Table of Contents

 

 

 

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**x****      Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**

 

**For the quarterly period ended March 31, 2011**

 

**or**

 

**o****         Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**

 

**For the transition period from                          to                         **

 

**Commission File Number:  0-24557**

 

**CARDINAL FINANCIAL CORPORATION**

(Exact name of registrant as specified in its charter)

 

| **Virginia**                    | ** ** | **54-1874630**      |
|---------------------------------|------------|---------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer    |
| incorporation or organization)  |       | Identification No.) |

 

| **8270 Greensboro Drive, Suite 500** |       |       |
|-------------------------------------------|------------|------------|
| **McLean, Virginia**                      | ** ** | **22102**  |
| (Address of principal executive offices)  |       | (Zip Code) |

 

**(703) 584-3400**

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

| Large accelerated filer o                |   | Accelerated filer x         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer o                  |   | Smaller reporting company o |
| (Do not check if a 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 o  No x

 

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

 

28,932,289 shares of common stock, par value $1.00 per share,

outstanding as of May 6, 2011

 

 

 

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Table of Contents

 

**CARDINAL FINANCIAL CORPORATION**

 

**INDEX TO FORM 10-Q**

 
| **PART I — FINANCIAL INFORMATION**                                                         |                                                                                                                                     |
|------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                           |                                                                                                                                     |
| Item 1. Financial Statements:                                                                        |                                                                                                                                     |
|                                                                                                 |                                                                                                                                     |
|                                                                                                 | Consolidated Statements of Condition   At March 31, 2011 (unaudited) and December 31, 2010                                     | 3 |
|                                                                                                 |                                                                                                                                     |   |
|                                                                                                 | Consolidated Statements of Income    For the three months ended March 31, 2011 and 2010 (unaudited)                                 | 4 |
|                                                                                                 |                                                                                                                                     |   |
|                                                                                                 | Consolidated Statements of Comprehensive Income    For the three months ended March 31, 2011 and 2010 (unaudited)                   | 5 |
|                                                                                                 |                                                                                                                                     |   |
|                                                                                                 | Consolidated Statements of Changes in Shareholders’   Equity    For the three months ended March 31, 2011 and 2010 (unaudited) | 6 |
|                                                                                                 |                                                                                                                                     |   |
|                                                                                                 | Consolidated Statements of Cash Flows    For the three months ended March 31, 2011 and 2010 (unaudited)                             | 7 |
|                                                                                                 |                                                                                                                                     |   |
|                                                                                                 | Notes to Consolidated Financial Statements (unaudited)                                                                                   | 8 |
|                                                                                                 |                                                                                                                                     |
| Item 2. Management’s Discussion and Analysis of   Financial Condition and Results of Operations | 38                                                                                                                                       |
|                                                                                                 |                                                                                                                                     |
| Item 3. Quantitative and Qualitative Disclosures About   Market Risk                                 | 62                                                                                                                                       |
|                                                                                                 |                                                                                                                                     |
| Item 4. Controls and Procedures                                                                      | 63                                                                                                                                       |
|                                                                                                 |                                                                                                                                     |
| **PART II — OTHER INFORMATION**                                                            | 64                                                                                                                                       |
| ** **                                                                                           |                                                                                                                                     |
| Item   1. Legal Proceedings                                                                          | 64                                                                                                                                       |
| Item   1A. Risk Factors                                                                              | 64                                                                                                                                       |
| Item 2. Unregistered Sales of Equity Securities and   Use of Proceeds                                | 64                                                                                                                                       |
| Item 3. Defaults Upon Senior Securities                                                              | 64                                                                                                                                       |
| Item   4. (Removed and Reserved)                                                                     | 64                                                                                                                                       |
| Item   5. Other Information                                                                          | 64                                                                                                                                       |
| Item 6. Exhibits                                                                                     | 64                                                                                                                                       |
|                                                                                                 |                                                                                                                                     |
| **SIGNATURES**                                                                                       | 65                                                                                                                                       |

 

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Table of Contents

 

**PART I — FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

** **

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

CONSOLIDATED STATEMENTS OF CONDITION

 

March 31, 2011 and December 31, 2010

 

(In thousands, except share data)

 

 
| ** **                                                                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **2011**           | ** ** | **2010**              | ** ** |
| ** **                                                                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                       |       |       |       |       |       |               |       |                  |       |
| Cash and due from banks                                                                                                                          |       |       |       |       |       | $                  | 14,344     |                  | $          | 12,963 |   |
| Federal funds sold                                                                                                                               |       |       |       |       |       | 7,289              |       | 12,905                |       |
| Total cash and cash equivalents                                                                                                                  |       |       |       |       |       | 21,633             |       | 25,868                |       |
| Investment securities available-for-sale                                                                                                         |       |       |       |       |       | 351,712            |       | 320,998               |       |
| Investment securities held-to-maturity (market   value of $12,560 and $17,733 at March 31, 2011 and December 31,   2010, respectively) |       |       |       |       |       | 16,211             |       | 21,879                |       |
| Investment securities-trading                                                                                                                    |       |       |       |       |       | 2,458              |       | 2,107                 |       |
| Total investment securities                                                                                                                      |       |       |       |       |       | 370,381            |       | 344,984               |       |
| Other investments                                                                                                                                |       |       |       |       |       | 16,469             |       | 16,469                |       |
| Loans held for sale                                                                                                                              |       |       |       |       |       | 168,569            |       | 206,047               |       |
| Loans receivable, net of deferred fees and costs                                                                                                 |       |       |       |       |       | 1,413,217          |       | 1,409,302             |       |
| Allowance for loan losses                                                                                                                        |       |       |       |       |       | (24,209            | )          | (24,210               | )          |
| Loans receivable, net                                                                                                                            |       |       |       |       |       | 1,389,008          |       | 1,385,092             |       |
| Premises and equipment, net                                                                                                                      |       |       |       |       |       | 17,418             |       | 16,717                |       |
| Deferred tax asset, net                                                                                                                          |       |       |       |       |       | 10,351             |       | 10,690                |       |
| Goodwill and intangibles, net                                                                                                                    |       |       |       |       |       | 10,639             |       | 10,688                |       |
| Bank-owned life insurance                                                                                                                        |       |       |       |       |       | 34,537             |       | 34,358                |       |
| Prepaid FDIC insurance premiums                                                                                                                  |       |       |       |       |       | 4,002              |       | 4,574                 |       |
| Other real estate owned                                                                                                                          |       |       |       |       |       | 1,250              |       | 1,250                 |       |
| Accrued interest receivable and other assets                                                                                                     |       |       |       |       |       | 15,786             |       | 15,281                |       |
| Total assets                                                                                                                                     |       |       |       |       |       | $                  | 2,060,043  |                  | $          | 2,072,018 |   |
| **Liabilities and Shareholders’ Equity**                                                                                                    |       |       |       |       |       |               |       |                  |       |
| Non-interest bearing deposits                                                                                                                    |       |       |       |       |       | $                  | 228,651    |                  | $          | 229,575 |   |
| Interest bearing deposits                                                                                                                        |       |       |       |       |       | 1,158,262          |       | 1,174,150             |       |
| Total deposits                                                                                                                                   |       |       |       |       |       | 1,386,913          |       | 1,403,725             |       |
| Other borrowed funds                                                                                                                             |       |       |       |       |       | 415,854            |       | 389,586               |       |
| Mortgage funding checks                                                                                                                          |       |       |       |       |       | 7,981              |       | 662                   |       |
| Escrow liabilities                                                                                                                               |       |       |       |       |       | 2,345              |       | 1,454                 |       |
| Accrued interest payable and other liabilities                                                                                                   |       |       |       |       |       | 17,606             |       | 53,689                |       |
| Total liabilities                                                                                                                                |       |       |       |       |       | 1,830,699          |       | 1,849,116             |       |
|                                                                                                                                             |       |       |       |       |       |               |       |                  |       |
| Common stock, $1 par value                                                                                                   | ** ** | **2011**   | ** ** | **2010**   | ** ** | ** **         | ** ** | ** **            | ** ** |
| Shares authorized                                                                                                                                |       | 50,000,000 |       | 50,000,000 |       |               |       |                  |       |
| Shares issued and outstanding                                                                                                                    |       | 28,923,789 |       | 28,769,849 |       | 28,924             |       | 28,770                |       |
| Additional paid-in capital                                                                                                                       |       |       |       |       |       | 162,148            |       | 160,859               |       |
| Retained earnings                                                                                                                                |       |       |       |       |       | 33,203             |       | 28,848                |       |
| Accumulated other comprehensive income, net                                                                                                      |       |       |       |       |       | 5,069              |       | 4,425                 |       |
| Total shareholders’ equity                                                                                                                  |       |       |       |       |       | 229,344            |       | 222,902               |       |
| Total liabilities and shareholders’ equity                                                                                                  |       |       |       |       |       | $                  | 2,060,043  |                  | $          | 2,072,018 |   |

 

See accompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

CONSOLIDATED STATEMENTS OF INCOME

 

Three months ended March 31, 2011 and 2010

(In thousands, except per share data)

(Unaudited)

** **
| ** **                                                      | ** ** | **2011** | ** ** | **2010** | ** ** |
|-----------------------------------------------------------------|------------|----------|------------|----------|------------|
| Interest income:                                                |       |     |       |     |       |
| Loans receivable                                                |       | $        | 18,819     |     | $          | 17,615 |   |
| Loans held for sale                                             |       | 1,301    |       | 1,305    |       |
| Federal funds sold                                              |       | 46       |       | 23       |       |
| Investment securities available-for-sale                        |       | 3,433    |       | 3,683    |       |
| Investment securities held-to-maturity                          |       | 155      |       | 287      |       |
| Other investments                                               |       | 31       |       | 10       |       |
| Total interest income                                           |       | 23,785   |       | 22,923   |       |
| Interest expense:                                               |       |     |       |     |       |
| Deposits                                                        |       | 3,416    |       | 4,635    |       |
| Other borrowed funds                                            |       | 2,708    |       | 3,021    |       |
| Total interest expense                                          |       | 6,124    |       | 7,656    |       |
| Net interest income                                             |       | 17,661   |       | 15,267   |       |
| Provision for loan losses                                       |       | 1,110    |       | 2,425    |       |
| Net interest income after provision for loan   losses           |       | 16,551   |       | 12,842   |       |
| Non-interest income:                                            |       |     |       |     |       |
| Service charges on deposit accounts                             |       | 413      |       | 479      |       |
| Loan fees                                                       |       | 456      |       | 418      |       |
| Investment fee income                                           |       | 548      |       | 1,009    |       |
| Realized and unrealized gains on mortgage banking   activities  |       | 3,091    |       | 2,822    |       |
| Net realized gain on investment securities   available-for-sale |       | 403      |       | 264      |       |
| Net realized gain on investment securities-trading              |       | 48       |       | 56       |       |
| Management fee income                                           |       | 299      |       | 577      |       |
| Increase in cash surrender value of bank-owned   life insurance |       | 180      |       | 148      |       |
| Loss on extinguishment of debt                                  |       | (450     | )          | —   |       |
| Other income                                                    |       | 8        |       | 8        |       |
| Total non-interest income                                       |       | 4,996    |       | 5,781    |       |
| Non-interest expense:                                           |       |     |       |     |       |
| Salary and benefits                                             |       | 6,653    |       | 6,143    |       |
| Occupancy                                                       |       | 1,473    |       | 1,453    |       |
| Professional fees                                               |       | 532      |       | 468      |       |
| Depreciation                                                    |       | 457      |       | 560      |       |
| Data communications                                             |       | 919      |       | 895      |       |
| FDIC insurance premiums                                         |       | 634      |       | 549      |       |
| Mortgage loan repurchases and settlements                       |       | 100      |       | 563      |       |
| Amortization of intangibles                                     |       | 49       |       | 60       |       |
| Other operating expenses                                        |       | 2,873    |       | 2,404    |       |
| Total non-interest expense                                      |       | 13,690   |       | 13,095   |       |
| Income before income taxes                                      |       | 7,857    |       | 5,528    |       |
| Provision for income taxes                                      |       | 2,636    |       | 1,728    |       |
| Net income                                                      |       | $        | 5,221      |     | $          | 3,800 |   |
| Earnings per common share - basic                               |       | $        | 0.18       |     | $          | 0.13 |   |
| Earnings per common share - diluted                             |       | $        | 0.18       |     | $          | 0.13 |   |
| Weighted-average common shares outstanding - basic              |       | 29,291   |       | 29,085   |       |
| Weighted-average common shares outstanding -   diluted          |       | 29,801   |       | 29,534   |       |

 

See accompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Three months ended March 31, 2011 and 2010

(In thousands)

(Unaudited)

 
| ** **                                                                                                                                                                      | ** ** | **2011** | ** ** | **2010** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                                                            |       |     |       |     |       |
| Net income                                                                                                                                                                      |       | $        | 5,221      |     | $          | 3,800 |   |
| Other comprehensive income:                                                                                                                                                     |       |     |       |     |       |
| Unrealized gain (loss) on available-for-sale   investment securities:                                                                                                           |       |     |       |     |       |
| Unrealized holding gain arising during the period,   net of tax expense of $131 thousand in 2011 and $442 thousand in 2010                                                      |       | 246      |       | 1,031    |       |
|                                                                                                                                                                            |       |     |       |     |       |
| Less: reclassification adjustment for net gains   included in net income net of tax expense of $131 thousand in 2011 and $91   thousand in 2010                                 |       | (271     | )          | (173     | )          |
|                                                                                                                                                                            |       |     |       |     |       |
|                                                                                                                                                                            |       | (25      | )          | 858      |       |
|                                                                                                                                                                            |       |     |       |     |       |
| Unrealized gain (loss) on derivative instruments   designated as cash flow hedges, net of tax expense of $353 thousand in 2011   and net of tax benefit of $41 thousand in 2010 |       | 669      |       | (78      | )          |
|                                                                                                                                                                            |       |     |       |     |       |
| Comprehensive income                                                                                                                                                            |       | $        | 5,865      |     | $          | 4,580 |   |

 

See accompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Three months ended March 31, 2011 and 2010

(In thousands)

(Unaudited)

 
| ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|------------|------------|
| ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **   | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **Common** | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **Shares** | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **Income**        | ** ** | **Total**  | ** ** |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Balance, December 31, 2009                  |       | 28,718     |       | $          | 28,718     |           | $          | 159,798      |       | $                 | 12,705     |       | $          | 3,286 |   | $ | 204,507 |   |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Stock options exercised                          |       | 3          |       | 3          |       | 15             |       | —       |       | —            |       | 18         |       |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Stock compensation expense, net of tax benefit   |       | —     |       | —     |       | 60             |       | —       |       | —            |       | 60         |       |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Dividends on common stock of $0.02 per share     |       | —     |       | —     |       | —         |       | (575         | )          | —            |       | (575       | )          |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Change in accumulated other comprehensive income |       | —     |       | —     |       | —         |       | —       |       | 780               |       | 780        |       |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Net income                                       |       | —     |       | —     |       | —         |       | 3,800        |       | —            |       | 3,800      |       |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Balance, March 31, 2010                     |       | 28,721     |       | $          | 28,721     |           | $          | 159,873      |       | $                 | 15,930     |       | $          | 4,066 |   | $ | 208,590 |   |
| Balance, December 31, 2010                  |       | 28,770     |       | $          | 28,770     |           | $          | 160,859      |       | $                 | 28,848     |       | $          | 4,425 |   | $ | 222,902 |   |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Stock options exercised                          |       | 154        |       | 154        |       | 1,226          |       | —       |       | —            |       | 1,380      |       |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Stock compensation expense, net of tax benefit   |       | —     |       | —     |       | 63             |       | —       |       | —            |       | 63         |       |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Dividends on common stock of $0.03 per share     |       | —     |       | —     |       | —         |       | (866         | )          | —            |       | (866       | )          |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Change in accumulated other comprehensive income |       | —     |       | —     |       | —         |       | —       |       | 644               |       | 644        |       |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Net income                                       |       | —     |       | —     |       | —         |       | 5,221        |       | —            |       | 5,221      |       |
|                                             |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Balance, March 31, 2011                     |       | 28,924     |       | $          | 28,924     |           | $          | 162,148      |       | $                 | 33,203     |       | $          | 5,069 |   | $ | 229,344 |   |

 

See accompanying notes to consolidated financial statements.

 

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** **

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF CASH FLOWS

Three Months Ended March 31, 2011 and 2010

(In thousands)

(Unaudited)

 
| ** **                                                                                  | ** ** | **2011**   | ** ** | **2010**   | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                                       |       |       |       |       |       |
| Net income                                                                                  |       | $          | 5,221      |       | $          | 3,800 |   |
| Adjustments to reconcile net income to net cash   provided by operating activities:         |       |       |       |       |       |
| Depreciation                                                                                |       | 457        |       | 560        |       |
| Amortization of premiums, discounts and intangibles                                         |       | 111        |       | 152        |       |
| Provision for loan losses                                                                   |       | 1,110      |       | 2,425      |       |
| Loans held for sale originated                                                              |       | (472,710   | )          | (461,534   | )          |
| Proceeds from the sale of loans held for sale                                               |       | 513,279    |       | 499,864    |       |
| Realized and unrealized gains on mortgage banking   activities                              |       | (3,091     | )          | (2,822     | )          |
| Proceeds from sale of investment   securities-trading                                       |       | —     |       | 140        |       |
| Purchase of investment securities-trading                                                   |       | (464       | )          | (188       | )          |
| Unrealized gain on investment securities-trading                                            |       | (48        | )          | (56        | )          |
| Gain on sale of investment securities   available-for-sale                                  |       | (403       | )          | (264       | )          |
| Gain on sale of other assets                                                                |       | —     |       | (3         | )          |
| Gain on sale of other real estate owned                                                     |       | —     |       | (31        | )          |
| Stock compensation expense, net of tax benefits                                             |       | 63         |       | 60         |       |
| Increase in cash surrender value of bank-owned   life insurance                             |       | (180       | )          | (148       | )          |
| Increase (decrease) in accrued interest receivable   and other assets                       |       | 1,091      |       | (675       | )          |
| Increase (decrease) in accrued interest payable,   escrow liabilities and other liabilities |       | (4,571     | )          | 226        |       |
| Net cash provided by operating activities                                                   |       | 39,865     |       | 41,506     |       |
| Cash flows from investing activities:                                                       |       |       |       |       |       |
| Net purchases of premises and equipment                                                     |       | (1,158     | )          | (587       | )          |
| Proceeds from maturity and call of investment   securities available-for-sale               |       | —     |       | 5,100      |       |
| Proceeds from maturity or call of investment   securities held-to-maturity                  |       | 4,264      |       | —     |       |
| Proceeds from sale of mortgage-backed securities   available-for-sale                       |       | 5,359      |       | 13,318     |       |
| Purchase of investment securities   available-for-sale                                      |       | (17,281    | )          | (10,088    | )          |
| Purchase of mortgage-backed securities   available-for-sale                                 |       | (62,539    | )          | (17,664    | )          |
| Redemptions of investment securities   available-for-sale                                   |       | 13,595     |       | 12,917     |       |
| Redemptions of investment securities   held-to-maturity                                     |       | 1,397      |       | 2,480      |       |
| Net increase in loans receivable, net of deferred   fees and costs                          |       | (5,026     | )          | (15,999    | )          |
| Net cash used in investing activities                                                       |       | (61,389    | )          | (10,523    | )          |
| Cash flows from financing activities:                                                       |       |       |       |       |       |
| Net increase (decrease) in deposits                                                         |       | (16,812    | )          | 29,133     |       |
| Net increase (decrease) in other borrowed funds -   short term                              |       | 41,268     |       | (51,545    | )          |
| Net increase (decrease) in mortgage funding checks                                          |       | 7,319      |       | (5,299     | )          |
| Repayment of FHLB advances                                                                  |       | (15,000    | )          | —     |       |
| Stock options exercised                                                                     |       | 1,380      |       | 18         |       |
| Dividends on common stock                                                                   |       | (866       | )          | (575       | )          |
| Net cash provided by (used in) financing   activities                                       |       | 17,289     |       | (28,268    | )          |
| Net increase (decrease) in cash and cash   equivalents                                      |       | (4,235     | )          | 2,715      |       |
| Cash and cash equivalents at beginning of the year                                          |       | 25,868     |       | 24,841     |       |
| Cash and cash equivalents at end of the period                                              |       | $          | 21,633     |       | $          | 27,556 |   |
| **Supplemental disclosure of cash   flow information:**                                     |       |       |       |       |       |
| Cash paid during the period for interest                                                    |       | $          | 6,037      |       | $          | 7,698 |   |
| Cash paid for income taxes                                                                  |       | 3,910      |       | 255        |       |
|                                                                                        |       |       |       |       |       |
| **Supplemental schedule of noncash   investing and financing activities:**                  |       |       |       |       |       |
| Unsettled purchases of investment securities   available-for-sale                           |       | —     |       | 8,613      |       |

 

See accompanying notes to consolidated financial statements.

 

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CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

 

Note 1

 

*Organization*

 

Cardinal Financial Corporation (the “Company”) is incorporated under the laws of the Commonwealth of Virginia as a financial holding company whose activities consist of investment in its wholly-owned subsidiaries. The principal operating subsidiary of the Company is Cardinal Bank (the “Bank”), a state-chartered institution and its subsidiary, George Mason Mortgage, LLC (“George Mason”), a mortgage banking company based in Fairfax, Virginia. In January 2009, the Bank organized a second mortgage subsidiary, Cardinal First Mortgage, LLC (“Cardinal First”) also based in Fairfax, Virginia.  The Bank has a trust division, Cardinal Trust and Investment Services.  In addition to the Bank, the Company has two nonbank subsidiaries; Wilson/Bennett Capital Management, Inc. (“Wilson/Bennett”), an asset management firm and Cardinal Wealth Services, Inc. (“CWS”), an investment services subsidiary.

 

*Basis of Presentation*

 

In the opinion of management, the accompanying consolidated financial statements have been prepared in accordance with the requirements of Regulation S-X, Article 10. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. However, all adjustments that are, in the opinion of management, necessary for a fair presentation have been included. The results of operations for the three months ended March 31, 2011 are not necessarily indicative of the results to be expected for the full year ending December 31, 2011. The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes to financial statements that are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

 

Note 2

 

*Stock-Based Compensation*

 

At March 31, 2011, the Company had two stock-based employee compensation plans, the 1999 Stock Option Plan (the “Option Plan”) and the 2002 Equity Compensation Plan (the “Equity Plan”).

 

In 1998, the Company adopted the Option Plan pursuant to which the Company may grant stock options for up to 625,000 shares of the Company’s common stock to employees and members of the Company’s and its subsidiaries’ boards of directors. As of November 23, 2008, the Option Plan expired, and therefore, there are no shares of common stock available to grant under this plan.

 

In 2002, the Company adopted the Equity Plan. The Equity Plan authorizes the granting of options, which may be incentive stock options or non-qualified stock options, stock appreciation rights, restricted stock awards, phantom stock awards and performance share awards to directors, eligible officers and key employees of the Company.  The Equity Plan authorizes grants and awards with respect to 2,420,000 shares of the Company’s common stock.  There were 280,668 shares of the Company’s common stock available for future grants and awards in the Equity Plan as of March 31, 2011.

 

Subsequent to March 31, 2011, the shareholders approved an amendment to the Equity Plan to increase the number of shares of common stock reserved for issuance under it from 2,420,000 to 3,170,000, an increase of 750,000 shares.  In addition, the amendment extended the term of the Equity Plan to February 21, 2021.

 

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Stock options are granted with an exercise price equal to the common stock’s fair market value at the date of grant. Director stock options have ten year terms and vest and become fully exercisable at the grant date. Employee stock options have ten year terms and vest and become fully exercisable in 20% increments beginning after their first year of service.

 

The Company has only made awards of stock options under the Option Plan and the Equity Plan.

 

Total expense related to the Company’s share-based compensation plans for the three months ended March 31, 2011 and 2010 was $63,000 and $60,000, respectively. The total income tax benefit recognized in the income statement for share-based compensation arrangements was $20,500 and $20,700 for the three months ended March 31, 2011 and 2010, respectively.

