rfb10q.htm
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, 2007

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
   
 50 South 16th Street, Philadelphia, Pennsylvania              19102
 (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 latestpracticable date.
10,320,908 shares of Issuer's Common Stock, par value
$0.01 per share, issued and outstanding as of November 7, 2007

Page 1

Exhibit index appears on page 36







TABLE OF CONTENTS
 
   
Part I:                      Financial Information
Page
   
Item 1: Financial Statements (unaudited)
   
Item 2:  Management’s Discussion and Analysis of Financial Condition and
Results of Operations
 
   
Item 3:  Quantitative and Qualitative Information about Market Risk
   
Item 4:  Controls and Procedures
   
Part II: Other Information
 
   
Item 1: Legal Proceedings
   
Item 1A: Risk Factors
   
Item 2: Unregistered Sales of Equity and Use of Proceeds
   
Item 3: Defaults Upon Senior Securities
   
Item 4: Submission of Matters to a Vote of Security Holders
   
Item 5: Other Information
   
Item 6: Exhibits



2



PART I - FINANCIAL INFORMATION



ITEM 1: FINANCIAL STATEMENTS

 
Page
   
   
Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006 (unaudited)
   
Consolidated Statements of Income for the three and nine months ended
 
September 30, 2007 and 2006 (unaudited)
   
Consolidated Statements of Cash Flows for the nine months ended
 
September 30, 2007 and 2006 (unaudited)
   
Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended
 
September 30, 2007 and 2006 (unaudited)
   
Notes to Consolidated Financial Statements (unaudited)
   




3


Republic First Bancorp, Inc. and Subsidiary
Consolidated Balance Sheets
As of September 30, 2007 and December 31, 2006
Dollars in thousands, except per share data
(unaudited)

ASSETS:
 
September 30, 2007
   
December 31, 2006
 
             
Cash and due from banks
  $
10,958
    $
19,454
 
Interest bearing deposits with banks
   
990
     
426
 
Federal funds sold
   
64,986
     
63,247
 
Total cash and cash equivalents
   
76,934
     
83,127
 
                 
Investment securities available for sale, at fair value
   
80,539
     
102,039
 
Investment securities held to maturity, at amortized cost
               
     (Fair value of $284 and $338,  respectively)
   
281
     
333
 
Restricted stock, at cost
   
10,471
     
6,804
 
Loans receivable (net of allowance for loan losses of
               
     $8,791 and $8,058, respectively)
   
832,983
     
784,002
 
Premises and equipment, net
   
10,946
     
5,648
 
Other real estate owned, net
   
42
     
572
 
Accrued interest receivable
   
5,429
     
5,370
 
Bank owned life insurance
   
11,604
     
11,294
 
Other assets
   
10,890
     
9,635
 
Total Assets
  $
1,040,119
    $
1,008,824
 
LIABILITIES AND SHAREHOLDERS' EQUITY:
               
Liabilities:
               
Deposits:
               
Demand – non-interest-bearing
  $
80,451
    $
78,131
 
Demand – interest-bearing
   
32,548
     
47,573
 
Money market and savings
   
246,311
     
260,246
 
Time less than $100,000
   
118,927
     
138,566
 
Time over $100,000
   
291,652
     
230,257
 
    Total Deposits
   
769,889
     
754,773
 
                 
Short-term borrowings
   
168,435
     
159,723
 
Accrued interest payable
   
4,302
     
5,224
 
Other liabilities
   
7,780
     
8,184
 
Subordinated debt
   
11,341
     
6,186
 
Total Liabilities
   
961,747
     
934,090
 
Shareholders’ Equity:
               
Preferred stock, par value $0.01 per share: 10,000,000 shares authorized;
               
    no shares issued
   
-
     
-
 
Common stock par value $0.01 per share, 20,000,000 shares authorized;
               
    shares issued 10,735,720 as of September 30, 2007
               
    and 9,746,312 as of December 31, 2006
   
107
     
97
 
Additional paid in capital
   
74,930
     
63,342
 
Retained earnings
   
7,350
     
13,511
 
Treasury stock at cost (416,303 and 250,555 shares, respectively)
    (2,993 )     (1,688 )
Stock held by deferred compensation plan
    (810 )     (810 )
Accumulated other comprehensive income (loss)
    (212 )    
282
 
Total Shareholders’ Equity
   
78,372
     
74,734
 
Total Liabilities and Shareholders’ Equity
  $
1,040,119
    $
1,008,824
 
 

(See notes to unaudited consolidated financial statements)

4



Republic First Bancorp, Inc. and Subsidiary
Consolidated Statements of Income
For the Three and Nine Months Ended September 30, 2007 and 2006
Dollars in thousands, except per share data
(unaudited)

   
Three months ended
   
Nine months ended   
 
   
September 30,   
   
September 30,   
 
   
2007
   
2006
   
2007
   
2006
 
Interest income:
                       
   Interest and fees on loans
  $
16,209
    $
14,868
    $
47,166
    $
42,773
 
   Interest and dividends on taxable investment securities
   
1,198
     
884
     
3,852
     
1,960
 
   Interest and dividends on tax-exempt investment securities
   
131
     
31
     
380
     
31
 
   Interest on federal funds sold and other interest-earning assets
   
139
     
248
     
543
     
900
 
   Total interest income
   
17,677
     
16,031
     
51,941
     
45,664
 
                                 
Interest expense:
                               
