rfb10qq208.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: June 30, 2008

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, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ____
Accelerated Filer X
 
Non-Accelerated filer ____
Smaller reporting company ____
 


      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
 
YES____
NO  X
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.
10,973,634 shares of Issuer's Common Stock, par value
$0.01 per share, issued and outstanding as of August 7, 2008

Page 1

Exhibit index appears on page 39



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 June 30, 2008 (unaudited) and December 31, 2007
   
Consolidated Statements of Operations for the three and six months ended
 
June 30, 2008 and 2007 (unaudited)
   
Consolidated Statement of Changes in Shareholders’ Equity for the six months ended
June 30, 2008 and 2007 (unaudited)
 
Consolidated Statements of Cash Flows for the six months ended
 
June 30, 2008 and 2007 (unaudited)
   
Notes to Consolidated Financial Statements (unaudited)
   




 
3

 

Republic First Bancorp, Inc. and Subsidiary
Consolidated Balance Sheets
As of June 30, 2008 and December 31, 2007
(Dollars in thousands, except share data)

ASSETS:
 
June 30, 2008
   
December 31, 2007
 
    (unaudited)  
Cash and due from banks
  $ 14,738     $ 10,996  
Interest bearing deposits with banks
    368       320  
Federal funds sold
    8,867       61,909  
Total cash and cash equivalents
    23,973       73,225  
                 
Investment securities available for sale, at fair value
    79,700       83,659  
Investment securities held to maturity, at amortized cost
               
     (Fair value of $269 and $285,  respectively)
    257       282  
Restricted stock, at cost
    4,615       6,358  
Loans receivable (net of allowance for loan losses of
               
     $6,760 and $8,508, respectively)
    784,115       813,041  
Premises and equipment, net
    12,359       11,288  
Other real estate owned, net
    14,245       3,681  
Accrued interest receivable
    4,193       5,058  
Bank owned life insurance
    11,931       11,718  
Other assets
    12,201       7,998  
Total Assets
  $ 947,589     $ 1,016,308  
LIABILITIES AND SHAREHOLDERS' EQUITY:
               
Liabilities:
               
Deposits:
               
Demand – non-interest-bearing
  $ 77,404     $ 99,040  
Demand – interest-bearing
    30,167       35,235  
Money market and savings
    239,314       223,645  
Time less than $100,000
    204,084       179,043  
Time over $100,000
    177,590       243,892  
    Total Deposits
    728,559       780,855  
                 
Short-term borrowings
    86,069       133,433  
Other borrowings
    25,000       -  
Accrued interest payable
    3,408       3,719  
Other liabilities
    3,678       6,493  
Subordinated debt
    22,476       11,341  
Total Liabilities
    869,190       935,841  
Shareholders’ Equity:
               
Preferred stock, par value $0.01 per share: 10,000,000 shares authorized;
               
    no shares issued as of June 30, 2008 and December 31, 2007
    -       -  
Common stock par value $0.01 per share, 20,000,000 shares authorized;
               
    shares issued 10,973,634 as of June 30, 2008
               
    and 10,737,211 as of December 31, 2007
    110       107  
Additional paid in capital
    76,016       75,321  
Retained earnings
    7,338       8,927  
Treasury stock at cost (416,303 shares)
    (2,993 )     (2,993 )
Stock held by deferred compensation plan
    (1,165 )     (1,165 )
Accumulated other comprehensive income (loss)
    (907 )     270  
Total Shareholders’ Equity
    78,399       80,467  
Total Liabilities and Shareholders’ Equity
  $ 947,589     $ 1,016,308  

(See notes to unaudited consolidated financial statements)

4



Republic First Bancorp, Inc. and Subsidiary
Consolidated Statements of Operations
For the Three and Six Months Ended June 30, 2008 and 2007
(Dollars in thousands, except share data)
(unaudited)

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2008
   
2007
   
2008
   
2007
 
Interest income:
                       
   Interest and fees on loans
  $ 12,160     $ 15,657     $ 25,613     $ 30,957  
   Interest and dividends on taxable investment securities
    1,004       1,236       2,142       2,654  
   Interest and dividends on tax-exempt investment securities
    106       125       220       249  
   Interest on federal funds sold and other interest-earning assets
    58       169       154       404  
   Total interest income
    13,328       17,187       28,129       34,264  
                                 
Interest expense:
                               
   Demand interest-bearing
    69       118       215       218  
   Money market and savings
    1,371       3,532       3,038       6,554  
   Time less than $100,000
    2,176       1,861       4,229       3,681  
   Time over $100,000
    1,993       2,789       4,380       5,240  
   Other borrowings
    715       1,377       2,041       3,496  
      6,324       9,677       13,903       19,189  
Net interest income
    7,004       7,510       14,226       15,075  
Provision for loan losses
    43       63       5,855       143  
Net interest income after provision  for loan losses
    6,961       7,447       8,371       14,932  
                                 
                                 
Non-interest income:
                               
    Loan advisory and servicing fees
    38       347       150       559  
    Service fees on deposit accounts
    297       280       584       582  
    Mastercard transaction
    309       -       309       -  
    Legal settlement
    -       -       100       -  
    Gains on sales and calls of investment securities
    -       -       5       -  
    Gain on sale of other real estate owned
    -       2       -       2  
    Bank owned life insurance income
    105       102       213       203  
    Other income
    87       24       140       49  
      836       755       1,501       1,395  
Non-interest expenses:
                               