 

Options granted for the three months ended March 31, 2011 and 2010 were 56,100 and 5,000, respectively.  The weighted average per share fair value of stock option grants for the three months ended March 31, 2011 and 2010 was $5.07 and $4.08, respectively.  The fair values of the options granted during the three months ended March 31, 2011 and 2010 were estimated as of the grant date using the Black-Scholes option-pricing model based on the following weighted average assumptions:

 
| ** **              | ** ** | **Three Months Ended   March 31,** | ** ** |
|-------------------------|------------|---------------------------------------------------|------------|
| ** **              | ** ** | **2011**                                          | ** ** | **2010** | ** ** |
| Estimated option life   |       | 6.5 Years                                         |       | 6.5 Years |   |
| Risk free interest rate |       | 2.75 — 2.76%                                 |       | 3.14% |   |
| Expected volatility     |       | 44.70%                                            |       | 45.90% |   |
| Expected dividend yield |       | 1.02%                                             |       | 0.89% |   |

 

Expected volatility is based upon the average annual historical volatility of the Company’s common stock. The estimated option life is derived from the “simplified method” formula as described in Staff Accounting Bulletin No. 110. The risk free interest rate is based upon the seven-year U.S. Treasury note rate in effect at the time of grant.  The expected dividend yield is based upon implied and historical dividend declarations.

 

Stock option activity during the three months ended March 31, 2011 is summarized as follows:

 
| ** **                                 | ** ** | ** **         | ** ** | ** **   | ** ** | **Weighted**          | ** ** | ** **    | ** ** |
|--------------------------------------------|------------|--------------------|------------|--------------|------------|-----------------------|------------|---------------|------------|
| ** **                                 | ** ** | ** **         | ** ** | **Weighted** | ** ** | **Average**           | ** ** | **Aggregate** | ** ** |
| ** **                                 | ** ** | ** **         | ** ** | **Average**  | ** ** | **Remaining**         | ** ** | **Intrinsic** | ** ** |
| ** **                                 | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Contractual**       | ** ** | **Value**     | ** ** |
| ** **                                 | ** ** | **Shares**         | ** ** | **Price**    | ** ** | **Term (Years)** | ** ** | **($000)**    | ** ** |
| Outstanding at December 31, 2010      |       | 2,197,289          |       | $            | 8.67       |                  |       |          |       |   |
| Granted                                    |       | 56,100             |       | 11.69        |       |                  |       |          |       |
| Exercised                                  |       | (153,940           | )          | 8.97         |       |                  |       |          |       |
| Forfeited                                  |       | (7,850             | )          | 11.33        |       |                  |       |          |       |
| Outstanding at March 31, 2011         |       | 2,091,599          |       | $            | 8.72       |                  | 4.34       |          | $          | 6,142,257 |   |
| Options exercisable at March 31, 2011 |       | 1,861,049          |       | $            | 8.32       |                  | 4.08       |          | $          | 5,653,973 |   |

 

The intrinsic value of options exercised during the three months ended March 31, 2011 and 2010 was $489,435 and $18,259, respectively.

 

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A summary of the status of the Company’s non-vested stock options and changes during the three months ended March 31, 2011 is as follows:

 
| ** **                        | ** ** | ** **         | ** ** | **Weighted**        | ** ** |
|-----------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                        | ** ** | ** **         | ** ** | **Average**         | ** ** |
| ** **                        | ** ** | **Number of** | ** ** | **Grant Date** | ** ** |
| ** **                        | ** ** | **Shares**         | ** ** | **Fair Value** | ** ** |
| Balance at December 31, 2010 |       | 211,500            |       | $                   | 3.93       |   |
| Granted                           |       | 56,100             |       | 5.07                |       |
| Vested                            |       | (31,900            | )          | 4.26                |       |
| Forfeited                         |       | (5,150             | )          | 5.47                |       |
| Balance at March 31, 2011    |       | 230,550            |       | $                   | 4.13       |   |

 

At March 31, 2011, there was $873,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the plans. The cost is expected to be recognized over a weighted average period of 4.0 years. The total fair value of shares that vested during the three months ended March 31, 2011 and 2010 were $136,000 and $166,000, respectively.

 

Note 3

 

*Segment Information*

 

The Company operates in three business segments: commercial banking, mortgage banking, and wealth management and trust services.

 

The commercial banking segment includes both commercial and consumer lending and provides customers with such products as commercial loans, real estate loans, business financing and consumer loans. In addition, this segment provides customers with several choices of deposit products including demand deposit accounts, savings accounts and certificates of deposit. The mortgage banking segment engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis. The wealth management and trust services segment provides investment and financial advisory services to businesses and individuals, including financial planning, retirement/estate planning, trust, estates, custody, investment management, escrows, and retirement plans.

 

Information about the reportable segments and reconciliation of this information to the consolidated financial statements at and for the three months ended March 31, 2011 and 2010 is as follows:

 

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**At and for the Three Months Ended March 31, 2011 (in thousands):**

 
| ** **                 | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------|------------|----------------|------------|--------------|------------|----------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                 | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                    | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                 | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net interest income        |       | $              | 17,437     |         | $          | 425                        |       | $          | —     |             | $          | (201             | )          |   |   | $ | 17,661 |   |
| Provision for loan losses  |       | 1,110          |       | —       |       | —                     |       | —     |       |             |       | 1,110            |       |
| Non-interest income        |       | 776            |       | 3,640        |       | 549                        |       | 53         |       | (22              | )          | 4,996            |       |
| Non-interest expense       |       | 8,995          |       | 3,251        |       | 773                        |       | 693        |       | (22              | )          | 13,690           |       |
| Provision for income taxes |       | 2,690          |       | 290          |       | (74                        | )          | (270       | )          |             |       | 2,636            |       |
| Net income (loss)          |       | $              | 5,418      |         | $          | 524                        |       | $          | (150       | )                | $          | (571             | )          | $ | — |   | $ | 5,221 |   |
|                       |       |           |       |         |       |                       |       |       |       |             |       |             |       |
| Total Assets               |       | $              | 2,035,241  |         | $          | 167,699                    |       | $          | 593        |             | $          | 250,203          |       | $ | (393,693 | ) | $ | 2,060,043 |   |
| Average Assets             |       | $              | 2,035,558  |         | $          | 111,596                    |       | $          | 575        |             | $          | 253,401          |       | $ | (354,662 | ) | $ | 2,046,468 |   |

 

**At and for the Three Months Ended March 31, 2010 (in thousands):**

 
| ** **                 | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------|------------|----------------|------------|--------------|------------|----------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                 | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                    | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                 | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net interest income        |       | $              |       | 14,983       |       | $                          | 484        |       | $          | —           |       | $                | (200       | ) | $ | — |   | $ | 15,267 |   |
| Provision for loan losses  |       | 2,425          |       | —       |       | —                     |       | —     |       | —           |       | 2,425            |       |
| Non-interest income        |       | 1,027          |       | 3,697        |       | 1,014                      |       | 59         |       | (16              | )          | 5,781            |       |
| Non-interest expense       |       | 8,344          |       | 3,326        |       | 819                        |       | 622        |       | (16              | )          | 13,095           |       |
| Provision for income taxes |       | 1,611          |       | 296          |       | 68                         |       | (247       | )          | —           |       | 1,728            |       |
| Net income (loss)          |       | $              |       | 3,630        |       | $                          | 559        |       | $          | 127              |       | $                | (516       | ) | $ | — |   | $ | 3,800 |   |
|                       |       |           |       |         |       |                       |       |       |       |             |       |             |       |
| Total Assets               |       | $              |       | 1,923,066    |       | $                          | 160,359    |       | $          | 3,500            |       | $                | 231,843    |   | $ | (369,500 | ) | $ | 1,949,268 |   |
| Average Assets             |       | $              |       | 1,907,211    |       | $                          | 108,065    |       | $          | 3,396            |       | $                | 232,892    |   | $ | (339,586 | ) | $ | 1,911,978 |   |

 

The Company did not have any operating segments other than those reported. Parent company financial information is included in the “Other” category and represents an overhead function rather than an operating segment. The parent company’s most significant assets are its net investments in its subsidiaries. The parent company’s net interest expense is comprised of interest income from short-term investments and interest expense on trust preferred securities.

 

Note 4

 

*Earnings Per Share*

 

The following is the calculation of basic and diluted earnings per share for the three months ended March 31, 2011 and 2010.  Antidilutive outstanding stock options excluded from the weighted average shares outstanding for the diluted earnings per share calculation were 7,211 and 69,514 for the three months ended March 31, 2011 and 2010, respectively.  These stock options have exercise prices that were greater than the average market price of the Company’s common stock for the periods presented.

 

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| **(In thousands,**                     | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| **except per share data)**   | ** ** | **2011**                         | ** ** | **2010** | ** ** |
| Net income available to common shareholders |       | $                                | 5,221      |   | $ | 3,800 |   |
| Weighted average common shares - basic      |       | 29,291                           |       | 29,085 |   |
| Weighted average common shares - diluted    |       | 29,801                           |       | 29,534 |   |
| Earnings per common share - basic           |       | $                                | 0.18       |   | $ | 0.13 |   |
| Earnings per common share - diluted         |       | $                                | 0.18       |   | $ | 0.13 |   |

 

Weighted average shares for the basic earnings per share calculation is increased by the number of shares required to be issued under the Company’s various deferred compensation plans.  These plans provide for a Company match, such match must be in the common stock of the Company.  Employees who participate in the Company’s deferred compensation plans can allocate, at their discretion, their contributions to various investment options, including an option to invest in Company Common Stock.  The incremental weighted average shares attributable to the deferred compensation plans included in diluted outstanding shares assumes the participants opt to invest all of their contributions into the Company’s Common Stock investment option.

 

The following shows the composition of basic outstanding shares for the three months ended March 31, 2011 and 2010:

 
| **(in thousands)**                                                   | ** ** | **2011** | ** ** | **2010** | ** ** |
|---------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                      |       |     |       |     |       |
| Weighted average common shares outstanding                                |       | 28,853   |       | 28,720   |       |
| Weighted average shares attributable to the   deferred compensation plans |       | 438      |       | 365      |       |
| Total weighted average shares - basic                                     |       | 29,291   |       | 29,085   |       |

 

The following shows the composition of diluted outstanding shares for the three months ended March 31, 2011 and 2010:

 
| **(in thousands)**                                                           | ** ** | **2011** | ** ** | **2010** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                              |       |     |       |     |       |
| Weighted average shares outstanding - basic (from   above)                        |       | 29,291   |       | 29,085   |       |
| Incremental weighted average shares attributable   to deferred compensation plans |       | 211      |       | 232      |       |
| Weighted average shares attributable to stock   options                           |       | 299      |       | 217      |       |
| Total weighted average shares - diluted                                           |       | 29,801   |       | 29,534   |       |

 

Note 5

 

*Investment Securities*

 

The approximate fair value and amortized cost of investment securities at March 31, 2011 and December 31, 2010 are shown in the table below.

 

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| ** **                                 | ** ** | **March 31, 2011** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | **Gross**                    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Amortized**                | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In thousands)**                    | ** ** | **Cost**                     | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| *Investment Securities Available-for-Sale* | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. government-sponsored agencies         |       | $                            | 35,832     |   | 1,181 |   | (165 | ) | $ | 36,848 |   |
| Mortgage-backed securities                 |       | 226,106                      |       | 6,096 |   | (537 | ) | 231,665 |   |
| Municipal securities                       |       | 76,617                       |       | 1,590 |   | (94 | ) | 78,113 |   |
| U.S. treasury securities                   |       | 4,928                        |       | 158 |   | — |   | 5,086 |   |
| Total                                      |       | $                            | 343,483    |   | $ | 9,025 |   | $ | (796 | ) | $ | 351,712 |   |
|                                       |       |                         |       |   |   |   |   |   |   |
| *Investment Securities   Held-to-Maturity* | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Mortgage-backed securities                 |       | 8,207                        |       | 419 |   | — |   | 8,626 |   |
| Corporate bonds                            |       | 8,004                        |       | — |   | (4,070 | ) | 3,934 |   |
| Total                                      |       | $                            | 16,211     |   | $ | 419 |   | $ | (4,070 | ) | $ | 12,560 |   |

 
| ** **                                   | ** ** | **December 31, 2010** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **Gross**                       | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In thousands)**                      | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| *Investment Securities   Available-for-Sale* | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. government-sponsored agencies           |       | $                               | 30,941     |   | $ | 1,262 |   | $ | (84 | ) | $ | 32,119 |   |
| Mortgage-backed securities                   |       | 212,583                         |       | 6,979 |   | (80 | ) | 219,482 |   |
| Municipal securities                         |       | 64,284                          |       | 424 |   | (425 | ) | 64,283 |   |
| U.S. treasury securities                     |       | 4,923                           |       | 191 |   | — |   | 5,114 |   |
| Total                                        |       | $                               | 312,731    |   | $ | 8,856 |   | $ | (589 | ) | $ | 320,998 |   |
|                                         |       |                            |       |   |   |   |   |   |   |
| *Investment Securities   Held-to-Maturity*   | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Mortgage-backed securities                   |       | 13,875                          |       | 661 |   | — |   | 14,536 |   |
| Corporate bonds                              |       | 8,004                           |       | — |   | (4,807 | ) | 3,197 |   |
| Total                                        |       | $                               | 21,879     |   | $ | 661 |   | $ | (4,807 | ) | $ | 17,733 |   |

 

The fair value and amortized cost of investment securities by contractual maturity at March 31, 2011 and December 31, 2010 are shown below.  Expected maturities may differ from contractual maturities because many issuers have the right to call or prepay obligations with or without call or prepayment penalties.

 

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| ** **                        | ** ** | **March 31, 2011** | ** ** |
|-----------------------------------|------------|------------------------------|------------|
| ** **                        | ** ** | **Available-for-Sale**       | ** ** | **Held-to-Maturity** | ** ** |
| ** **                        | ** ** | **Amortized**                | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| **(In thousands)**           | ** ** | **Cost**                     | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** |
| After 1 year but within 5 years   |       | $                            | 5,666      |   | 5,829 |   | — |   |   |   |
| After 5 years but within 10 years |       | 52,136                       |       | 53,644 |   | — |   |   |   |
| After 10 years                    |       | 59,575                       |       | 60,574 |   | 8,004 |   | 3,934 |   |
| Mortgage-backed securities        |       | 226,106                      |       | 231,665 |   | 8,207 |   | 8,626 |   |
| Total                             |       | $                            | 343,483    |   | $ | 351,712 |   | $ | 16,211 |   | $ | 12,560 |   |
|                                   |            |                              |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                        | ** ** | **December 31, 2010** | ** ** |
|-----------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | **Available-for-Sale**          | ** ** | **Held-to-Maturity** | ** ** |
| ** **                        | ** ** | **Amortized**                   | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| **(In thousands)**           | ** ** | **Cost**                        | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** |
| After 1 year but within 5 years   |       | $                               | 4,923      |   | $ | 5,114 |   | $ | — |   | $ | — |   |
| After 5 years but within 10 years |       | 41,322                          |       | 42,637 |   | — |   | — |   |
| After 10 years                    |       | 53,903                          |       | 53,765 |   | 8,004 |   | 3,197 |   |
| Mortgage-backed securities        |       | 212,583                         |       | 219,482 |   | 13,875 |   | 14,536 |   |
| Total                             |       | $                               | 312,731    |   | $ | 320,998 |   | $ | 21,879 |   | $ | 17,733 |   |

 

The following table shows the Company’s investment securities’ gross unrealized losses and their fair value, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position at March 31, 2011 and December 31, 2010.

 

**March 31, 2011**

 
| **Investment Securities Available-for-Sale** | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**           | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|---------------------|------------|
| **(In thousands)**                                | ** ** | **Fair value**                    | ** ** | **Unrealized loss**             | ** ** | **Fair value** | ** ** | **Unrealized loss** | ** ** | **Fair value** | ** ** | **Unrealized loss** | ** ** |
| U.S. government - sponsored agencies                   |       | 9,875                                  |       | (165                                 | )          | —              |       | — |   | 9,875 |   | (165 | ) |
| Mortgage-backed securities                             |       | 34,156                                 |       | (483                                 | )          | 808                 |       | (54 | ) | 34,964 |   | (537 | ) |
| Municipal securities                                   |       | 7,261                                  |       | (84                                  | )          | 1,475               |       | (10 | ) | 8,736 |   | (94 | ) |
| Total temporarily impaired securities                  |       | $                                      | 51,292     |                                 | $          | (732                | )          | $ | 2,283 |   | $ | (64 | ) | $ | 53,575 |   | $ | (796 | ) |
|                                                        |            |                                        |            |                                      |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **Investment Securities Held-to-Maturity** | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**           | ** ** |
|------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|---------------------|------------|
| **(In thousands)**                              | ** ** | **Fair value**                    | ** ** | **Unrealized loss**             | ** ** | **Fair value** | ** ** | **Unrealized loss** | ** ** | **Fair value** | ** ** | **Unrealized loss** | ** ** |
| Corporate bonds                                      |       | —                                 |       | —                               |       | 3,934               |       | (4,070 | ) | 3,934 |   | (4,070 | ) |
| Total temporarily impaired securities                |       | $                                      | —     |                                 | $          | —              |       | $ | 3,934 |   | $ | (4,070 | ) | $ | 3,934 |   | $ | (4,070 | ) |
|                                                      |            |                                        |            |                                      |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**December 31, 2010**

 
| **Investment Securities Available-for-Sale** | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**           | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|---------------------|------------|
| **(In thousands)**                                | ** ** | **Fair value**                    | ** ** | **Unrealized loss**             | ** ** | **Fair value** | ** ** | **Unrealized loss** | ** ** | **Fair value** | ** ** | **Unrealized loss** | ** ** |
| U.S. government - sponsored agencies                   |       | $                                      | 9,957      |                                 | $          | (84                 | )          | $ | — |   | $ | — |   | $ | 9,957 |   | $ | (84 | ) |
| Mortgage-backed securities                             |       | 4,892                                  |       | (14                                  | )          | 814                 |       | (66 | ) | 5,706 |   | (80 | ) |
| Municipal securities                                   |       | 27,845                                 |       | (415                                 | )          | 1,475               |       | (10 | ) | 29,320 |   | (425 | ) |
| Total temporarily impaired securities                  |       | $                                      | 42,694     |                                 | $          | (513                | )          | $ | 2,289 |   | $ | (76 | ) | $ | 44,983 |   | $ | (589 | ) |

 
| **Investment Securities Held-to-Maturity** | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**           | ** ** |
|------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|---------------------|------------|
| **(In thousands)**                              | ** ** | **Fair value**                    | ** ** | **Unrealized loss**             | ** ** | **Fair value** | ** ** | **Unrealized loss** | ** ** | **Fair value** | ** ** | **Unrealized loss** | ** ** |
| Corporate bonds                                      |       | $                                      | —     |                                 | $          | —              |       | $ | 3,197 |   | $ | (4,807 | ) | $ | 3,197 |   | $ | (4,807 | ) |
| Total temporarily impaired securities                |       | $                                      | —     |                                 | $          | —              |       | $ | 3,197 |   | $ | (4,807 | ) | $ | 3,197 |   | $ | (4,807 | ) |

 

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The Company completes reviews for other-than-temporary impairment at least quarterly.  As of March 31, 2011, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency.  Investment securities which carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk.  At March 31, 2011, 97% of the Company’s mortgage-related securities are guaranteed by the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Government National Mortgage Association (GNMA).

 

The Company has $6.4 million in non-government non-agency mortgage-related securities.  These securities are rated from AAA to AA.  The various protective elements on the non agency securities may change in the future if market conditions or the financial stability of credit insurers changes, which could impact the ratings of these securities.

 

At March 31, 2011, certain of the Company’s investment grade securities were in an unrealized loss position.  Investment securities with unrealized losses are a result of pricing changes due to recent and negative conditions in the current market environment and not as a result of permanent credit impairment.  Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government.  Other mortgage-backed securities and municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due.  The Company does not intend to sell nor does the Company believe it will be required to sell any of the temporarily impaired securities prior to the recovery of the amortized cost.

 

The held-to-maturity portfolio includes investments in four pooled trust preferred securities, totaling $8.0 million of par value at March 31, 2011 (each security has a par value of $2.0 million).  These securities are presented as corporate bonds in the above tables.  The collateral underlying these structured securities are instruments issued by financial institutions or insurers.  The Company owns the A-3 tranches in each issuance.  Each of the bonds is rated by more than one rating agency.  One security has a composite rating of A, one security has a composite rating of A-, one of the securities has a composite rating of BB- and the other security has a composite rating of B-.  Observable trading activity remains limited for these types of securities.  The Company has estimated the fair value of the securities through the use of internal calculations and through information provided by external pricing services.  Given the level of subordination below the A-3 tranches, and the actual and expected performance of the underlying collateral, the Company expects to receive all contractual interest and principal payments recovering the amortized cost basis of each of the four securities, and concluded that these securities are not other-than-temporarily impaired.  The Company continuously monitors the financial condition of the underlying issues and the level of subordination below the A-3 tranches.  The Company also utilizes a multi-scenario model which assumes varying levels of additional defaults and deferrals and the effects of such adverse developments on the contractual cash flows for the A-3 tranches.  In each of the adverse scenarios, there was no indication of a break to the A-3 contractual cash flows.  Significant judgment is involved in the evaluation of other-than-temporary impairment.  The Company does not intend to sell nor does the Company believe it is probable that it will be required to sell these corporate bonds prior to the recovery of its investment.

 

In one of the pooled trust preferred securities issues, 41% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $147 million of the remaining $308 million, or 48% of the performing collateral defaulted or deferred payment.  In another of the pooled trust preferred securities issues, 42% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $88 million of the remaining $265 million, or 34% of the performing collateral defaulted or deferred payment.  In the third of the pooled trust preferred securities issues, 74% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $149 million of the remaining $176 million, or 85% of the performing collateral defaulted or deferred payment.  In the fourth of the pooled trust preferred securities issues, 50% of the principal balance is subordinate to our class of

 

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ownership, and it is estimated that a break in contractual cash flow would occur if $276 million of the remaining $378 million, or 73% of the performing collateral defaulted to deferred payment.

 

No other-than-temporary impairment has been recognized on the securities in the Company’s investment portfolio for the three months ended March 31, 2011.  The Company does not continue to hold any investment securities for which the Company previously recognized other-than-temporary impairment.

 

Note 6

 

*Loans Receivable and Allowance for Loan Losses*

 

The loan portfolio at March 31, 2011 and December 31, 2010 consist of the following:

 
| **(In thousands)**       | ** ** | **2011**  | ** ** | **2010**  | ** ** |
|-------------------------------|------------|-----------|------------|-----------|------------|
| Commercial and industrial     |       | $         | 186,262    |      | $          | 200,384 |   |
| Real estate - commercial      |       | 647,614   |       | 631,292   |       |
| Real estate - construction    |       | 242,364   |       | 240,007   |       |
| Real estate - residential     |       | 213,933   |       | 217,130   |       |
| Home equity lines             |       | 121,893   |       | 119,403   |       |
| Consumer                      |       | 3,260     |       | 3,042     |       |
|                          |       | 1,415,326 |       | 1,411,258 |       |
| Net deferred fees             |       | (2,109    | )          | (1,956    | )          |
| Loans receivable, net of fees |       | 1,413,217 |       | 1,409,302 |       |
| Allowance for loan losses     |       | (24,209   | )          | (24,210   | )          |
| Loans receivable, net         |       | $         | 1,389,008  |      | $          | 1,385,092 |   |

 

The Company’s allowance for loan losses is based first, on a segmentation of its loan portfolio by general loan type, or portfolio segments, as presented in the preceding table.  Certain portfolio segments are further disaggregated and evaluated collectively for impairment based on class segments, which are largely based on the type of collateral underlying each loan.

