499
   
137
 
Accrued interest receivable
   
5,114
   
3,784
 
Business owned life insurance
   
11,196
   
10,926
 
Other assets
   
9,577
   
10,806
 
               
Total Assets
 
$
980,344
 
$
850,855
 
LIABILITIES AND SHAREHOLDERS' EQUITY:
             
Liabilities:
             
Deposits:
             
Demand – non-interest-bearing
 
$
69,399
 
$
88,862
 
Demand – interest-bearing
   
57,378
   
69,940
 
Money market and savings
   
241,344
   
223,129
 
Time under $100,000
   
154,381
   
128,022
 
Time $100,000 or more
   
220,489
   
137,890
 
Total Deposits
   
742,991
   
647,843
 
               
Short-term borrowings
   
145,794
   
123,867
 
Accrued interest payable
   
5,381
   
1,813
 
Other liabilities
   
7,925
   
7,469
 
Subordinated debt
   
6,186
   
6,186
 
Total Liabilities
   
908,277
   
787,178
 
               
Shareholders’ Equity:
             
Preferred Stock, par value $0.01 per share; 10,000,000 shares
             
authorized; no shares issued as of September 30, 2006
             
and December 31, 2005
   
-
   
-
 
Common stock par value $0.01 per share; 20,000,000 shares
             
authorized; shares issued 9,743,204 as of
             
September 30, 2006 and 8,753,998 as of December 31, 2005
   
97
   
88
 
Additional paid in capital
   
63,057
   
50,203
 
Retained earnings
   
11,026
   
15,566
 
Treasury stock at cost (250,555 shares)
   
(1,688
)
 
(1,688
)
Stock held by deferred compensation plan
   
(573
)
 
(573
)
Accumulated other comprehensive income
   
148
   
81
 
Total Shareholders’ Equity
   
72,067
   
63,677
 
Total Liabilities and Shareholders’ Equity
 
$
980,344
 
$
850,855
 

(See notes to consolidated financial statements)
4


Republic First Bancorp, Inc. and Subsidiary
Consolidated Statements of Income
For the Three and Nine Months Ended September 30, 2006 and 2005
Dollars in thousands, except per share data
(unaudited) 

   
Three Months Ended 
 
Nine Months Ended 
 
 
 
September 30, 
 
September 30, 
 
 
 
2006
 
2005
 
2006
 
2005
 
Interest Income:
                         
Interest and fees on loans
 
$
14,868
 
$
10,576
 
$
42,773
 
$
30,347
 
Interest and dividend income on federal
                         
funds sold and other interest-earning balances
   
248
   
192
   
900
   
863
 
Interest and dividends on investment securities
   
915
   
465
   
1,991
   
1,350
 
Total interest income
   
16,031
   
11,233
   
45,664
   
32,560
 
                           
Interest expense:
                         
Demand interest-bearing
   
165
   
79
   
379
   
236
 
Money market and savings
   
2,437
   
1,886
   
6,381
   
4,457
 
Time under $100,000
   
1,625
   
730
   
4,096
   
2,272
 
Time $100,000 or more
   
1,851
   
524
   
5,425
   
2,270
 
Other borrowed funds
   
1,626
   
757
   
3,561
   
1,939
 
Total interest expense
   
7,704
   
3,976
   
19,842
   
11,174
 
Net interest income
   
8,327
   
7,257
   
25,822
   
21,386
 
Provision for loan losses
   
-
   
315
   
1,374
   
1,137
 
Net interest income after provision
                         
for loan losses
   
8,327
   
6,942
   
24,448
   
20,249
 
                           
Non-Interest income:
                         
Loan advisory and servicing fees
   
194
   
187
   
1,022
   
477
 
Service fees on deposit accounts
   
309
   
466
   
1,167
   
1,452
 
Gains on sales and calls of investment securities
   
-
   
-
   
-
   
97
 
Gains on sale of other real estate owned
   
130
   
-
   
130
   
-
 
Other income
   
241
   
251
   
514
   
780
 
     
874
   
904
   
2,833
   
2,806
 
                           
Non-Interest expense:
                         
Salaries and benefits
   
3,083
   
2,447
   
8,938
   
7,097
 
Occupancy
   
482
   
360
   
1,347
   
1,141
 
Depreciation
   
253
   
214
   
661
   
795
 
Legal
   
145
   
188
   
450
   
528
 
Advertising
   
173
   
37
   
361
   
126
 
Data processing
   
138
   
129
   
417
   
326
 
Taxes, other
   
176
   
192
   
567
   
512
 
Other expenses
   
1,053
   
1,036
   
2,925
   
3,089
 
     
5,503
   
4,603
   
15,666
   
13,614
 
                           
                           
Income before income taxes
   
3,698
   
3,243
   
11,615
   
9,441
 
Provision for income taxes
   
1,263
   
1,102
   
3,982
   
3,144
 
Net income
 
$
2,435
 
$
2,141
 
$
7,633
 
$
6,297
 
                           
Net income per share
                         
Basic
 
$
0.26
 
$
0.23
 
$
0.81
 
$
0.69
 
Diluted
 
$
0.25
 
$
0.22
 
$
0.79
 
$
0.66
 
 
(See notes to consolidated financial statements)

5

 

 
 Consolidated Statements of Cash Flows
 
 For the Nine Months Ended September 30, 2006 and 2005
 
 Dollars in thousands
 
 (unaudited)
 
   
Nine months ended
 
   
September 30,
 
   
2006
 
2005
 
Cash flows from operating activities:
             
Net income
 
$
7,633
 
$
6,297
 
Adjustments to reconcile net income to net
             
cash provided by operating activities:
             
Provision for loan losses
   
1,374
   
1,137
 
Gain on sale of other real estate owned
   
(130
)
 
-
 
Depreciation
   
661
   
795
 
Stock compensation expense
   
10
   
-
 
Gain on call of securities
   
-
   
(97
)
Amortization of discounts on investment securities
   
116
   
222
 
Increase in value of business owned life insurance
   
(270
)
 
(248
)
Decrease (increase) in accrued interest receivable
             
and other assets
   
(333
)
 
1,810
 
Decrease (increase) in accrued expenses
             
and other liabilities
   
4,024
   
(1,330
)
Net cash provided by operating activities
   
13,085
   
8,586
 
Cash flows from investing activities:
             