   Salaries and employee benefits
    2,703       2,545       5,433       5,161  
   Occupancy
    595       604       1,198       1,141  
   Depreciation and amortization
    339       355       665       689  
   Legal
    274       195       471       272  
   Writedown/ loss on sale of other real estate owned
    40       -       1,056       -  
   Other real estate
    342       17       342       20  
   Advertising
    149       159       278       244  
   Data processing
    203       155       406       314  
   Insurance
    148       94       252       187  
   Professional fees
    144       124       243       250  
   Regulatory assessments and costs
    178       52       230       87  
   Taxes, other
    251       211       512       414  
   Other expenses
    695       772       1,423       1,499  
      6,061       5,283       12,509       10,278  
                                 
Income (loss) before provision for income tax (benefit) expense
    1,736       2,919       (2,637 )     6,049  
Provision (benefit) for income taxes
    547       951       (1,048 )     1,977  
                                 
Net income (loss)
  $ 1,189     $ 1,968     $ (1,589 )   $ 4,072  
                                 
Net income (loss) per share:
                               
Basic
  $ 0.11     $ 0.19     $ (0.16 )   $ 0.39  
Diluted
  $ 0.11     $ 0.18     $ (0.16 )   $ 0.38  
(See notes to unaudited consolidated financial statements)
 

 
5

 


Republic First Bancorp, Inc. and Subsidiary
Consolidated Statements of Changes in Shareholders’ Equity
For the Six Months Ended June 30, 2008 and 2007
(Dollars in thousands, except share data)
                (unaudited)

   
 
Comprehensive
Income (Loss)
   
 
Common
Stock
   
Additional
Paid in
Capital
   
 
Retained
Earnings
   
 
Treasury Stock
   
Stock Held by
Deferred
Compensation
Plan
   
Accumulated
Other
Comprehensive
Income
   
Total
Shareholders’
Equity
 
                                                 
                                                 
Balance January 1, 2008
        $ 107     $ 75,321     $ 8,927     $ (2,993 )   $ (1,165 )   $ 270     $ 80,467  
 
Total other comprehensive loss, net of taxes of $(606)
  $ (1,177 )                                   (1,177 )     (1,177 )
Net loss
    (1,589 )                 (1,589 )                       (1,589 )
                                                                 
Total comprehensive loss
  $ (2,766 )                                                        
Stock based compensation
                  75                               75  
Options exercised
(236,423 shares)
            3       620                               623  
Balance June 30, 2008
          $ 110     $ 76,016     $ 7,338     $ (2,993 )   $ (1,165 )   $ (907 )   $ 78,399  

   
 
Comprehensive
Income
   
 
Common
Stock
   
Additional
Paid in
Capital
   
 
Retained
Earnings
   
 
Treasury Stock
   
Stock Held by
Deferred
Compensation
Plan
   
Accumulated
Other
Comprehensive
Income
   
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 $(513)
  $ (996 )                                   (996 )     (996 )
Net income
    4,072                   4,072                         4,072  
                                                                 
Total comprehensive income
  $ 3,076                                                          
Stock based compensation
                  59                               59  
Stock dividend
(974,441 shares)
            10       11,459       (11,469 )                        
Options exercised
(15,067 shares)
                  36                               36  
Purchase of treasury shares
(44,500 shares)
                              (436 )                 (436 )
                                                                 
Balance June 30, 2007
          $ 107     $ 74,896     $ 6,114     $ (2,124 )   $ (810 )   $ (714 )   $ 77,469  

 (See notes to unaudited consolidated financial statements)

 
6

 

Republic First Bancorp, Inc. and Subsidiary
 
Consolidated Statements of Cash Flows
 
For the Six Months Ended June 30, 2008 and 2007
 
Dollars in thousands
 
(unaudited)
 
             
     
Six months ended
 
     
June 30,
 
     
2008
   
2007
 
Cash flows from operating activities:
             
Net income (loss)
    $ (1,589 )   $ 4,072  
Adjustments to reconcile net income (loss) to net
               
cash provided by operating activities:
               
Provision for loan losses
      5,855       143  
Writedown/ loss (gain) on sale of other real estate owned
    1,056       (2 )
Depreciation  and amortization
    665       689  
Stock based compensation
      75       59  
Amortization of discounts on investment securities
    (108 )     (72 )
Increase in value of bank owned life insurance
    (213 )     (203 )
Increase in accrued interest receivable and other assets
    (459 )     (595 )
Increase (decrease) in accrued interest payable and other liabilities
    (3,126 )     2,401  
Net cash provided by operating activities
    2,156       6,492  
Cash flows from investing activities:
                 
Purchase of securities:
                 
Available for sale
      (6,363 )     (886 )
Proceeds from maturities and calls of securities:
               
Held to maturity
      25       42  
Available for sale
      8,647       22,517  
Purchase of FHLB stock
      -       (816 )
Proceeeds from sale of FHLB stock
    1,743          
Net decrease (increase) in loans
      1,687       (45,078 )
Net proceeds from sale of other real estate owned
    7,491       75  
Premises and equipment expenditures
    (1,736 )     (3,554 )
Net cash provided by (used in) investing activities
    11,494       (27,700 )
Cash flows from financing activities:
                 
Net proceeds from exercise of stock options
    623       36  
Purchase of treasury shares
      -       (436 )
Net (decrease) increase in demand, money market and savings deposits
    (11,035 )     10,987  
Net decrease in short term borrowings
    (47,364 )     (37,932 )
Increase in other borrowings
      25,000       -  
Issuance of subordinated debt
      11,135       5,155  
Net increase (decrease) in time deposits
    (41,261 )     32,410  
Net cash (used in) provided by financing activities
    (62,902 )     10,220  
Decrease in cash and cash equivalents
      (49,252 )     (10,988 )
Cash and cash equivalents, beginning of period
    73,225       83,127  
Cash and cash equivalents, end of period
    $ 23,973     $ 72,139  
Supplemental disclosure:
                 
Interest paid
    $ 14,214     $ 17,374  
Taxes paid
    $ 400     $ 2,150  
Non-monetary transfers from loans to other real estate owned
  $ 21,384     $ -  
Non-monetary transfers from other real estate owned to other assets
  $ 2,273     $ -  
 
(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.
 