   Demand interest-bearing
   
109
     
165
     
327
     
379
 
   Money market and savings
   
2,816
     
2,437
     
9,370
     
6,381
 
   Time less than $100,000
   
1,829
     
1,625
     
5,510
     
4,096
 
   Time over $100,000
   
2,921
     
1,851
     
8,161
     
5,425
 
   Other borrowings
   
2,198
     
1,626
     
5,694
     
3,561
 
   Total interest expense
   
9,873
     
7,704
     
29,062
     
19,842
 
Net interest income
   
7,804
     
8,327
     
22,879
     
25,822
 
Provision for loan losses
   
1,282
     
-
     
1,425
     
1,374
 
Net interest income after provision
                               
     for loan losses
   
6,522
     
8,327
     
21,454
     
24,448
 
                                 
Non-interest income:
                               
    Loan advisory and servicing fees
   
156
     
194
     
715
     
1,022
 
    Service fees on deposit accounts
   
289
     
309
     
871
     
1,167
 
    Gain on sale of other real estate owned
   
183
     
130
     
185
     
130
 
    Bank owned life insurance
   
106
     
93
     
309
     
270
 
    Other income
   
26
     
148
     
75
     
244
 
     
760
     
874
     
2,155
     
2,833
 
Non-interest expenses:
                               
   Salaries and employee benefits
   
2,713
     
3,083
     
7,874
     
8,938
 
   Occupancy
   
688
     
482
     
1,829
     
1,347
 
   Depreciation and amortization
   
347
     
253
     
1,036
     
661
 
   Legal
   
166
     
145
     
438
     
450
 
   Other real estate
   
3
     
-
     
23
     
3
 
   Advertising
   
141
     
173
     
385
     
361
 
   Data processing
   
172
     
113
     
486
     
351
 
   Insurance
   
106
     
96
     
293
     
261
 
   Professional fees
   
129
     
144
     
379
     
410
 
   Taxes, other
   
204
     
176
     
618
     
567
 
   Other expenses
   
819
     
838
     
2,405
     
2,317
 
     
5,488
     
5,503
     
15,766
     
15,666
 
                                 
Income before provision for income taxes
   
1,794
     
3,698
     
7,843
     
11,615
 
Provision for income taxes
   
558
     
1,263
     
2,535
     
3,982
 
                                 
Net income
  $
1,236
    $
2,435
    $
5,308
    $
7,633
 
                                 
Net income per share (1):
                               
Basic
  $
0.12
    $
0.23
    $
0.51
    $
0.73
 
Diluted
  $
0.12
    $
0.23
    $
0.50
    $
0.72
 

(1) 2006 amounts adjusted for 10% stock dividend paid on April 17, 2007
 
(See notes to unaudited consolidated financial statements)

 
5



    Republic First Bancorp, Inc. and Subsidiary
 
    Consolidated Statements of Cash Flows
 
    For the Nine Months Ended September 30, 2007 and 2006
 
    Dollars in thousands  
 
    (unaudited)   
 
   
Nine months ended
 
   
September 30,
 
   
2007
   
2006
 
Cash flows from operating activities:
           
Net income
  $
5,308
    $
7,633
 
Adjustments to reconcile net income to net
               
   cash provided by operating activities:
               
Provision for loan losses
   
1,425
     
1,374
 
Gain on sale of other real estate owned
    (185 )     (130 )
Depreciation  and amortization
   
1,036
     
661
 
Stock based compensation
   
92
     
10
 
Amortization of (discounts) premiums on investment securities
    (127 )    
116
 
Increase in value of bank owned life insurance
    (309 )     (270 )
Increase in accrued interest receivable
               
   and other assets
    (1,061 )     (600 )
Increase (decrease) in accrued interest payable
               
   and other liabilities
    (1,326 )    
4,024
 
Net cash provided by operating activities
   
4,853
     
12,818
 
Cash flows from investing activities:
               
Purchase of securities:
               
Available for sale
    (4,644 )     (41,066 )
Proceeds from maturities and calls of securities:
               
Held to maturity
   
52
     
54
 
Available for sale
   
25,523
     
1,662
 
Purchase of restricted stock
    (3,667 )    
-
 
Proceeds from sale of restricted stock
   
-
     
225
 
Net increase in loans
    (50,406 )     (84,774 )
Net proceeds from sale of other real estate owned
   
715
     
267
 
Premises and equipment expenditures
    (6,334 )     (2,841 )
Net cash used in investing activities
    (38,761 )     (126,473 )
Cash flows from financing activities:
               
Net proceeds from exercise of stock options
   
37
     
680
 
Purchase of treasury shares
    (1,305 )    
-
 
Net decrease in demand, money market and savings deposits
    (26,640 )     (13,810 )
Increase of short term borrowings
   
8,712
     
21,927
 
Issuance of subordinated debt
   
5,155
     
-
 
Net increase in time deposits
   
41,756
     
108,958
 
Net cash provided by financing activities
   
27,715
     
117,755
 
(Decrease) increase in cash and cash equivalents
    (6,193 )    
4,100
 
Cash and cash equivalents, beginning of period
   
83,127
     
106,974
 
Cash and cash equivalents, end of period
  $
76,934
    $
111,074
 
Supplemental disclosure:
               
Interest paid
  $
29,984
    $
16,274
 
Taxes paid
  $
2,625
    $
3,700
 
 
(See notes to unaudited consolidated financial statements)