 

Activity in the Company’s allowance for loan losses for the three months ended March 31, 2011 and 2010 is shown below.

 
| **(In thousands)**           | ** ** | **2011** | ** ** | **2010** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Beginning balance, January 1 |       | $        | 24,210     |     | $          | 18,636 |   |
| Provision for loan losses         |       | 1,110    |       | 2,425    |       |
| Loans charged off                 |       | (1,225   | )          | (1,786   | )          |
| Recoveries                        |       | 114      |       | 12       |       |
| Ending balance, March 31     |       | $        | 24,209     |     | $          | 19,287 |   |

 

An analysis of the allowance for loan losses based on loan type, or segment, and the Company’s loan portfolio, which identifies certain loans that are evaluated for individual or collective impairment, as of March 31, 2011 and December 31, 2010, are below:

 

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**Allowance for Loan Losses**

**At March 31, 2011**

**(In thousands)**

 
| ** **                              | ** ** | **Commercial and   Industrial** | ** ** | **Real Estate -   Commercial** | ** ** | **Real Estate -   Construction** | ** ** | **Real Estate -   Residential** | ** ** | **Home Equity   Lines** | ** ** | **Consumer** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|------------------------------|------------|--------------|------------|-----------|------------|
| Allowance   for loan losses:            |       |                                 |       |                                     |       |                                       |       |                                      |       |                         |       |         |       |      |       |
| Beginning   Balance, January 1     |       | $                                    | 2,941      |                                     | $          | 10,558                                     |       | $                                         | 7,593      |                         | $          | 1,875        |       | $         | 1,175      |   | $ | 68 |   | $ | 24,210 |   |
| Charge-offs                             |       | (117                                 | )          | —                                   |       | (1,098                                     | )          | —                                    |       | —                       |       | (10          | )          | (1,225    | )          |
| Recoveries                              |       | 1                                    |       | —                                   |       | —                                     |       | 112                                       |       | —                       |       | 1            |       | 114       |       |
| Provision   for loan losses             |       | 116                                  |       | (187                                     | )          | 1,249                                      |       | (101                                      | )          | 21                           |       | 12           |       | 1,110     |       |
| Ending   Balance, March 31, 2011   |       | $                                    | 2,941      |                                     | $          | 10,371                                     |       | $                                         | 7,744      |                         | $          | 1,886        |       | $         | 1,196      |   | $ | 71 |   | $ | 24,209 |   |
|                                    |       |                                 |       |                                     |       |                                       |       |                                      |       |                         |       |         |       |      |       |
| Ending   Balance, March 31, 2011:  |       |                                 |       |                                     |       |                                       |       |                                      |       |                         |       |         |       |      |       |
| Individually   evaluated for impairment |       | $                                    | 453        |                                     | $          | 646                                        |       | $                                         | 4,105      |                         | $          | 79           |       | $         | —     |   | $ | — |   | $ | 5,283 |   |
| Collectively   evaluated for impairment |       | 2,488                                |       | 9,725                                    |       | 3,639                                      |       | 1,807                                     |       | 1,196                        |       | 71           |       | 18,926    |       |

 

**Loans Receivable**

**At March 31, 2011**

**(In thousands)**

 
| ** **                              | ** ** | **Commercial and   Industrial** | ** ** | **Real Estate -   Commercial** | ** ** | **Real Estate -   Construction** | ** ** | **Real Estate -   Residential** | ** ** | **Home Equity   Lines** | ** ** | **Consumer** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|------------------------------|------------|--------------|------------|-----------|------------|
| Loans   Receivable:                     |       |                                 |       |                                     |       |                                       |       |                                      |       |                         |       |         |       |      |       |
| Ending   Balance, March 31, 2011   |       | $                                    | 186,262    |                                     | $          | 647,614                                    |       | $                                         | 242,364    |                         | $          | 213,933      |       | $         | 121,893    |   | $ | 3,260 |   | $ | 1,415,326 |   |
|                                    |       |                                 |       |                                     |       |                                       |       |                                      |       |                         |       |         |       |      |       |
| Ending   Balance, March 31, 2011:  |       |                                 |       |                                     |       |                                       |       |                                      |       |                         |       |         |       |      |       |
| Individually   evaluated for impairment |       | $                                    | 3,853      |                                     | $          | 12,795                                     |       | $                                         | 15,698     |                         | $          | 561          |       | $         | 100        |   | $ | — |   | $ | 33,007 |   |
| Collectively   evaluated for impairment |       | 182,409                              |       | 634,819                                  |       | 226,666                                    |       | 213,372                                   |       | 121,793                      |       | 3,260        |       | 1,382,319 |       |

 

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**Allowance for Loan Losses**

**At December 31, 2010**

**(In thousands)**

 
| ** **                                | ** ** | **Commercial and   Industrial** | ** ** | **Real Estate -   Commercial** | ** ** | **Real Estate -   Construction** | ** ** | **Real Estate -   Residential** | ** ** | **Home Equity   Lines** | ** ** | **Consumer** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|------------------------------|------------|--------------|------------|-----------|------------|
| Allowance   for loan losses:              |       |                                 |       |                                     |       |                                       |       |                                      |       |                         |       |         |       |      |       |
| Ending   Balance, December 31, 2010  |       | $                                    | 2,941      |                                     | $          | 10,558                                     |       | $                                         | 7,593      |                         | $          | 1,875        |       | $         | 1,175      |   | $ | 68 |   | $ | 24,210 |   |
|                                      |       |                                 |       |                                     |       |                                       |       |                                      |       |                         |       |         |       |      |       |
| Ending   Balance, December 31, 2010: |       |                                 |       |                                     |       |                                       |       |                                      |       |                         |       |         |       |      |       |
| Individually   evaluated for impairment   |       | $                                    | 209        |                                     | $          | 1,095                                      |       | $                                         | 3,996      |                         | $          | 33           |       | $         | 5          |   | $ | — |   | $ | 5,338 |   |
| Collectively   evaluated for impairment   |       | 2,732                                |       | 9,463                                    |       | 3,597                                      |       | 1,842                                     |       | 1,170                        |       | 68           |       | 18,872    |       |

 

**Loans Receivable**

**At December 31, 2010**

**(In thousands)**

 
| ** **                                | ** ** | **Commercial and   Industrial** | ** ** | **Real Estate -   Commercial** | ** ** | **Real Estate -   Construction** | ** ** | **Real Estate -   Residential** | ** ** | **Home Equit   Lines** | ** ** | **Consumer** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|-----------------------------|------------|--------------|------------|-----------|------------|
| Loans   Receivable:                       |       |                                 |       |                                     |       |                                       |       |                                      |       |                        |       |         |       |      |       |
| Ending   Balance, December 31, 2010  |       | $                                    | 200,384    |                                     | $          | 631,292                                    |       | $                                         | 240,007    |                        | $          | 217,130      |       | $         | 119,403    |   | $ | 3,042 |   | $ | 1,411,258 |   |
|                                      |       |                                 |       |                                     |       |                                       |       |                                      |       |                        |       |         |       |      |       |
| Ending   Balance, December 31, 2010: |       |                                 |       |                                     |       |                                       |       |                                      |       |                        |       |         |       |      |       |
| Individually   evaluated for impairment   |       | $                                    | 4,142      |                                     | $          | 13,955                                     |       | $                                         | 16,494     |                        | $          | 845          |       | $         | 49         |   | $ | — |   | $ | 35,485 |   |
| Collectively   evaluated for impairment   |       | 196,242                              |       | 617,337                                  |       | 223,513                                    |       | 216,285                                   |       | 119,354                     |       | 3,042        |       | 1,375,773 |       |

 

The accounting policy related to the allowance for loan losses is considered a critical policy given the level of estimation, judgment and uncertainty in evaluating the levels of the allowance required for the inherent probable losses in the loan portfolio and the material effect such estimation, judgment and uncertainty can be on the consolidated financial results.

 

The Company’s ongoing credit quality management process relies on a system of activities to assess and evaluate various factors that impact the estimation of the allowance for loan losses.  These factors include, but are not limited to; current economic conditions; loan concentrations, collateral adequacy and value; past loss experience for particular types of loans, size, composition and nature of loans; migration of loans through our loan rating methodology; trends in charge-offs and recoveries.  This process also contemplates a disciplined approach to managing and monitoring credit exposures to ensure that the structure and pricing of credit is always consistent with the Company’s assessment of the risk.  The loan officer has frequent contact with the borrower and is a key player in the credit management process and must develop and diligently practice sound credit management skills and habits to ensure effectiveness.  Under the direction of our loan committee and the chief credit officer, the credit risk management function works with the loans officers and other groups within the Company to monitor our loan portfolio, maintain our watch list, and compile the analysis necessary to determine the allowance for loan losses.

 

Loans are added to the watch list when circumstances appear to warrant the inclusion of the relationship.  As a general rule, loans are added to the watch list when they are deemed to be problem assets.  Problem assets are defined as those that have been risk rated substandard or lower.   Successful problem asset management requires early recognition of deteriorating credits and timely corrective or risk management actions.  Generally, risk ratings are either approved or amended by the loan committee accordingly.

 

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Problem loans are maintained on the watch list until the loan is either paid off or circumstances around the borrower’s situation improve to the point that the risk rating on the loan is adjusted upward.

 

In addition to internal activities, the Company also engages an external consultant on a quarterly basis to review the Company’s loan portfolio.  This external loan review function helps to ensure the soundness of the loan portfolio through a third party review of existing exposures in the portfolio, supporting the commercial loan officers in the execution of its credit management responsibilities, and promoting and monitoring the adherence to the Company’s credit risk management standards.

 

The following tables report the Company’s nonaccrual and past due loans at March 31, 2011 and December 31, 2010.  In addition, the credit quality of the loan portfolio is provided as of March 31, 2011 and December 31, 2010.

 

**Nonaccrual and Past Due Loans**

**At March 31, 2011**

( In thousands)

 
| ** **                   | ** ** | **30-59 Days   Past Due** | ** ** | **60-89 Days   Past Due** | ** ** | **90 Days or More   Past Due (includes   nonaccrual)** | ** ** | **Total Past Due** | ** ** | **Current** | ** ** | **Total Loans** | ** ** | **90 Days Past Due   and Still Accruing** | ** ** | **Nonaccrual Loans** | ** ** |
|------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|---------------------------------------------------------------------------------|------------|------------------------------|------------|-------------|------------|----------------------|------------|--------------------------------------------------------------------|------------|---------------------------|------------|
| Commercial   and industrial  |       | $                                   | —     |                                | $          | —                                                                          |       | $                            | 2,908      |        | $          | 2,908                |       | $                                                                  | 183,354    |                      | 186,262    |   | $ | — |   | $ | 2,908 |   |
|                         |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Real   estate - commercial   |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Owner   occupied             |       | —                              |       | —                              |       | 238                                                                             |       | 238                          |       | 188,821     |       | 189,059              |       | —                                                             |       | 238                       |       |
| Non-owner   occupied         |       | —                              |       | —                              |       | —                                                                          |       | —                       |       | 458,555     |       | 458,555              |       | —                                                             |       | —                    |       |
|                         |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Real   estate - construction |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Residential                  |       | —                              |       | —                              |       | 2,632                                                                           |       | 2,632                        |       | 25,179      |       | 27,811               |       | —                                                             |       | 2,632                     |       |
| Commercial                   |       | 662                                 |       | —                              |       | 2,944                                                                           |       | 3,606                        |       | 210,947     |       | 214,553              |       | —                                                             |       | 2,944                     |       |
|                         |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Real   estate - residential  |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Single   family              |       | 1,590                               |       | —                              |       | 561                                                                             |       | 2,151                        |       | 164,970     |       | 167,121              |       | —                                                             |       | 561                       |       |
| Multi-family                 |       | —                              |       | —                              |       | —                                                                          |       | —                       |       | 46,812      |       | 46,812               |       | —                                                             |       | —                    |       |
|                         |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Home   equity lines          |       | —                              |       | —                              |       | —                                                                          |       | —                       |       | 121,893     |       | 121,893              |       | —                                                             |       | —                    |       |
|                         |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Consumer                     |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Installment                  |       | —                              |       | —                              |       | —                                                                          |       | —                       |       | 2,830       |       | 2,830                |       | —                                                             |       | —                    |       |
| Credit   cards               |       | 8                                   |       | —                              |       | —                                                                          |       | 8                            |       | 422         |       | 430                  |       | —                                                             |       | —                    |       |
|                         |       | $                                   | 2,260      |                                | $          | —                                                                          |       | $                            | 9,283      |        | $          | 11,543               |       | $                                                                  | 1,403,783  |                      | $          | 1,415,326 |   | $ | — |   | $ | 9,283 |   |
|                              |            |                                     |            |                                     |            |                                                                                 |            |                              |            |             |            |                      |            |                                                                    |            |                           |            |  |  |  |  |  |  |  |  |

 

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**Nonaccrual and Past Due Loans**

**At December 31, 2010**

(In thousands)

 
| ** **                   | ** ** | **30-59 Days   Past Due** | ** ** | **60-89 Days   Past Due** | ** ** | **90 Days or More   Past Due (includes   nonaccrual)** | ** ** | **Total Past Due** | ** ** | **Current** | ** ** | **Total Loans** | ** ** | **90 Days Past Due   and Still Accruing** | ** ** | **Nonaccrual Loans** | ** ** |
|------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|---------------------------------------------------------------------------------|------------|------------------------------|------------|-------------|------------|----------------------|------------|--------------------------------------------------------------------|------------|---------------------------|------------|
| Commercial   and industrial  |       | $                                   | 664        |                                | $          | —                                                                          |       | $                            | 2,887      |        | $          | 3,551                |       | $                                                                  | 196,833    |                      | 200,384    |   | $ | — |   | $ | 2,887 |   |
|                         |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Real   estate - commercial   |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Owner   occupied             |       | —                              |       | —                              |       | 238                                                                             |       | 238                          |       | 196,139     |       | 196,377              |       | —                                                             |       | 238                       |       |
| Non-owner   occupied         |       | —                              |       | —                              |       | —                                                                          |       | —                       |       | 434,915     |       | 434,915              |       | —                                                             |       | —                    |       |
|                         |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Real   estate - construction |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Residential                  |       | 715                                 |       | —                              |       | —                                                                          |       | 715                          |       | 60,020      |       | 60,735               |       | —                                                             |       | —                    |       |
| Commercial                   |       | —                              |       | —                              |       | 3,546                                                                           |       | 3,546                        |       | 175,726     |       | 179,272              |       | —                                                             |       | 3,546                     |       |
|                         |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Real   estate - residential  |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Single   family              |       | 653                                 |       | —                              |       | 845                                                                             |       | 1,498                        |       | 169,505     |       | 171,003              |       | —                                                             |       | 845                       |       |
| Multi-family                 |       | —                              |       | —                              |       | —                                                                          |       | —                       |       | 46,127      |       | 46,127               |       | —                                                             |       | —                    |       |
|                         |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Home   equity lines          |       | 99                                  |       | —                              |       | 49                                                                              |       | 148                          |       | 119,255     |       | 119,403              |       | 49                                                                 |       | —                    |       |
|                         |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Consumer                     |       |                                |       |                                |       |                                                                            |       |                         |       |        |       |                 |       |                                                               |       |                      |       |
| Installment                  |       | —                              |       | —                              |       | —                                                                          |       | —                       |       | 2,203       |       | 2,203                |       | —                                                             |       | —                    |       |
| Credit   cards               |       | —                              |       | —                              |       | —                                                                          |       | —                       |       | 839         |       | 839                  |       | —                                                             |       | —                    |       |
|                         |       | $                                   | 2,131      |                                | $          | —                                                                          |       | $                            | 7,565      |        | $          | 9,696                |       | $                                                                  | 1,401,562  |                      | $          | 1,411,258 |   | $ | 49 |   | $ | 7,516 |   |
|                              |            |                                     |            |                                     |            |                                                                                 |            |                              |            |             |            |                      |            |                                                                    |            |                           |            |  |  |  |  |  |  |  |  |

 

Additional information on the Company’s impaired loans that were evaluated for specific reserves as of March 31, 2011 and December 31, 2010, including the recorded investment on the statement of condition and the unpaid principal balance, is shown below:

 

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**Impaired Loans**

**At March 31, 2011**

**(In thousands)**

 
| ** **                 | ** ** | **Recorded Investment** | ** ** | **Unpaid Principal Balance** | ** ** | **Related Allowance** | ** ** | **Interest Income   Recognized** | ** ** |
|----------------------------|------------|------------------------------|------------|----------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
| With no related allowance: |       |                         |       |                                   |       |                       |       |                                  |       |
| Commercial and industrial  |       | $                            | 2,908      |                                   | $          | 3,246                      |       | $                                     | —     |   | $ | 50 |   |
| Real estate - commercial   |       |                         |       |                                   |       |                       |       |                                  |       |
| Owner occupied             |       | 238                          |       | 286                                    |       | —                     |       | —                                |       |
| Non-owner occupied         |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Real estate - construction |       |                         |       |                                   |       |                       |       |                                  |       |
| Residential                |       | 2,632                        |       | 3,730                                  |       | —                     |       | 15                                    |       |
| Commercial                 |       | 2,944                        |       | 4,956                                  |       | —                     |       | 43                                    |       |
| Real estate - residential  |       |                         |       |                                   |       |                       |       |                                  |       |
| Single family              |       | 561                          |       | 776                                    |       | —                     |       | 8                                     |       |
| Multi-family               |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Home equity lines          |       | —                       |       | —                                 |       | —                     |       | —                                |       |
|                       |       |                         |       |                                   |       |                       |       |                                  |       |
| With related allowance:    |       |                         |       |                                   |       |                       |       |                                  |       |
| Commercial and industrial  |       | $                            | 545        |                                   | $          | 545                        |       | $                                     | 162        |   | $ | 8 |   |
| Real estate - commercial   |       |                         |       |                                   |       |                       |       |                                  |       |
| Owner occupied             |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Non-owner occupied         |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Real estate - construction |       |                         |       |                                   |       |                       |       |                                  |       |
| Residential                |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Commercial                 |       | 11,040                       |       | 11,040                                 |       | 3,550                      |       | 141                                   |       |
| Real estate - residential  |       |                         |       |                                   |       |                       |       |                                  |       |
| Single family              |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Multi-family               |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Home equity lines          |       | —                       |       | —                                 |       | —                     |       | —                                |       |
|                       |       |                         |       |                                   |       |                       |       |                                  |       |
| By segment total:          |       |                         |       |                                   |       |                       |       |                                  |       |
| Commercial and industrial  |       | $                            | 3,453      |                                   | $          | 3,791                      |       | $                                     | 162        |   | $ | 58 |   |
| Real estate - commercial   |       | 238                          |       | 286                                    |       | —                     |       | —                                |       |
| Real estate - construction |       | 16,616                       |       | 19,726                                 |       | 3,550                      |       | 199                                   |       |
| Real estate - residential  |       | 561                          |       | 776                                    |       | —                     |       | 8                                     |       |
| Home equity lines          |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Total                      |       | $                            | 20,868     |                                   | $          | 24,579                     |       | $                                     | 3,712      |   | $ | 265 |   |

 

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**Impaired Loans**

**At December 31, 2010**

**(In thousands)**

 
| ** **                 | ** ** | **Recorded Investment** | ** ** | **Unpaid Principal Balance** | ** ** | **Related Allowance** | ** ** | **Interest Income   Recognized** | ** ** |
|----------------------------|------------|------------------------------|------------|----------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
| With no related allowance: |       |                         |       |                                   |       |                       |       |                                  |       |
| Commercial and industrial  |       | $                            | 2,887      |                                   | $          | 4,346                      |       | $                                     | —     |   | $ | 72 |   |
| Real estate - commercial   |       |                         |       |                                   |       |                       |       |                                  |       |
| Owner occupied             |       | 238                          |       | 286                                    |       | —                     |       | 14                                    |       |
| Non-owner occupied         |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Real estate - construction |       |                         |       |                                   |       |                       |       |                                  |       |
| Residential                |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Commercial                 |       | 3,546                        |       | 4,737                                  |       | —                     |       | 261                                   |       |
| Real estate - residential  |       |                         |       |                                   |       |                       |       |                                  |       |
| Single family              |       | 845                          |       | 1,196                                  |       | —                     |       | 23                                    |       |
| Multi-family               |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Home equity lines          |       | 49                           |       | 49                                     |       | —                     |       | —                                |       |
|                       |       |                         |       |                                   |       |                       |       |                                  |       |
| With related allowance:    |       |                         |       |                                   |       |                       |       |                                  |       |
| Commercial and industrial  |       | $                            | 555        |                                   | $          | 555                        |       | $                                     | 162        |   | $ | 33 |   |
| Real estate - commercial   |       | —                       |       |                                   |       |                       |       |                                  |       |
| Owner occupied             |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Non-owner occupied         |       | 3,730                        |       | 3,730                                  |       | 418                        |       | 192                                   |       |
| Real estate - construction |       | —                       |       |                                   |       |                       |       |                                  |       |
| Residential                |       | —                       |       |                                   |       |                       |       |                                  |       |
| Commercial                 |       | 10,898                       |       | 10,898                                 |       | 3,550                      |       | 537                                   |       |
| Real estate - residential  |       | —                       |       |                                   |       |                       |       |                                  |       |
| Single family              |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Multi-family               |       | —                       |       | —                                 |       | —                     |       | —                                |       |
| Home equity lines          |       | —                       |       | —                                 |       | —                     |       | —                                |       |
|                       |       |                         |       |                                   |       |                       |       |                                  |       |
| By segment total:          |       |                         |       |                                   |       |                       |       |                                  |       |
| Commercial and industrial  |       | $                            | 3,442      |                                   | $          | 4,901                      |       | $                                     | 162        |   | $ | 105 |   |
| Real estate - commercial   |       | 3,968                        |       | 4,016                                  |       | 418                        |       | 206                                   |       |
| Real estate - construction |       | 14,444                       |       | 15,635                                 |       | 3,550                      |       | 798                                   |       |
| Real estate - residential  |       | 845                          |       | 1,196                                  |       | —                     |       | 23                                    |       |
| Home equity lines          |       | 49                           |       | 49                                     |       | —                     |       | —                                |       |
| Total                      |       | $                            | 22,748     |                                   | $          | 25,797                     |       | $                                     | 4,130      |   | $ | 1,132 |   |

 

One of the most significant factors in assessing the credit quality of the Company’s loan portfolio is the risk rating.  The Company uses the following risk ratings to manage the credit quality of its loan portfolio: pass, substandard, doubtful and loss.  Substandard risk rated loans are those loans whose full final collectability may not appear to be a matter for serious doubt, but which nevertheless have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and require close supervision by management.  Loans that have a risk rating of doubtful has all the weakness inherent in one graded substandard with the added provision that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and value, highly questionable.  A loss loan is one that is considered uncollectible and will be charged-off immediately.  All other loans not rated substandard, doubtful or loss are considered to have a pass risk rating.  Substandard and doubtful risk rated loans are evaluated for impairment.  The following table presents a summary of the risk ratings by portfolio segment and class segment as of March 31, 2011 and December 31, 2010.

 

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**Internal Risk Rating Grades**

At March 31, 2011

**(In thousands)**

 
| ** **                 | ** ** | **Pass** | ** ** | **Substandard** | ** ** | **Doubtful** | ** ** | **Loss** | ** ** |
|----------------------------|------------|----------|------------|-----------------|------------|--------------|------------|----------|------------|
| Commercial and industrial  |       | $        | 182,409    |            | $          | 3,853        |       | $        | —     |   | $ | — |   |
|                       |       |     |       |            |       |         |       |     |       |
| Real estate - commercial   |       |     |       |            |       |         |       |     |       |
| Owner occupied             |       | 182,920  |       | 6,139           |       | —       |       | —   |       |
| Non-owner occupied         |       | 451,899  |       | 6,656           |       | —       |       | —   |       |
|                       |       |     |       |            |       |         |       |     |       |
| Real estate - construction |       |     |       |            |       |         |       |     |       |
| Residential                |       | 27,811   |       | —          |       | —       |       | —   |       |
| Commercial                 |       | 198,855  |       | 15,698          |       | —       |       | —   |       |
|                       |       |     |       |            |       |         |       |     |       |
| Real estate - residential  |       |     |       |            |       |         |       |     |       |
| Single family              |       | 166,560  |       | —          |       | 561          |       | —   |       |
| Multi-family               |       | 46,812   |       | —          |       | —       |       | —   |       |
|                       |       |     |       |            |       |         |       |     |       |
| Home equity lines          |       | 121,793  |       | 100             |       | —       |       | —   |       |
|                       |       |     |       |            |       |         |       |     |       |
| Consumer                   |       |     |       |            |       |         |       |     |       |
| Installment                |       | 430      |       | —          |       | —       |       | —   |       |
| Credit cards               |       | 2,830    |       | —          |       | —       |       | —   |       |
|                       |       | $        | 1,382,319  |            | $          | 32,446       |       | $        | 561        |   | $ | — |   |

 

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**Internal Risk Rating Grades**

At Decmeber 31, 2010

**(In thousands)**

 
| ** **                 | ** ** | **Pass** | ** ** | **Substandard** | ** ** | **Doubtful** | ** ** | **Loss** | ** ** |
|----------------------------|------------|----------|------------|-----------------|------------|--------------|------------|----------|------------|
| Commercial and industrial  |       | $        | 196,242    |            | $          | 4,142        |       | $        | —     |   | $ | — |   |
|                       |       |     |       |            |       |         |       |     |       |
| Real estate - commercial   |       |     |       |            |       |         |       |     |       |
| Owner occupied             |       | 190,190  |       | 6,187           |       | —       |       | —   |       |
| Non-owner occupied         |       | 427,147  |       | 7,768           |       | —       |       | —   |       |
|                       |       |     |       |            |       |         |       |     |       |
| Real estate - construction |       |     |       |            |       |         |       |     |       |
| Residential                |       | 58,935   |       | 1,800           |       | —       |       | —   |       |
| Commercial                 |       | 164,578  |       | 14,694          |       | —       |       | —   |       |
|                       |       |     |       |            |       |         |       |     |       |
| Real estate - residential  |       |     |       |            |       |         |       |     |       |
| Single family              |       | 170,158  |       | —          |       | 845          |       | —   |       |
| Multi-family               |       | 46,127   |       | —          |       | —       |       | —   |       |
|                       |       |     |       |            |       |         |       |     |       |
| Home equity lines          |       | 119,354  |       | —          |       | 49           |       | —   |       |
|                       |       |     |       |            |       |         |       |     |       |
| Consumer                   |       |     |       |            |       |         |       |     |       |
| Installment                |       | 839      |       | —          |       | —       |       | —   |       |
| Credit cards               |       | 2,203    |       | —          |       | —       |       | —   |       |
|                       |       | $        | 1,375,773  |            | $          | 34,591       |       | $        | 894        |   | $ | — |   |

 

There were no loans modified during the three months ended March 31, 2011 that would be considered a troubled debt restructuring.