Purchase of securities:
             
Available for sale
   
(41,066
)
 
(18,912
)
Proceeds from principal receipts, calls and maturities of securities:
             
Held to maturity
   
54
   
212
 
Available for sale
   
1,662
   
4,310
 
Purchase of FHLB stock
   
-
   
(2,913
)
Proceeds from sale of FHLB stock
   
225
   
-
 
Net increase in loans
   
(84,774
)
 
(96,345
)
Decrease in other interest-earning restricted cash
   
-
   
612
 
Premises and equipment expenditures
   
(2,841
)
 
(757
)
Net cash used in investing activities
   
(126,740
)
 
(113,793
)
Cash flows from financing activities:
             
Net proceeds from exercise of stock options
   
680
   
949
 
Net increase (decrease) in demand, money market and savings deposits
   
(13,810
)
 
33,288
 
Increase of overnight borrowings
   
21,927
   
99,723
 
Repayment of long term borrowings
   
-
   
(25,000
)
Net increase in time deposits
   
108,958
   
41,010
 
Net cash provided by financing activities
   
117,755
   
149,970
 
Increase in cash and cash equivalents
   
4,100
   
44,763
 
Cash and cash equivalents, beginning of period
   
106,974
   
36,703
 
Cash and cash equivalents, end of period
 
$
111,074
 
$
81,466
 
Supplemental disclosure:
             
Interest paid
 
$
16,274
 
$
11,733
 
Taxes paid
 
$
3,700
 
$
3,600
 
 
 
(See notes to consolidated financial statements)

6

Republic First Bancorp, Inc. and Subsidiary
Consolidated Statements of Changes in Shareholders’ Equity
For the Nine Months Ended September 30, 2006 and 2005
Dollars in thousands
 (unaudited)
 
   
 
 
Comprehensive
Income/(loss)
 
 
 
Common
Stock
 
 
Additional
Paid in
Capital
 
 
 
Retained
Earnings
 
 
Treasury Stock at Cost
 
Stock Held by
Deferred
Compensation
Plan
 
Accumulated
Other
Comprehensive
Income
 
 
Total
Shareholders’
Equity
 
                                   
                                   
Balance January 1, 2006
       
$
88
 
$
50,203
 
$
15,566
 
$
(1,688
)
$
(573
)
$
81
 
$
63,677
 
 
Total other comprehensive income, net of reclassification adjustments and taxes
   
67
   
-
   
-
   
-
   
-
   
-
   
67
   
67
 
Net income
   
7,633
   
-
   
-
   
7,633
   
-
   
-
   
-
   
7,633
 
Total comprehensive income 
 
$
7,700
                                           
Stock based compensation
         
-
   
10
   
-
   
-
   
-
   
-
   
10
 
Stock dividend
(885,279 shares)
         
8
   
12,165
   
(12,173
)
                   
-
 
Options exercised
(114,140 shares)
         
1
   
679
   
-
   
-
   
-
   
-
   
680
 
                                                   
                                                   
Balance September 30, 2006
       
$
97
 
$
63,057
 
$
11,026
 
$
(1,688
)
$
(573
)
$
148
 
$
72,067
 
                                                   
 
 
 
 Comprehensive
Income/(loss)
   
Common
Stock
 
 
Additional
Paid in
Capital
 
 
Retained
Earnings
 
 
Treasury Stock at Cost
 
 
Stock Held by
Deferred
Compensation
Plan
 
 
Accumulated
Other
Comprehensive
Income
 
 
Total
Shareholders’
Equity
 
                                                   
                                                   
Balance January 1, 2005
       
$
74
 
$
42,494
 
$
23,867
 
$
(1,541
)
$
-
 
$
330
 
$
65,224
 
 
Total other comprehensive loss, net of reclassification adjustments and taxes
   
(241
)
 
-
   
-
   
-
   
-
   
-
   
(241
)
 
(241
)
Net income
   
6,297
   
-
   
-
   
6,297
   
-
   
-
   
-
   
6,297
 
Total comprehensive income
 
$
6,056
                                           
Stock dividend
(924,022 shares)
         
9
   
10,968
   
(10,977
)
 
-
   
-
   
-
   
-
 
Options exercised (325,181 shares)
         
4
   
945
   
-
   
-
   
-
   
-
   
949
 
First Bank of Delaware spin-off
               
(5,157
)
 
(6,217
)
 
-
   
-
   
(22
)
 
(11,396
)
Balance September 30, 2005
       
$
87
 
$
49,250
 
$
12,970
 
$
(1,541
)
$
-
 
$
67
 
$
60,833
 
                                                   
(See notes to consolidated financial statements)

7

 
REPUBLIC FIRST BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1: Organization
 
Republic First Bancorp, Inc. (“the Company”) spun off its former subsidiary, the First Bank of Delaware, through a pro-rata distribution of one share of the common stock of the First Bank of Delaware (“FBD”) for every share of the Company’s common stock outstanding on January 31, 2005. The Company’s financial statements are presented herein with an effective date of the spin-off as of January 1, 2005. The Company is now a one-bank holding company organized and incorporated under the laws of the Commonwealth of Pennsylvania. It is comprised of one wholly owned subsidiary, Republic First Bank (“Republic”), a Pennsylvania state chartered bank. Republic offers a variety of banking services to individuals and businesses throughout the greater Philadelphia and south New Jersey area through its offices and branches in Philadelphia, Montgomery, Delaware and Camden counties.
 
Both Republic and FBD share data processing, accounting, human resources and compliance services through BSC Services Corp. (”BSC”), which is a subsidiary of FBD. BSC allocates its cost on the basis of usage, to Republic and FBD, which classify such costs to the appropriate non-interest expense categories.
 
The Company and Republic encounter vigorous competition for market share in the geographic areas they serve from bank holding companies, other community banks, thrift institutions and other non-bank financial organizations, such as mutual fund companies, insurance companies and brokerage companies.

The Company and Republic are subject to regulations of certain state and federal agencies. These regulatory agencies periodically examine the Company and its subsidiary for adherence to laws and regulations. As a consequence, the cost of doing business may be affected.