6

        Republic First Bancorp, Inc. and Subsidiary
Consolidated Statements of Changes in Shareholders’ Equity
For the Nine Months Ended September 30, 2007 and 2006
Dollars in thousands
                (unaudited)
 

 
   
Comprehensive
Income
   
Common
Stock
   
Additional
Paid in
Capital
   
Retained
Earnings
   
Treasury Stock, at Cost
   
Stock Held by
Deferred
Compensation
Plan
   
Accumulated
Other
Comprehensive
Income (Loss)
   
Total
Shareholders’
Equity
 
                                                 
                                                 
Balance January 1, 2007
        $
97
    $
63,342
    $
13,511
    $ (1,688 )   $ (810 )   $
282
    $
74,734
 
 
Total other comprehensive loss, net of taxes of $(254)
    (494 )    
     
     
     
     
      (494 )     (494 )
Net income
   
5,308
     
     
     
5,308
     
     
     
     
5,308
 
Total comprehensive income
  $
4,814
                                                         
Stock based compensation
           
     
92
     
     
     
     
     
92
 
Stock dividend
(974,441 shares)
           
10
     
11,459
      (11,469 )    
     
     
     
 
Options exercised
(15,067 shares)
           
     
37
     
     
     
     
     
37
 
Purchase of treasury shares
(140,700 shares)
           
     
     
      (1,305 )    
     
      (1,305 )
                                                                 
Balance September 30, 2007
          $
107
    $
74,930
    $
7,350
    $ (2,993 )   $ (810 )   $ (212 )   $
78,372
 
                                                                 
   
Comprehensive
Income
   
Common
Stock
   
Additional
Paid in
Capital
   
Retained
Earnings
   
Treasury Stock, at Cost
   
Stock Held by
Deferred
Compensation
Plan
   
Accumulated
Other
Comprehensive
Income (Loss)
   
Total
Shareholders’
Equity
 
                                                                 
                                                                 
Balance January 1, 2006
          $
88
    $
50,203
    $
15,566
    $ (1,688 )   $ (573 )   $
81
    $
63,677
 
 
Total other comprehensive loss, net of taxes of $35
   
67
     
     
     
     
     
     
67
     
67
 
Net income
   
7,633
     
     
     
7,633
     
     
     
     
7,633
 
Total comprehensive income
  $
7,700
                                                         
Stock based compensation
           
     
10
     
     
     
     
     
10
 
Stock dividend declared
(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
 
                                                                 
 (See notes to unaudited 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”) is 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 Jersey area through its offices and branches in Philadelphia, Montgomery, Delaware, and Camden counties.
 
Both Republic and First Bank of Delaware (“FBD”), a former subsidiary, 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 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, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. 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, other than temporary impairment of investment securities and the realization of deferred tax assets. 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 these estimates 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 could differ materially in the near term.  In estimating the carrying values of other real estate owned, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fait value, less the cost to sell.  In estimating other than temporary impairment of investment securities, securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary.  To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the security for a period of time sufficient to allow for an anticipated recovery in the fair value.  The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of investment.  Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.  In evaluating our ability to recover deferred tax assets, management considers all available positive and negative evidence, including our past operating results and our forecast of future taxable income.  In determining future taxable income, management makes assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies.  These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business.  Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets.  An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.
 
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.
 
Share-Based Compensation:

At September 30, 2007, 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
 
9

maximum term of 10 years.  The Black-Sholes option pricing model is utilized to determine the fair market value of stock options.  In 2007 the following assumptions were utilized; a cash dividend yield of 0%; expected volatility of 25.24%; a risk-free interest rate of 4.70% and an expected life of 7.0 years.  A dividend yield of 0% is utilized, because cash dividends have never been paid.  The expected life reflects a 3 to 4 year “all or nothing” vesting period, the maximum ten year term and review of historical behavior.  The volatility was based on Bloomberg’s seven year volatility calculation for “FRBK” stock.  The risk-free interest rate is based on the seven year Treasury bond.  No shares vested in the first nine months of 2007, but expense is recognized ratably over the period required to vest.  There were 12,100 unvested options at January 1, 2007 with a fair value of $61,710 with $46,282 of that amount remaining to be recognized as expense.  At September 30, 2007, there were 105,050 unvested options with a fair value of $486,885 with $379,301 of that amount remaining to be recognized as expense. At that date, the intrinsic value of the 739,332 options outstanding was $1,190,325, while the intrinsic value of the 634,282 exercisable (vested) was $1,585,705. During the first nine months of 2007, 6,050 options were forfeited, with a weighted average grant fair value of $30,855.

A summary of the status of the Company’s stock options under the Plan as of September 30, 2007 and 2006 and changes during the nine months ended September 30, 2007 and 2006 are presented below:

   
For the Nine Months Ended September 30,
 
   
2007
   
2006
 
   
Shares
   
Weighted
Average
Exercise
Price
   
Shares
   
Weighted
Average
Exercise
Price
 
Outstanding, beginning of year
   
661,449
    $
5.55
     
780,309
    $
5.43
 
Granted
   
99,000
     
11.77
     
12,100
     
12.14
 
Exercised
    (15,067 )     (2.42 )     (125,554 )     (5.42 )
Forfeited
    (6,050 )     (12.14 )     (1,988 )     (6.74 )
Outstanding, end of period
   
739,332
     
6.39
     
664,867
     
5.55
 
Options exercisable at period-end
   
634,282
     
5.50
     
652,767
     
5.43
 
Weighted average fair value of options granted during the period
          $
4.61
            $
5.10
 

   
For the Nine Months Ended
 September 30,
 
   
2007
   
2006
 
Number of options exercised
   
15,067
     
125,554
 
Cash received
  $
36,413
    $
680,253
 
Intrinsic value
   
115,589
     
858,634
 
Tax benefit
   
40,456
     
300,522
 

The following table summarizes information about options outstanding under the Plan as of September 30, 2007.