 

Note 7

 

*Derivative Instruments and Hedging Activities*

 

The Company enters into rate lock commitments with its mortgage customers.  The Company is also a party to forward mortgage loan sales contracts to sell loans servicing released.  The rate lock commitment and forward sale agreement are undesignated derivatives and marked to fair value through earnings.  The fair value of the rate lock derivative includes the servicing premium and the interest spread for the difference between retail and wholesale mortgage rates.  Realized and unrealized gains on mortgage banking activities presents the gain recognized for the period presented and associated with these elements of fair value.  On the date the mortgage loan closes, the loan held for sale is designated as the hedged item in a cash flow hedge relationship and the forward loan sale commitment is designated as the hedging instrument.

 

At March 31, 2011, accumulated other comprehensive income included an unrealized gain, net of tax, of $624,000 related to forward loan sales contracts designated as the hedging instrument in the cash flow hedge. Loans held for sale are generally sold within sixty days of closing and, therefore, all or substantially all of the amount recorded in accumulated other comprehensive income at March 31, 2011 which is related to the Company’s cash flow hedges will be recognized in earnings during the second quarter of 2011.

 

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At March 31, 2011, the Company had $131.5 million in residential mortgage rate lock commitments and associated forward sales, and $122.0****million in forward loan sales associated with $168.6 million of loans that had closed and presented as held for sale.

 

The Company has interest rate swaps to mitigate its exposure to interest rate risk.  These interest rate swaps have an aggregate notional amount of $10.0 million to hedge against changes in cash flows caused by movement in interest rates related to the Company’s issuance of $20.0 million in trust preferred securities.  At March 31, 2011, accumulated other comprehensive income included an after-tax unrealized gain of $45,000 related to these interest rate swaps.  In addition, the Company has an interest rate swap to mitigate the variability in the fair value for one loan receivable.  For the three months ended March 31, 2011 and 2010, the change in fair value recorded for this fair value hedge was $150,000 and $152,000, respectively.  The amount of ineffectiveness reflected in earnings was not significant in either period.

 

Note 8

* *

*Fair Value of Derivative Instruments and Hedging Activities*

 

The following tables disclose the derivative instruments’ location on the Company’s statement of condition and the fair value of those instruments at March 31, 2011 and December 31, 2010.  In addition, the gains and losses related to these derivative instruments is provided for the three months ended March 31, 2011 and 2010.

 

**Derivative Instruments and Hedging Activities**

**At of March 31, 2011**

**(in thousands)**

 
| ** **                                                    | ** ** | **Asset Derivatives**                     | ** ** | **Liability Derivatives** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                    | ** ** | **Balance Sheet   Location**              | ** ** | **Fair Value**            | ** ** | **Balance Sheet   Location** | ** ** | **Fair Value** | ** ** |
| **Derivatives Designated as Hedging   Instruments**           |       |                                           |       |                           |       |   |   |   |   |
| Interest Rate Swaps                                           |       | Accrued   Interest Receivable and Other Assets |       | $                              | —     |   | Accrued   Interest Payable and Other Liabilities |   | $ | 1,607 |   |
| Forward Loan Sales Commitments                                |       | Accrued   Interest Receivable and Other Assets |       | 977                            |       | Accrued   Interest Payable and Other Liabilities |   | 665 |   |
| **Total Derivatives Designated as   Hedging Instruments**     |       |                                           |       | 977                            |       |   |   | 2,272 |   |
|                                                          |       |                                           |       |                           |       |   |   |   |   |
| **Derivatives Not Designated as   Hedging Instruments**       |       |                                           |       |                           |       |   |   |   |   |
| Rate Lock and Forward Loan Sales Commitments                  |       | Accrued   Interest Receivable and Other Assets |       | 4,100                          |       | Accrued   Interest Payable and Other Liabilities |   | 38 |   |
| Rate Lock Commitments                                         |       | Accrued   Interest Receivable and Other Assets |       | 38                             |       | Accrued   Interest Payable and Other Liabilities |   | 362 |   |
| **Total Derivatives Not Designated as   Hedging Instruments** |       |                                           |       | 4,138                          |       |   |   | 400 |   |
|                                                          |       |                                           |       |                           |       |   |   |   |   |
| **Total Derivatives**                                         |       |                                           |       | $                              | 5,115      |   |   |   | $ | 2,672 |   |

 

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**Derivative Instruments and Hedging Activities**

**At December 31, 2010**

**(in thousands)**

 
| ** **                                                    | ** ** | **Asset Derivatives**                     | ** ** | **Liability Derivatives** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                    | ** ** | **Balance Sheet   Location**              | ** ** | **Fair Value**            | ** ** | **Balance Sheet   Location** | ** ** | **Fair Value** | ** ** |
| **Derivatives Designated as Hedging   Instruments**           |       |                                           |       |                           |       |   |   |   |   |
| Interest Rate Swaps                                           |       | Accrued   Interest Receivable and Other Assets |       | $                              | —     |   | Accrued   Interest Payable and Other Liabilities |   | $ | 1,837 |   |
| Forward Loan Sales Commitments                                |       | Accrued   Interest Receivable and Other Assets |       | 1,465                          |       | Accrued   Interest Payable and Other Liabilities |   | 2,441 |   |
| **Total Derivatives Designated as   Hedging Instruments**     |       |                                           |       | 1,465                          |       |   |   | 4,278 |   |
|                                                          |       |                                           |       |                           |       |   |   |   |   |
| **Derivatives Not Designated as   Hedging Instruments**       |       |                                           |       |                           |       |   |   |   |   |
| Rate Lock and Forward Loan Sales Commitments                  |       | Accrued   Interest Receivable and Other Assets |       | 2,951                          |       | Accrued   Interest Payable and Other Liabilities |   | 264 |   |
| Rate Lock Commitments                                         |       | Accrued   Interest Receivable and Other Assets |       | 264                            |       | Accrued   Interest Payable and Other Liabilities |   | 77 |   |
| **Total Derivatives Not Designated as   Hedging Instruments** |       |                                           |       | 3,215                          |       |   |   | 341 |   |
|                                                          |       |                                           |       |                           |       |   |   |   |   |
| **Total Derivatives**                                         |       |                                           |       | $                              | 4,680      |   |   |   | $ | 4,619 |   |

 

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**Impact of Derivative Instruments on the Statement of Income**

**For the Three Months Ended March 31, 2011**

**(in thousands)**

 
| **Derivatives in Fair Value Hedging   Relationships** | ** ** | **Locations of Gain   (Loss) Recognized   in Income on   Derivative** | ** ** | **Amount of Gain   (Loss) Recognized in   Income on Derivative** | ** ** | **Location of Gain   (Loss) Recognized   in Income on   Hedged Item** | ** **     | **Amount of Gain   (Loss) Recognized   in Income on   Hedged Item** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|----------------|---------------------------------------------------------------------------------------------------|------------|
|                                                                      |       |                                                                                           |       |                                                                                           |       |                                                                                                |           |                                                                                              |       |
| Interest Rate Swaps                                                       |       | Other   Income                                                                                 |       | $                                                                                              | (162       | )                                                                                                   | Other   Income |                                                                                              | $          | 162 |   |
| **Total**                                                                 |       |                                                                                           | ** ** | **$**                                                                                          | **(162**   | **)**                                                                                               |           | ** **                                                                                        | **$**      | **162** | ** ** |

 
| **Derivatives in Cash Flow Hedging   Relationships** | ** ** | **Amount of Gain   (Loss) Recognized   in Other   Comprehensive   Income on   Derivative   (Effective Portion)** | ** ** | **Location of Gain   (Loss) Reclassified   from Accumulated   Other Comprehensive   Income into Income   (Effective Portion)** | ** **   | **Amount of Gain   (Loss) Reclassified   from Accumulated   Other   Comprehensive   Income into Income   (Effective Portion)** | ** ** | **Location of Gain   (Loss) Recognized   in Income on   Derivative   (Ineffective Portion   and Amount   Excluded from   Effectiveness   Testing)** | ** ** | **Amount of Gain   (Loss) Recognized   in Income on   Derivative   (Ineffective   Portion and   Amount Excluded   from Effectiveness   Testing)** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                                     |       |                                                                                                                                           |       |                                                                                                                                                                   |         |                                                                                                                                                              |       |                                                                                                                                                                                        |       |                                                                                                                                                                                      |       |
| Interest   Rate Swaps                                                    |       | $                                                                                                                                              | 45         |                                                                                                                                                                   | Other Income |                                                                                                                                                              | $          | —                                                                                                                                                                                      |       | Other Income                                                                                                                                                                              |       | $ | — |   |
|                                                                     |       |                                                                                                                                           |       |                                                                                                                                                                   |         |                                                                                                                                                              |       |                                                                                                                                                                                        |       |                                                                                                                                                                                      |       |
| Forward   Loan Sales Commitments                                         |       | 624                                                                                                                                            |       | Other Income                                                                                                                                                           |         | (2,263                                                                                                                                                            | )          | Other Income                                                                                                                                                                                |       | —                                                                                                                                                                                    |       |
| **Total**                                                                | ** ** | **$**                                                                                                                                          | **669**    |                                                                                                                                                                   |         | ** **                                                                                                                                                        | **$**      | **(2,263**                                                                                                                                                                                  | **)**      |                                                                                                                                                                                      | ** ** | **$** | **—** | ** ** |

 
| **Derivatives   Not Designated as Hedging Instruments**    | ** ** | **Amount of Gain   (Loss) Recognized   in Income on   Derivative** | ** ** | **Location of Gain   (Loss) Recognized in   Income on Derivative** | ** **                                                     |
|------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|----------------------------------------------------------------|
| Forward Loan Sales Commitments and Rate Lock   Commitments |       | $                                                                                           | 3,738      |                                                                                             | Realized   and unrealized gains on mortgage banking activities |   |
| Forward Loan Sales Commitments                             |       | 324                                                                                         |       | Other   Income                                                                                   |                                                           |
| Rate Lock Commitments                                      |       | (324                                                                                        | )          | Other   Income                                                                                   |                                                           |
| **Total**                                                  | ** ** | **$**                                                                                       | **3,738**  |                                                                                             |                                                           |   |

 

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**Impact of Derivative Instruments on the Statement of Income**

**For the Three Months Ended March 31, 2010**

**(in thousands)**

 
| **Derivatives in Fair Value Hedging   Relationships** |   | **Locations of Gain   (Loss) Recognized   in Income on   Derivative** | ** ** | **Amount of Gain   (Loss) Recognized in   Income on Derivative** | ** ** | **Location of Gain   (Loss) Recognized   in Income on   Hedged Item** | ** **   | **Amount of Gain   (Loss) Recognized   in Income on   Hedged Item** |   |    |   |
|---------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|--------------|---------------------------------------------------------------------------------------------------|--------|---------|--------|
| ** **                                                                |   | ** **                                                                                     | ** ** | ** **                                                                                     | ** ** | ** **                                                                                          | ** **   | ** **                                                                                        |   |    |   |
| Interest   Rate Swaps                                                     |   | Other Income                                                                                   |       | $                                                                                              | 61         |                                                                                                | Other Income |                                                                                              | $      | (61     | )      |   |   |
| **Total**                                                                 |   |                                                                                           | ** ** | **$**                                                                                          | **61**     |                                                                                                |         | ** **                                                                                        | **$**  | **(61** | **)**  |   |   |

 
| **Derivatives in Cash Flow Hedging   Relationships** | ** ** | **Amount of Gain   (Loss) Recognized   in Other   Comprehensive   Income on   Derivative   (Effective Portion)** | ** ** | **Location of Gain   (Loss) Reclassified   from Accumulated   Other Comprehensive   Income into Income   (Effective Portion)** | ** **   | **Amount of Gain   (Loss) Reclassified   from Accumulated   Other   Comprehensive   Income into Income   (Effective Portion)** | ** ** | **Location of Gain   (Loss) Recognized   in Income on   Derivative   (Ineffective Portion   and Amount   Excluded from   Effectiveness   Testing)** | ** ** | **Amount of Gain   (Loss) Recognized   in Income on   Derivative   (Ineffective   Portion and   Amount Excluded   from Effectiveness   Testing)** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                                     |       |                                                                                                                                           |       |                                                                                                                                                                   |         |                                                                                                                                                              |       |                                                                                                                                                                                        |       |                                                                                                                                                                                      |       |
| Interest   Rate Swaps                                                    |       | $                                                                                                                                              | (78        | )                                                                                                                                                                      | Other Income |                                                                                                                                                              | $          | —                                                                                                                                                                                      |       | Other Income                                                                                                                                                                              |       | $ | — |   |
|                                                                     |       |                                                                                                                                           |       |                                                                                                                                                                   |         |                                                                                                                                                              |       |                                                                                                                                                                                        |       |                                                                                                                                                                                      |       |
| Forward   Loan Sales Commitments                                         |       | (1                                                                                                                                             | )          | Other Income                                                                                                                                                           |         | (2,205                                                                                                                                                            | )          | Other Income                                                                                                                                                                                |       | 1                                                                                                                                                                                         |       |
| **Total**                                                                | ** ** | **$**                                                                                                                                          | **(79**    | **)**                                                                                                                                                                  |         | ** **                                                                                                                                                        | **$**      | **(2,205**                                                                                                                                                                                  | **)**      |                                                                                                                                                                                      | ** ** | **$** | **1** | ** ** |

 
| **Derivatives Not Designated as   Hedging Instruments** |   | **Amount of Gain   (Loss) Recognized   in Income on   Derivative** |      | **Location of Gain   (Loss) Recognized in   Income on Derivative** |                                                           |   |   |   |   |
|-----------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------|-----------|--------------------------------------------------------------------------------------------------|----------------------------------------------------------------|--------|--------|--------|--------|
| Forward   Loan Sales Commitments and Rate Lock Commitments                  |   | $                                                                                           | 2,941     |                                                                                             | Realized and unrealized   gains on mortgage banking activities |   |   |   |   |   |
| Forward   Loan Sales Commitments                                            |   | 190                                                                                         |      | Other Income                                                                                     |                                                           |   |   |   |   |
| Rate   Lock Commitments                                                     |   | (190                                                                                        | )         | Other Income                                                                                     |                                                           |   |   |   |   |
| **Total**                                                                   |   | **$**                                                                                       | **2,941** |                                                                                             |                                                           |   |   |   |   |   |

 

Note 9

 

*Goodwill and Other Intangibles*

 

Information concerning total amortizable other intangible assets at March 31, 2011 is as follows:

 

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| ** **                        | ** ** | **Mortgage Banking**        | ** ** |
|-----------------------------------|------------|----------------------------------|------------|
| **(In thousands)**           | ** ** | **Gross Carrying   Amount** | ** ** | **Accumulated   Amortization** | ** ** |
| Balance at December 31, 2010 |       | $                                | 1,781      |   | $ | 1,237 |   |
| 2011 activity:                    |       |                             |       |   |   |
| Customer relationship intangibles |       | —                           |       | 49 |   |
| Balance at March 31, 2011    |       | $                                | 1,781      |   | $ | 1,286 |   |

 

The aggregate amortization expense was $49,000 and $60,000 for the three months ended March 31, 2011 and 2010, respectively.

 

The estimated amortization expense for the next three years is as follows:

 
| **(In thousands)**           | ** ** | ** ** | ** ** |
|-----------------------------------|------------|------------|------------|
| 2011 (April — December) |       | $          | 148        |   |
| 2012                              |       | 198        |       |
| 2013                              |       | 149        |       |
|                                   |            |            |            |  |

 

The carrying amount of goodwill at March 31, 2011 was as follows:

 
| **(In thousands)**           | ** ** | **Commercial   Banking** | ** ** | **Mortgage   Banking** | ** ** | **Wealth   Management   and Trust   Services** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|--------------------------|------------|------------------------|------------|-----------------------------------------------------|------------|-----------|------------|
| Balance at December 31, 2010 |       | $                        | 24         |                   | $          | 10,120                                              |       | $         | —     |   | $ | 10,144 |   |
| No activity                       |       | —                   |       | —                 |       | —                                              |       | —    |       |
| Balance at March 31, 2011    |       | $                        | 24         |                   | $          | 10,120                                              |       | $         | —     |   | $ | 10,144 |   |

 

Goodwill of each of the Company’s business segments is tested for impairment on an annual basis or more frequently if events or circumstances warrant.

 

Note 10

 

*Commitments and Contingencies*

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit and financial guarantees. Commitments to extend credit are agreements to lend to a customer so long as there is no violation of any condition established in the contract.  Commitments usually have fixed expiration dates up to one year or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  These instruments represent obligations of the Company to extend credit or guarantee borrowings and are not recorded on the consolidated statements of financial condition.  The rates and terms of these instruments are competitive with others in the market in which the Company operates.

 

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Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of the contractual obligations by a customer to a third party.  The majority of these guarantees extend until satisfactory completion of the customer’s contractual obligations.  All standby letters of credit outstanding at March 31, 2011 are collateralized.

 

The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.  The Company evaluates each customer’s creditworthiness on a case-by-case basis and requires collateral to support financial instruments when deemed necessary.  The amount of collateral obtained upon extension of credit is based upon management’s evaluation of the counterparty.  Collateral held varies but may include deposits held by the Company, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

 

Commitments to extend credit of $529.5 million primarily have floating rates as of March 31, 2011.  At March 31, 2011, standby letters of credit were $21.1 million. Commitments to extend credit of $135.6 million as of March 31, 2011 are related to George Mason’s mortgage loan funding commitments and are of a short term nature.

 

These off-balance sheet financial instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition.  Credit risk is defined as the possibility of sustaining a loss because the other parties to a financial instrument fail to perform in accordance with the terms of the contract.  The Company’s maximum exposure to credit loss under standby letters of credit and commitments to extend credit is represented by the contractual amounts of those instruments. It is uncertain as to the amount, if any, that we will be required to fund on these commitments as many such arrangements expire with no amounts drawn.

 

George Mason provides for its estimated exposure to repurchase loans previously sold to investors for which borrowers failed to provide full and accurate information on their loan application or for which appraisals have not been acceptable or where the loan was not underwritten in accordance with the loan program specified by the loan investor, and for other exposure to its investors related to loan sales activities.  At March 31, 2011, this reserve had a balance of $100,000.  The Company evaluates the merits of each claim and estimates its reserve based on actual and expected claims received and considers the historical amounts paid to settle such claims.

 

The Company has derivative counter-party risk that may arise from the possible inability of George Mason’s third party investors to meet the terms of their forward sales contracts.  George Mason works with third-party investors that are generally well-capitalized, are investment grade and exhibit strong financial performance to mitigate this risk.  The Company does not expect any third-party investor to fail to meet its obligation.  In addition, the Company has derivative counterparty risk relating to certain interest rate swaps it has with third parties.  This risk may arise from the inability of the third party to meet the terms of the contracts.  The Company monitors the financial condition of these third parties on an annual basis.  The Company does not expect any of these third parties to fail to meet its obligations.

 

Note 11

 

*Fair Value Measurements*

 

The fair value framework under U.S. generally accepted accounting principles defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  It also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring the fair value.  There are three levels of inputs that may be used to measure fair value:

 

Level 1 — Quoted prices in active markets for identical assets or liabilities as of the measurement date.

 

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Level 2 — Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

 

Level 3 — Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

 

*Recurring Fair Value Measurements*

 

All classes of the Company’s investment securities available-for-sale with the exception of its treasury securities, the Company’s trading investment securities, which include cash equivalents and mutual funds, and bank-owned life insurance are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service and therefore fall into the Level 2 category.  This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information.  Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.  The Company’s treasury securities are recorded at fair value using unadjusted quoted market prices for identical securities and therefore fall under the Level 1 category.

 

The Company has an interest rate swap to hedge against the change in fair value of one fixed rate commercial loan.  This loan is recorded at fair value using published yield curve rates from a national valuation service.  These observable rates and inputs are applied to a third party industry-wide valuation model, and therefore, the valuations fall into a Level 2 category.  Commercial and residential loans are evaluated for impairment and the carrying value of such loans is recorded at fair value based on appraisals of the underlying collateral completed by third parties using Level 2 valuation inputs.

 

The Company’s two other interest rate swap derivatives designated as cash flow hedges are recorded at fair value using published yield curve rates from a national valuation service.  These observable rates and inputs are applied to a third party industry-wide valuation model, and therefore, the valuations fall into a Level 2 category.

 

The Company records its interest rate lock commitments and forward loan sales commitments at fair value determined as the amount that would be required to settle each of these derivative financial instruments at the balance sheet date.  In the normal course of business, George Mason and Cardinal First (collectively, the “mortgage companies”) enter into contractual interest rate lock commitments to extend credit to borrowers with fixed expiration dates.  The commitments become effective when the borrowers “lock-in” a specified interest rate within the time frames established by the mortgage companies.  All borrowers are evaluated for credit worthiness prior to the extension of the commitment.  Market risk arises if interest rates move adversely between the time of the interest rate lock by the borrower and the sale date of the loan to the investor.  To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, the mortgage companies enter into best efforts forward sales contracts to sell loans to investors.  The forward sales contracts lock in an interest rate and price for the sale of loans similar to the specific rate lock commitments.  Both the rate lock commitments to the borrowers and the forward sales contracts to the investors through to the date the loan closes are undesignated derivatives and accordingly, are marked to fair value through earnings.  These valuations fall into a Level 2 category.

 

There were no significant transfers into and out of Level 1, Level 2 and Level 3 measurements in the fair value hierarchy during the three months ended March 31, 2011.  Transfers between levels are recognized at the end of each reporting period.  The valuation technique used for fair value measurements using significant other observable inputs (Level 2) is the market approach for each class of assets and liabilities.