Note 2:  Summary of Significant Accounting Policies:
 
 
Basis of Presentation:
 
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Republic. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ended December 31, 2006. All significant inter-company accounts and transactions have been eliminated in the consolidated financial statements.
 
Risks and Uncertainties and Certain Significant Estimates:
 
The earnings of the Company depend on the earnings of Republic. Earnings are dependent primarily upon the level of net interest income, which is the difference between interest earned on its interest-earning assets, such as loans and investments, and the interest paid on its interest-bearing liabilities, such as deposits and borrowings. Accordingly, the results of operations are subject to risks and uncertainties surrounding their exposure to change in the interest rate environment.
 
8

Prepayments on residential real estate mortgage and other fixed rate loans and mortgage-backed securities vary significantly and may cause significant fluctuations in interest margins.
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
 
Significant estimates are made by management in determining the allowance for loan losses, carrying values of other real estate owned and income taxes. Consideration is given to a variety of factors in establishing these estimates. In estimating the allowance for loan losses, management considers current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ perceived financial and managerial strengths, the adequacy of underlying collateral, if collateral dependent, or present value of future cash flows and other relevant factors. Since the allowance for loan losses and carrying value of other real estate owned are dependent, to a great extent, on the general economy and other conditions that may be beyond Republic’s control, it is at least reasonably possible that the estimates of the allowance for loan losses and the carrying values of other real estate owned could differ materially in the near term.
 
The Company and Republic are subject to federal and state regulations governing virtually all aspects of their activities, including but not limited to, lines of business, liquidity, investments, the payment of dividends, and others. Such regulations and the cost of adherence to such regulations can have a significant impact on earnings and financial condition.


Stock Based Compensation:

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No, 123R (revised 2004), “Share-Based Payment”, which revises SFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”. This statement requires an entity to recognize the cost of employee services received in share-based payment transactions and measure the cost on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. The provisions of SFAS No. 123R were effective January 1, 2006.

In March 2005, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin (“SAB”) No. 107 which expressed the views of the SEC regarding the interaction between SFAS No. 123R and certain SEC rules and regulations. SAB No. 107 provides guidance related to the valuation of share-based payment arrangements for public companies, including assumptions such as expected volatility and expected term.

In 2005, the Company vested all previously issued unvested options. As a result the impact of the adoption of SFAS 123 on operations in future periods will be the value imputed on future options grants using the methods prescribed in SFAS No. 123R.

At September 30, 2006, the Company maintains a Stock Option Plan (the “Plan”) under which the Company grants options to its employees and directors. Under terms of the plan, 1.5 million shares of common stock, plus an annual increase equal to the number of shares needed to restore the maximum number of shares that may be available for grant under the plan to 1.5 million shares, are reserved for such options. The Plan provides that the exercise price of each option granted equals the market price of the Company’s stock on the date of grant. Any options granted vest within one to five years and have a maximum term of 10 years.

9

A summary of the status of the Company’s stock options under the Stock Option Plan as of September 30, 2006 and 2005 and changes during the nine months ended September 30, 2006 and 2005 are presented below:

 
For the Nine Months Ended September 30,
 
2006
2005
 
 
 
 
Shares
 
Weighted
Average
Exercise
Price
 
 
 
 
Shares
 
Weighted
Average
Exercise
Price
Outstanding, beginning of year
709,372
 
$ 5.97
 
1,018,615
 
$ 4.68
Granted
11,000
 
13.35
 
150,501
 
11.05
Exercised
(114,140)
 
(5.96)
 
(357,699)
 
(2.50)
Forfeited
(1,807)
 
(7.41)
 
(5,985)
 
(7.07)
Outstanding, end of period
604,425
 
6.10
 
805,432
 
5.39
Options exercisable at period-end
593,425
 
5.97
 
654,931
 
4.09
Weighted average fair value of options granted during the period
   
$ 5.61
     
$ 4.47
 
The fair value of each option granted in 2006 is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for those grants: dividend yield of 0%; expected volatility of 29.03%; risk-free interest rate of 4.83% and an expected life of 7.0 years.

The following table summarizes information about options outstanding under the Stock Option Plan as of September 30, 2006.
   
   
 
Options outstanding
 
Options exercisable
 
 
Range of Exercise Prices
 
Number
outstanding
at September 30,
2006
 
Weighted
Average
remaining
contractual
life (years)
 
 
Weighted
Average
exercise
price
 
 
Shares
 
Weighted
Average
Exercise
Price
$1.99
103,673
 
4.3
 
$ 1.99
 
103,673
 
$ 1.99
$2.99 to $3.91
160,591
 
5.5
 
3.23
 
160,591
 
3.23
$4.14 to $5.08
26,693
 
4.9
 
4.39
 
26,693
 
4.39
$6.63 to $7.41
157,203
 
7.3
 
6.85
 
157,203
 
6.85
$10.93 to $13.35
156,265
 
8.7
 
11.33
 
145,265
 
11.18
 
604,425
     
$ 6.10
 
593,425
 
$5.97

During the nine months ended September 30, 2006, $10,000 was recognized in compensation expense for the Stock Option Plan. Prior to January 1, 2006, the Company accounted for the Stock Option Plan under the recognition and measurement principles of APB No. 25 and related interpretations. Share-based employee compensation costs were not reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of the grant. In 2005, the Company vested all previously issued unvested options and the Company has granted 11,000 options during the nine months ended September 30, 2006, compensation expense is recognized on the Stock Option Plan for only the options granted during the nine months ended September 30, 2006.
 
In accordance with SFAS No. 123, the following table shows pro forma net income and earnings per share assuming stock options had been expensed based on the fair value of the options granted along with significant assumptions used in the Black-Scholes option valuation model (dollars in thousands,except per share data).
 