10

   
 
Options outstanding
   
Options exercisable
 
Range of Exercise Prices
Shares
 
Weighted
Average
remaining
contractual
life (years)
 
Weighted
Average
exercise
price
     
 
Shares
 
Weighted
Average
Exercise
Price
$1.81
106,586
 
3.3
 
$ 1.81
     
106,586
 
$ 1.81
$2.72 to $3.55
170,687
 
4.5
 
2.94
     
170,687
 
2.94
$3.76  to $4.62
27,275
 
4.0
 
4.00
     
27,275
 
4.00
$6.03  to $6.74
169,942
 
6.3
 
6.23
     
169,942
 
6.23
$9.94 to $12.14
264,842
 
8.3
 
10.81
     
159,792
 
10.16
 
739,332
     
$ 6.39
     
634,282
 
$5.50
 
 
For the Nine Months Ended,
 
September 30, 2007
 
    Number of shares
 
Weighted average grant date fair value
Nonvested at beginning of year
12,100
 
$  5.10
Granted
99,000
 
4.61
Vested
-
 
-
Forfeited
(6,050)
 
(5.10)
Nonvested at end of period
105,050
 
$ 4.64
 
During the three months ended September 30, 2007, $33,000 was recognized in compensation expense, with a 35% assumed tax benefit, for the Plan.  During the nine months ended September 30, 2007, $92,000 was recognized in compensation expense, with a 35% assumed tax benefit, for the Plan.  During the three months and nine months ended September 30, 2006, $5,000 and $10,000, respectively, was recognized in compensation expense for the Plan.
 
Note 3Reclassifications 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 share information) have been restated for a 10% stock dividend paid on April 17, 2007.
 
Note 4:  Recent Accounting Pronouncements

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. This statement amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement resolves issues addressed in Statement 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interest in Securitized Financial Assets. This Statement 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 adopted this guidance on January 1, 2007. The adoption did not have any effect on the Company’s financial position or results of operations.

11

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Asset- An Amendment of FASB Statement No. 140. This statement amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This statement requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. It also permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. The Company adopted this statement effective January 1, 2007. The adoption did not have a material effect on the Company’s financial position or results of operations.

In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. The adoption did not have any impact on the Company’s financial position or results of operations.

In September 2006, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) in Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF 06-4 applies to life insurance arrangements that provide an employee with a specified benefit that is not limited to the employee’s active service period, including certain bank-owned life insurance (“BOLI”) policies. EITF 06-4 requires an employer to recognize a liability and related compensation costs for future benefits that extend to postretirement periods. EITF 06-4 is effective for fiscal years beginning after December 15, 2007, with earlier application permitted. The Company is continuing to evaluate the impact of this consensus, which may require the Company to recognize an additional liability and compensation expense related to its deferred compensation agreements.

In September 2006, the FASB ratified the consensus reached by the EITF in Issue 06-5, Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance. Technical Bulletin No. 85-4 states that an entity should report as an asset in the statement of financial position the amount that could be realized under the insurance contract.  EITF 06-5 clarifies certain factors that should be considered in the determination of the amount that could be realized. EITF 06-5 is effective for fiscal years beginning after December 15, 2006, with earlier application permitted under certain circumstances. The Company adopted this guidance on January 1, 2007.  The adoption did not have any effect on the Company’s financial position or results of operations.

In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. FASB Statement 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 potential impact, if any, of the adoption of FASB Statement No. 157 on our consolidated financial position or results of operations.

In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements. SAB No. 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
 
12

No. 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 No. 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 adopted this guidance on January 1, 2007.  The adoption did not have any effect on the Company’s financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. An entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No.157. The Company is currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 159 on our consolidated financial position or results of operations.

In March 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10 “Accounting for Collateral Assignment Split-Dollar Life Insurance Agreements” (EITF 06-10). EITF 06-10 provides guidance for determining a liability for the postretirement benefit obligation as well as recognition and measurement of the associated asset on the basis of the terms of the collateral assignment agreement. EITF 06-10 is effective for fiscal years beginning after December 15, 2007. The Company is currently assessing the impact of EITF 06-10 on its consolidated financial position and results of operations.

In March 2007, the FASB ratified EITF Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” EITF 06-11 requires companies to recognize the income tax benefit realized from dividends or dividend equivalents that are charged to retained earnings and paid to employees for nonvested equity-classified employee share-based payment awards as an increase to additional paid-in capital. EITF 06-11 is effective for fiscal years beginning after September 15, 2007. The Company does not expect EITF 06-11 will have a material impact on its financial position, results of operations or cash flows.
 
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
 
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.
 
13

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, 2007, there were 264,842 stock options to purchase common stock, which were excluded from the computation of earnings per share because the option price was greater than the average market price.  No stock options were anti-dilutive at September 30, 2006.  The following tables are a comparison of EPS for the three months ended September 30, 2007 and 2006.  EPS has been restated for a stock dividend paid on April 17, 2007 (See Note 3).
 