 

Assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010 are shown below:

 

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**At March 31, 2011**

**(in thousands)**

 
| ** **                                                            | ** ** | ** **  | ** ** | **Fair Value Measurements Using**                                                       | ** ** |
|-----------------------------------------------------------------------|------------|-------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| **Description**                                                       | ** ** | **Balance** | ** ** | **Quoted Prices in   Active markets for   Identical Assets   (Level 1)** | ** ** | **Significant   Other   Observable   Inputs   (Level 2)** | ** ** | **Significant   Unobservable   Inputs   (Level 3)** | ** ** |
| Investment securities available-for-sale:                             |       |        |       |                                                                                                   |       |   |   |   |   |
| U.S. treasury securities                                              |       | $           | 5,086      |                                                                                                   | $          | 5,086 |   | $ | — |   | $ | — |   |
| U.S. government- sponsored agencies                                   |       | 36,848      |       | —                                                                                                 |       | 36,848 |   | — |   |
| Mortgage-backed securities                                            |       | 231,665     |       | —                                                                                                 |       | 231,665 |   | — |   |
| Municipal securities                                                  |       | 78,113      |       | —                                                                                                 |       | 78,113 |   | — |   |
| Total investment securities available-for-sale                        |       | 351,712     |       | 5,086                                                                                                  |       | 346,626 |   | — |   |
| Investment securities — trading                                  |       | 2,458       |       | —                                                                                                 |       | 2,458 |   | — |   |
| Loans receivable                                                      |       | 12,792      |       | —                                                                                                 |       | 12,792 |   | — |   |
| Bank-owned life insurance                                             |       | 34,537      |       | —                                                                                                 |       | 34,537 |   | — |   |
| Derivative liability - interest rate swaps                            |       | 1,607       |       | —                                                                                                 |       | 1,607 |   | — |   |
| Derivative asset - rate lock and forward loan   sales commitments     |       | 5,077       |       | —                                                                                                 |       | 5,077 |   | — |   |
| Derivative asset — interest rate lock commitments                |       | 38          |       | —                                                                                                 |       | 38 |   | — |   |
| Derivative liability - rate lock and forward loan   sales commitments |       | 703         |       | —                                                                                                 |       | 703 |   | — |   |
| Derivative liability — interest rate lock   commitments          |       | 362         |       | —                                                                                                 |       | 362 |   | — |   |
|                                                                       |            |             |            |                                                                                                        |            |  |  |  |  |  |  |  |  |

 

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**At December 31, 2010**

**(In thousands)**

 
| ** **                                                            | ** ** | ** **  | ** ** | **Fair Value Measurements Using**                                                       | ** ** |
|-----------------------------------------------------------------------|------------|-------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| **Description**                                                       | ** ** | **Balance** | ** ** | **Quoted Prices in   Active markets for   Identical Assets   (Level 1)** | ** ** | **Significant   Other   Observable   Inputs   (Level 2)** | ** ** | **Significant   Unobservable   Inputs   (Level 3)** | ** ** |
| Investment securities available-for-sale:                             |       |        |       |                                                                                                   |       |   |   |   |   |
| U.S. treasury securities                                              |       | $           | 5,114      |                                                                                                   | $          | 5,114 |   | $ | — |   | $ | — |   |
| U.S. government- sponsored agencies                                   |       | 32,119      |       | —                                                                                                 |       | 32,119 |   | — |   |
| Mortgage-backed securities                                            |       | 219,482     |       | —                                                                                                 |       | 219,482 |   | — |   |
| Municipal securities                                                  |       | 64,283      |       | —                                                                                                 |       | 64,283 |   | — |   |
| Total investment securities available-for-sale                        |       | 320,998     |       | 5,114                                                                                                  |       | 315,884 |   | — |   |
| Investment securities — trading                                  |       | 2,107       |       | —                                                                                                 |       | 2,107 |   | — |   |
| Loan receivable designated in fair value hedge                        |       | 13,004      |       | —                                                                                                 |       | 13,004 |   | — |   |
| Bank-owned life insurance                                             |       | 34,358      |       | —                                                                                                 |       | 34,358 |   | — |   |
| Derivative liability - interest rate swaps                            |       | 1,837       |       | —                                                                                                 |       | 1,837 |   | — |   |
| Derivative asset - rate lock and forward loan   sales commitments     |       | 4,416       |       | —                                                                                                 |       | 4,416 |   | — |   |
| Derivative asset — interest rate lock commitments                |       | 264         |       | —                                                                                                 |       | 264 |   | — |   |
| Derivative liability - rate lock and forward loan   sales commitments |       | 2,705       |       | —                                                                                                 |       | 2,705 |   | — |   |
| Derivative liability — interest rate lock   commitments          |       | 77          |       | —                                                                                                 |       | 77 |   | — |   |
|                                                                       |            |             |            |                                                                                                        |            |  |  |  |  |  |  |  |  |

 

*Nonrecurring Fair Value Measurements*

 

Certain assets and liabilities are measured at fair value on a nonrecurring basis and are not included in the tables above.  These assets include the valuation of the Company’s corporate bonds held in its held-to-maturity investment securities portfolio, loans receivable — evaluated for impairment and other real estate owned.

 

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**At March 31, 2011  (in thousands)**

 
| ** **                                       | ** ** | ** **  | ** ** | **Fair Value Measurements Using**                                                    | ** ** |
|--------------------------------------------------|------------|-------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| **Description**                                  | ** ** | **Balance** | ** ** | **Quoted Prices   in Active   markets for   Identical Assets   (Level 1)** | ** ** | **Significant   Other   Observable   Inputs   (Level 2)** | ** ** | **Significant   Unobservable   Inputs   (Level 3)** | ** ** |
| Corporate bonds                                  |       | $           | 3,934      |                                                                                                | $          | — |   | $ | — |   | $ | 3,934 |   |
| Loans receivable — evaluated for impairment |       | 33,007      |       | —                                                                                              |       | 12,336 |   | 20,671 |   |
| Other real estate owned                          |       | 1,250       |       | —                                                                                              |       | 1,250 |   | — |   |
|                                                  |            |             |            |                                                                                                     |            |  |  |  |  |  |  |  |  |

 

**At December 31, 2010  (In thousands)**

 
| ** **                                       | ** ** | ** **  | ** ** | **Fair Value Measurements Using**                                                    | ** ** |
|--------------------------------------------------|------------|-------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| **Description**                                  | ** ** | **Balance** | ** ** | **Quoted Prices   in Active   markets for   Identical Assets   (Level 1)** | ** ** | **Significant   Other   Observable   Inputs   (Level 2)** | ** ** | **Significant   Unobservable   Inputs   (Level 3)** | ** ** |
| George Mason — Reporting Unit               |       | $           | 27,490     |                                                                                                | $          | — |   | $ | — |   | $ | 27,490 |   |
| Corporate bonds                                  |       | 3,197       |       | —                                                                                              |       | — |   | 3,197 |   |
| Loans receivable — evaluated for impairment |       | 31,355      |       | —                                                                                              |       | 12,942 |   | 18,413 |   |
| Other real estate owned                          |       | 1,250       |       | —                                                                                              |       | 1,250 |   | — |   |
|                                                  |            |             |            |                                                                                                     |            |  |  |  |  |  |  |  |  |

 

The Company’s held-to-maturity portfolio includes investments in four pooled trust preferred securities, totaling $8.0 million of par value at March 31, 2011 (each security has a par value of $2.0 million).  The collateral underlying these structured securities are instruments issued by financial institutions or insurers.  The Company owns the A-3 tranches in each issuance.  Observable trading activity remains limited for these types of securities.  The Company has estimated the fair value of the securities through the use of internal calculations and through information provided by external pricing services.  Given the level of subordination below the A-3 tranches, and the actual and expected performance of the underlying collateral, the Company expects to receive all contractual interest and principal payments recovering the amortized cost basis of each of the four securities, and concluded that these securities are not other-than-temporarily impaired.  The Company utilizes a multi-scenario model which assumes varying levels of additional defaults and deferrals and the effects of such adverse developments on the contractual cash flows for the A-3 tranches.  In each of the adverse scenarios, there was no indication of a break to the A-3 contractual cash flows.

 

The Company’s loans receivable — evaluated for impairment are measured at the present value of its expected future cash flows discounted at the loan’s coupon rate, or at the loan’s observable market price or 

 

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fair value of the collateral if the loan is collateral dependent.  The Company measures the collateral value on loans receivable — evaluated for impairment by obtaining an updated appraisal of the underlying collateral and may discount further the appraised value, if necessary, to an amount equal to the expected cash proceeds in the event the loan is foreclosed upon and the collateral is sold.  In addition, an estimate of costs to sell the collateral is assumed.  The Company values other real estate owned by obtaining an updated appraisal of the property foreclosed upon, and discounts further the appraised value to an amount equal to the expected cash proceeds upon the sale of the property.  Loans receivable — evaluated for impairment and other real estate owned are valued using third party appraisal data that is based on market comparisons and may be subject to further adjustment for certain non-observable criteria.

 

Loans receivable — evaluated for impairment that are measured at fair value using Level 3 inputs on a nonrecurring basis total $20.7 million at March 31, 2011.  Collateral is in the form of real estate or business assets including equipment, inventory, and accounts receivable.  The vast majority of the Company’s collateral is real estate.  The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2).  However, in certain instances, the Company applies a discount to the valuation of the collateral if the collateral being evaluated is in process of construction or a residence.  In addition, the Company considers past experience of actual sales of collateral and may further discount the appraisal of the collateral being evaluated.  This is considered a Level 3 valuation.  The value of business equipment is based upon the net book value on the applicable business’s financial statements if not considered significant using observable market data.  Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3).  Fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income.  At March 31, 2011, the Company’s Level 3 loans consisted of four relationships, secured primarily by commercial real estate of $14.2 million with a valuation allowance of $3.6 million; one relationship, secured by accounts receivable, inventory, equipment and commercial real estate of $2.8 million which did not have a valuation allowance; and five relationships, primarily secured by residential real estate of $3.6 million which did not have a valuation allowance.

 

Although management uses its best judgment in estimating the fair value of financial instruments, there are inherent limitations in any estimation technique.  Because of the wide range of valuation techniques and the numerous estimates and assumptions which must be made, it may be difficult to make reasonable comparisons between the Company’s fair value information and that of other banking institutions.  It is important that the many uncertainties be considered when using the estimated fair value disclosures and that, because of these uncertainties, the aggregate fair value amount should not be construed as representative of the underlying value of the Company

 

**Fair Value of Financial Instruments**

 

The assumptions used and the estimates disclosed represent management’s best judgment of appropriate valuation methods for estimating the fair value of financial instruments.  These estimates are based on pertinent information available to management at the valuation date.  In certain cases, fair values are not subject to precise quantification or verification and may change as economic and market factors and management’s evaluation of those factors change.

 

The following summarizes the significant methodologies and assumptions used in estimating the fair values presented in the following table, and not disclosed elsewhere in this footnote.

 

*Cash and Cash Equivalents*

 

The carrying amount of cash and cash equivalents is used as a reasonable estimate of fair value.

 

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*Investment Securities Held-to-Maturity and Other Investments*

 

Fair values for investment securities held-to-maturity are based on quoted market prices or prices quoted for similar financial instruments.

 

*Loans Held for Sale*

 

Loans held for sale are carried at the lower of cost or estimated fair value.  The estimated fair value is based upon the related purchase price commitments from secondary market investors.

 

*Loans Receivable, Net*

 

In order to determine the fair market value for loans receivable, the loan portfolio was segmented based on loan type, credit quality and maturities.  For certain variable rate loans with no significant credit concerns and frequent repricings, estimated fair values are based on current carrying amounts.  The fair values of other loans are estimated using discounted cash flow analyses, at interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  This method of estimating fair value does not incorporate the exit-price concept of fair value which is appropriate for this disclosure.

 

*Deposits*

 

The fair values for demand deposits are equal to the carrying amount since they are payable on demand at the reporting date.  The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit (CDs) approximate their fair value at the reporting date.  Fair values for fixed-rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered on CDs to a schedule of aggregated expected monthly maturities on time deposits.

 

*Other Borrowed Funds*

 

The fair value of other borrowed funds is estimated using a discounted cash flow calculation that applies interest rates currently available for loans with similar terms.

 

*Accrued Interest Receivable*

 

The carrying amount of accrued interest receivable approximates its fair value.

 

The following summarizes the carrying amount of these financial assets and liabilities that the Company has not recorded at fair value on a recurring basis at March 31, 2011 and December 31, 2010:

 
| ** **                                                     | ** ** | **March 31, 2011** | ** ** |
|----------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                     | ** ** | **Carrying**                 | ** ** | **Estimated** | ** ** |
| **(In thousands)**                                        | ** ** | **Amount**                   | ** ** | **Fair Value** | ** ** |
| Financial assets:                                              |       |                         |       |   |   |
| Cash and cash equivalents                                      |       | $                            | 21,633     |   | 21,633 |   |
| Investment securities held-to-maturity and other   investments |       | 24,676                       |       | 25,095 |   |
| Loans held for sale                                            |       | 168,569                      |       | 168,569 |   |
| Loans receivable, net                                          |       | 1,367,418                    |       | 1,387,332 |   |
| Accrued interest receivable                                    |       | 6,575                        |       | 6,575 |   |
| Financial liabilities:                                         |       |                         |       |   |   |
| Demand deposits                                                |       | $                            | 228,651    |   | 228,651 |   |
| Interest checking                                              |       | 130,935                      |       | 130,935 |   |
| Money market and statement savings                             |       | 386,026                      |       | 386,026 |   |
| Certificates of deposit                                        |       | 641,302                      |       | 648,200 |   |
| Other borrowed funds                                           |       | 415,854                      |       | 443,833 |   |
| Accrued interest payable                                       |       | 1,556                        |       | 1,556 |   |

 

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| ** **                                                     | ** ** | **December 31, 2010** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                     | ** ** | **Carrying**                    | ** ** | **Estimated** | ** ** |
| **(In thousands)**                                        | ** ** | **Amount**                      | ** ** | **Fair Value** | ** ** |
| Financial assets:                                              |       |                            |       |   |   |
| Cash and cash equivalents                                      |       | $                               | 25,868     |   | $ | 25,868 |   |
| Investment securities held-to-maturity and other   investments |       | 30,344                          |       | 30,999 |   |
| Loans held for sale                                            |       | 206,047                         |       | 206,047 |   |
| Loans receivable, net                                          |       | 1,360,813                       |       | 1,384,836 |   |
| Accrued interest receivable                                    |       | 6,699                           |       | 6,699 |   |
| Financial liabilities:                                         |       |                            |       |   |   |
| Demand deposits                                                |       | $                               | 229,575    |   | $ | 229,575 |   |
| Interest checking                                              |       | 135,395                         |       | 135,395 |   |
| Money market and statement savings                             |       | 379,320                         |       | 379,320 |   |
| Certificates of deposit                                        |       | 659,435                         |       | 668,247 |   |
| Other borrowed funds                                           |       | 389,586                         |       | 416,396 |   |
| Accrued interest payable                                       |       | 1,415                           |       | 1,415 |   |

 

Note 12

 

*Loss on Extinguishment of Debt*

 

During the first quarter of 2011, the Company extinguished $15.0 million in Federal Home Loan Bank (“FHLB”) advances which had an average cost of 2.81%, or $422,000 annually.  As part of the prepayment arrangement with the FHLB, the Company paid a one-time penalty of $450,000 during the first quarter of 2011 related to these advances.

 

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**Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations**

 

The following presents management’s discussion and analysis of our consolidated financial condition at March 31, 2011 and December 31, 2010 and the unaudited results of our operations for the three months ended March 31, 2011 and 2010. This discussion should be read in conjunction with our unaudited consolidated financial statements and the notes thereto appearing elsewhere in this report and the audited consolidated financial statements and the notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

**Caution About Forward-Looking Statements**

 

We make certain forward-looking statements in this Form 10-Q that are subject to risks and uncertainties.  These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals.  The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward-looking statements.

 

These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:

 

·                  the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;

·                  changes in assumptions underlying the establishment of reserves for possible loan losses, reserves for repurchases of mortgage loans sold and other estimates;

·                  changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and disruption of the capital and credit markets, soundness of other financial institutions we do business with;

·                  risks inherent in making loans such as repayment risks and fluctuating collateral values;

·                  declines in the prices of assets and market illiquidity may cause us to record an other-than-temporary impairment or other lossses, specifically in our pooled trust preferred securities portfolio resulting from increases in underlying issuers’ defaulting or deferring payments.

·                  changes in operations of wealth management and trust services segment, its customer base and assets under management;

·                  changes in operations of George Mason Mortgage, LLC as a result of the activity in the residential real estate market and any associated impact on the fair value of goodwill in the future;

·                  legislative and regulatory changes, including the Dodd Frank Wall Street Reform and Consumer Protection Act (the “Financial Reform Act”), and other changes in banking, securities, and tax laws and regulations and their application by our regulators, and changes in the scope and cost of FDIC insurance and other coverages;

·                  exposure to repurchase loans sold to investors for which borrowers failed to provide

 

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full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;

·                  the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;

·                  the ability to successfully manage our growth or implement our growth strategies as we implement new or change internal operating systems or if we are unable to identify attractive markets, locations or opportunities to expand in the future;

·                  the effects of future economic, business and market conditions;

·                  governmental monetary and fiscal policies;

·                  changes in accounting policies, rules and practices;

·                  maintaining cost controls and asset quality as we open or acquire new branches;

·                  maintaining capital levels adequate to support our growth;

·                  reliance on our management team, including our ability to attract and retain key personnel;

·                  competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;

·                  risks and uncertainties related to future trust operations;

·                  demand, development and acceptance of new products and services;

·                  problems with technology utilized by us;

·                  changing trends in customer profiles and behavior; and

·                  other factors described from time to time in our reports filed with the SEC.

 

Because of these uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.  In addition, our past results of operations do not necessarily indicate our future results.

 

In addition, this section should be read in conjunction with the description of our “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010.

 

**Overview**

 

We are a financial holding company formed in 1997 and headquartered in Fairfax County, Virginia.  We were formed principally in response to opportunities resulting from the consolidation of several Virginia-based banks.  These bank consolidations were typically accompanied by the dissolution of local boards of directors and relocation or termination of management and customer service professionals and a general deterioration of personalized customer service.

 

We own Cardinal Bank (the “Bank”), a Virginia state-chartered community bank with 26 banking offices located in Northern Virginia and the greater Washington D.C. metropolitan area.  The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers.  Our commercial relationship managers focus on attracting small and medium sized businesses as well as government contractors, commercial real estate developers and builders and professionals, such as physicians, accountants and attorneys.

 

Additionally, we complement our core banking operations by offering a wide range of services through our various subsidiaries, including mortgage banking through George Mason Mortgage, LLC (“George Mason”) and Cardinal First Mortgage, LLC, (“Cardinal First”),

 

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collectively the “mortgage banking” segment; and retail securities brokerage through Cardinal Wealth Services, Inc. (“CWS”), asset management through Wilson/Bennett Capital Management, Inc. (“Wilson/Bennett”), and trust, estate, custody, investment management and retirement planning through the trust division of Cardinal Bank, collectively the “wealth management and trust services” segment.

 

Net interest income is our primary source of revenue. We define revenue as net interest income plus noninterest income. As discussed further in the interest rate sensitivity section, we manage our balance sheet and interest rate risk exposure to maximize, and concurrently stabilize, net interest income. We do this by monitoring our liquidity position and the spread between the interest rates earned on interest-earning assets and the interest rates paid on interest-bearing liabilities. We attempt to minimize our exposure to interest rate risk, but are unable to eliminate it entirely.  In addition to management of interest rate risk, we analyze our loan portfolio for exposure to credit risk. Loan defaults and foreclosures are inherent risks in the banking industry, and we attempt to limit our exposure to these risks by carefully underwriting and then monitoring our extensions of credit. In addition to net interest income, noninterest income is an important source of revenue for us and includes, among other things, service charges on deposits and loans, investment fee income, which includes trust revenues, gains and losses on sales of investment securities available-for-sale, gains on sales of mortgage loans, and management fee income.

 

**Critical Accounting Policies**

 

*General*

 

U. S. generally accepted accounting principles are complex and require management to apply significant judgment to various accounting, reporting, and disclosure matters.  Management must use assumptions, judgments and estimates when applying these principles where precise measurements are not possible or practical.  These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates.  Changes in such judgments, assumptions and estimates may have a significant impact on the consolidated financial statements.  Actual results, in fact, could differ from initial estimates.

 

The accounting policies we view as critical are those relating to judgments, assumptions and estimates regarding the determination of the allowance for loan losses, the fair value measurements of certain assets and liabilities, accounting for economic hedging activities, accounting for impairment testing of goodwill, accounting for the impairment of amortizing intangible assets and other long-lived assets, and the valuation of deferred tax assets.

 

*Allowance for Loan Losses*

 

We maintain the allowance for loan losses at a level that represents management’s best estimate of known and inherent losses in our loan portfolio.  Both the amount of the provision expense and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers.  Unusual and infrequently occurring events, such as weather-related disasters, may impact our assessment of possible credit losses.  As a part of our analysis, we use comparative peer group data and qualitative factors such as levels of and trends in delinquencies and nonaccrual loans, national and local economic trends and conditions and concentrations of loans exhibiting similar risk profiles to support our estimates.

 

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For purposes of our analysis, we categorize our loans into one of five categories:  commercial and industrial, commercial real estate (including construction), home equity lines of credit, residential mortgages, and consumer loans. In the absence of meaningful historical loss factors, peer group loss factors are applied and are adjusted by the qualitative factors mentioned above. The indicated loss factors resulting from this analysis are applied for each of the five categories of loans. In addition, we individually assign loss factors to all loans that have been identified as having loss attributes, as indicated by deterioration in the financial condition of the borrower or a decline in underlying collateral value if the loan is collateral dependent. Since we have limited historical data on which to base loss factors for classified loans, we typically apply, in accordance with regulatory guidelines, a 5% loss factor to loans classified as special mention, a 15% loss factor to loans classified as substandard and a 50% loss factor to loans classified as doubtful. Loans classified as loss loans are fully reserved or charged off.  In certain instances, we evaluate the impairment of certain loans on a loan by loan basis.  For these loans, we analyze the fair value of the collateral underlying the loan and consider estimated costs to sell the collateral on a discounted basis.  If the net collateral value is less than the loan balance (including accrued interest and any unamortized premium or discount associated with the loan) we recognize an impairment and establish a specific reserve for the impaired loan.

 

Credit losses are an inherent part of our business and, although we believe the methodologies for determining the allowance for loan losses and the current level of the allowance are adequate, it is possible that there may be unidentified losses in the portfolio at any particular time that may become evident at a future date pursuant to additional internal analysis or regulatory comment. Additional provisions for such losses, if necessary, would be recorded in the commercial banking or mortgage banking segments, as appropriate, and would negatively impact earnings.

 

*Fair Value Measurements*

 

We determine the fair values of financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value.  Our investment securities available-for-sale are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service.  This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information.  Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.  For certain of our held-to-maturity investment securities where there is minimal observable trading activity, we use a discounted cash flow approach to estimate fair value based on internal calculations and compare our results to information provided by external pricing sources.  Our interest rate swap derivatives are recorded at fair value using observable inputs from a national valuation service.  These inputs are applied to a third party industry-wide valuation model.

 

We also fair value our interest rate lock commitments and forward loan sales commitments.  The fair value of our interest rate lock commitments considers the expected premium (discount) to par and we apply certain fallout rates for those rate lock commitments for which we do not close a mortgage loan.  In addition, we calculate the effects of the changes in interest rates from the date of the commitment through loan origination, and then period end, using applicable published mortgage-backed investment security prices.  The fair value of the forward sales contracts to investors considers the market price movement of the same type of security between the trade date and the balance sheet date.  At loan closing, the fair value of the

 

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interest rate lock commitment is included in the cost basis of loans held for sale, which are carried at the lower of cost or fair value.

 

*Accounting for Economic Hedging Activities*

 

We record all derivative instruments on the statement of condition at their fair values*.*We do not enter into derivative transactions for speculative purposes. For derivatives designated as hedges, we contemporaneously document the hedging relationship, including the risk management objective and strategy for undertaking the hedge, how effectiveness will be assessed at inception and at each reporting period and the method for measuring ineffectiveness.  We evaluate the effectiveness of these transactions at inception and on an ongoing basis.  Ineffectiveness is recorded through earnings.  For derivatives designated as cash flow hedges, the fair value adjustment is recorded as a component of other comprehensive income, except for the ineffective portion which is recorded in earnings.  For derivatives designated as fair value hedges, the fair value adjustments for both the hedged item and the hedging instrument are recorded through the income statement with any difference considered the ineffective portion of the hedge.

 

We discontinue hedge accounting prospectively when it is determined that the derivative is no longer highly effective. In situations in which cash flow hedge accounting is discontinued, we continue to carry the derivative at its fair value on the statement of condition and recognize any subsequent changes in fair value in earnings over the term of the forecasted transaction. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, we recognize immediately in earnings any gains and losses that were accumulated in other comprehensive income.

 

In the normal course of business, we enter into contractual commitments, including rate lock commitments, to finance residential mortgage loans. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the time frame established by us. Interest rate risk arises on these commitments and subsequently closed loans if interest rates change between the time of the interest rate lock and the delivery of the loan to the investor. Loan commitments related to residential mortgage loans intended to be sold are considered derivatives and are marked to market through earnings.