Republic shares data processing, accounting, human resources and compliance services with a previously affiliated entity through BSC Services Corp. (”BSC”).  BSC allocates its cost on the basis of usage to Republic which classifies 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 six month periods ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ended December 31, 2008. 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 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 June 30, 2008, 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
 
9

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 has a maximum term of 10 years.  The Black-Sholes option pricing model is utilized to determine the fair market value of stock options.  In 2008 the following assumptions were utilized; a dividend yield of 0%; expected volatility of 24.98%; a risk-free interest rate of 3.08% and an expected life of 7.0 years.  In 2007 the following assumptions were utilized; a 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 six months of 2008, but expense is recognized ratably over the period required to vest.  There were 105,050 unvested options at January 1, 2008 with a fair value of $486,885 with $346,012 of that amount remaining to be recognized as expense.  At June 30, 2008, there were 135,050 unvested options with a fair value of $494,275 with $310,622 of that amount remaining to be recognized as expense. At that date, the intrinsic value of the 448,572 options outstanding was $487,221, while the intrinsic value of the 313,522 exercisable (vested) was $430,577. During the first six months of 2008, 22,000 nonvested options were forfeited, with a weighted average grant fair value of $101,340.

A summary of the status of the Company’s stock options under the Stock Option Plan as of June 30, 2008 and 2007 and changes during the six months ended June 30, 2008 and 2007 are presented below:

   
For the Six Months Ended June 30,
 
   
2008
   
2007
 
   
Shares
   
Weighted
Average
Exercise
Price
   
Shares
   
Weighted
Average
Exercise
Price
 
Outstanding, beginning of year
    737,841     $ 6.39       661,449     $ 5.55  
Granted
    52,000       6.18       99,000       11.77  
Exercised
    (236,423 )     2.63       (15,067 )     2.42  
Forfeited
    (104,846 )     8.72       (6,050 )     12.14  
Outstanding, end of period
    448,572       7.80       739,332       6.39  
Options exercisable at period-end
    313,522       7.01       634,282       5.50  
Weighted average fair value of options granted during the period
          $ 2.11             $ 4.61  

   
For the Six Months Ended
 June 30,
 
   
2008
   
2007
 
Number of options exercised
    236,426       15,067  
Cash received
  $ 622,559     $ 36,413  
Intrinsic value
    621,816       115,589  
Tax benefit
    217,636       40,456  


10

 

The following table summarizes information about options outstanding under the Stock Option Plan as of June 30, 2008.

   
 
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
28,324
 
2.5
 
$ 1.81
     
28,324
 
$ 1.81
$2.72 to $3.12
23,106
 
3.4
 
2.80
     
23,106
 
2.80
$3.76  to $4.62
12,964
 
2.1
 
3.99
     
12,964
 
3.99
$5.99  to $6.74
180,202
 
6.7
 
6.22
     
128,202
 
6.24
$9.94 to $12.14
203,976
 
7.6
 
10.84
     
120,926
 
10.17
 
448,572
     
$ 7.80
     
313,522
 
$7.01



   
For the Six Months Ended,
 
   
June 30, 2008
 
   
Number of shares
   
Weighted average grant date fair value
 
Nonvested at beginning of year
    105,050     $ 4.64  
Granted
    52,000       2.11  
Forfeited
    (22,000 )     4.61  
Nonvested at end of period
    135,050     $ 3.66  

 
During the three months ended June 30, 2008, $40,000 was recognized in compensation expense, with a 35% assumed tax benefit, for the Stock Option Plan.  During the six months ended June 30, 2008, $75,000 was recognized in compensation expense, with a 35% assumed tax benefit for the Stock Option Plan.  During the three months ended June 30, 2007, $33,000 was recognized in compensation expense, with a 35% assumed tax benefit for the Stock Option Plan.  During the six months ended June 30, 2007, $59,000 was recognized in compensation expense, with a 35% assumed tax benefit, for the Stock Option Plan.


 Note 3:Reclassifications

     None

Note 4:                      Recent Accounting Pronouncements

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,
 
11

2007, with earlier application permitted. 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. The adoption did not have any effect on the Company’s 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 adoption did not have any effect on the Company’s financial position or results of operations.

In December 2007, the FASB issued SFAS No. 141 (R), Business Combinations.  This statement establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree.  The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.  The guidance will become effective as of the beginning of a company’s fiscal year beginning after December 15, 2008.  The new pronouncement will impact the Company’s accounting for business combinations completed beginning January 1, 2009.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements- an amendment of ARB No. 51.  This statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.    The guidance will become effective as of the beginning of a company’s fiscal year beginning after December 15, 2008.  The company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements.

