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

FORM 10-Q
(Mark One)
( X )              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2011

OR

(   )              TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to_________

Commission File Number 0-25923

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

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

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

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

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

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

As of May 5, 2011, the registrant had 19,812,212 shares of Common Stock outstanding.
 
1

 
EAGLE BANCORP, INC.
TABLE OF CONTENTS

PART I.
FINANCIAL INFORMATION
   
       
   
     
     
     
     
       
     
       
   
     
     
     
       
   
       
   
       
   
       
   
       
   
       
   
       
   
       
   
       
   
       
   
       
     

 
 
2

 
Item 1 – Financial Statements

EAGLE BANCORP, INC.
Consolidated Balance Sheets
March 31, 2011 and December 31, 2010
(dollars in thousands, except per share data)
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
Assets
 
(Unaudited)
   
(Audited)
 
Cash and due from banks
  $ 22,768     $ 12,414  
Federal funds sold
    74,209       34,048  
Interest bearing deposits with banks and other short-term investments
    10,188       11,652  
Investment securities available for sale, at fair value
    228,507       228,048  
Federal Reserve and Federal Home Loan Bank stock
    10,406       9,528  
Loans held for sale
    12,459       80,571  
Loans
    1,790,084       1,675,500  
Less allowance for credit losses
    (25,582 )     (24,754 )
Loans, net
    1,764,502       1,650,746  
Premises and equipment, net
    10,217       9,367  
Deferred income taxes
    14,302       14,471  
Bank owned life insurance
    13,443       13,342  
Intangible assets, net
    4,330       4,188  
Other real estate owned
    3,529       6,701  
Other assets
    17,408       14,294  
Total Assets
  $ 2,186,268     $ 2,089,370  
                 
Liabilities and Stockholders' Equity
               
Liabilities
               
Deposits:
               
Noninterest bearing demand
  $ 402,041     $ 400,291  
Interest bearing transaction
    61,219       61,771  
Savings and money market
    780,386       737,071  
Time, $100,000 or more
    370,326       344,747  
Other time
    212,908       182,918  
Total deposits
    1,826,880       1,726,798  
Customer repurchase agreements
    89,753       97,584  
Long-term borrowings
    49,300       49,300  
Other liabilities
    10,216       10,972  
Total liabilities
    1,976,149       1,884,654  
                 
Shareholders' Equity
               
Preferred stock, par value $.01 per share, shares authorized
               
1,000,000, Series A, $1,000 per share liquidation preference,
               
shares issued and outstanding 23,235 at each period, discount
               
 of $554, and $601 respectively, net
    22,629       22,582  
Common stock, par value $.01 per share; shares authorized 50,000,000, shares
         
issued and outstanding 19,811,532 and 19,700,387, respectively
    197       197  
Warrant
    946       946  
Additional paid in capital
    130,703       130,382  
Retained earnings
    53,349       48,551  
Accumulated other comprehensive income
    2,295       2,058  
Total shareholders' equity
    210,119       204,716  
Total Liabilities and Shareholders' Equity
  $ 2,186,268     $ 2,089,370  
 
See notes to consolidated financial statements.
 
3

 
EAGLE BANCORP, INC.
Consolidated Statements of Operations
For the Three Month Periods Ended March 31, 2011 and 2010 (Unaudited)
 (dollars in thousands, except per share data)
 
   
Three Months Ended
 
   
March 31,
 
Interest Income
 
2011
   
2010
 
Interest and fees on loans
  $ 24,615     $ 20,462  
Interest and dividends on investment securities
    1,620       1,977  
Interest on balances with other banks and short-term investments
    19       33  
Interest on federal funds sold
    42       36  
Total interest income
    26,296       22,508  
Interest Expense
               
Interest on deposits
    4,111       4,538  
Interest on customer repurchase agreements
    150       183  
Interest on short-term borrowings
    -       18  
Interest on long-term borrowings
    529       546  
Total interest expense
    4,790       5,285  
Net Interest Income
    21,506       17,223  
Provision for Credit Losses
    2,116       1,689  
Net Interest Income After Provision For Credit Losses
    19,390       15,534  
                 
Noninterest Income
               
Service charges on deposits
    749       730  
Gain on sale of loans
    1,701       54  
Increase in the cash surrender value of  bank owned life insurance
    101       110  
Other income
    382       328  
Total noninterest income
    2,933       1,222  
Noninterest Expense
               
Salaries and employee benefits
    7,311       5,675  
Premises and equipment expenses
    1,991       2,092  
Marketing and advertising
    234       247  
Data processing
    689       615  
Legal, accounting and professional fees
    1,136       574  
FDIC insurance
    743       634  
Other expenses
    2,209       1,626  
Total noninterest expense
    14,313       11,463  
Income Before Income Tax Expense
    8,010       5,293  
Income Tax Expense
    2,874       1,902  
Net Income
    5,136       3,391  
Preferred Stock Dividends and Discount Accretion
    320       320  
Net Income Available to Common Shareholders
  $ 4,816     $ 3,071  
                 
Earnings Per Common Share
               
Basic
  $ 0.24     $ 0.16  
Diluted
  $ 0.24     $ 0.15  
 
See notes to consolidated financial statements.
 