 

To mitigate the effect of the interest rate risk inherent in providing rate lock commitments, we economically hedge our commitments by entering into best efforts delivery forward loan sales contracts. During the rate lock commitment period, these forward loan sales contracts are marked to market through earnings and are not designated as accounting hedges. Exclusive of the fair value elements of the rate lock commitment related to servicing and the wholesale and retail rate spread, the changes in fair value related to movements in market rates of the rate lock commitments and the forward loan sales contracts generally move in opposite directions, and the net impact of changes in these valuations on net income during the loan commitment period is generally inconsequential. At the closing of the loan, the loan commitment derivative expires and we record a loan held for sale and continue to be obligated under the same forward loan sales contract.  The forward sales contract is then designated as a hedge against the variability in cash to be received from the loan sale.  Loans held for sale are accounted for at the lower of cost or fair value*.*

 

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*Accounting for Impairment Testing of Goodwill*

 

To test goodwill for impairment, we perform an analysis to compare the fair value of the reporting unit to which the goodwill is assigned to the carrying value of the reporting unit. We make estimates of the discounted cash flows from the expected future operations of the reporting unit. This discounted cash flow analysis involves the use of unobservable inputs including:  estimated future cash flows from operations; an estimate of a terminal value; a discount rate; and other inputs.  Our estimated future cash flows are largely based on our historical actual cash flows.  If the analysis indicates that the fair value of the reporting unit is less than its carrying value, we do an analysis to compare the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. The implied fair value of the goodwill is determined by allocating the fair value of the reporting unit to all its assets and liabilities. If the implied fair value of the goodwill is less than the carrying value, an impairment loss is recognized.

 

*Accounting for the Impairment of Amortizing Intangible Assets and Other Long-Lived Assets*

 

We continually review our long-lived assets for impairment whenever events or changes in circumstances indicate that the remaining estimated useful life of such assets might warrant revision or that the balances may not be recoverable. We evaluate possible impairment by comparing estimated future cash flows, before interest expense and on an undiscounted basis, with the net book value of long-term assets, including amortizable intangible assets. If undiscounted cash flows are insufficient to recover assets, further analysis is performed in order to determine the amount of the impairment.

 

An impairment loss is then recorded for the excess of the carrying amount of the assets over their fair values. Fair value is usually determined based on the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved.

 

*Valuation of Deferred Tax Assets*

 

We record a provision for income tax expense based on the amounts of current taxes payable or refundable and the change in net deferred tax assets or liabilities during the year. Deferred tax assets and liabilities are recognized for the tax effects of differing carrying values of assets and liabilities for tax and financial statement purposes that will reverse in future periods. When substantial uncertainty exists concerning the recoverability of a deferred tax asset, the carrying value of the asset is reduced by a valuation allowance. The amount of any valuation allowance established is based upon an estimate of the deferred tax asset that is more likely than not to be recovered. Increases or decreases in the valuation allowance result in increases or decreases to the provision for income taxes.

 

**New Financial Accounting Standards**

 

In April 2011, the FASB issued ASU No. 2011-02, *Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. *This amendment clarifies the guidance on the evaluation made by a creditor on whether a restructuring constitutes a troubled debt restructuring.  It clarifies the guidance related to a creditor’s evaluation of whether it has granted a concession to a debtor and also clarifies the guidance on a creditor’s evaluation of whether the debtor is experiencing financial difficulties.  The amendment is effective for public entities for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption.  The disclosures required which were deferred by ASU No. 2011-01, *Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,*is effective for interim and annual period beginning on or after June 15, 2011.  Early

 

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adoption is permitted.  The adoption of this standard is not expected to have a material impact on our consolidated financial condition or results of operations.

 

**2011 Economic Environment**

 

Despite the challenges in the national and global economies, the metropolitan Washington, D.C. area, the region we operate in, continues to perform relatively well as compared to other geographic regions.  Our credit quality continues to remain strong despite the challenging economic environment.  During the first quarter of 2011, the reported unemployment rate dropped to 8.8%, the lowest it’s been for over two years, an indication that the U.S. economy has continued its slow recovery.  At March 31, 2011, we have non-accrual loans totaling $9.3 million and no loans contractually past due 90 days or more as to principal or interest.  Annualized net charge-offs were 0.32% of our average loans receivable for the three months ended March 31, 2011. Due to continued low mortgage loan rates, originations from our mortgage banking segment for the first three months of 2011 have surpassed originations for the same period of 2010.

 

Market illiquidity continues to impact certain portions of our investment securities portfolio, specifically the ratings of certain corporate bonds. We hold investments of $8.0 million in par value of pooled trust preferred securities, which are significantly below book value as of March 31, 2011 due to the lack of liquidity in the market and investor apprehension for investing in these types of investments.

 

We expect challenging economic and operating conditions and an evolving regulatory regime to continue for the foreseeable future.  These conditions could continue to affect the markets in which we do business and could adversely impact our results for the remainder of 2011. The degree of the impact is dependent upon the duration and severity of the aforementioned conditions.

 

While we continue to experience loan growth, continued negative economic conditions could adversely affect our loan portfolio, including causing increases in delinquencies and default rates, which we expect could impact our charge-offs and provision for loan losses.  Deterioration in real estate values and household incomes could result in higher credit losses for us.  Also, in the ordinary course of business, we may be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer.  A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our businesses, perhaps materially. The systems by which we set limits and monitor the level of our credit exposure to individual entities and industries also may not function as we have anticipated.

 

Liquidity is essential to our business.  The primary sources of funding for our Bank include customer deposits and wholesale funding.  Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits.  This situation may arise due to circumstances that we may be unable to control, such as general market disruption, negative views about the financial services industry generally, or an operational problem that affects a third party or us.  Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events.  While we believe we have a healthy liquidity position, any of the above factors could materially impact our liquidity position in the future.

 

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The U.S. government continues to enact legislation and develop various programs and initiatives designed to regulate the financial services industry, stabilize the housing markets and stimulate the economy.  In July 2010, the Financial Reform Act was signed into law.  We are unsure of the full impact this legislation will have on our business, operations or our financial condition.

 

**Statements of Income**

 

*General*

 

For the three months ended March 31, 2011 and 2010, we reported net income of $5.2 million and $3.8 million, respectively, an increase of $1.4 million, or 37%.  Net interest income after the provision for loan losses increased $3.7 million to $16.6 million for the three months ended March 31, 2011 compared to $12.8 million for the three months ended March 31, 2010.  Provision for loan losses for the three months ended March 31, 2011 was $1.1 million, a decrease of $1.3 million, compared to $2.4 million for the same period of 2010.  A stabilization and slight improvement in certain of our credit quality indicators led to the positive adjustments to the loss factors employed in our provision for loan losses calculation model.  Additionally, the rate of loan growth in our loan portfolio for the first quarter of 2011 was less than the rate of growth for the comparable period in 2010.  Noninterest income for the three months ended March 31, 2011 and 2010 was $5.0 million and $5.8 million, respectively, a decrease of $785,000.  The decrease in noninterest income is mostly attributable to the decrease in investment fee income from our wealth management and trust services segment, a result of our renegotiation of the service contract with a trust customer.  For the three months ended March 31, 2011, noninterest expense increased to $13.7 million, compared to $13.1 million for the same period of 2010.  The increase in noninterest expense is attributable to increases in salary and benefits expense as we have added business development officers in our commercial banking and mortgage banking operations.

 

For the three months ended March 31, 2011, basic and diluted income per common share were each $0.18.  Basic and diluted earnings per common share for the three months ended March 31, 2010 were each $0.13.  Weighted average fully diluted shares outstanding for the three months ended March 31, 2011 and 2010 were 29,800,738 and 29,534,387, respectively.

 

Return on average assets for the three months ended March 31, 2011 and 2010 was 1.02% and 0.79%, respectively. Return on average equity for the three months ended March 31, 2011 and 2010 was 9.18% and 7.28%, respectively.

 

*General —Business Segments*

 

We operate in three business segments: commercial banking, mortgage banking, and wealth management and trust services.  Net income attributable to the commercial banking segment for the three months ended March 31, 2011 was $5.4 million compared to net income of $3.6 million for the three months ended March 31, 2010.  Net interest income increased $2.5 million to $17.4 million for the three months ended March 31, 2011, compared to $15.0 million for the same period of 2010.  Provision for loan losses decreased $1.3 million to $1.1 million for the three months ended March 31, 2011 compared to $2.4 million for the same period of 2010.  The decrease in provision expense is primarily due to more modest loan growth during the first quarter of 2011 and a stabilization of credit quality during the quarter.  Noninterest income decreased to $776,000 for the three months ended March 31, 2011 compared to $1.0 million for the three months ended March 31, 2010.  The decrease in noninterest income primarily was a result of a loss recorded on

 

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the extinguishment of debt.  See “*Noninterest Income*” below for more information on this debt extinguishment.  Noninterest expense was $9.0 million for the three months ended March 31, 2011, compared to $8.3 million for the same period of 2010.  The increase in noninterest expense for the first quarter of 2011 as compared to the same period of 2010 is primarily due to expenses related to additions to our business development staff at the Bank.

 

The mortgage banking segment reported net income of $524,000 for the three months ended March 31, 2011 compared to net income of $559,000 for the three months ended March 31, 2010.  Historically, mortgage lending activity is slow during the first quarter of each year and the seasonal results recorded reflect this decreased activity.

 

The wealth management and trust services segment, which includes CWS, Wilson/Bennett and the trust division of the Bank, recorded a net loss of $150,000 for the three months ended March 31, 2011, compared to net income of $127,000 for the three months ended March 31, 2010.  The decrease in net income during 2011 is primarily attributable to our renegotiation of the service agreement with a trust customer.

 

*Net Interest Income*

 

Net interest income is our primary source of revenue, representing the difference between interest and fees earned on interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. Net interest income for the three months ended March 31, 2011 and 2010 was $17.7 million and $15.3 million, respectively, a period-to-period increase of $2.4 million, or 16%. The yields on our loans receivable portfolio decreased marginally during the first quarter of 2011 as we continued to decrease our overall funding costs by lowering the interest rates on our deposit liabilities and extending the near term maturities on $95 million of our FHLB advances for an average cost savings of 0.99% on those borrowings.  In addition, we extinguished $15 million of FHLB advances with an average cost of 2.81%.

 

Interest income on loans receivable, increased $1.2 million for the three months ended March 31, 2011 compared to the same three month period of 2010.  The increase in interest income on loans receivable is primarily a result of an increase in the volume of our loans receivable portfolio.  Interest income on loans held for sale was $1.3 million for each of the three months ended March 31, 2011 and 2010.

 

Interest income on investment securities, decreased $382,000 for the three months ended March 31, 2011 as compared to the three months ended March 31, 2010.  The decrease in interest income on investment securities is due to the decreased yield of the portfolio for the three months ended March 31, 2011 compared to the same period of 2010.  Because of the current low interest rate environment, new purchases of investment securities are at lower rates which are contributing to the decrease in the yield in the portfolio.

 

Total interest expense has decreased $1.5 million for the three months ended March 31, 2011 as compared to the same period of 2010.  The decrease in total interest expense is mostly related to the reductions in the interest rates we pay on our interest and money market checking and savings deposit accounts given the current low interest rate environment.  In addition, our certificates of deposit are repricing at lower interest rates.  During the first quarter of 2011, we implemented two cost of funds reduction strategies related to our FHLB advances.  Approximately $95 million of these advances with near term maturities were extended

 

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by an average maturity of 2.9 years.  We are now paying an average 3.22% on these borrowings, a yield reduction of 0.99%, equating to approximately $940,000 in interest expense annually.  In addition, we extinguished $15.0 million in FHLB advances which had an average cost of 2.81%, or $422,000 annually.  As part of the prepayment arrangement with the FHLB, we paid a one-time penalty of $450,000 during the first quarter of 2011 related to these advances.

 

Our net interest margin, on a tax-equivalent basis, which equals net interest income divided by average interest earning assets, was 3.67% and 3.40% for the three months ended March 31, 2011 and 2010, respectively.  The increase in our net interest margin is again attributable to our balance sheet management and strategically decreasing the interest rates we pay on our deposit liabilities.  The following tables present an analysis of average earning assets and interest-bearing liabilities with related components of interest income and interest expense on a tax equivalent basis.

 

**Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities**

Three Months Ended March 31, 2011, 2010 and 2009

(In thousands)

 
| ** **                                                    | ** ** | **2011**    | ** ** | **2010**     | ** ** | **2009**    | ** ** |
|---------------------------------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                                                    | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** |
| ** **                                                    | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield/**  | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** |
| ** **                                                    | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning   assets:                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans   (1):                                                  |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial   and industrial                                   |       | $           | 185,574    |         | $          | 2,076       |       | 4.45 | % | $ | 160,009 |   | $ | 1,841 |   | 4.59 | % | $ | 170,513 |   | $ | 2,092 |   | 4.91 | % |
| Real   estate - commercial                                    |       | 629,657     |       | 9,463        |       | 5.98        | %          | 599,412 |   | 9,148 |   | 6.10 | % | 489,712 |   | 7,651 |   | 6.25 | % |
| Real   estate - construction                                  |       | 241,215     |       | 3,334        |       | 5.53        | %          | 190,545 |   | 2,615 |   | 5.49 | % | 179,708 |   | 1,766 |   | 3.93 | % |
| Real   estate - residential                                   |       | 215,281     |       | 2,806        |       | 5.21        | %          | 227,125 |   | 2,923 |   | 5.15 | % | 206,975 |   | 2,828 |   | 5.46 | % |
| Home   equity lines                                           |       | 121,642     |       | 1,111        |       | 3.70        | %          | 118,574 |   | 1,061 |   | 3.63 | % | 105,867 |   | 976 |   | 3.74 | % |
| Consumer                                                      |       | 3,017       |       | 41           |       | 5.51        | %          | 2,687 |   | 40 |   | 5.95 | % | 2,513 |   | 36 |   | 5.89 | % |
| Total   loans                                                 |       | 1,396,386   |       | 18,831       |       | 5.39        | %          | 1,298,352 |   | 17,628 |   | 5.43 | % | 1,155,288 |   | 15,349 |   | 5.31 | % |
|                                                          |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans   held for sale                                         |       | 108,874     |       | 1,301        |       | 4.78        | %          | 99,333 |   | 1,305 |   | 5.25 | % | 171,812 |   | 1,825 |   | 4.25 | % |
| Investment   securities available-for-sale                    |       | 330,400     |       | 3,638        |       | 4.40        | %          | 331,774 |   | 3,858 |   | 4.65 | % | 232,342 |   | 2,988 |   | 5.14 | % |
| Investment   securities held-to-maturity                      |       | 20,705      |       | 155          |       | 2.99        | %          | 33,982 |   | 287 |   | 3.38 | % | 49,059 |   | 484 |   | 3.95 | % |
| Other   investments                                           |       | 15,728      |       | 31           |       | 0.80        | %          | 15,728 |   | 10 |   | 0.27 | % | 15,633 |   | (19 | ) | -0.50 | % |
| Federal   funds sold                                          |       | 77,580      |       | 46           |       | 0.24        | %          | 38,941 |   | 23 |   | 0.24 | % | 23,163 |   | 13 |   | 0.23 | % |
|                                                          |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total   interest-earning assets and interest income (2)  |       | 1,949,673   |       | 24,002       |       | 4.92        | %          | 1,818,110 |   | 23,111 |   | 5.08 | % | 1,647,297 |   | 20,640 |   | 5.01 | % |
|                                                          |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-earning   assets:                                 |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash   and due from banks                                     |       | 14,617      |       |         |       |        |       | $ | 5,476 |   |   |   |   |   | $ | 91 |   |   |   |   |   |
| Premises   and equipment, net                                 |       | 16,743      |       |         |       |        |       | 15,773 |   |   |   |   |   | 16,307 |   |   |   |   |   |
| Goodwill   and other intangibles, net                         |       | 10,669      |       |         |       |        |       | 13,913 |   |   |   |   |   | 14,153 |   |   |   |   |   |
| Accrued   interest and other assets                           |       | 79,382      |       |         |       |        |       | 77,804 |   |   |   |   |   | 57,258 |   |   |   |   |   |
| Allowance   for loan losses                                   |       | (24,616     | )          |         |       |        |       | (19,098 | ) |   |   |   |   | (14,727 | ) |   |   |   |   |
| Total   assets                                                |       | $           | 2,046,468  |         |       |        |       |   | $ | 1,911,978 |   |   |   |   |   | $ | 1,720,379 |   |   |   |   |   |
|                                                          |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**                 |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest   - bearing liabilities:                             |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest   - bearing deposits:                                |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                          |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest   checking                                           |       | 131,336     |       | 62           |       | 0.19        | %          | 132,129 |   | 210 |   | 0.64 | % | 119,175 |   | 376 |   | 1.28 | % |
| Money   markets                                               |       | 151,282     |       | 156          |       | 0.41        | %          | 83,420 |   | 161 |   | 0.77 | % | 44,307 |   | 147 |   | 1.33 | % |
| Statement   savings                                           |       | 255,270     |       | 228          |       | 0.36        | %          | 287,471 |   | 612 |   | 0.86 | % | 261,450 |   | 1,185 |   | 1.84 | % |
| Certificates   of deposit                                     |       | 656,769     |       | 2,970        |       | 1.83        | %          | 646,533 |   | 3,652 |   | 2.26 | % | 606,588 |   | 5,049 |   | 3.33 | % |
| Total   interest - bearing deposits                           |       | 1,194,657   |       | 3,416        |       | 1.14        | %          | 1,149,553 |   | 4,635 |   | 1.64 | % | 1,031,520 |   | 6,757 |   | 2.66 | % |
|                                                          |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other   borrowed funds                                        |       | 363,790     |       | 2,708        |       | 3.02        | %          | 368,700 |   | 3,021 |   | 3.32 | % | 374,121 |   | 3,142 |   | 3.41 | % |
|                                                          |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total   interest-bearing liabilities and interest expense     |       | 1,558,447   |       | 6,124        |       | 1.59        | %          | 1,518,253 |   | 7,656 |   | 2.05 | % | 1,405,641 |   | 9,899 |   | 2.86 | % |
|                                                          |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing   liabilities:                            |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand   deposits                                             |       | 233,152     |       |         |       |        |       | 163,840 |   |   |   |   |   | 133,775 |   |   |   |   |   |
| Other   liabilities                                           |       | 27,354      |       |         |       |        |       | 20,975 |   |   |   |   |   | 19,569 |   |   |   |   |   |
| Common   shareholders’ equity                            |       | 227,515     |       |         |       |        |       | 208,910 |   |   |   |   |   | 161,394 |   |   |   |   |   |
| Total   liabilities and shareholders’ equity             |       | $           | 2,046,468  |         |       |        |       |   | $ | 1,911,978 |   |   |   |   |   | $ | 1,720,379 |   |   |   |   |   |
|                                                          |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net   interest income and net interest margin (2)             |       |        |       | $            | 17,878     |        | 3.67       | % |   |   | $ | 15,455 |   | 3.40 | % |   |   | $ | 10,741 |   | 2.61 | % |

 

----

(1)   Non-accrual loans are included in average balances and do not have a material effect on the average yield.  Interest income on non-accruing loans was not material for the periods presented.

(2)   Interest income for loans receivable and investment securities available-for-sale is reported on a fully taxable-equivalent basis at a rate of 35% for 2011, 34.5% for 2010 and 2009.

 

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**Rate and Volume Analysis**

Three Months Ended March 31, 2011, 2010 and 2009

(In thousands)

 
| ** **                               | ** ** | **2011 Compared to 2010** | ** ** | **2010 Compared to 2009** | ** ** |
|------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                               | ** ** | **Change Due to**              | ** ** | ** **                               | ** ** | **Change Due to** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Average**                              | ** ** | **Average**                              | ** ** | **Increase** | ** ** | **Average** | ** ** | **Average** | ** ** | **Increase** | ** ** |
| ** **                               | ** ** | **Volume (3)**                      | ** ** | **Rate**                                 | ** ** | **(Decrease)** | ** ** | **Volume (3)** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| **Interest income:**                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Loans (1):                               |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Commercial and industrial                |       | $                                        | 299        |                                     | $          | (64 | ) | $ | 235 |   | $ | (125 | ) | $ | (126 | ) | $ | (251 | ) |
| Real estate - commercial                 |       | 509                                      |       | (194                                     | )          | 315 |   | 1,715 |   | (218 | ) | 1,497 |   |
| Real estate - construction               |       | 695                                      |       | 24                                       |       | 719 |   | 106 |   | 743 |   | 849 |   |
| Real estate - residential                |       | (152                                     | )          | 35                                       |       | (117 | ) | 270 |   | (175 | ) | 95 |   |
| Home equity lines                        |       | 27                                       |       | 23                                       |       | 50 |   | 117 |   | (32 | ) | 85 |   |
| Consumer                                 |       | 4                                        |       | (3                                       | )          | 1 |   | 4 |   | 0 |   | 4 |   |
| Total loans                              |       | 1,382                                    |       | (179                                     | )          | 1,203 |   | 2,087 |   | 192 |   | 2,279 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Loans held for sale                      |       | 124                                      |       | (128                                     | )          | (4 | ) | (767 | ) | 247 |   | (520 | ) |
| Investment securities available-for-sale |       | (16                                      | )          | (204                                     | )          | (220 | ) | 1,276 |   | (406 | ) | 870 |   |
| Investment securities held-to-maturity   |       | (112                                     | )          | (20                                      | )          | (132 | ) | (149 | ) | (48 | ) | (197 | ) |
| Other investments                        |       | —                                   |       | 21                                       |       | 21 |   | (0 | ) | 29 |   | 29 |   |
| Federal funds sold                       |       | 23                                       |       | 0                                        |       | 23 |   | 10 |   | 0 |   | 10 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Total interest income (2)                |       | 1,401                                    |       | (510                                     | )          | 891 |   | 2,457 |   | 14 |   | 2,471 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| **Interest expense:**                    |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:             |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Interest checking                        |       | (3                                       | )          | (145                                     | )          | (148 | ) | 45 |   | (211 | ) | (166 | ) |
| Money markets                            |       | 129                                      |       | (134                                     | )          | (5 | ) | 128 |   | (114 | ) | 14 |   |
| Statement savings                        |       | (67                                      | )          | (317                                     | )          | (384 | ) | 123 |   | (696 | ) | (573 | ) |
| Certificates of deposit                  |       | 15                                       |       | (697                                     | )          | (682 | ) | 309 |   | (1,706 | ) | (1,397 | ) |
| Total interest - bearing deposits        |       | 74                                       |       | (1,293                                   | )          | (1,219 | ) | 605 |   | (2,727 | ) | (2,122 | ) |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Other borrowed funds                     |       | (44                                      | )          | (269                                     | )          | (313 | ) | (37 | ) | (84 | ) | (121 | ) |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Total interest expense                   |       | 30                                       |       | (1,562                                   | )          | (1,532 | ) | 568 |   | (2,811 | ) | (2,243 | ) |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Net interest income (2)                  |       | $                                        | 1,371      |                                     | $          | 1,052 |   | $ | 2,423 |   | $ | 1,889 |   | $ | 2,825 |   | $ | 4,714 |   |

 

----

(1)   Non-accrual loans are included in average balances and do not have a material effect on the average yield.  Interest income on non-accruing loans was not material for the periods presented.

(2)   Interest income for loans receivable and investment securities available-for-sale is reported on a fully taxable-equivalent basis at a rate of 35% for 2011, 34.5% for 2010 and 2009.

(3)   Changes attributable to rate/volume have been allocated to volume.

 

*Provision for Loan Losses*

 

The provision for loan losses for the three months ended March 31, 2011 and 2010 was $1.1 million and $2.4 million, respectively. The decrease in our provision expense during 2011 compared to 2010 is a result of more modest loan growth during the first quarter of 2011 as compared to 2010 and a stabilization of the credit quality in our loan portfolio and the qualitative factors we use to determine the adequacy of our loan loss reserves as described above in “Critical Accounting Policies—Allowance for Loan Losses.”

 

During 2011, we recorded partial charge-offs on two impaired commercial loans totaling $1.2 million.  Impairment was recognized during 2010 on these same two loans and we placed them on nonaccrual status during the three months ended March 31, 2011 because these loans deteriorated further by falling significantly past-due and repayment of these loans under their current agreements with the Bank is highly unlikely.  The deterioration of these loans is based on isolated incidences with respect to these borrowers and is not a reflection of the overall credit quality of our loan portfolio.  In addition, consumer loans totaling $10,000 were charged-off during 2011.  Recoveries from previously charged-off loans totaled $114,000 for the three months ended March 31, 2011.  The majority of these recoveries were from previously charged-off residential loans. Nonperforming loans at March 31, 2011 and December 31, 2010, were $9.3 million and $7.6 million, respectively.