Three months ended September 30,
 
2007
   
2006
 
                             
Net Income
  $
1,236,000
          $
2,435,000
       
           
Per
           
Per
 
   
Shares
   
Share
   
Shares
   
Share
 
Weighted average shares
                           
for period
   
10,344,662
           
10,441,591
       
Basic EPS
          $
0.12
            $
0.23
 
Add common stock equivalents
representing dilutive stock options
   
253,557
             
281,921
         
Effect on basic EPS of dilutive CSE
          $
-
            $
-
 
Equals total weighted average
                               
shares and CSE (diluted)
   
10,598,219
             
10,723,517
         
Diluted EPS
          $
0.12
            $
0.23
 

The following tables are a comparison of EPS for the nine months ended September 30, 2007 and 2006.  EPS has been restated for a stock dividend paid on April 17, 2007 (See Note 3).

Nine months ended September 30,
 
2007
   
2006
 
                         
Net Income
  $
5,308,000
          $
7,633,000
       
           
Per
           
Per
 
   
Shares
   
Share
   
Shares
   
Share
 
Weighted average shares
                           
for period
   
10,413,044
           
10,404,066
       
Basic EPS
          $
0.51
            $
0.73
 
Add common stock equivalents
representing dilutive stock options
   
284,577
             
280,547
         
Effect on basic EPS of dilutive CSE
          $ (0.01 )           $ (0.01 )
Equals total weighted average
                               
shares and CSE (diluted)
   
10,697,621
             
10,684,613
         
Diluted EPS
          $
0.50
            $
0.72
 


14

 
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, 2006, Quarterly Reports on Form 10-Q, filed by the Company in 2007 and 2006, and any Current Reports on Form 8-K filed by the Company, as well as other filings.

Financial Condition:

September 30, 2007 Compared to December 31, 2006
 
Assets increased $31.3 million to $1.04 billion at September 30, 2007, versus $1.01 billion at December 31, 2006. This increase reflected a $49.0 million increase in net loans partially offset by a $21.6 million decrease in investment securities and a $6.2 million decrease in cash and cash equivalents.
 
15

 
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 $49.0 million, to $833.0 million at September 30, 2007, versus $784.0 million at December 31, 2006. 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 typically range between $250,000 and $5,000,000 but customers may borrow significantly larger amounts up to the legal lending limit of approximately $13.3 million at September 30, 2007. Individual customers may have several loans that are secured by different collateral, which were in total subject to that lending limit.
 
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, municipal securities, and debt securities which include corporate bonds and trust preferred securities. Available-for-sale securities totaled $80.5 million at September 30, 2007, compared to $102.0 million at year-end 2006. The decrease reflected principal payments on U.S. government agency and mortgage backed securities. At September 30, 2007 and December 31, 2006, the portfolio had net unrealized losses of $321,000 and net unrealized gains of $427,000, 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 and stocks. At September 30, 2007, securities held to maturity totaled $281,000, compared to $333,000 at year-end 2006.
 
Restricted Stock:
 
Republic 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, 2007, FHLB stock totaled $10.3 million, an increase of $3.7 million from $6.7 million at December 31, 2006.
 
Republic is also required to maintain ACBB stock as a condition of a rarely used contingency line of credit.  At September 30, 2007 and December 31, 2006, ACBB stock totaled $143,000.
 
Cash and Cash Equivalents:
 
Cash and due from banks, interest bearing deposits and federal funds sold comprise this category which consists of the Company’s most liquid assets. The aggregate amount in these three categories decreased by $6.2 million, to $76.9 million at September 30, 2007, from $83.1 million at December 31, 2006, primarily reflecting a decrease in cash and due from banks.
 
Fixed Assets:
 
The balance in premises and equipment, net of accumulated depreciation, was $10.9 million at September 30, 2007, compared to $5.6 million at December 31, 2006, reflecting main office relocation expenditures and branch expansion.
 
16

Other Real Estate Owned:
 
Other real estate owned amounted to $42,000 at September 30, 2007 compared to $572,000 at December 31, 2006, as a result of sales of parcels of land in the second and third quarters of 2007.
 
Bank Owned Life Insurance:
 
The balance of bank owned life insurance amounted to $11.6 million at September 30, 2007 and $11.3 million at December 31, 2006. The income earned on these policies is reflected in non-interest income.
 
Other Assets:
 
Other assets increased by $1.3 million to $10.9 million at September 30, 2007, from $9.6 million at December 31, 2006, principally resulting from increases in the deferred tax asset related to market value changes in investment securities, prepaid expenses, and receivables.
 
Deposits:
 
Deposits, which include non-interest and interest-bearing demand deposits, money market, savings and time deposits including some 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.  Total deposits increased by $15.1 million to $769.9 million at September 30, 2007 from $754.8 million at December 31, 2006.  Average transaction account balances decreased 2.8% or $10.5 million from the prior year period to $365.1 million in the third quarter of 2007. Period end time deposits increased $41.8 million, or 11.3% to $410.6 million at September 30, 2007, versus $368.8 million at the prior year-end.  In addition, period end transaction deposits decreased $26.6 million, or 6.9% to $359.3 million at September 30, 2007 versus $386.0 million at December 31, 2006.
 
FHLB Borrowings and Overnight Advances:
 
FHLB borrowings and overnight advances are utilized as additional funding sources.   The Company had no term borrowings at September 30, 2007 and December 31, 2006.  The Company had short-term borrowings (overnight) of $168.4 million at September 30, 2007 versus $159.7 million at the prior year-end.
 