10


     
Three months ended
 
 
Nine months ended
 
 
 
September 30,
 
September 30,
 
 
 
2005
 
2005
 
Net Income as reported
 
$
2,141
 
$
6,297
 
Stock-based employee compensation costs determined
             
if the fair value method had been applied to all awards,
             
net of tax
   
-
   
(496
)
               
Pro-forma net income
 
$
2,141
 
$
5,801
 
               
Basic Earnings per Common Share:
             
As reported
 
$
0.23
 
$
0.69
 
Pro-forma
 
$
0.23
 
$
0.63
 
               
Diluted Earnings per Common Share:
             
As reported
 
$
0.22
 
$
0.66
 
Pro-forma
 
$
0.22
 
$
0.60
 
 
 
The pro forma compensation expense is based upon the fair value of the option at grant date. The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for those grants: dividend yield of 0%; expected volatility of 22.17%; risk-free interest rate of 4.03% and an expected life of 9.0 years


Note 3: Reclassifications and Restatement for 10% Stock Dividend

Certain items in the consolidated financial statements and accompanying notes have been reclassified to conform to the current year’s presentation format. There was no effect on net income for the periods presented herein as a result of reclassifications. All applicable amounts in these consolidated financial statements (including stock options and earnings per share information) have been restated for a 10% stock dividend paid on May 17, 2006.


Note 4:  Recent Accounting Pronouncements

In November 2005, the FASB issued final FSP No. 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” The FSP provides an alternative method of calculating excess tax benefits (the Additional Paid-in Capital “APIC” pool) from the method defined in FAS 123(R) for share-based payments. A one-time election to adopt the transition method in this FSP is available to those entities adopting 123(R) using either the modified retrospective or modified prospective method. Up to one year from the initial adoption of FAS 123(R) or the effective date of the FSP is provided to make this one-time election. However, until an entity makes its election, it must follow the guidance in FAS 123(R). The Company is currently evaluating the potential impact of calculating the APIC pool with this alternative method and has not yet determined which method we will adopt, or the expected impact on the Company’s financial position or results of operations.
 
11

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. SFAS No. 155 amends FASB Statement No. 133 and FASB Statement No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting that eliminates exemptions and provides a means to simplify the accounting for these instruments. Specifically, SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company is required to adopt the provisions of SFAS No. 155, as applicable, beginning in fiscal year 2007. Management does not believe the adoption of SFAS No. 155 will have a material impact on the Company’s financial position and results of operations.
 
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets —An Amendment of FASB Statement No. 140” (“SFAS 156”). SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The statement permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. SFAS 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006, which for the Company will be as of the beginning of fiscal 2007. The Company does not believe that the adoption of SFAS 156 will have a significant effect on its financial statements.
 
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that companies recognize in their financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact of adopting FIN 48 on our financial statements.
 
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157), which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. The Company is currently evaluating the impact, if any, of the adoption of SFAS No. 157 on its financial statements.
 
On September 29, 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS 158”), which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date — the date at which the benefit obligation and plan assets are measured — is required to be the company’s fiscal year end. SFAS 158 is effective for publicly-held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company is currently analyzing the effects of SFAS 158 but does not expect its implementation will have a significant impact on its financial statements.

12

 
 
On September 13, 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, companies might evaluate the materiality of financial-statement misstatements using either the income statement or balance sheet approach, with the income statement approach  focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. The Company has analyzed SAB 108 and determined that upon adoption it will have no impact on its financial statements.
 
In September 2006, the FASB issued FASB Staff Position AUG AIR-1, “Accounting for Planned Major Maintenance Activities” which is effective for fiscal years beginning after December 15, 2006. This position statement eliminates the accrue-in-advance method of accounting for planned major maintenance activities. The Company does not expect this pronouncement to have a significant impact on the determination or reporting of its financial results.

 
Note 5: Legal Proceedings
 
The Company and Republic are from time to time parties (plaintiff or defendant) to lawsuits in the normal course of business. While any litigation involves an element of uncertainty, management, after reviewing pending actions with legal counsel, is of the opinion that the liabilities of the Company and Republic, if any, resulting from such actions will not have a material effect on the financial condition or results of operations of the Company.

 
Note 6: Segment Reporting
 
As a result of the spin-off of FBD in the first quarter of 2005, the tax refund products and short-term consumer loan segments were also spun off as they were divisions of that bank. After the spin off, the Company has one reportable segment: community banking. The community bank segment primarily encompasses the commercial loan and deposit activities of Republic, as well as consumer loan products in the area surrounding its branches.
 


Note 7: Earnings Per Share:
 
Earnings per share (“EPS”) consists of two separate components: basic EPS and diluted EPS. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding for each period presented. Diluted EPS is calculated by dividing net income by the weighted average number of common shares outstanding plus dilutive common stock equivalents (“CSEs”). CSEs consist of dilutive stock options granted through the Company’s stock option plan. The following table is a reconciliation of the numerator and denominator used in calculating basic and diluted EPS. CSEs which are anti-dilutive are not included in the following calculation. At September 30, 2006, and 2005, respectively, there were no stock options that were not included in the calculation of EPS because the
 
13

option exercise price is greater than the average market price for the period. The following tables are a comparison of EPS for the three months ended September 30, 2006 and 2005.
 
       
Three months ended September 30,
 
 
 
 
 
   
 2006
     
2005
     
                   
Net Income
 
$
2,435,000
       
$
2,141,000
       
 
   
 
 
 
Per 
         
Per
 
 
   
Shares 
   
Share
   
Shares
   
Share
 
Weighted average shares
                         
For period
   
9,492,360
         
9,309,321
       
Basic EPS
       
$
0.26
       
$
0.23
 
Add common stock equivalents
representing dilutive stock options
   
256,292
         
337,901
       
Effect on basic EPS of dilutive CSE
       
$
(0.01
)
     
$
(0.01
)
Equals total weighted average
   
9,748,652
         
9,647,222
       
shares and CSE (diluted)
                         
Diluted EPS
       
$
0.25
       
$
0.22
 
 
The following tables are a comparison of EPS for the nine months ended September 30, 2006 and 2005.

 
       
Nine months ended September 30,
 
2006
 
2005
 
                   
Net Income
 
$
7,633,000
       
$
6,297,000
       
 
   
Shares 
 
 
Per
Share
 
 
Shares
 
 
Per
Share
 
Weighted average shares
                         
For period
   
9,458,242
         
9,152,400
       
Basic EPS
       
$
0.81
       
$
0.69
 
Add common stock equivalents
representing dilutive stock options
   
255,042
         
424,581
       
Effect on basic EPS of dilutive CSE
       
$
(.02
)
     
$
(.03
)
Equals total weighted average
                         
shares and CSE (diluted)
   
9,713,284
         
9,576,981
       
Diluted EPS
       
$
0.79
       
$
0.66
 
 
14


Note 8: Comprehensive Income

The following table displays net income and the components of other comprehensive income to arrive at total comprehensive income. The only components of other comprehensive income are those related to the unrealized gains (losses) on available for sale investment securities.  