 

The allowance for loan losses was $24.2 million at March 31, 2011 and December 31, 2010. Our allowance for loan losses ratio to loans receivable, net was 1.71% and 1.72% at March 31, 2011 and December 31, 2010, respectively.

 

Continued challenging economic conditions could adversely affect our home equity loans of credit, credit card and other loan portfolios, including causing increases in delinquencies and default rates, which we expect could impact our charge-offs and provision for loan losses.  Continued deterioration in commercial and residential real estate values, employment data and household incomes could result in higher credit losses for us.  Also, in the ordinary course of business, we may be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer.  At March 31, 2011, our commercial real estate (including construction lending) portfolio was 63% of our total loan portfolio.  A deterioration in the

 

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financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our businesses, perhaps materially, and the systems by which we set limits and monitor the level of our credit exposure to individual entities and industries, may not function as we have anticipated.

 

Additional information on the allowance for loan losses, its allocation to the loans receivable portfolio and information on nonperforming loans can be found in the following tables.

 

**Allowance for Loan Losses**

Three Months Ended March 31, 2011 and 2010

(In thousands)

 
| ** **                        | ** ** | **2011** | ** ** | **2010** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Beginning balance, January 1 |       | $        | 24,210     |     | $          | 18,636 |   |
|                              |       |     |       |     |       |
| Provision for loan losses         |       | 1,110    |       | 2,425    |       |
|                              |       |     |       |     |       |
| Loans charged off:                |       |     |       |     |       |
| Commercial and industrial         |       | (1,215   | )          | (1,362   | )          |
| Residential                       |       | —   |       | (389     | )          |
| Consumer                          |       | (10      | )          | (35      | )          |
| Total loans charged off           |       | (1,225   | )          | (1,786   | )          |
|                              |       |     |       |     |       |
| Recoveries:                       |       |     |       |     |       |
| Commercial and industrial         |       | 1        |       | 3        |       |
| Consumer                          |       | 1        |       | —   |       |
| Residential                       |       | 112      |       | 9        |       |
| Total recoveries                  |       | 114      |       | 12       |       |
|                              |       |     |       |     |       |
| Net (charge offs) recoveries      |       | (1,111   | )          | (1,774   | )          |
|                              |       |     |       |     |       |
| Ending balance, March 31,    |       | $        | 24,209     |     | $          | 19,287 |   |

 
| ** **                                                  | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                  | ** ** | **2011**           | ** ** | **2010**           | ** ** |
| **Loans:**                                                  |       |               |       |               |       |
| Balance at period end                                       |       | $                  | 1,413,217  |               | $          | 1,307,657 |   |
| Allowance for loan losses to loans receivable net   of fees |       | 1.71               | %          | 1.47               | %          |
| Annualized net charge-offs to average loans   receivable    |       | 0.32               | %          | 0.55               | %          |
|                                                             |            |                    |            |                    |            |  |  |

 

**Allocation of the Allowance for Loan Losses**

At March 31, 2011 and December 31, 2010

(In thousands)

 
| ** **                      | ** ** | **March 31,** | ** ** | **December 31,**     | ** ** |
|---------------------------------|------------|--------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **2011**           | ** ** | **2010**                  | ** ** |
| ** **                      | ** ** | **Allocation**     | ** ** | **% of Total*** | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial and industrial       |       | $                  | 2,941      |                      | 13.16      | % | $ | 2,941 |   | 14.20 | % |
| Real estate - commercial        |       | 10,371             |       | 45.76                     | %          | 10,558 |   | 44.73 | % |
| Real estate - construction      |       | 7,744              |       | 17.12                     | %          | 7,593 |   | 17.01 | % |
| Real estate - residential       |       | 1,886              |       | 15.12                     | %          | 1,875 |   | 15.39 | % |
| Home equity lines               |       | 1,196              |       | 8.61                      | %          | 1,175 |   | 8.46 | % |
| Consumer                        |       | 71                 |       | 0.23                      | %          | 68 |   | 0.21 | % |
|                            |       |               |       |                      |       |   |   |   |   |
| Total allowance for loan losses |       | $                  | 24,209     |                      | 100.00     | % | $ | 24,210 |   | 100.00 | % |

 

----

*      Percentage of loan type to the total loan portfolio.

 

**Nonperforming Loans**

At March 31, 2011 and December 31, 2010

(In thousands)

 
| ** **                                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2011**           | ** ** | **2010**              | ** ** |
| Nonaccruing loans                            |       | $                  | 9,283      |                  | $          | 7,516 |   |
|                                         |       |               |       |                  |       |
| Loans contractually past-due 90 days or more |       | —             |       | 49                    |       |
|                                         |       |               |       |                  |       |
| Total nonperforming loans                    |       | $                  | 9,283      |                  | $          | 7,565 |   |

 

*Noninterest Income*

 

Noninterest income includes service charges on deposits and loans, realized and unrealized gains on mortgage banking activities, investment fee income, management fee income, and gains on sales of investment securities available-for-sale, and continues to be an important factor in our operating results. Noninterest income for the three months ended March 31, 2011 and 2010 was $5.0 million and $5.8 million, respectively.  Realized and unrealized gains on mortgage banking activities by our mortgage banking segment for the three months ended March 31, 2011 and 2010 were $3.1 million and $2.8 million, respectively, an increase of $269,000, or 10%.  Included in realized and unrealized gains on mortgage banking activities are any origination, underwriting, and discount points and other funding fees and gains associated with our sales of loans to third party investors.  Costs include direct costs associated with the loan origination, such as commissions and salaries that are deferred at the time of origination.

 

Management fee income, which represents the income earned for services George Mason provides to other mortgage companies owned by local home builders and generally fluctuates based on the volume of loan sales, decreased $278,000 to $299,000 for the three months ended March 31, 2011 as compared to $577,000 for the three months ended March 31, 2010.  During the first quarter of 2011, one of the managed companies ceased operating independently and was converted to a branch office of George Mason because of the increased regulatory requirements placed on mortgage companies.  The employees of this managed company are now employees of George Mason.  The income once earned from this managed company is now reflected in realized and unrealized gains on mortgage banking activities, as we now earn 100% of the revenues generated from their originations.

 

Investment fee income decreased $461,000 to $548,000 for the three months ended March 31, 2011 compared to $1.0 million for the same period of 2010. The decrease in fee income is directly attributable to the renegotiation of our service contract with a trust customer.  We are currently repositioning our wealth management operations for future growth and less risk.

 

The increase in the cash surrender value of our bank-owned life insurance for the three and months ended March 31, 2011 and 2010 was $180,000, and $148,000, respectively.  The increase is directly related to increases in the underlying value of the investments.

 

For the three months ended March 31, 2011 and 2010, we recorded net gains on sales of investment securities available-for-sale of $403,000 and $264,000, respectively.

 

During the first quarter of 2011, we prepaid $15 million in FHLB advances to reduce our funding costs at the Bank.  As part of the arrangement with the FHLB, we paid a prepayment

 

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penalty of $450,000 to extinguish these borrowings prior to their maturity.  No such expense occurred during 2010.

 

Noninterest income represented 22% and 27% of our total revenues for the three months ended March 31, 2011 and 2010, respectively.

 

*Noninterest Expense*

 

Noninterest expense includes, among other things, salaries and benefits, occupancy costs, professional fees, depreciation, data processing, telecommunications and miscellaneous expenses. Noninterest expense for the three months ended March 31, 2011 was $13.7 million, compared to $13.1 million for the same period of 2010, an increase of $595,000, or 5%.

 

For the quarter ended March 31, 2011, salaries and benefits expense increased to $6.7 million up from $6.1 million for the quarter ended March 31, 2010.  The increase in salaries and benefits expense is mostly related to increases in our business development personnel at our commercial banking and mortgage banking segments.  Expenses related to mortgage loan repurchases and putbacks decreased $463,000 to $100,000 for the three months ended March 31, 2011 compared to the same period of 2010, a result of our limiting exposure to loan repurchases through agreements we entered into with various investors.  Additional increases in noninterest expense are related to increases in marketing and business development expense.

 

*Income Taxes*

 

For the three months ended March 31, 2011, we recorded a provision for income taxes of $2.6 million, compared to $1.7 million for the same period of 2010.  Our effective tax rate for the three months ended March 31, 2011 and 2010 was 33.6% and 31.3%, respectively.  Our effective tax rate is less than the statutory rate because of income we receive on tax-exempt investments.  See also “Critical Accounting Policies — Valuation of Deferred Tax Assets.”

 

**Statements of Condition**

 

Total assets were $2.06 billion and $2.07 billion at March 31, 2011 and December 31, 2010, respectively.

 

*Investment Securities*

 

Our investment securities portfolio is used as a source of income and liquidity.  Investment securities were $370.4 million at March 31, 2011, compared to $345.0 million at December 31, 2010, an increase of $25.4 million. The increase in investment securities during 2011 as compared to December 31, 2010 is a result of new purchases because of the decrease in the funding needs for our loans held for sale portfolio during the first quarter of 2011.  The investment securities portfolio consists of investment securities available-for-sale, investment securities held-to-maturity and trading securities. Investment securities available-for-sale are those securities that we intend to hold for an indefinite period of time, but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability strategy, liquidity management or regulatory capital management.  Investment securities held-to-maturity are those securities that we have the intent and ability to hold to maturity and are carried at amortized cost. Investment securities-trading are securities we purchase to economically hedge against fair value changes in our nonqualified deferred compensation plan liability.  These

 

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securities include cash equivalents, equities and mutual funds.  See the following table for additional information on our investment securities portfolio.

 

**Investment Securities**

At March 31, 2011 and December 31, 2010

(In thousands)

 
| ** **                                                   | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|--------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at March 31, 2011** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S. government-sponsored agencies                           |       |          |       |      |       |        |       |
| Five to ten years                                            |       | $             | 35,832     |      | $          | 36,848      |       | 3.97 | % |
| Total U.S. government-sponsored agencies                     |       | 35,832        |       | 36,848    |       | 3.97        | %          |
|                                                         |       |          |       |      |       |        |       |
| Mortgage-backed securities (1)                               |       |          |       |      |       |        |       |
| One to five years                                            |       | 2             |       | 2         |       | 9.04        | %          |
| Five to ten years                                            |       | 19,351        |       | 20,293    |       | 4.26        | %          |
| After ten years                                              |       | 206,753       |       | 211,370   |       | 4.35        | %          |
| Total mortgage-backed securities                             |       | 226,106       |       | 231,665   |       | 4.34        | %          |
|                                                         |       |          |       |      |       |        |       |
| Tax exempt municipal securities (2)                          |       |          |       |      |       |        |       |
| One to five years                                            |       | 738           |       | 743       |       | 5.62        | %          |
| Five to ten years                                            |       | 12,989        |       | 13,405    |       | 3.45        | %          |
| After ten years                                              |       | 58,579        |       | 59,591    |       | 4.00        | %          |
| Taxable municipal securities                                 |       |          |       |      |       |        |       |
| Five to ten years                                            |       | 3,315         |       | 3,391     |       | 4.96        | %          |
| After ten years                                              |       | 996           |       | 983       |       | 5.10        | %          |
| Total municipal securities                                   |       | 76,617        |       | 78,113    |       | 3.98        | %          |
|                                                         |       |          |       |      |       |        |       |
| U. S. treasury securities                                    |       |          |       |      |       |        |       |
| One to five years                                            |       | 4,928         |       | 5,086     |       | 2.36        | %          |
| Total U.S. treasury securities                               |       | 4,928         |       | 5,086     |       | 2.36        | %          |
| Total investment securities available-for-sale               |       | $             | 343,483    |      | $          | 351,712     |       | 4.18 | % |

 
| ** **                                                 | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at March 31, 2011** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| Mortgage-backed securities (1)                             |       |          |       |      |       |        |       |
| Five to ten years                                          |       | 2,323         |       | 2,453     |       | 4.63        | %          |
| After ten years                                            |       | 5,884         |       | 6,173     |       | 4.05        | %          |
| Total mortgage-backed securities                           |       | 8,207         |       | 8,626     |       | 4.21        | %          |
|                                                       |       |          |       |      |       |        |       |
| Corporate bonds                                            |       |          |       |      |       |        |       |
| After ten years                                            |       | 8,004         |       | 3,934     |       | 1.36        | %          |
| Total corporate bonds                                      |       | 8,004         |       | 3,934     |       | 1.36        | %          |
| Total investment securities held-to-maturity               |       | 16,211        |       | 12,560    |       | 2.80        | %          |
|                                                       |       |          |       |      |       |        |       |
| Total investment securities                                |       | $             | 359,694    |      | $          | 364,272     |       | 4.13 | % |
|                                                            |            |               |            |           |            |             |            |  |  |

 

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| ** **                                                      | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-----------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| ** **                                                      | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| **Available-for-sale at December 31, 2010** |       |          |       |      |       |        |       |
| U.S. government-sponsored agencies                              |       |          |       |      |       |        |       |
| Five to ten years                                               |       | $             | 30,941     |      | $          | 32,119      |       | 3.95 | % |
| Total U.S. government-sponsored agencies                        |       | 30,941        |       | 32,119    |       | 3.95        | %          |
|                                                            |       |          |       |      |       |        |       |
| Mortgage-backed securities (1)                                  |       |          |       |      |       |        |       |
| One to five years                                               |       | 7             |       | 7         |       | 9.02        | %          |
| Five to ten years                                               |       | 21,976        |       | 22,997    |       | 4.24        | %          |
| After ten years                                                 |       | 190,600       |       | 196,478   |       | 4.54        | %          |
| Total mortgage-backed securities                                |       | 212,583       |       | 219,482   |       | 4.51        | %          |
|                                                            |       |          |       |      |       |        |       |
| Tax exempt municipal securities (2)                             |       |          |       |      |       |        |       |
| Five to ten years                                               |       | 7,063         |       | 7,198     |       | 3.38        | %          |
| After ten years                                                 |       | 52,907        |       | 52,776    |       | 3.98        | %          |
| Taxable municipal securities                                    |       |          |       |      |       |        |       |
| Five to ten years                                               |       | 3,318         |       | 3,320     |       | 4.96        | %          |
| After ten years                                                 |       | 996           |       | 989       |       | 5.10        | %          |
| Total municipal securities                                      |       | 64,284        |       | 64,283    |       | 3.73        | %          |
|                                                            |       |          |       |      |       |        |       |
| U. S. treasury securities                                       |       |          |       |      |       |        |       |
| One to five years                                               |       | 4,923         |       | 5,114     |       | 2.36        | %          |
| Total U.S. treasury securities                                  |       | 4,923         |       | 5,114     |       | 2.36        | %          |
| Total investment securities available-for-sale                  |       | $             | 312,731    |      | $          | 320,998     |       | 4.26 | % |

 
| ** **                                       | ** ** | **Amortized** | ** ** | **Fair**   | ** ** | **Average** | ** ** |
|--------------------------------------------------|------------|---------------|------------|------------|------------|-------------|------------|
| ** **                                       | ** ** | **Cost**      | ** ** | **Value**  | ** ** | **Yield**   | ** ** |
| **Held-to-maturity at   December 31, 2010** | ** ** | ** **    | ** ** | ** ** | ** ** | ** **  | ** ** |
| Mortgage-backed securities (1)                   |       |          |       |       |       |        |       |
| One to five years                                |       | $             | 351        |       | $          | 368         |       | 4.14 | % |
| Five to ten years                                |       | 3,766         |       | 3,965      |       | 4.63        | %          |
| After ten years                                  |       | 9,758         |       | 10,203     |       | 4.12        | %          |
| Total mortgage-backed securities                 |       | 13,875        |       | 14,536     |       | 4.26        | %          |
|                                             |       |          |       |       |       |        |       |
| Corporate bonds                                  |       |          |       |       |       |        |       |
| After ten years                                  |       | 8,004         |       | 3,197      |       | 1.34        | %          |
| Total corporate bonds                            |       | 8,004         |       | 3,197      |       | 1.34        | %          |
| Total investment securities held-to-maturity     |       | 21,879        |       | 17,733     |       | 3.19        | %          |
|                                             |       |          |       |       |       |        |       |
| Total investment securities                      |       | $             | 334,610    |       | $          | 338,731     |       | 4.19 | % |

 

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(1) Based on contractual maturities.

(2) Yields for tax-exempt municipal securities are not reported on a tax-equivalent basis.

 

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We complete reviews for other-than-temporary impairment at least quarterly.  As of March 31, 2011, the majority of our investment securities portfolio consisted of securities rated AAA by a leading rating agency.  Investment securities which carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk.  At March 31, 2011, 97% of our mortgage-related investment securities portfolio is guaranteed by the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Government National Mortgage Association (GNMA).

 

We have $6.4 million in non-government non-agency mortgage-related securities.  These securities are rated from AAA to AA.  The various protective elements on the non-agency securities may change in the future if market conditions or the financial stability of credit insurers changes, which could impact the ratings of these securities.

 

At March 31, 2011, certain of our investment grade securities were in an unrealized loss position.  Investment securities with unrealized losses are a result of pricing changes due to recent and negative conditions in the current market environment and not as a result of permanent credit impairment. Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government.  Other mortgage-backed securities and municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due.  We do not intend to sell nor do we believe we will be required to sell any of our temporarily impaired securities prior to the recovery of their amortized cost.

 

Our held-to-maturity portfolio includes investments in four pooled trust preferred securities, totaling $8.0 million of par value at March 31, 2011 (each security has a par value of $2.0 million).  These securities are presented as corporate bonds in the table below.  The collateral underlying these structured securities are instruments issued by financial institutions or insurers.  We own the A-3 tranches in each issuance.  Each of the bonds are rated by more than one rating agency.  One security has a composite rating of A, one security has a composite rating of A-, one of the securities has a composite rating of BB- and the other security has a composite rating of B-.  Observable trading activity remains limited for these types of securities.  We have estimated the fair value of these securities through the use of internal calculations and through information provided by external pricing services.  Given the level of subordination below our A-3 tranches, and the actual and expected performance of the underlying collateral, we expect to receive all contractual interest and principal payments recovering the amortized cost basis of each of the four securities, and concluded that these securities are not other-than-temporarily impaired.  We continuously monitor the financial condition of the underlying issues and the level of subordination below the A-3 tranches.  We also use a multi-scenario model which assumes varying levels of additional defaults and deferrals and the effects of such adverse developments on the contractual cash flows for the A-3 tranches.  In each of the adverse scenarios, there was no indication of a break to the A-3 contractual cash flows.  Significant judgment is involved in the evaluation of other-than-temporary impairment.  We do not intend to sell nor do we believe it is probable that we will be required to sell these corporate bonds prior to the recovery of our investment.

 

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No other-than-temporary impairment has been recognized on the securities in our investment portfolio during 2011.

 

We hold $15.7 million in FHLB stock at March 31, 2011, which is included in other investment on the statement of condition.  During 2008, the FHLB of Atlanta announced a change in their dividend declaration and payment schedule beginning during the fourth quarter of 2008.  The change was initiated so that the dividend can be declared and paid to member banks after the FHLB has calculated their net income for the preceding quarter.  During 2009, the FHLB announced changes to its capital stock requirements.  Specifically, the Board of Directors increased the dollar cap on its stock purchases from $25 million to $26 million and repurchases of member excess stock will be evaluated on a quarterly basis instead of a daily basis.  We do not expect the above changes to materially impact our liquidity position.

 

*Loans Receivable*

 

Total loans receivable, net of deferred fees and costs, were $1.41 billion at March 31, 2011 and December 31, 2010.  Loan growth during the first quarter of 2011 was offset by several large loans which matured during this same quarter.  See the following table for details on the loans receivable portfolio. Loans held for sale at March 31, 2011 were $168.6 million compared to $206.0 million at December 31, 2010.  The decrease in our loans held for sale portfolio is a result of seasonal loan origination activity.  We historically experience low mortgage lending activity during the first quarter of each year.  Loans held for sale are valued at the lower of cost or fair value.

 

**Loans Receivable**

At March 31, 2011 and December 31, 2010

(In thousands)

 
| ** **                      | ** ** | **March 31, 2011** | ** ** | **December 31, 2010** | ** ** |
|---------------------------------|------------|------------------------------|------------|---------------------------------|------------|
|                            |       |                         |       |                            |       |   |   |   |   |
| Commercial and industrial       |       | $                            | 186,262    |                            | 13.16      | % | $ | 200,384 |   | 14.20 | % |
| Real estate - commercial        |       | 647,614                      |       | 45.76                           | %          | 631,292 |   | 44.73 | % |
| Real estate - construction      |       | 242,364                      |       | 17.12                           | %          | 240,007 |   | 17.01 | % |
| Real estate - residential       |       | 213,933                      |       | 15.12                           | %          | 217,130 |   | 15.39 | % |
| Home equity lines               |       | 121,893                      |       | 8.61                            | %          | 119,403 |   | 8.46 | % |
| Consumer                        |       | 3,260                        |       | 0.23                            | %          | 3,042 |   | 0.21 | % |
|                            |       |                         |       |                            |       |   |   |   |   |
| Gross loans                     |       | $                            | 1,415,326  |                            | 100.00     | % | 1,411,258 |   | 100.00 | % |
|                            |       |                         |       |                            |       |   |   |   |   |
| Net deferred (fees) costs       |       | (2,109                       | )          |                            |       | (1,956 | ) |   |   |
| Less: allowance for loan losses |       | (24,209                      | )          |                            |       | (24,210 | ) |   |   |
|                            |       |                         |       |                            |       |   |   |   |   |
| Loans receivable, net           |       | $                            | 1,389,008  |                            |       |   | $ | 1,385,092 |   |   |   |

 

*Deposits*

 

Total deposits were $1.39 billion at March 31, 2011 compared to $1.40 billion at December 31, 2010. During 2011, we had decreases in our noninterest bearing checking products, interest checking, savings and certificates of deposit. These decreases were related to customers who held larger deposit balances at December 31, 2010 compared to March 31, 2011, a result of certain business activities for those particular customers.  See the following table for details on certificates of deposit with balances of $100,000 or more. We are a member of the Certificates of Deposit Account Registry Service (“CDARS”).   CDARS allows our customers to access FDIC insurance protection on multi-million dollar certificates of deposit through our Bank.  When a customer places a large deposit through CDARS, we place their funds into certificates of deposit with other banks in the CDARS network in increments of less than $250,000 so that principal and interest are eligible for FDIC insurance protection.  At March 31, 2011 and December 31, 2010, we had $31.6 million and $43.5 million, respectively, in CDARS deposits, which are considered to be brokered deposits.  The decrease in our CDARS deposits was mostly attributable to customers who moved their deposits to other financial institutions who are willing to pay a higher interest rate than us.  Brokered certificates of deposit not in the CDARS network were $59.8 million and $44.8 million at March 31, 2011 and December 31, 2010, respectively. We issued additional brokered certificates of deposit during the first quarter of 2011 to lock in low cost term funding.

 

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**Certificates of Deposit of $100,000 or More**

At March 31, 2011

(In thousands)

 
| ** **                            | ** ** | **Fixed Term** | ** ** | **No-Penalty*** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|---------------------|------------|-----------------|------------|-----------|------------|
| **Maturities:**                       |       |                |       |            |       |      |       |   |   |   |
| Three months or less                  |       | $                   | 50,435     |            | $          | 10,575    |       | $ | 61,010 |   |
| Over three months through six months  |       | 48,391              |       | 6,644           |       | 55,035    |       |
| Over six months through twelve months |       | 66,766              |       | 1,462           |       | 68,228    |       |
| Over twelve months                    |       | 108,677             |       | 31,569          |       | 140,246   |       |
|                                  |       | $                   | 274,269    |            | $          | 50,250    |       | $ | 324,519 |   |

 

----

* No-Penalty certificates of deposit can be redeemed at anytime at the request of the depositor.

 

*Borrowings*

 

Other borrowed funds increased $26.3 million to $415.9 million at March 31, 2011, compared to $389.6 million at December 31, 2010.  Treasury, Tax & Loan Note option borrowings decreased $600,000 to $870,000 at March 31, 2011 compared to $1.5 million at December 31, 2010.  FHLB advances decreased $15.0 million to $265.0 million at March 31, 2011 compared to $280.0 million at December 31, 2010. During the first quarter of 2011, we prepaid $15 million in FHLB advances to reduce our funding costs at the Bank.  Customer repurchase agreements increased $2.1 million to $85.4 million at March 31, 2011 compared to $87.5 million at December 31, 2010.  We had federal funds purchased of $44.0 million at March 31, 2011 compared to none at December 31, 2010.  We purchased federal funds at the end of March 2011 due to short-term funding needs related to increased loan production at George Mason.  The following table provides information on our borrowings.