Subordinated debt:
 
Subordinated debt amounted to $11.3 million at September 30, 2007, compared to $6.2 million at December 31, 2006, as a result of a $5.2 million issuance of trust preferred securities in June 2007 at a rate of LIBOR plus 1.55%.
 
Shareholders’ Equity:
 
Total shareholders’ equity increased $3.6 million to $78.4 million at September 30, 2007, versus $74.7 million at December 31, 2006. This increase was primarily the result of year-to-date net income of $5.3 million partially offset by $1.3 million in stock repurchases and nine months other comprehensive loss of $494,000.


Three Months Ended September 30, 2007 compared to September 30, 2006
Results of Operations:

Overview

The Company's net income decreased to $1.2 million or $0.12 per diluted share for the three months ended September 30, 2007, compared to $2.4 million, or $0.23 per diluted share for the comparable
 
17

prior year period.  There was a $1.6 million, or 10.3%, increase in total interest income, reflecting a 12.8% increase in average loans outstanding and a 49.1% increase in average investment securities while interest expense increased $2.2 million, reflecting a 10.4% increase in average interest-bearing deposits outstanding and higher rates thereon as well as a 42.1% increase in average borrowed funds.   Accordingly, net interest income decreased $523,000 between the periods.  Contributing to the $523,000 decrease in net interest income was the impact of interest income reductions due to the increase in non-performing loans in the third quarter of 2007. The provision for loan losses in the third quarter of 2007 increased to $1.3 million, compared to no provision expense in the third quarter of 2006 due to an increase in non accrual loans in third quarter 2007 as well as an increase in reserves on certain loans due to a downturn in the housing market.  Non-interest income decreased $114,000 to $760,000 in third quarter 2007 compared to $874,000 in third quarter 2006. Non-interest expenses decreased $15,000 to $5.5 million compared to $5.5 million in the third quarter of 2006. Return on average assets and average equity of 0.50% and 6.29% respectively, in the third quarter of 2007 compared to 1.13% and 13.66% respectively for the same period in 2006.

18


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.  Interest income and yields are adjusted for tax equivalency for tax exempt municipal securities income.
 
   
For the three months ended      
   
For the three months ended      
 
   
September 30, 2007      
   
September 30, 2006      
 
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
  $
10,817
    $
139
      5.10 %   $
18,524
    $
248
      5.31 %
Securities
   
89,042
     
1,399
      6.28 %    
59,736
     
931
      6.23 %
Loans receivable
   
837,417
     
16,209
      4.68 %    
742,420
     
14,868
      7.95 %
Total interest-earning assets
   
937,276
     
17,747
      7.51 %    
820,680
     
16,047
      7.76 %
                                                 
Other assets
   
40,513
                     
36,593
                 
                                                 
Total assets
  $
977,789
                    $
857,273
                 
                                                 
Interest-bearing liabilities:
                                               
Demand-non interest
                                               
bearing
  $
80,646
                    $
78,942
                 
Demand interest-bearing
   
35,009
    $
109
      1.24 %    
54,003
    $
165
      1.21 %
Money market & savings
   
249,450
     
2,816
      4.48 %    
242,621
     
2,437
      3.99 %
Time deposits
   
358,192
     
4,750
      5.26 %    
285,448
     
3,476
      4.83 %
Total deposits
   
723,297
     
7,675
      4.21 %    
661,014
     
6,078
      3.65 %
Total interest-bearing
                                               
deposits
   
642,651
     
7,675
      4.74 %    
582,072
     
6,078
      4.19 %
                                                 
Other borrowings (1)
   
162,268
     
2,198
      5.37 %    
114,227
     
1,626
      5.65 %
                                                 
Total interest-bearing
                                               
liabilities
  $
804,919
    $
9,873
      4.87 %   $
696,299
    $
7,704
      4.39 %
Total deposits and
                                               
other borrowings
   
885,565
     
9,873
      4.42 %    
775,241
     
7,704
      3.94 %
                                                 
Non interest-bearing
                                               
liabilites
   
14,266
                     
11,309
                 
Shareholders' equity
   
77,958
                     
70,723
                 
Total liabilities and
                                               
shareholders' equity
  $
977,789
                    $
857,273
                 
                                                 
Net interest income
          $
7,874
                    $
8,343
         
Net interest spread
                    2.64 %                     3.37 %
                                                 
Net interest margin
                    3.33 %                     4.03 %
                                                 
(1) Includes $11.3 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, 2007
 
   
versus September 30, 2006   
 
   
(dollars in thousands)
 
   
Due to change in:
 
   
Volume
   
Rate
   
Total
 
Interest earned on:
                 
                   
          Federal funds sold
  $ (98 )   $ (11 )   $ (109 )
          Securities (1)
   
464
     
4
     
468
 
          Loans
   
1,839
      (498 )    
1,341
 
     Total interest-earning assets (1)
   
2,205
      (505 )    
1,700
 
                         
Interest expense of deposits
                       
         Interest-bearing demand deposits
   
59
      (3 )    
56
 
         Money market and savings
    (77 )     (303 )     (380 )
         Time deposits
    (964 )     (309 )     (1,273 )
     Total deposit interest expense
    (982 )     (615 )     (1,597 )
         Other borrowings
    (651 )    
79
      (572 )
              Total interest expense
    (1,633 )     (536 )     (2,169 )
Net interest income (1)
  $
572
    $ (1,041 )   $ (469 )
                         
(1) As adjusted for tax equivalency for tax exempt municipal securities income
         

The Company’s tax equivalent net interest margin decreased 70 basis points to 3.33% for the three months ended September 30, 2007, versus 4.03% in the prior year comparable period.