In December 2007, the SEC issued SAB No. 110 which amends and replaces Question 6 of Section D.2 of Topic 14, Share-Based Payment, of the Staff Accounting Bulletin series.  Question 6 of Section D.2 of Topic 14 expresses the views of the staff regarding the use of the “simplified” method in developing an estimate of expected term of “plain vanilla” share options and allows usage of the “simplified” method for share option grants prior to December 31, 2007.  SAB 110 allows public companies which do not have historically sufficient experience to provide a reasonable estimate to continue use of the “simplified” method for estimating the expected term of “plain vanilla” share option grants after December 31, 2007.  SAB 110 is effective January 1, 2008.  The adoption did not have any effect on the Company’s financial position or results of operations.

In December 2007, the SEC issued SBA No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings expresses the views of the staff regarding written loan commitments that are accounted for at fair value through earnings under generally accepted accounting principles.  To make the staff’s views consistent with current authoritative accounting guidance, the SAB revises and rescinds portions of SAB No. 105, Application of Accounting Principles to Loan Commitments.  Specifically, the SAB revises the SEC staff’s views on incorporating expected net future cash flows related to loan servicing activities in the fair value measurement of a written loan commitment.  The SAB retains the staff’s views on incorporating expected net future cash flows related to internally-developed intangible assets in the fair value measurement of a written loan commitment.  The staff expects registrants to
 
12

apply the views in Question 1 of SAB 109 on a prospective basis to derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007.  The adoption did not have any effect on the Company’s financial position or results of operations.

In June 2007, the EITF reached a consensus on Issue no. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (EITF 06-11).  EITF 06-11 states that an entity should recognize a realized tax benefit associated with dividends on nonvested equity shares, nonvested equity share units and outstanding equity share options charged to retain earnings as an increase in additional paid in capital.  The amount recognized in additional paid in capital should be included in the pool of excess tax benefits available to absorb potential future tax deficiencies on share-based payment awards.  EITF 06-11 should be applied prospectively to income tax benefits of dividends on equity-classified share-based payment awards that are declared in fiscal years beginning after December 15, 2007.  The adoption did not have any effect on the Company’s financial position or results of operations.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.”  This Statement identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements.  This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.”  The Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of the Useful Life of Intangible Assets.”  This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”).  The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141R, and other GAAP.  This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited.  The Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements.

In May 2008, the FASB issued FASB Staff Position (FSP) APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)" which clarifies the accounting for convertible debt instruments that may be settled in cash (including partial cash settlement) upon conversion.  The FSP requires issuers to account separately for the liability and equity components of certain convertible debt instruments in a manner that reflects the issuer's nonconvertible debt borrowing rate when interest cost is recognized.  The FSP requires bifurcation of a component of the debt, classification of that component in equity and the accretion of the resulting discount on the debt to be recognized as part of interest expense.  The FSP requires retrospective application to the terms of instruments as they existed for all periods presented.  The FSP is effective for fiscal years beginning after December 15, 2008, and interim periods within those years.  Early adoption is not permitted.  The Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements.

In June 2008, the FASB issued FASB Staff Position (FSP) EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.”  This FSP clarifies that all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends participate in undistributed earnings with common shareholders.  Awards of this nature are considered participating securities and the two-class method of computing basic and diluted earnings per share must be applied.  This FSP is effective for fiscal years beginning after December 15, 2008.  The
 
13

Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements.


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.
 

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 and convertible debt resulting from the trust preferred securities issuance in June 2008. 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 June 30, 2008, there were 384,178 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.  At June 30, 2007, there were 130,460 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.   The following tables are a comparison of EPS for the three months ended June 30, 2008 and 2007.


Three months ended June 30,
 
2008
   
2007
 
                         
Net Income
  $ 1,189,000           $ 1,968,000        
           
Per
           
Per
 
   
Shares
   
Share
   
Shares
   
Share
 
Weighted average shares
                           
for period
    10,445,181             10,448,394        
Basic EPS
          $ 0.11             $ 0.19  
                                 
Add common stock equivalents
representing dilutive stock options and convertible debt
    416,948               289,924          
Effect on basic EPS of dilutive CSE
          $ -             $ (0.01 )
Equals total weighted average
                               
shares and CSE (diluted)
    10,862,129               10,738,318          
Diluted EPS
          $ 0.11             $ 0.18  


14

 
The following tables are a comparison of EPS for the six months ended June 30, 2008 and 2007.

Six months ended June 30,
 
2008
   
2007
 
                         
Net Income (Loss)
  $ (1,589,000 )         $ 4,072,000        
           
Per
           
Per
 
   
Shares
   
Share
   
Shares
   
Share
 
Weighted average shares
                           
for period
    10,404,279             10,447,236        
Basic EPS
          $ (0.16 )           $ 0.39  
Add common stock equivalents
representing dilutive stock options and convertible debt
    288,749               301,692          
Effect on basic EPS of dilutive CSE
          $ -             $ (0.01 )
Equals total weighted average
                               
shares and CSE (diluted)
    10,693,028               10,748,928          
Diluted EPS
          $ (0.16 )           $ 0.38  


Note 8:      Fair Value of Financial Instruments:
    SFAS No.157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS No.157 are described below:
 
Basis of Fair Value Measurement:

    Level 1 – Unadjusted quoted prices in active markets that are accessible at the measurement date for  identical, unrestricted assets or liabilities;
    Level 2 – Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability;
    Level 3 – Prices or valuation techniques that require inputs that are both significant to the fair value measurement and observable (i.e., supported by little or no market activity).