4

 
EAGLE BANCORP, INC.
Consolidated Statements of Changes in Shareholders’ Equity
For the Three Month Periods Ended March 31, 2011 and 2010 (Unaudited)
 (dollars in thousands, except per share data)

                                 
Accumulated
       
                                 
Other
   
Total
 
   
Preferred
   
Common
         
Additional Paid
   
Retained
   
Comprehensive
   
Stockholders'
 
   
Stock
   
Stock
   
Warrants
   
in Capital
   
Earnings
   
Income
   
Equity
 
Balance, January 1, 2011
  $ 22,582     $ 197     $ 946     $ 130,382     $ 48,551     $ 2,058     $ 204,716  
Comprehensive Income
                                                       
Net Income
                                    5,136               5,136  
Other comprehensive income:
                                                       
Unrealized gain on securities available for sale (net of
taxes)
                                            237       237  
Total Comprehensive Income
                                                    5,373  
Stock-based compensation
                            186                       186  
Exercise of options for 27,692 shares of common stock
                            88                       88  
Tax benefit on non-qualified options exercise
                            47                       47  
Preferred stock:
                                                       
Preferred stock dividends
                                    (291 )             (291 )
Discount accretion
    47                               (47 )             -  
Balance, March 31, 2011
  $ 22,629     $ 197     $ 946     $ 130,703     $ 53,349     $ 2,295     $ 210,119  
                                                         
Balance, January 1, 2010
  $ 22,612     $ 195     $ 946     $ 129,211     $ 33,024     $ 2,333     $ 188,321  
Comprehensive Income
                                                       
Net Income
                                    3,391               3,391  
Other comprehensive income:
                                                       
Unrealized gain on securities available for sale (net of
taxes)
                                            819       819  
Total Comprehensive Income
                                                    4,210  
Stock-based compensation
                            154                       154  
Exercise of options for 24,090 shares of common stock
            1               43                       44  
Tax benefit on non-qualified options exercise
                            42                       42  
Capital raise issuance cost
                            (16 )                     (16 )
Preferred stock:
                                                       
Preferred stock dividends
                                    (290 )             (290 )
Discount accretion
    (163 )                             163               -  
Balance, March 31, 2010
  $ 22,449     $ 196     $ 946     $ 129,434     $ 36,288     $ 3,152     $ 192,465  
 
See notes to consolidated financial statements.
 
5

 
EAGLE BANCORP, INC.
Consolidated Statements of Cash Flows
For the Three Month Periods Ended March 31, 2011 and 2010 (Unaudited)
 (dollars in thousands, except per share data)
 
   
2011
   
2010
 
Cash Flows From Operating Activities:
           
Net income
  $ 5,136     $ 3,391  
Adjustments to reconcile net income to net cash
               
  (used in) provided by operating activities:
               
Provision for credit losses
    2,116       1,689  
Depreciation and amortization
    575       712  
Gains on sale of loans
    (1,701 )     (54 )
Origination of loans held for sale
    (81,049 )     (8,315 )
Proceeds from sale of loans held for sale
    150,862       8,830  
Net increase in cash surrender value of BOLI
    (101 )     (110 )
Decrease deferred income taxes
    169       546  
Net loss on sale of other real estate owned
    39       85  
Stock-based compensation expense
    186       154  
Excess tax benefit from stock-based compensation
    (47 )     (42 )
Increase in other assets
    (2,877 )     (1,479 )
(Decrease) increase in other liabilities
    (756 )     377  
Net cash provided by operating activities
    72,552       5,784  
Cash Flows From Investing Activities:
               
Decrease (increase) in interest bearing deposits with other banks
               
   and short term investments
    1,464       (57 )
Purchases of available for sale investment securities
    (8,325 )     (27,535 )
Proceeds from maturities of available for sale securities
    7,866       9,022  
Purchases of Federal Reserve and Federal Home Loan Bank stock
    (878 )     -  
Net increase in loans
    (117,971 )     (29,175 )
Proceeds from sale of other real estate owned
    5,073       1,200  
Bank premises and equipment acquired
    (1,361 )     (124 )
Net cash used in investing activities
    (114,132 )     (46,669 )
Cash Flows From Financing Activities:
               
Increase in deposits
    100,082       16,665  
(Decrease) increase in customer repurchase agreements and
               
   federal funds purchased
    (7,831 )     7,047  
Payment of dividends on preferred stock
    (291 )     (290 )
Proceeds from exercise of stock options
    88       44  
Excess tax benefit from stock-based compensation
    47       42  
Net cash provided by financing activities
    92,095       23,508  
Net Increase (Decrease) In Cash and Cash Equivalents
    50,515       (17,377 )
Cash and Cash Equivalents at Beginning of Period
    46,462       110,203  
Cash and Cash Equivalents at End of Period
  $ 96,977     $ 92,826  
Supplemental Cash Flows Information:
               
Interest paid
  $ 5,303     $ 6,154  
Income taxes paid
  $ 1,730     $ 72  
Non-Cash Investing Activities
               
Transfers from loans to other real estate owned
  $ 1,645     $ -  
 
See notes to consolidated financial statements.
 