While yields on interest-bearing assets decreased 25 basis points to 7.51% in third quarter 2007 from 7.76% in third quarter 2006, the yield on total deposits and other borrowings increased 48 basis points to 4.42% from 3.94% between those respective periods. The decrease in yields on assets resulted primarily from interest income reductions due to the increase in non-performing loans in third quarter 2007.  The increase in yields on deposits was due to the repricing of maturing time deposits at higher rates and increases in rates on money market and savings deposits.
 
The Company's tax equivalent net interest income decreased $469,000, or 5.6%, to $7.9 million for the three months ended September 30, 2007, from $8.3 million for the prior year comparable period. As shown in the Rate Volume table above, the decrease in net interest income was due primarily to higher rates on deposits and lower rates on loans as discussed in the previous paragraph.  These factors more than offset the increased income from growth in average interest-earning assets, primarily loans. Average interest-earning assets amounted to $937.3 million for third quarter 2007 and $820.7 million for third quarter 2006.  The $116.6 million increase resulted from loan growth of $95.0 million and securities growth of $29.3 million.
 
The Company’s total tax equivalent interest income increased $1.7 million, or 10.6%, to $17.7 million for the three months ended September 30, 2007, from $16.0 million for the prior year comparable period.  Interest and fees on loans increased $1.3 million, or 9.0%, to $16.2 million for the three months ended September 30, 2007, from $14.9 million for the prior year comparable period.  A total gross increase in interest and fees on loans reflected a 12.8% increase in average loans outstanding less interest reductions due to increase in non-performing loans from $10.0 million at September 30, 2006 to $25.4 million at September 30, 2007.  Interest and dividends on investment securities increased $468,000 to $1.4 million for the three months ended September 30, 2007, from $931,000 for the prior year comparable period.  This increase reflected an increase in average securities outstanding of $29.3 million, or 49.1%, to $89.0 million from $59.7 million for the prior year comparable period.  Interest on federal funds sold and other interest-earning assets decreased $109,000, or 44.0%, due to the $7.7 million decrease in average balances to $10.8 million for third quarter 2007 from $18.5 million for the comparable prior year period.
 
20

The Company's total interest expense increased $2.2 million, or 28.2%, to $9.9 million for the three months ended September 30, 2007, from $7.7 million for the prior year comparable period. Interest-bearing liabilities averaged $804.9 million for the three months ended September 30, 2007, versus $696.3 million for the prior year comparable period, or an increase of $108.6 million. The increase reflected additional funding utilized for loan growth and securities growth. Average deposit balances increased $62.3 million and average other borrowings increased $48.0 million. The average rate paid on interest-bearing liabilities increased 48 basis points to 4.87% for the three months ended September 30, 2007. Interest expense on time deposit balances increased $1.3 million to $4.8 million in third quarter 2007, from $3.5 million in the comparable prior year period.  Money market and savings interest expense increased $379,000 to $2.8 million in third quarter 2007, from $2.4 million in the comparable prior year period. The increase in interest expense on deposits reflected higher average deposit balances as well as higher interest rates, as detailed in the rate/volume table.  Short-term interest rates decreased 50 basis points in September 2007 but the potential impact on deposit rates will be delayed as time deposits mature. Accordingly, rates on total interest-bearing deposits increased 55 basis points in third quarter 2007 compared to third quarter 2006.

Interest expense on other borrowings increased $572,000 to $2.2 million in third quarter 2007, as a result of increased average balances. Average other borrowings, primarily overnight FHLB borrowings, increased $48.0 million, or 42.1%, between those respective periods. These increases in balances, along with the increase in average deposits, reflected additional funding utilized for loan growth.  Rates on other borrowings, partially due to the 50 basis point decrease in short-term interest rates in September 2007, decreased to 5.37% in third quarter 2007, from 5.65% in the comparable prior year period. Interest expense on other borrowings also includes the expense from $11.3 million of average 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. The provision for loan losses amounted to $1.3 million in third quarter 2007 compared to $0 in third quarter 2006.  The Company increased its provision for loan losses $952,000 for loans transferred to non accrual status in third quarter 2007 and $546,000 for increases in reserves on certain loans due to a downtown in the housing market.  The provision in both periods also reflected amounts required to increase the allowance for loan growth in accordance with the Company’s methodology.  Total non-accrual loans increased from $16.6 million at June 30, 2007 to $25.4 million at September 30, 2007.  The comparable third quarter 2006 provision reflected the impact of $154,000 for recoveries on tax refund loans.

Non-Interest Income

Total non-interest income decreased $114,000 to $760,000 for third quarter 2007 compared to $874,000 for the three months ended September 30, 2006, primarily due to a $122,000 decrease in other income, primarily related to legal fee recoveries recorded in third quarter 2006.  A $183,000 gain on the sale of OREO property in third quarter 2007 was partially offset by a $130,000 gain on the sale of OREO property in third quarter 2006.  In addition, loan advisory and servicing fees decreased $38,000, or 19.6%, to $156,000 in third quarter 2007, compared to third quarter 2006 due to lower advisory fee income, and service fees on deposit accounts decreased $20,000, or 6.5%, to $289,000 in third quarter 2007, versus $309,000 for the comparable prior year period reflecting the termination of services to several large customers.
 