    A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

     The Company’s cash instruments are generally classified within level 1 or level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.

     The types of instruments valued based on quoted market prices in active markets include all of the Company’s U.S. government and agency securities, municipal obligations and corporate bonds and trust preferred securities. Such instruments are generally classified within level 1 or level 2 of the fair value hierarchy. As required by SFAS No. 157, the Bank does not adjust the quoted price for such instruments.

     The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of transparency for securities
 
15

which the bank owns may include investment- grade corporate bonds, municipal obligations, and trust preferred securities. Such instruments are generally classified within level 2 of the fair value hierarchy.

      Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, and may be adjusted to reflect illiquidity and/or non-transferability, with such adjustment generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows. The Company does not have any such securities at present.

The Company’s investment securities classified as available for sale were accounted for at fair values as of June 30, 2008 by level within the fair value hierarchy as follows: Quoted Prices in Active Markets for Identical Assets (Level 1) $67.7 million; Significant Other Observable Inputs (Level 2) $12.0 million; Significant Unobservable Inputs (Level 3) $0.   The Company’s other real estate owned was accounted for at fair values as of June 30, 2008 as follows:  Significant Unobservable Inputs (Level 3) $14.2 million.  As required by SFAS No. 157, financial assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Note 9:  Convertible Trust Preferred Securities

The Company issued $10.8 million of convertible trust preferred securities in June 2008 as part of the Company’s strategic capital plan.  The securities were purchased by various investors, including Vernon W. Hill, II ($7.8 million) and Harry D. Madonna ($3.0 million), Chairman, President and Chief Executive Officer of the Company.  Republic First Capital Trust IV (“RFCT”) holds, as its sole asset, the subordinated debentures issued by the Company in June 2008.  The Company does not consolidate the RFCTs.  The non-consolidation results in the investment in the common stock of the RFCT to be included in other assets with a corresponding increase in outstanding debt of $335,000 at June 30, 2008.
The trust preferred securities will pay interest at an annual rate of 8.0%, have a conversion price of $6.50, and be convertible into 1.7 million shares of common stock.  This represents ownership of approximately 13.3% of the Company on a pro forma basis.  The trust preferred securities will have a term of 30 years and will be callable after the fifth year.  The securities will be convertible into common shares anytime after June 30, 2009 at the option of the purchaser and under certain conditions prior to June 30, 2009.  The issuer will also retain certain option conversion triggers after the fifth year.


16

 

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, 2007, Quarterly Reports on Form 10-Q, filed by the Company in 2008 and 2007, and any Current Reports on Form 8-K filed by the Company, as well as other filings.

Financial Condition:

June 30, 2008 Compared to December 31, 2007
 
Assets decreased $68.7 million to $947.6 million at June 30, 2008, versus $1.0 billion at December 31, 2007. This decrease reflected a $49.3 million decrease in cash and cash equivalents, a $28.9 million decrease in loans receivable partially offset by a $10.6 million increase in other real estate owned.

 
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. Gross loans decreased $30.7 million, to $790.9 million at June 30, 2008, versus $821.5 million at December 31, 2007, as the Company adopted a defensive balance sheet strategy as a result of the economic downturn.  Meaningful loan growth is anticipated by year end 2008. Substantially all of the decrease 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 $15.0 million at June 30, 2008. Individual customers may have several loans that are secured by different collateral, which were in total subject to that lending limit.
 
17

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 $79.7 million at June 30, 2008, compared to $83.7 million at year-end 2007. The decrease reflected sales on selected municipal securities. At June 30, 2008 and December 31, 2007, the portfolio had net unrealized losses of $1.4 million and net realized gains of $409,000, 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 June 30, 2008, securities held to maturity totaled $257,000, compared to $282,000 at year-end 2007.
 
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 June 30, 2008, FHLB stock totaled $4.5 million, a decrease of $1.7 million from $6.2 million at December 31, 2007.
 
Republic is also required to maintain ACBB stock as a condition of a rarely used contingency line of credit.  At June 30, 2008 and December 31, 2007, 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 $49.3 million, to $24.0 million at June 30, 2008, from $73.2 million at December 31, 2007, primarily reflecting a decrease in federal funds sold.
 
Fixed Assets:
 
The balance in premises and equipment, net of accumulated depreciation, was $12.4 million at June 30, 2008, compared to $11.3 million at December 31, 2007, reflecting primarily branch expansion.
 
Other Real Estate Owned:
 
Other real estate owned amounted to $14.2 million at June 30, 2008 compared to $3.7 million at December 31, 2007, primarily reflecting transfers from loans of $21.4 million, partially offset by net proceeds from sales of $7.5 million, a transfer of $2.3 million to other assets reflecting a sale of OREO property still pending settlement and $1.1 million in property writedowns and losses on sales.
 
Bank Owned Life Insurance:
 
The balance of bank owned life insurance amounted to $11.9 million at June 30, 2008 and $11.7 million at December 31, 2007. The income earned on these policies is reflected in non-interest income.
 
Other Assets:
 
Other assets increased by $4.2 million to $12.2 million at June 30, 2008, from $8.0 million at December 31, 2007, principally resulting from an increase in short-term receivables relating to the sale of OREO property still pending settlement, which are to be collected in the third quarter of 2008.
 