(dollar amounts in thousands)
 
 Three months ended
 
 Nine months ended
 
   
 September 30,
 
 September 30,
 
   
2006
 
2005
 
2006
 
2005
 
Net income
 
$
2,435
 
$
2,141
 
$
7,633
 
$
6,297
 
                           
Other comprehensive loss:
                         
Unrealized gains (losses) on securities:
                         
Arising during the period, net of tax benefit and reclassification adjustments
   
255
   
(60
)
 
67
   
(241
)
Comprehensive income
 
$
2,690
 
$
2,081
 
$
7,700
 
$
6,056
 


The accumulated balances related to each component of other comprehensive income are as follows (in thousands):

               
   
September 30,
 
   
2006
 
 
 
2005
 
               
Unrealized gains on securities, net of tax
 
$
148
       
$
67
 

 

15


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


The following is management’s discussion and analysis of significant changes in the Company’s results of operations, financial condition and capital resources presented in the accompanying consolidated financial statements. This discussion should be read in conjunction with the accompanying notes to the consolidated financial statements.

Certain statements in this document may be considered to be “forward-looking statements” as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that include the words “may,” “believes,” “expect,” “estimate,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “target,” “objective” and similar expressions or variations on such expressions. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For example, risks and uncertainties can arise with changes in: general economic conditions, including their impact on capital expenditures; new service and product offerings by competitors and price pressures; and similar items. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. The Company undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, Quarterly Reports on Form 10-Q, filed by the Company in 2006 and 2005, and any Current Reports on Form 8-K filed by the Company, as well as other filings.

Financial Condition:

September 30, 2006 Compared to December 31, 2005
 
Assets increased $129.5 million to $980.3 million at September 30, 2006, versus $850.9 million at December 31, 2005. This increase reflected a $83.4 million increase in net loans and a $39.3 million increase in investment securities. These increases were funded primarily by increases in deposits of $95.1 million and short-term borrowings of $21.9 million.
 
Loans:
 
The loan portfolio represents the Company’s largest asset category and is its most significant source of interest income. The Company’s lending strategy focuses on small and medium size businesses and professionals that seek highly personalized banking services. Net loans increased $83.4 million, to $753.9 million at September 30, 2006, versus $670.5 million at December 31, 2005. Substantially all of the increase resulted from commercial and construction loans. The loan portfolio consists of secured and unsecured commercial loans including commercial real estate, construction loans, residential mortgages, automobile loans, home improvement loans, home equity loans and lines of credit, overdraft lines of credit and others. Commercial loans are originated as either fixed or variable rate loans with typical terms of 1 to 5 years. Commercial loans typically range between $250,000 and $5,000,000 but customers may borrow significantly larger amounts up to the legal lending limit of approximately $11.5 million at September 30, 2006. Individual customers may have several loans that are secured by different collateral.
 
16

Investment Securities:
 
Investment securities available-for-sale are investments which may be sold in response to changing market and interest rate conditions and for liquidity and other purposes. The Company’s investment securities available-for-sale consist primarily of U.S. Government debt securities, U.S. Government agency issued mortgage-backed securities, and debt securities which include corporate bonds and trust preferred securities. Available-for-sale securities totaled $76.6 million at September 30, 2006, compared to $37.3 million at year-end 2005. The increase of $39.3 million reflected purchases of long term mortgage backed securities and tax-exempt municipal securities. At September 30, 2006 and December 31, 2005, the portfolio had net unrealized gains of $225,000 and $123,000, respectively.
 
Investment securities held-to-maturity are investments for which there is the intent and ability to hold the investment to maturity. These investments are carried at amortized cost. The held-to-maturity portfolio consists primarily of debt securities. At September 30, 2006, securities held to maturity totaled $505,000, compared to $559,000 at year-end 2005.
 
FHLB Stock:
 
The Company is required to maintain FHLB stock in proportion to its outstanding debt to FHLB. When the debt is repaid, the purchase price of the stock is refunded. At September 30, 2006, FHLB stock totaled $6.1 million, a decrease of $225,000 from $6.3 million at December 31, 2005.
 
Cash and Cash Equivalents:
 
Cash and due from banks, interest bearing deposits and federal funds sold are all liquid funds. The aggregate amount in these three categories increased by $4.1 million, to $111.1 million at September 30, 2006, from $107.0 million at December 31, 2005, reflecting an $11.6 million increase in federal funds sold partially offset by a $7.2 million decrease in cash and due from banks.
 
Fixed Assets:
 
Premises and equipment, net of accumulated depreciation, increased $2.2 million to $5.8 million at September 30, 2006, compared to $3.6 million at December 31, 2005, reflecting 2006 premises and equipment expenditures primarily related to branch expansion.
 
Other Real Estate Owned:
 
Other real estate owned amounted to $499,000 at September 30, 2006 compared to $137,000 December 31, 2005, reflecting the transfer of two commercial real estate properties from non-accrual loans partially offset by the sale of the one commercial real estate property, carried at $137,000.
 
Business Owned Life Insurance:
 
The balance of business owned life insurance amounted to $11.2 million at September 30, 2006 and $10.9 million at December 31, 2005. The income earned on these policies is reflected in other income.
 
Deposits:
 
Deposits, which include non-interest and interest-bearing demand deposits, money market, savings and time deposits including brokered deposits, are the Company’s major source of funding. Deposits are generally solicited from the Company’s market area through the offering of a variety of products to attract and retain customers, with a primary focus on multi-product relationships. Institutional deposits also may be utilized when they represent a lower-cost funding alternative.
 
Period end deposits increased by $95.1 million to $743.0 million at September 30, 2006, from $647.8 million at December 31, 2005. Average core deposits for the quarter decreased 10.0% or $41.6 million from the prior year third quarter to $375.6 million in the third quarter of 2006. Period end time
 
17

deposits increased $109.0 million, or 41.0% to $374.9 million at September 30, 2006, versus $265.9 million at the prior year-end.
 