Non-Interest Expenses
 
Total non-interest expenses decreased $15,000 or 0.3% to $5.5 million for the three months ended September 30, 2007, from $5.5 million for the prior year comparable period. Salaries and employee
 
21

benefits decreased $370,000 or 12.0%, to $2.7 million for the three months ended September 30, 2007, from $3.1 million for the prior year comparable period. That decrease primarily reflected a reduction in bonus and incentive expense of $448,000 partially offset by $100,000 in one-time costs related to staff reductions.
 
Occupancy expense increased $206,000, or 42.7%, to $688,000 in third quarter 2007, compared to $482,000 in third quarter 2006. The increase reflected the corporate headquarters move in second quarter 2007 as well as one additional branch which opened in the third quarter of 2007.
 
Depreciation expense increased $94,000 or 37.2% to $347,000 for the three months ended September 30, 2007, versus $253,000 for the prior year comparable period.  The increase was primarily due to the impact of the corporate headquarters move and the additional branch location.
 
Legal fees increased $21,000, or 14.5%, to $166,000 in third quarter 2007, compared to $145,000 in third quarter 2006, resulting from increased fees on a number of different matters.
 
Advertising expense decreased $32,000, or 18.5%, to $141,000 in third quarter 2007, compared to $173,000 in third quarter 2006.  The decrease was primarily due to higher levels of advertising in 2006 centered on two additional branches which opened in the second and third quarters of 2006.
 
Data processing expense increased $59,000, or 52.2%, to $172,000 in third quarter 2007, compared to $113,000 in third quarter 2006, primarily due to Check 21 related expenses and other system enhancements.
 
Insurance expense increased $10,000, or 10.4%, to $106,000 in third quarter 2007, compared to $96,000 in third quarter 2006, resulting from the overall growth of the Company.
 
Professional fees decreased $15,000, or 10.4%, to $129,000 in third quarter 2007, compared to $144,000 in third quarter 2006, reflecting decreases in recruiting expenses.
 
Taxes, other increased $28,000, or 15.9%, to $204,000 for the three months ended September 30, 2007, versus $176,000 for the comparable prior year period.  The increase reflected an increase in Pennsylvania shares tax, which is assessed at an annual rate of 1.25% on a 6 year moving average of regulatory capital.  The full amount of the increase resulted from increased capital.
 
 Other expenses decreased $19,000, or 2.3% to $819,000 for the three months ended September 30, 2007, from $838,000 for the prior year comparable period.
 


22


Provision for Income Taxes
 
The provision for income taxes decreased $705,000, to $558,000 for the three months ended September 30, 2007, from $1.3 million for the prior year comparable period. That decrease was primarily the result of the decrease in pre-tax income.  The effective tax rates in those periods were 31% and 34% respectively.  The reduction in the third quarter 2007 effective tax rate was due to the higher amount of tax exempt income in 2007.
 

Nine Months Ended September 30, 2007 compared to September 30, 2006
Results of Operations:

Overview

The Company's net income decreased to $5.3 million or $0.50 per diluted share for the nine months ended September 30, 2007, compared to $7.6 million, or $0.72 per diluted share for the comparable prior year period.  There was a $6.3 million, or 13.7%, increase in total interest income, reflecting a 14.6% increase in average loans outstanding and a 104.1% increase in average investment securities while interest expense increased $9.2 million, reflecting a 14.8% increase in average interest-bearing deposits outstanding and higher rates thereon as well as a 60.7% increase in average borrowings outstanding.  Accordingly, net interest income decreased $2.9 million between the periods.  Contributing to the $2.9 million decrease in net interest income was the impact of $1.6 million in net interest income related to tax refund loans in 2006 which was not earned in the first nine months of 2007 due to the discontinuation of the program. Also there were interest reductions due to the increase in non-performing loans in the first nine months of 2007. The provision for loan losses in the first nine months of 2007 increased $51,000 to $1.4 million, compared to $1.4 million provision expense in the first nine months of 2006, reflecting the impact of a 2007 increase in the provision for loan losses due to an increase in non accrual loans in 2007 as well as an increase in reserves on certain loans due to a downturn in the housing market which was offset by $256,000 of net tax refund recoveries in first nine months of 2007 and $646,000 in net tax refund charge-offs in first nine months of 2006.  Non-interest income decreased $678,000 to $2.2 million in first nine months of 2007 compared to $2.8 million in first nine months of 2006 reflecting decreases in advisory fees on loans and service charges on deposit accounts.  Non-interest expenses increased $100,000 to $15.8 million compared to $15.7 million in the first nine months of 2006. Return on average assets and average equity of 0.73% and 9.21% respectively, in the first nine months of 2007 compared to 1.24% and 15.01% respectively for the same period in 2006.

23

 
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.  Interest income and yields are adjusted for tax equivalency for tax exempt municipal securities income.

   
For the nine months ended   
   
For the nine months ended   
 
   
September 30, 2007      
   
September 30, 2006      
 
Interest-earning assets:
                                   
         
Interest
               
Interest
       
(Dollars in thousands)
 
Average
   
Income/
   
Yield/
   
Average
   
Income/
   
Yield/
 
   
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
 
Federal funds sold