Deposits:
 
Deposits, which include non-interest and interest-bearing demand deposits, money market, savings and time deposits including some brokered deposits, are Republic’s major source of funding. Deposits are generally solicited from the Company’s market area through the offering of a variety of products to
 
18

attract and retain customers, with a primary focus on multi-product relationships.  Total deposits decreased by $52.3 million to $728.6 million at June 30, 2008 from $780.9 million at December 31, 2007.  Average transaction account balances decreased 25.5% or $108.5 million less than the prior year period to $316.6 million in the second quarter of 2008. Period end time deposits decreased $41.3 million, or 9.8% to $381.7 million at June 30, 2008, versus $422.9 million at the prior year-end.  The decrease reflected intentional reductions of higher cost deposits.
 
FHLB Borrowings and Overnight Advances:
 
FHLB borrowings and overnight advances are used to supplement deposit generation.   Republic had $25.0 million in term borrowings at June 30, 2008 versus $0 at December 31, 2007.  The term borrowings have maturities of less than two years.  Republic had short-term borrowings (overnight) of $86.1 million at June 30, 2008 versus $133.4 million at the prior year-end.

Subordinated Debt:
 
Subordinated debt amounted to $22.5 million at June 30, 2008, compared to $11.3 million at December 31, 2007, as a result of an $11.1 million issuance of convertible trust preferred securities in June 2008 at a rate of 8%.  The securities have a conversion price of $6.50 and are convertible into 1.7 million shares of common stock.  The trust preferred securities will have a term of 30 years and will be callable after the fifth year.  The securities will be convertible into common shares anytime after June 30, 2009 at the option of the purchaser and under certain conditions prior to June 30, 2009.  The issuer will also retain certain optional conversion triggers after the fifth year.

Shareholders’ Equity:
 
Total shareholders’ equity decreased $2.1 million to $78.4 million at June 30, 2008, versus $80.5 million at December 31, 2007.   This decrease was primarily the result of a year-to-date net loss of $1.6 million and a year-to-date other comprehensive loss of $1.2 million, partially offset by net proceeds from exercise of stock options of $623,000.


Three Months Ended June 30, 2008 compared to June 30, 2007
Results of Operations:

Overview

The Company's net income decreased to $1.2 million or $0.11 per diluted share for the three months ended June 30, 2008, compared to $2.0 million, or $0.18 per diluted share for the comparable prior year period.  There was a $3.9 million, or 22.4%, decrease in total interest income, reflecting a 152 basis point decrease in the yield on average loans outstanding while interest expense decreased $3.4 million, reflecting a 144 basis point decrease in the rate on average interest-bearing deposits outstanding and a 269 basis point decrease in the rate on average borrowings outstanding.   Accordingly, net interest income decreased $506,000 between the periods. The reduced net interest income reflected funding costs which were abnormally high in relation to historical spreads to the prime rate and the impact of higher rate certificates of deposit still on the books.  Net interest margins are expected to improve going forward as funding costs and spreads to the prime rate normalize and as higher cost certificates of deposit reprice.  The provision for loan losses in the second quarter of 2008 decreased to $43,000, compared to a $63,000 provision expense in the second quarter of 2007.  Non-interest income increased $81,000 to $836,000 in second quarter 2008 compared to $755,000 in second quarter 2007.  Non-interest expenses increased $778,000 to $6.1 million compared to $5.3 million in the second quarter of 2007, primarily due to a $365,000 increase in other real estate owned expenses, a $158,000 increase in salaries and employee benefits expense, and a $126,000 increase in regulatory assessments and costs. Return on average assets and average equity from continuing operations of 0.51% and 6.12%
 
19

respectively, in the second quarter of 2008 compared to 0.81% and 10.18% respectively for the same period in 2007.



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.  Yields are adjusted for tax equivalency.

   
For the three months ended
   
For the three months ended
 
   
June 30, 2008
   
June 30, 2007
 
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
  $ 10,618     $ 58       2.20 %   $ 12,785     $ 169       5.30 %
Securities (2)
    82,392       1,167       5.67 %     97,328       1,428       5.87 %
Loans receivable
    797,233       12,160       6.13 %     821,173       15,657       7.65 %
Total interest-earning assets
    890,243       13,385       6.05 %     931,286       17,254       7.43 %
                                                 
Other assets
    55,336                       39,124                  
                                                 
Total assets
  $ 945,579                     $ 970,410                  
                                                 
Interest-bearing liabilities:
                                               
Demand-non interest
                                               
bearing
  $ 74,126                     $ 77,010                  
Demand interest-bearing
    31,236     $ 69       0.89 %     40,577     $ 118       1.17 %
Money market & savings
    211,281       1,371       2.61 %     307,512       3,532       4.61 %
Time deposits
    441,069       4,169       3.80 %     353,792       4,650       5.27 %
Total deposits
    757,712       5,609       2.98 %     778,891       8,300       4.27 %
Total interest-bearing
                                               
deposits
    683,586       5,609       3.30 %     701,881       8,300       4.74 %
                                                 
Other borrowings (1)
    101,186       715       2.84 %     99,873       1,377       5.53 %
                                                 
Total interest-bearing
                                               
liabilities
  $ 784,772     $ 6,324       3.24 %   $ 801,754     $ 9,677       4.84 %
Total deposits and
                                               
other borrowings
    858,898       6,324       2.96 %     878,764       9,677       4.42 %
                                                 