Short-term Borrowings:
 
Short-term borrowings, primarily FHLB borrowings, totaled $145.8 million at September 30, 2006 and $123.9 million at December 31, 2005. The balances were comprised wholly of overnight borrowings.
 
Shareholders’ Equity:
 
Total shareholders’ equity increased $8.4 million to $72.1 million at September 30, 2006, versus $63.7 million at December 31, 2005. This increase was primarily the result of year-to-date net income of $7.6 million, with the balance of the increase resulting from the exercise of stock options and a minimal increase in accumulated other comprehensive income.


Three Months Ended September 30, 2006 Compared to September 30, 2005
Results of Operations:

Overview

The Company's net income increased to $2.4 million or $0.25 per diluted share for the three months ended September 30, 2006, compared to $2.1 million, or $0.22 per diluted share for the comparable prior year period. The improvement reflected a $4.8 million, or 42.7%, increase in total interest income, primarily due to higher rates and secondarily to a 22.8% increase in average loans outstanding. Interest expense increased $3.7 million, reflecting higher rates, a 15.7% increase in average deposits outstanding and a 53.4% increase in higher cost average other borrowings. Accordingly, net interest income increased $1.1 million between the periods. There was no provision for loan losses in the third quarter of 2006, compared to a $315,000 provision expense in the third quarter of 2005 as a result of recoveries. Non-interest expenses increased $900,000 to $5.5 million compared to $4.6 million in the third quarter of 2005, primarily due to higher salaries and benefits reflecting additional commercial loan production and new branch staff. The return on average assets and average equity of 1.13% and 13.66% respectively, in the third quarter of 2006 compared to 1.19% and 14.24% respectively for the same period in 2005.

Analysis of Net Interest Income

Historically, the Company's earnings have depended significantly upon net interest income, which is the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is impacted by changes in the mix of the volume and rates of interest-earning assets and interest-bearing liabilities.
 
18


   
For the three months ended
 
For the three months ended
 
 
 
September 30, 2006
 
September 30, 2005
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest
 
 
 
 
 
Interest
 
 
 
(Dollars in thousands)
 
Average
 
Income/
 
Yield/
 
Average
 
Income/
 
Yield/
 
 
 
Balance
 
Expense
 
Rate
 
Balance
 
Expense
 
Rate
 
Federal funds sold
                                     
and other interest-
                                     
earning assets
 
$
18,524
 
$
248
   
5.31
%
$
20,952
 
$
192
   
3.64
%
Securities
   
59,736
   
915
   
6.13
%
 
48,752
   
465
   
3.82
%
Loans receivable
   
742,420
   
14,868
   
7.95
%
 
604,531
   
10,576
   
6.94
%
Total interest-earning assets
   
820,680
   
16,031
   
7.75
%
 
674,235
   
11,233
   
6.61
%
                                       
Other assets
   
36,593
               
39,460
             
                                       
Total assets
 
$
857,273
             
$
713,695
             
                                       
Interest-bearing liabilities:
                                     
Demand-non interest
                                     
bearing
 
$
78,942
             
$
86,015
             
Demand interest-bearing
   
54,003
 
$
165
   
1.21
%
 
45,972
 
$
79
   
0.68
%
Money market & savings
   
242,621
   
2,437
   
3.99
%
 
285,140
   
1,886
   
2.62
%
Time deposits
   
285,448
   
3,476
   
4.83
%
 
154,399
   
1,254
   
3.22
%
Total deposits
   
661,014
   
6,078
   
3.65
%
 
571,526
   
3,219
   
2.23
%
Total interest-bearing
                                     
deposits
   
582,072
   
6,078
   
4.19
%
 
485,511
   
3,219
   
2.63
%
                                       
Other borrowings (1)
   
114,227
   
1,626
   
5.65
%
 
74,441
   
757
   
4.03
%
                                       
Total interest-bearing
                                     
liabilities
 
$
696,299
 
$
7,704
   
4.39
%
$
559,952
 
$
3,976
   
2.82
%
Total deposits and
                                     
other borrowings
   
775,241
   
7,704
   
3.94
%
 
645,967
   
3,976
   
2.44
%
                                       
Non interest-bearing
                                     
liabilites
   
11,309
               
8,022
             
Shareholders' equity
   
70,723
               
59,706
             
Total liabilities and
                                     
shareholders' equity
 
$
857,273
             
$
713,695
             
                                       
Net interest income
       
$
8,327
             
$
7,257
       
Net interest spread
               
3.36
%
             
3.79
%
                                       
Net interest margin
               
4.03
%
             
4.27
%
                                       
(1) Includes $6.2 million of trust preferred securities.
                                     

The rate volume table below presents an analysis of the impact on interest income and expense resulting from changes in average volumes and rates during the period. For purposes of this table, changes in interest income and expense are allocated to volume and rate categories based upon the respective changes in average balances and average rates.

19

Rate/Volume Table

   
Three months ended September 30, 2006
 
 
 
versus September 30, 2005
 
 
 
(dollars in thousands)
 
 
 
Due to change in:
 
 
 
Volume
 
Rate
 
Total
 
Interest earned on:
             
               
Federal funds sold
 
$
(32
)
$
88
 
$
56
 
Securities
   
170
   
280
   
450
 
Loans
   
2,761
   
1,531
   
4,292
 
Total interest-earning assets
   
2,899
   
1,899
   
4,798
 
                     
Interest expense of deposits
                   
Interest-bearing demand deposits
   
(25
)
 
(61
)
 
(86
)
Money market and savings
   
427
   
(978
)
 
(551
)
Time deposits
   
(1,596
)
 
(626
)
 
(2,222
)
Total deposit interest expense
   
(1,194
)
 
(1,665
)
 
(2,859
)
Other borrowings
   
(566
)
 
(303
)
 
(869
)
Total interest expense
   
(1,760
)
 
(1,968
)
 
(3,728
)
Net interest income
 
$
1,139
 
$
(69
)
$
1,070
 

The Company’s net interest margin decreased 24 basis points to 4.03% for the three months ended September 30, 2006, versus a comparable 4.27% in the prior year comparable period, reflecting increased funding costs.