 

**Short-Term Borrowings and Other Borrowed Funds**

At March 31, 2011

(In thousands)

 
| **Advance Date**                                                 | ** ** | **Term of Advance** | ** ** | **Maturity or   Call Date** | ** ** | **Interest Rate** | ** ** | **Amount    Outstanding** | ** **  |
|-----------------------------------------------------------------------|------------|-------------------------------|------------|---------------------------------------|------------|------------------------|------------|---------------------------|-------------|
|                                                                  |       |                          |       |                                  |       |                   |       |                      |        |
| **Other short-term borrowed funds:**                                  |       |                          |       |                                  |       |                   |       |                      |        |
| TT&L note option                                                  |       |                          |       |                                  |       | 0.00                   | %          | $                         | 870         |   |
| Customer repurchase agreements                                        |       |                          |       |                                  |       | 0.24                   | %          | 85,365                    |        |
| Federal funds purchased                                               |       |                          |       |                                  |       | 0.25                   | %          | 44,000                    |        |
| **Total other short-term borrowed   funds and weighted average rate** | ** ** | ** **                    | ** ** | ** **                            | ** ** | **0.24**               | **%**      | **$**                     | **130,235** | ** ** |
| ** **                                                            |       |                          |       |                                  |       |                   |       |                      |        |
| **Other borrowed funds:**                                             |       |                          |       |                                  |       |                   |       |                      |        |
| Trust preferred                                                       |       |                          |       |                                  |       | 3.95                   | %          | $                         | 20,619      |   |
| FHLB advances - long term                                             |       |                          |       |                                  |       | 3.61                   | %          | 265,000                   |        |
| **Other borrowed funds and weighted   average rate**                  | ** ** |                          | ** ** | ** **                            | ** ** | **3.63**               | **%**      | **$**                     | **285,619** | ** ** |
|                                                                  |       |                          |       |                                  |       |                   |       |                      |        |
| **Total other borrowed funds and   weighted average rate**            | ** ** | ** **                    | ** ** | ** **                            | ** ** | **2.57**               | **%**      | **$**                     | **415,854** | ** ** |

 

*Shareholders’ Equity*

 

Shareholders’ equity at March 31, 2011 was $229.3 million compared to $222.9 million at December 31, 2010, an increase of $6.4 million, or 3%. The increase in shareholders’ equity at March 31, 2011 compared to December 31, 2010 is primarily attributable to net income of $5.2 million for the three months ended March 31, 2011.  In addition, accumulated other comprehensive income increased $644,000 for the three months ended March 31, 2011.  Book value per share at March 31, 2011 was $7.93 compared to $7.26 at December 31, 2010. Tangible book value per share (which is book value per share adjusted for changes in other comprehensive income, less goodwill and other intangible assets) at March 31, 2011 was $7.39 compared to $6.64 at December 31, 2010.

 

**Business Segment Operations**

 

We provide banking and non-banking financial services and products through our subsidiaries. We operate in three business segments, commercial banking, mortgage banking and wealth management and trust services.

 

*Commercial Banking*

 

The commercial banking segment includes both commercial and consumer lending and provides customers such products as commercial loans, real estate loans, and other business financing and consumer loans. In addition, this segment also provides customers with various deposit products including demand deposit accounts, savings accounts and certificates of deposit.

 

For the three months ended March 31, 2011, the commercial banking segment recorded net income of $5.4 million compared to $3.6 million for the same period of 2010. See “**Statements of Income** — *General—Business**Segments*” above for additional information regarding the operating results for the commercial banking segment for the periods presented.  At March 31, 2011, total assets for this segment were $2.04 billion, loans receivable, net of deferred fees and costs, were $1.41 billion and total deposits were $1.39 billion. At March 31, 2010, total

 

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assets were $1.92 billion, loans receivable, net of deferred fees and costs, were $1.31 billion and total deposits were $1.33 billion.

 

*Mortgage Banking*

 

The operations of the mortgage banking segment are conducted through George Mason, and Cardinal First. Both George Mason and Cardinal First engage primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis.

 

For the three months ended March 31, 2011 and 2010, the mortgage banking segment recorded net income of $524,000 and $559,000, respectively. See “**Statements of Income** — *General—Business**Segments*” above for additional information regarding the operating results for the mortgage banking segment for the periods presented.  At March 31, 2011, total assets for this segment were $167.7 million; loans held for sale were $153.4 million and mortgage funding checks were $8.0 million. At March 31, 2010, total assets were $160.4 million; loans held for sale were $144.0 million and mortgage funding checks were $8.6 million.

 

*Wealth Management and Trust Services*

 

The wealth management and trust services segment provides investment and financial services to businesses and individuals, including financial planning, retirement/estate planning, trusts, estates, custody, investment management, escrows, and retirement plans. Operations of the Bank’s trust division, CWS and Wilson/Bennett are included in this operating segment.

 

For the three months ended March 31, 2011 and 2010, the wealth management and trust services segment recorded a net loss of $150,000 and net income of $127,000, respectively. See “**Statements of Income** — *General—Business**Segments*” above for additional information regarding the operating results for this business segment for the periods presented.  At March 31, 2011, total assets were $593,000 and managed and custodial assets were $3.2 billion. At March 31, 2010, total assets for this segment were $3.5 million and managed and custodial assets were $3.2 billion.

 

Additional information pertaining to our business segments can be found in Note 3 to the notes to consolidated financial statements.

 

**Capital Resources**

 

Capital adequacy is an important measure of our financial stability and performance. Our objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.

 

Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profile of the financial institution. The guidelines define capital as both Tier 1 (which includes common shareholders’ equity and certain debt obligations) and Tier 2 (which includes certain other debt obligations, a portion of the allowance for loan losses, and 45% of any unrealized gains in equity securities).

 

At March 31, 2011, our Tier 1 and total (Tier 1 and Tier 2) risk-based capital ratios were 12.80% and 14.17%, respectively. At December 31, 2010, our Tier 1 and total risk-based capital ratios were 12.67% and 14.06%, respectively.  Our regulatory capital levels for the Bank and bank holding company meet those established for well-capitalized institutions.  The increase in

 

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our risk-based capital ratios was primarily a result of the changes in the risk weightings of certain assets during 2011, offset by an increase in shareholders’ equity at March 31, 2011 compared to December 31, 2010.

 

The following table provides additional information pertaining to our capital ratios.

** **

**Capital Components**

At March 31, 2011 and December 31, 2010

(In thousands)

 
| ** **                                                        | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well**   | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                                        | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                                                        | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                                                        | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                                        | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| ** **                                                        | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** |
| **Cardinal Financial Corporation (Consolidated):** | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** |
| **At March 31, 2011**                                        | ** ** |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total risk-based capital                                          |       | $          | 254,200    |                       | 14.17      | %                          | $          | 143,562                    | >  | 8.00                       | %          | $ | 179,452 | >  | 10.00 | % |
| Tier I risk-based capital                                         |       | 229,637    |       | 12.80                      | %          | 71,781                     | >  | 4.00                       | %          | 107,671                    | >  | 6.00 | % |
| Leverage capital ratio                                            |       | 229,637    |       | 11.28                      | %          | 81,432                     | >  | 4.00                       | %          | 101,790                    | >  | 5.00 | % |
|                                                              |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| **At December 31, 2010**                                     | ** ** |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total risk-based capital                                          |       | $          | 248,294    |                       | 14.06      | %                          | $          | 141,284                    | >  | 8.00                       | %          | $ | 176,606 | >  | 10.00 | % |
| Tier I risk-based capital                                         |       | 223,789    |       | 12.67                      | %          | 70,642                     | >  | 4.00                       | %          | 105,963                    | >  | 6.00 | % |
| Leverage capital ratio                                            |       | 223,789    |       | 10.82                      | %          | 82,753                     | >  | 4.00                       | %          | 103,441                    | >  | 5.00 | % |

 
| ** **                    | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well**   | ** ** |
|-------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                    | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                    | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                    | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| ** **                    |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| **Cardinal Bank:**       |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| **At March 31, 2011**    |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total risk-based capital      |       | $          | 238,301    |                       | 13.38      | %                          | $          | 142,501                    | >  | 8.00                       | %          | $ | 178,126 | >  | 10.00 | % |
| Tier I risk-based capital     |       | 213,737    |       | 12.00                      | %          | 71,250                     | >  | 4.00                       | %          | 106,876                    | >  | 6.00 | % |
| Leverage capital ratio        |       | 213,737    |       | 10.57                      | %          | 80,895                     | >  | 4.00                       | %          | 101,119                    | >  | 5.00 | % |
|                          |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| **At December 31, 2010** |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total risk-based capital      |       | $          | 232,274    |                       | 13.25      | %                          | $          | 140,262                    | >  | 8.00                       | %          | $ | 175,328 | >  | 10.00 | % |
| Tier I risk-based capital     |       | 207,768    |       | 11.85                      | %          | 70,131                     | >  | 4.00                       | %          | 105,197                    | >  | 6.00 | % |
| Leverage capital ratio        |       | 207,768    |       | 10.09                      | %          | 82,383                     | >  | 4.00                       | %          | 102,979                    | >  | 5.00 | % |

 

**Liquidity**

 

Liquidity in the banking industry is defined as the ability to meet the demand for funds of both depositors and borrowers. We must be able to meet these needs by obtaining funding from depositors or other lenders or by converting non-cash items into cash.  The objective of our liquidity management program is to ensure that we always have sufficient resources to meet the demands of our depositors and borrowers. Stable core deposits and a strong capital position provide the base for our liquidity position. We believe we have demonstrated our ability to attract deposits because of our convenient branch locations, personal service and pricing.

 

In addition to deposits, we have access to different wholesale funding markets. These markets include the brokered CD market, the repurchase agreement market and the federal funds market. We are a member of the Certificates of Deposit Account Registry Service (“CDARS”).  CDARS allows our customers to access FDIC insurance protection on multi-million dollar certificates of deposit through our Bank.  When a customer places a large deposit through CDARS, we place their funds into certificates of deposit with other banks in the CDARS network in increments of less than $250,000 so that principal and interest are eligible for FDIC insurance protection.  We also maintain secured lines of credit with the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Atlanta. Having diverse funding alternatives reduces our reliance on any one source for funding.

 

Cash flow from amortizing assets or maturing assets can also provide funding to meet the needs of depositors and borrowers.

 

We have established a formal liquidity contingency plan which establishes a liquidity management team and provides guidelines for liquidity management. For our liquidity management program, we first determine our current liquidity position and then forecast liquidity based on anticipated changes in the balance sheet. In this forecast, we expect to maintain a liquidity cushion. We also stress test our liquidity position under several different stress scenarios. Guidelines for the forecasted liquidity cushion and for liquidity cushions for each stress scenario have been established. In addition, one stress test combines all other stress tests to see how liquidity would react to several negative scenarios occurring at the same time. We believe that we have sufficient resources to meet our liquidity needs.

 

Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $373.3 million at March 31, 2011 or 18% of total assets. We held investments that are classified as held-to-maturity in the amount of $16.2 million at March 31, 2011. To maintain ready access to the Bank’s secured lines of credit, the Bank has pledged roughly half of its investment securities and a portion of its commercial real estate and residential real estate loan portfolios to the Federal Home Loan Bank of Atlanta with additional investment securities and certain loans in its commercial & industrial loan portfolio pledged to the Federal Reserve Bank of Richmond. Additional borrowing capacity at the Federal Home Loan Bank of Atlanta at March 31, 2011 was $162.6 million. Borrowing capacity with the Federal Reserve 

 

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Bank of Richmond was $128.1 million at March 31, 2011. These facilities are subject to the FHLB and the Federal Reserve approving disbursement to us.  In addition, we have unsecured federal funds purchased lines of $315 million available to us.  We anticipate maintaining liquidity at a level sufficient to protect depositors, provide for reasonable growth and fully comply with all regulatory requirements.

 

**Contractual Obligations**

 

We have entered into a number of long-term contractual obligations to support our ongoing activities. These contractual obligations will be funded through operating revenues and liquidity sources held or available to us and exclude contractual interest costs, where applicable. During the first quarter of 2011, we implemented two cost of funds reduction strategies related to our FHLB advances.  Approximately $95 million of these advances with near term maturities were extended by an average maturity of 2.9 years.  We are now paying an average 3.22% on these borrowings, a yield reduction of 0.99%, equating to approximately $940,000 in interest expense annually.  These transactions pushed our FHLB advance funding further out from the 1-3 year maturity term to the 3-5 year maturity term.  In addition, we extinguished $15.0 million in FHLB advances which had an average cost of 2.81%, or $422,000 annually.

 

The required payments under such obligations are detailed in the following table.

 

**Contractual Obligations**

At March 31, 2011

(In thousands)

 
| ** **                                            | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                            | ** ** | **Total**                                 | ** ** | **Less than 1   Year** | ** ** | **1 - 2 Years** | ** ** | **3 - 5 Years** | ** ** | **More than 5   Years** | ** ** |
| Long-Term Debt Obligations:                           | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Certificates of deposit                               |       | $                                         | 549,933    |   | $ | 298,860 |   | $ | 100,292 |   | $ | 118,069 |   | $ | 32,712 |   |
|                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Brokered certificates of deposit                      |       | 91,369                                    |       | 33,680 |   | 33,655 |   | 24,034 |   | — |   |
|                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Advances from the Federal Home Loan Bank of   Atlanta |       | 265,000                                   |       | — |   | 20,000 |   | 100,000 |   | 145,000 |   |
|                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Trust preferred securities                            |       | 20,619                                    |       | — |   | — |   | — |   | 20,619 |   |
|                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Operating lease obligations                           |       | 26,532                                    |       | 3,943 |   | 3,322 |   | 8,420 |   | 10,847 |   |
|                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Total                                                 |       | $                                         | 953,453    |   | $ | 336,483 |   | $ | 157,269 |   | $ | 250,523 |   | $ | 209,178 |   |

 

**Financial Instruments with Off-Balance-Sheet Risk and Credit Risk**

 

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized on the balance sheet.

 

The Bank’s maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. We evaluate each customer’s credit worthiness on a case-by-case basis and require collateral to support financial instruments when deemed necessary.  The amount of collateral obtained upon extension of credit is based on management’s credit evaluation of the counterparty.  Collateral held varies but may include deposits held by us, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have expiration dates up to one year or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future funding requirements. These instruments represent obligations to extend credit or guarantee borrowings and are not recorded on the consolidated statements of condition.  The rates and terms of these instruments are competitive with others in the market in which we do business.

 

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Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers.  Those lines of credit may not be drawn upon to the total extent to which we have committed.

 

Standby letters of credit are conditional commitments we issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers. We hold certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.

 

At March 31, 2011 and December 31, 2010, commitments to extend credit were $529.5 million and $526.6 million, respectively.  Standby letters of credit were $21.1 million and $22.3 million at March 31, 2011 and December 31, 2010, respectively. Commitments to extend credit of $135.6 million as of March 31, 2011 are related to the mortgage banking segment’s mortgage loan funding commitments and are of a short term nature, compared to $87.8 million as of December 31, 2010.  The increase in mortgage loan funding commitments is related to the increased origination production which occurred at George Mason towards the end of March 2011.

 

We have counter-party risk which may arise from the possible inability of George Mason’s third-party investors to meet the terms of their forward sales contracts. George Mason works with third-party investors that are generally well-capitalized, are investment grade and exhibit strong financial performance to mitigate this risk.  We do not expect any third-party investor to fail to meet its obligation.  In addition, we have derivative counterparty risk relating to three interest rate swaps we have with third parties.  This risk may arise from the inability of the third party to meet the terms of the contract.  We continuously monitor the financial condition of these third parties.  We do not expect these third parties to fail to meet their obligations.

 

George Mason provides for its estimated exposure to repurchase loans previously sold to investors for which borrowers failed to provide full and accurate information on their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor, and for other exposure to its investors related to loan sales activities. We evaluate the merits of each claim and estimate the reserve based on actual and expected claims received and consider the historical amounts paid to settle such claims.  During the past two years, we have taken steps to limit our exposure to such loan repurchases through agreements entered into with various investors.  During 2010, we experienced favorable results in resolving various investor claims and have reduced our reserve related to such claims.  As of March 31, 2011, this reserve has a balance of $100,000.

 

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**Interest Rate Sensitivity**

 

We are exposed to various business risks including interest rate risk. Our goal is to maximize net interest income without incurring excessive interest rate risk. Management of net interest income and interest rate risk must be consistent with the level of capital and liquidity that we maintain. We manage interest rate risk through an asset and liability committee (“ALCO”). ALCO is responsible for managing our interest rate risk in conjunction with liquidity and capital management.

 

We employ an independent consulting firm to model our interest rate sensitivity.  We use a net interest income simulation model as our primary tool to measure interest rate sensitivity. 

 

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Many assumptions are developed based on expected activity in the balance sheet. For maturing assets, assumptions are created for the redeployment of these assets. For maturing liabilities, assumptions are developed for the replacement of these funding sources. Assumptions are also developed for assets and liabilities that could reprice during the modeled time period. These assumptions also cover how we expect rates to change on non-maturity deposits such as interest checking, money market checking, savings accounts as well as certificates of deposit. Based on inputs that include the current balance sheet, the current level of interest rates and the developed assumptions, the model then produces an expected level of net interest income assuming that market rates remain unchanged. This is considered the base case. Next, the model determines what net interest income would be based on specific changes in interest rates. The rate simulations are performed for a two year period and include ramped rate changes of down 100 basis points and up 200 basis points. The down 200 basis point scenario was discontinued given the current level of interest rates.  In the ramped down rate change, the model moves rates gradually down 100 basis points over the first year and then rates remain flat in the second year.

 

For the up 200 basis point scenario, rates are gradually moved up 200 basis points in the first year and then rates remain flat in the second year. In both the up and down scenarios, the model assumes a parallel shift in the yield curve. The results of these simulations are then compared to the base case.

 

At March 31, 2011, our asset/liability position was neutral based on our interest rate sensitivity model.  Our net interest income would decrease by less than 0.8% in a down 100 basis point scenario and would increase less than 0.7% in an up 200 basis point scenario over a one-year time frame.  In the two-year time horizon, our net interest income would decrease by less than 1.8% in a down 100 basis point scenario and would increase by less than 0.4% in an up 200 basis point scenario.

 

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**Item 3.  Quantitative and Qualitative Disclosures About Market Risk**

 

Our Asset/Liability Committee is responsible for reviewing our liquidity requirements and maximizing our net interest income consistent with capital requirements, liquidity, interest rate and economic outlooks, competitive factors and customer needs. Interest rate risk arises because the assets of the Bank and the liabilities of the Bank have different maturities and characteristics. In order to measure this interest rate risk, we use a simulation process that measures the impact of changing interest rates on net interest income. This model is run for the Bank by an independent consulting firm. The simulations incorporate assumptions related to expected activity in the balance sheet. For maturing assets, assumptions are developed for the redeployment of these assets. For maturing liabilities, assumptions are developed for the replacement of these funding sources. Assumptions are also developed for assets and liabilities that reprice during the modeled time period. These assumptions also cover how we expect rates to change on non-maturity deposits such as interest checking, money market checking, savings accounts as well as certificates of deposit. Based on inputs that include the most recent period end balance sheet, the current level of interest rates and the developed assumptions, the model then produces an expected level of net interest income assuming that interest rates remain unchanged. This becomes the base case. Next, the model determines the impact on net interest income given specified changes in interest rates. The rate simulations are performed for a two year period and include ramped rate changes of down 100 basis points and up 200 basis points. The down 200 basis point scenario was discontinued given the current level of interest rates.  In the ramped down rate change, the model moves rates gradually down 100 basis points over the first year and then rates remain flat in the second year.

 

For the up 200 basis point scenario, rates are gradually increased by 200 basis points in the first year and remain flat in the second year. In both the up and down scenarios, the model assumes a parallel shift in the yield curve. The results of these simulations are then compared to the base case.

 

At March 31, 2011, our asset/liability position was neutral based on our interest rate sensitivity model.  Our net interest income would decrease by less than 0.8% in a down 100 basis point scenario and would increase less than 0.7% in an up 200 basis point scenario over a one-year time frame.  In the two-year time horizon, our net interest income would decrease by less than 1.8% in a down 100 basis point scenario and would increase by less than 0.4% in an up 200 basis point scenario.

 

See also “Interest Rate Sensitivity” in Item 2 above for a discussion of our interest rate risk.

 

We have counter-party risk that may arise from the possible inability of George Mason’s third party investors to meet the terms of their forward sales contracts.  George Mason works with third-party investors that are generally well-capitalized, are investment grade and exhibit strong financial performance to mitigate this risk.  We do not expect any third-party investor to fail to meet its obligation.  In addition, we have derivative counterparty risk relating to certain interest rate swaps we have with third parties.  This risk may arise from the inability of the third party to meet the terms of the contracts.  We monitor the financial condition of these third parties on an annual basis.  We do not expect these third parties to fail to meet its obligation.

 

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**Item 4.  Controls and Procedures**

 

The Company maintains disclosure controls and procedures that are designed to ensure that the information required to be disclosed by it in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission, including, without limitation, those controls and procedures designed to ensure that such information is accumulated and communicated to the Company’s management to allow timely decisions regarding required disclosures.

 

As of the end of the period covered by this report, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was carried out under the supervision and with the participation of the Company’s management, including its chief executive officer and chief financial officer. Based on and as of the date of such evaluation, these officers concluded that the Company’s disclosure controls and procedures were effective.

 

The Company also maintains a system of internal accounting controls that is designed to provide assurance that assets are safeguarded and that transactions are executed in accordance with management’s authorization and are properly recorded. This system is continually reviewed and is augmented by written policies and procedures, the careful selection and training of qualified personnel and an internal audit program to monitor its effectiveness. There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that materially affected, or are likely to materially affect, our internal control over financial reporting.

 

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**PART II — OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

In the ordinary course of our operations, we become party to various legal proceedings.  Currently, we are not party to any material legal proceedings, and no such proceedings are, to management’s knowledge, threatened against us.

 

**Item 1A.  Risk Factors**

 

Our operations are subject to many risks that could adversely affect our future financial condition and performance and, therefore, the market value of our securities, including the risk factors that are outlined in our Annual Report on Form 10-K for the year ended December 31, 2010.  There have been no material changes in our risk factors from those disclosed.

 

**Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds**

 

(a)  None.

(b)  Not applicable.

(c)  For the three months ended March 31, 2011, we did not purchase shares of our common stock.

 

**Item 3.  Defaults Upon Senior Securities**

 

(a)  None.

(b)  None.

 

**Item 4.  (Removed and Reserved)**

 

**Item 5.  Other Information**

 

(a)  None.

(b)  None.

 

**Item 6.  Exhibits**

 

31.1         Rule 13a-14(a) Certification of Chief Executive Officer

31.2         Rule 13a-14(a) Certification of Chief Financial Officer

32.1         Statement of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350

32.2         Statement of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

 
|                   | CARDINAL   FINANCIAL CORPORATION                       |
|------------------------|--------------------------------------------------------|
|                   | (Registrant)                                           |
|                   |                                                   |
|                   |                                                   |
| Date: May 9, 2011 | /s/   Bernard H. Clineburg                             |
|                   | Bernard   H. Clineburg                                 |
|                   | Chairman   and Chief Executive Officer                 |
|                   | (Principal   Executive Officer)                        |
|                   |                                                   |
|                   |                                                   |
| Date: May 9, 2011 | /s/   Mark A. Wendel                                   |
|                   | Mark   A. Wendel                                       |
|                   | Executive   Vice President and Chief Financial Officer |
|                   | (Principal   Financial Officer)                        |
|                   |                                                   |
|                   |                                                   |
| Date: May 9, 2011 | /s/   Jennifer L. Deacon                               |
|                   | Jennifer   L. Deacon                                   |
|                   | Senior   Vice President and Chief Accounting Officer   |
|                   | (Principal   Accounting Officer)                       |

 

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** **

**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                |
|----------------------|------------|--------------------------------------------------------------------------------|
| 31.1                 |       | Rule 13a-14(a) Certification   of Chief Executive Officer            |
| 31.2                 |       | Rule 13a-14(a) Certification   of Chief Financial Officer            |
| 32.1                 |       | Statement of Chief   Executive Officer Pursuant to 18 U.S.C. Section 1350 |
| 32.2                 |       | Statement of Chief   Financial Officer Pursuant to 18 U.S.C. Section 1350 |

 

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