Non interest-bearing
                                               
liabilites
    8,532                       14,086                  
Shareholders' equity
    78,149                       77,560                  
Total liabilities and
                                               
shareholders' equity
  $ 945,579                     $ 970,410                  
                                                 
Net interest income
          $ 7,061                     $ 7,577          
Net interest spread
                    2.81 %                     2.59 %
                                                 
Net interest margin
                    3.19 %                     3.26 %
                                                 
(1) Includes term borrowings and trust preferred securities
         
(2) On a tax equivalent basis
         

 
20

 

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

   
Three months ended June 30, 2008
 
   
versus June 30, 2007
 
    (dollars in thousands)  
   
Due to change in:
 
   
Volume
   
Rate
   
Total
 
Interest earned on:
                 
                   
          Federal funds sold
  $ (12 )   $ (99 )   $ (111 )
          Securities ( tax equivalent basis)
    (211 )     (50 )     (261 )
          Loans
    (366 )     (3,131 )     (3,497 )
     Total interest-earning assets
    (589 )     (3,280 )     (3,869 )
                         
Interest expense of deposits
                       
         Interest-bearing demand deposits
    21       28       49  
         Money market and savings
    626       1,535       2,161  
         Time deposits
    (827 )     1,308       481  
     Total deposit interest expense
    (180 )     2,871       2,691  
         Other borrowings
    (9 )     671       662  
              Total interest expense
    (189 )     3,542       3,353  
Net interest income
  $ (778 )   $ 262     $ (516 )

The Company’s tax equivalent net interest margin decreased 7 basis points to 3.19% for the three months ended June 30, 2008, versus 3.26% in the prior year comparable period.  The reduced net interest margin reflected funding costs which were abnormally high in relation to historical spreads to the prime rate and the impact of higher rate certificates of deposit still on the books.  Net interest margins are expected to improve going forward as funding costs and spreads to the prime rate normalize and as higher cost certificates of deposit reprice.

While yields on interest-bearing assets decreased 138 basis points to 6.05% in second quarter 2008 from 7.43% in second quarter 2007, the rate on total deposits and other borrowings decreased 146 basis points to 2.96% from 4.42% between those respective periods. The decrease in yields on assets and rates on deposits and borrowings was primarily due to the repricing of assets and liabilities as a result of actions taken by the Federal Reserve since September 2007.
 
The Company's tax equivalent net interest income decreased $516,000, or 6.8%, to $7.1 million for the three months ended June 30, 2008, from $7.6 million for the prior year comparable period. As shown in the Rate Volume table above, the decrease in net interest income was due to a decrease in average interest earning assets as well as a larger concentration of higher rate time deposits that offset a decrease
 
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in average money market and savings deposits. Average interest-earning assets amounted to $890.3 million for second quarter 2008 and $931.3 million for second quarter 2007.  The $41.0 million decrease resulted from a reduction of loans, securities, and federal funds sold as the Company adopted a defensive balance sheet strategy as a result of the economic downturn.  Meaningful loan growth is anticipated by year end 2008.
 
The Company’s total tax equivalent interest income decreased $3.9 million, or 22.4%, to $13.4 million for the three months ended June 30, 2008, from $17.3 million for the prior year comparable period.  Interest and fees on loans decreased $3.5 million, or 22.3%, to $12.2 million for the three months ended June 30, 2008, from $15.7 million for the prior year comparable period.  The decrease was due primarily to the 152 basis point decline in the yield on loans resulting from the repricing of the variable rate loan portfolio as a result of actions taken by the Federal Reserve.  Interest and dividends on investment securities decreased $261,000, or 18.3%, to $1.2 million for the three months ended June 30, 2008, from $1.4 million for the prior year comparable period.  This decrease reflected a decrease in average securities outstanding of $14.9 million, or 15.3%, to $82.4 million from $97.3 million for the prior year comparable period.  Interest on federal funds sold and other interest-earning assets decreased $111,000, or 65.7%, reflecting decreases in short-term interest rates.
 
The Company's total interest expense decreased $3.4 million, or 34.6%, to $6.3 million for the three months ended June 30, 2008, from $9.7 million for the prior year comparable period. Interest-bearing liabilities averaged $784.8 million for the three months ended June 30, 2008, versus $801.8 million for the prior year comparable period, or a decrease of $17.0 million. The decrease primarily reflected reduced funding requirements due to a decrease in average interest earning assets. Average deposit balances decreased $21.2 million while there was a $1.3 million increase in average other borrowings. The average rate paid on interest-bearing liabilities decreased 160 basis points to 3.24% for the three months ended June 30, 2008. Interest expense on time deposit balances decreased $481,000 to $4.2 million in second quarter 2008, from $4.7 million in the comparable prior year period, reflecting lower rates which more than offset the impact of higher average balances.  Money market and savings interest expense decreased $2.2 million to $1.4 million in second quarter 2008, from $3.5 million in the comparable prior year period. The decrease in interest expense on deposits reflected the impact of the lower short-term interest rate environment. Accordingly, rates on total interest-bearing deposits decreased 144 basis points in second quarter 2008 compared to second quarter 2007.

Interest expense on other borrowings decreased $662,000 to $715,000 in second quarter 2008, also as a result of the lower short-term interest rate environment. Average other borrowings, primarily overnight FHLB borrowings, increased $1.3 million, or 1.3%, between those respective periods. Rates on overnight borrowings reflected the lower short-term interest rate environment as the rate of other borrowings decreased to 2.84% in second quarter 2008, from 5.53% in the comparable prior year period. Interest expense on other borrowings also includes the interest on average balances of $13.9 million of trust preferred securities and $6.9 million of FHLB term borrowings.