While yields on interest-bearing assets increased 114 basis points to 7.75% in third quarter 2006 from 6.61% in third quarter 2005, the yield on total deposits and other borrowings increased 150 basis points to 3.94% from 2.44% between those respective periods. The increase in yields on assets resulted primarily from the 200 basis points of increases in short-term interest rates between the two quarters. Increases in short-term interest rates increased yields on loans tied to prime, were more than offset by increases in interest paid on deposits, and higher cost borrowed funds, primarily overnight FHLB borrowings.
 
The Company's net interest income increased $1.1 million, or 14.7%, to $8.3 million for the three months ended September 30, 2006, from $7.3 million for the prior year comparable period. As shown in the Rate Volume table above, the increase in net interest income was due primarily to the increased volume of loans. Higher rates on loans resulted primarily from variable rate loans which immediately adjust to increases in the prime rate. Interest expense increased primarily as a result of higher rates on deposits and borrowed funds. Average interest-earning assets amounted to $820.7 million for third quarter 2006 and $674.2 million for third quarter 2005. Substantially all of the $146.4 million increase resulted from loan growth.
 
The Company's total interest income increased $4.8 million, or 42.7%, to $16.0 million for the three months ended September 30, 2006, from $11.2 million for the prior year comparable period. Interest and fees on loans increased $4.3 million, or 40.6%, to $14.9 million for the three months ended September 30, 2006, from $10.6 million for the prior year comparable period. The majority of the increase in both loan interest and total interest income resulted from a 22.8% increase in average loan balances. In third quarter 2006, average loan balances amounted to $742.4 million, compared to $604.5 million in the comparable prior year period. The balance of the 40.6% increase in interest on loans resulted primarily from the repricing of the variable rate portfolio to higher short term market interest rates. Interest and
 
20

dividends on investment securities increased $450,000 to $915,000 for the three months ended September 30, 2006, from $465,000 for the prior year comparable period. This increase reflected rate increases on variable rate securities as well as an $11.0 million, or 22.5%, increase in average securities outstanding to $59.7 million for third quarter 2006 from the comparable prior year period. Interest on federal funds sold and other interest-earning assets increased $56,000, or 29.2%, as increases in short-term market interest rates more than offset the impact of the $2.4 million decrease in average balances to $18.5 million for third quarter 2006 from $21.0 million for the comparable prior year period.
 
The Company's total interest expense increased $3.7 million, or 93.8%, to $7.7 million for the three months ended September 30, 2006, from $4.0 million for the prior year comparable period. Interest-bearing liabilities averaged $696.3 million for the three months ended September 30, 2006, versus $560.0 million for the prior year comparable period, or an increase of $136.3 million. The increase reflected additional funding primarily for loan growth. The $136.3 million increase reflected average deposit balances which increased $89.5 million and average other borrowings which increased $39.8 million. The average rate paid on interest-bearing liabilities increased 157 basis points to 4.39% for the three months ended September 30, 2006. Interest expense on time deposit balances increased $2.2 million to $3.5 million in third quarter 2006, from $1.3 million in the comparable prior year period. As certificates of deposit (time deposits) mature, they generally reprice at market rates which are in excess of 5%. Money market and savings interest expense increased $551,000 to $2.4 million in third quarter 2006, from $1.9 million in the comparable prior year period. The majority of the increase in interest expense on deposits reflected the higher short-term interest rate environment. Rates on total interest-bearing deposits increased 151 basis points in third quarter 2006 compared to third quarter 2005, while short term rates increased approximately 200 basis points between those periods. In addition, higher cost average time deposit balances increased $131.0 million while average money market and savings deposit balances decreased $42.5 million.

Interest expense on other borrowings increased $869,000 to $1.6 million in third quarter 2006, primarily as a result of increased average balances. Average other borrowings, primarily overnight FHLB borrowings, increased $40.0 million, or 53.4%, between those respective periods. Rates on overnight borrowings reflected the higher short-term interest rate environment as the rate of other borrowings increased to 5.65% in third quarter 2006, from 4.03% in the comparable prior year period. Interest expense on other borrowings also includes the interest expense of $6.2 million of trust preferred securities.

Provision for Loan Losses
 
The provision for loan losses is charged to operations in an amount necessary to bring the total allowance for loan losses to a level that reflects the known and estimated inherent losses in the portfolio. There was no provision for loan losses in third quarter 2006 compared to $315,000 in third quarter 2005, as the provision required for portfolio growth was offset by the $154,000 in net recoveries on tax refund loans. The offsetting provision in third quarter 2006 primarily reflected amounts required to increase the allowance for loan growth in accordance with the Company’s methodology. The comparable third quarter 2005 provision reflected $68,000 in net recoveries on tax refund loans.
 
Non-Interest Income

Total non-interest income decreased $30,000 to $874,000 for the three months ended September 30, 2006, compared to $904,000 for the prior year comparable period. A decrease of $157,000 in third quarter 2006 related to service fees on deposit accounts was partially offset by a $130,000 gain on the sale of OREO property. The decrease in service charge on deposits resulted from the elimination of currency related services.
 
21

Non-Interest Expenses
 
Total non-interest expenses increased $900,000 or 19.6% to $5.5 million for the three months ended September 30, 2006, from $4.6 million for the prior year comparable period. Salaries and employee benefits increased $636,000 or 26.0%, to $3.1 million for the three months ended September 30, 2006, from $2.4 million for the prior year comparable period. That increase reflected additional salary expense related to commercial loan and deposit production including related support staff and two new branches. It also reflected annual merit increases which are targeted at approximately 3.5%.
 
Occupancy expense increased $122,000, or 34%, to $482,000 in third quarter 2006, compared to $360,000 in third quarter 2005. Contributing to the increase was the opening of two new branches in 2006.
 
Depreciation expense increased $39,000 or 18.2% to $253,000 for the three months ended September 30, 2006, versus $214,000 for the prior year comparable period, reflecting the impact of the new branches.
 
Legal fees decreased $43,000, or 22.9%, to $145,000 in third quarter 2006, compared to $188,000 in third quarter 2005.
 
Advertising expense increased $136,000, or 367.6%, to $173,000 in third quarter 2006, compared to $37,000 in third quarter 2005. The increase was primarily due to higher levels of print and direct mail advertising including advertising related to the new branches and deposit promotions.
 