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 $43,000 in second quarter 2008 compared to $63,000 in second quarter 2007.  The provision in both periods reflected amounts required to increase the allowance for loan growth in accordance with the Company’s methodology.

Non-Interest Income

Total non-interest income increased $81,000 to $836,000 for second quarter 2008 compared to $755,000 for the three months ended June 30, 2007, primarily due to a one time Mastercard transaction of $309,000 and other miscellaneous items totaling $63,000 which were partially offset by a $309,000
 
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decrease in loan advisory and servicing fees.  The decrease in loan advisory and servicing fees resulted from lower advisory and prepayment fee income, primarily due to volume.

Non-Interest Expenses
 
Total non-interest expenses increased $778,000 or 14.7% to $6.1 million for the three months ended June 30, 2008, from $5.3 million for the prior year comparable period. Salaries and employee benefits increased $158,000 or 6.2%, to $2.7 million for the three months ended June 30, 2008, from $2.5 million for the prior year comparable period. That increase reflected decreased salary deferrals based on lower loan originations, as well as annual merit increases up to 3%.
 
Occupancy expense decreased $9,000, or 1.5%, to $595,000 in second quarter 2008, compared to $604,000 in second quarter 2007.
 
Depreciation expense decreased $16,000 or 4.5% to $339,000 for the three months ended June 30, 2008, versus $355,000 for the prior year comparable period.
 
Legal fees increased $79,000, or 40.5%, to $274,000 in second quarter 2008, compared to $195,000 in second quarter 2007, resulting from increased fees on a number of different matters.
 
Other real estate expenses increased $365,000 to $382,000 for the three months ended June 30, 2008 compared to $17,000 for the second quarter 2007 due to $342,000 in second quarter 2008 property maintenance expenses and a $40,000 loss on the sale of an OREO property.
 
Advertising expense decreased $10,000, or 6.3%, to $149,000 in second quarter 2008, compared to $159,000 in second quarter 2007.
 
Data processing expense increased $48,000, or 31.0%, to $203,000 in second quarter 2008, compared to $155,000 in second quarter 2007, primarily due to system enhancements.
 
Insurance expense increased $54,000, or 57.4%, to $148,000 in second quarter 2008, compared to $94,000 in second quarter 2007, resulting primarily from higher rates.
 
Professional fees increased $20,000, or 16.1%, to $144,000 in second quarter 2008, compared to $124,000 in second quarter 2007, resulting primarily from increased consulting fees.
 
Regulatory assessments and costs increased $126,000 or 242.3% to $178,000 in second quarter 2008, compared to $52,000 in second quarter 2007, resulting primarily from increases in statutory FDIC insurance rates.
 
Taxes, other increased $40,000, or 19.0%, to $251,000 for the three months ended June 30, 2008, versus $211,000 for the comparable prior year period.  The increase reflected an increase in Pennsylvania shares tax which is assessed at an amount 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 $77,000, or 10.0% to $695,000 for the three months ended June 30, 2008, from $772,000 for the prior year comparable period.
 

Provision for Income Taxes
 
The provision for income taxes decreased $404,000 to $547,000 for the three months ended June 30, 2008, from $951,000 for the prior year comparable period. That reduction was primarily the result of the decrease in pre-tax income.  The effective tax rates in those periods were 32% and 33% respectively.
 
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Six Months Ended June 30, 2008 compared to June 30, 2007
Results of Operations:

Overview
 
The Company’s net income decreased to a $1.6 million loss or $(0.16) per diluted share for the six months ended June 30, 2008, compared to $4.1 million, or $.38 per diluted share for the comparable prior year period.  There was a $6.1 million, or 17.9%, decrease in total interest income, reflecting a 133 basis point decrease in the yield on average loans outstanding while interest expense decreased $5.3 million, reflecting a 109 basis point decrease in the rate on average interest- bearing deposits outstanding and a 228 basis point decrease in the rate on average borrowings outstanding.  Net interest income decreased $865,000 between the periods.  The provision for loan losses in the first six months of 2008 increased to $5.9 million, compared to $143,000 provision expense in the first six months of 2007, reflecting additional reserves on certain loans.  Non- interest income increased $106,000 to $1.5 million in the first six months of 2008 compared to $1.4 million in the first six months of 2007.  Non- interest expenses increased $2.2 million to $12.5 million compared to $10.3 million in the first six months of 2007, primarily due to $1.1 million in writedowns of other real estate owned, an increase of $322,000 in other real estate expenses related to property maintenance, and an increase of $272,000 in salaries and employee benefits expense.  Return on average assets and average equity of (0.33)% and (4.02)% respectively, in the first six months of 2008 compared to 0.85% and 10.71% respectively for the same period in 2007.
 
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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.  Yields are adjusted for tax equivalency for tax exempt municipal securities income in the first six months of 2008 and 2007.

   
For the six months ended
   
For the six months ended
 
   
June 30, 2008
   
June 30, 2007
 
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
  $ 11,444     $ 154       2.71 %   $ 16,257     $ 404       5.01 %
Securities (2)
    84,969       2,480       5.84 %     103,414       3,037       5.87 %
Loans receivable
    807,468       25,613       6.38 %     810,003       30,957       7.71 %
Total interest-earning assets
    903,881       28,247       6.28 %     929,674       34,398       7.46 %
                                                 
Other assets
    49,157                       38,595                  
                                                 
Total assets
  $ 953,038