Data processing expense increased $9,000, or 7.0%, to $138,000 in third quarter 2006, compared to $129,000 in third quarter 2005.
 
Taxes, other than income decreased $16,000, or 8.3%, to $176,000 for the three months ended September 30, 2006, versus $192,000 for the comparable prior year period.
 
Other expenses increased $17,000, or 1.6% to $1.1 million for the three months ended September 30, 2006, from $1.0 million for the prior year comparable period. The increase reflected higher levels of professional fees, training and development expenses, and various loan related expenses which totaled $111,000. These expenses were offset by a decrease of $106,000 in internal auditing expense which reflected reduction in Sarbanes Oxley expenditures.

22


Provision for Income Taxes
 
The provision for income taxes for continuing operations increased $161,000, to $1.3 million for the three months ended September 30, 2006, from $1.1 million for the prior year comparable period. That increase was primarily the result of the increase in pre-tax income. The effective tax rates in those periods were comparable at 35% and 34% respectively.
 

Nine Months Ended September 30, 2006 Compared to September 30, 2005

Results of Operations:

Overview

The Company's net income increased to $7.6 million or $0.79 per diluted share for the nine months ended September 30, 2006, compared to $6.3 million, or $0.66 per diluted share for the comparable prior year period. The improvement reflected a $13.1 million, or 40.2%, increase in total interest income, due primarily to higher rates and secondarily to a 22.6% increase in average loans outstanding. Total interest expense increased $8.7 million, also reflecting higher rates and a 13.7% increase in average deposits outstanding. Accordingly, net interest income increased $4.4 million between the periods. The provision for loan losses in the first nine months of 2006 increased to $1.4 million, compared to $1.1 million provision expense in the first nine months of 2005, reflecting the impact of $287,000 of commercial and construction loan recoveries in 2005. Non-interest income remained constant at $2.8 million in the first nine months of 2006, compared to the first nine months of 2005. Non-interest expense increased $2.1 million to $15.6 million compared to $13.6 million in the first nine months of 2005, due primarily to higher salaries and benefits. The return on average assets and average equity of 1.24% and 15.01% respectively, in the first nine months of 2006 compared to 1.18% and 14.71% respectively for the same period in 2005.

Analysis of Net Interest Income

Historically, the Company's earnings have depended significantly upon net interest income, which is the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is impacted by changes in the mix of the volume and rates of interest-earning assets and interest-bearing liabilities.
 

23


   
For the nine months ended
 
For the nine months ended
 
 
 
September 30, 2006
 
September 30, 2005
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest
 
 
 
 
 
Interest
 
 
 
(Dollars in thousands)
 
Average
 
Income/
 
Yield/
 
Average
 
Income/
 
Yield/
 
 
 
Balance
 
Expense
 
Rate
 
Balance
 
Expense
 
Rate
 
Federal funds sold
                                     
and other interest-
                                     
earning assets
 
$
25,039
 
$
900
   
4.81
%
$
41,885
 
$
863
   
2.75
%
Securities
   
48,300
   
1,991
   
5.50
%
 
47,526
   
1,350
   
3.79
%
Loans receivable
   
714,695
   
42,773
   
8.00
%
 
583,033
   
30,347
   
6.96
%
Total interest-earning assets
   
788,034
   
45,664
   
7.75
%
 
672,444
   
32,560
   
6.47
%
                                       
Other assets
   
36,940
               
41,205
             
                                       
Total assets
 
$
824,974
             
$
713,649
             
                                       
Interest-bearing liabilities:
                                     
Demand-non interest
                                     
bearing
 
$
83,231
             
$
88,046
             
Demand interest-bearing
   
54,270
 
$
379
   
0.93
%
 
48,898
 
$
236
   
0.65
%
Money market & savings
   
236,160
   
6,381
   
3.61
%
 
242,284
   
4,457
   
2.46
%
Time deposits
   
286,542
   
9,521
   
4.44
%
 
201,570
   
4,542
   
3.01
%
Total deposits
   
660,203
   
16,281
   
3.30
%
 
580,798
   
9,235
   
2.13
%
Total interest-bearing
                                     
deposits
   
576,972
   
16,281
   
3.77
%
 
492,752
   
9,235
   
2.51
%
                                       
Other borrowings (1)
   
86,603
   
3,561
   
5.50
%
 
67,353
   
1,939
   
3.85
%
                                       
Total interest-bearing
                                     
liabilities
 
$
663,575
 
$
19,842
   
4.00
%
$
560,105
 
$
11,174
   
2.67
%
Total deposits and
                                     
other borrowings
   
746,806
   
19,842
   
3.55
%
 
648,151
   
11,174
   
2.30
%
                                       
Non interest-bearing
                                     
liabilites
   
10,194
               
8,211
             
Shareholders' equity
   
67,974
               
57,287
             
Total liabilities and
                                     
shareholders' equity
 
$
824,974
             
$
713,649
             
                                       
Net interest income
       
$
25,822
             
$
21,386
       
Net interest spread
               
3.75
%
             
3.80
%
                                       
Net interest margin
               
4.38
%
             
4.25
%
Net interest margin not including
                                     
tax refund loans
               
4.15
%
             
3.92
%
                                       
(1) Includes $6.2 million of trust preferred securities.
                                     

24

The rate volume table below presents an analysis of the impact on interest income and expense resulting from changes in average volumes and rates during the period. For purposes of this table, changes in interest income and expense are allocated to volume and rate categories based upon the respective changes in average balances and average rates.

Rate/Volume Table

   
Nine months ended September 30, 2006
 
 
 
versus September 30, 2005
 
 
 
(dollars in thousands)
 
 
 
Due to change in:
 
 
 
Volume
 
Rate
 
Total
 
Interest earned on:
             
               
Federal funds sold
   
($607
)
$
644
 
$
37
 
Securities
   
32
   
609
   
641
 
Loans
   
7,880
   
4,546
   
12,426
 
Total interest-earning assets
   
7,305
   
5,799
   
13,104
 
                     
Interest expense of
                   
Deposits
                   
Interest-bearing demand deposits
   
(38
)
 
(105
)
 
(143
)
Money market and savings
   
165
   
(2,089
)
 
(1,924
)
Time deposits
   
(2,823
)