6

 
 EAGLE BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three Months Ended March 31, 2011 and 2010 (Unaudited)
 
1. Summary of Significant Accounting Policies

Basis of Presentation

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

The consolidated financial statements of the Company included herein are unaudited.  The consolidated financial statements reflect all adjustments, consisting only of normal recurring accruals that in the opinion of management, are necessary to present fairly the results for the periods presented. The amounts as of and for the year ended December 31, 2010 were derived from audited consolidated financial statements. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. There have been no significant changes to the Company’s Accounting Policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The Company believes that the disclosures are adequate to make the information presented not misleading. Certain reclassifications have been made to amounts previously reported to conform to the current period presentation.

These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. Operating results for the three months ended March 31, 2011 are not necessarily indicative of the results of operations to be expected for the remainder of the year, or for any other period.

Nature of Operations

The Company, through the Bank, conducts a full service community banking business, primarily in Montgomery County, Maryland; Washington, D.C.; and Fairfax County, Northern Virginia. The primary financial services offered by the Bank include real estate, commercial and consumer lending, as well as traditional deposit and repurchase agreement products. The Bank  is also active in the origination and sale of residential mortgage loans and the origination of small business loans. The guaranteed portion of small business loans is typically sold through the Small Business Administration, in a transaction apart from the loan’s origination. The Bank offers its products and services through thirteen banking offices and various electronic capabilities, including remote deposit services. Eagle Commercial Ventures, LLC (“ECV”), a direct subsidiary of the Company, provides subordinated financing for the acquisition, development and construction of real estate projects, where the primary financing is provided by the Bank or others.   These transactions involve higher levels of risk, together with commensurate higher returns. Refer to Higher Risk Lending – Revenue Recognition below.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes.  Actual results may differ from those estimates and such differences could be material to the financial statements.

Cash Flows

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, and federal funds sold (items with an original maturity of three months or less).
 
7

 
Loans Held for Sale

The Company engages in sales of residential mortgage loans and the guaranteed portion of Small Business Administration (“SBA”) loans originated by the Bank. Loans held for sale are carried at the lower of aggregate cost or fair value. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of these loans are recorded as a component of noninterest income in the Consolidated Statements of Operations.

The Company’s current practice is to sell residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing as of March 31, 2011 and December 31, 2010. The sale of the guaranteed portion of SBA loans on a servicing retained basis gives rise to an Excess Servicing Asset, which is computed on a loan by loan basis and the unamortized amount of which  is included in other assets. This Excess Servicing Asset is being amortized on a straight line basis (with adjustment for prepayments) as an offset of servicing fees collected and is included in other noninterest income.

The Company enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitments). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 15 to 60 days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at a premium at the time the borrower commits to an interest rate with the intent that the buyer has assumed the interest rate risk on the loan. As a result, the Company is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates.

The market values of rate lock commitments and best efforts contracts are not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss occurs on the rate lock commitments.

Investment Securities

The Company has no securities classified as trading, nor are any investment securities classified as held to maturity. Marketable equity securities and debt securities not classified as held to maturity or trading are classified as available-for-sale. Securities available-for-sale are acquired as part of the Company’s asset/liability management strategy and may be sold in response to changes in interest rates, loan demand, changes in prepayment risk and other factors. Securities available-for-sale are carried at fair value, with unrealized gains or losses being reported as accumulated other comprehensive income, a separate component of stockholders’ equity, net of deferred tax. Realized gains and losses, using the specific identification method, are included as a separate component of noninterest income. Premiums and discounts on investment securities are amortized / accreted to the earlier of call or maturity based on expected lives, which lives are adjusted for securities based on prepayments and call optionality. Declines in the fair value of individual available-for-sale securities below their cost that are other-than-temporary in nature result in write-downs of the individual securities to their fair value. Factors affecting the determination of whether other-than-temporary impairment has occurred include a downgrading of the security by a rating agency, a significant deterioration in the financial condition of the issuer, or a change in management’s intent and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) structure of the security.

The entire amount of an impairment loss is recognized in earnings only when (1) the Company intends to sell the debt security, (2) it is more likely than not that the Company will have to sell the security before recovery of its amortized cost basis or (3) the Company does not expect to recover the entire amortized cost basis of the security. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in stockholders’ equity as comprehensive income, net of deferred taxes.
 
8

 
Loans

Loans are stated at the principal amount outstanding, net of unamortized deferred costs and fees.  Interest income on loans is accrued at the contractual rate on the principal amount outstanding.  It is the Company’s policy to discontinue the accrual of interest when circumstances indicate that collection is doubtful.  Deferred fees and costs on loans originated through October 2005 are being amortized on the straight line method over the term of the loan. Deferred fees and costs on loans originated subsequent to October 2005 are being amortized on the interest method over the term of the loan.  The difference between the straight line method and the interest method is considered immaterial.

Management considers loans impaired when, based on current information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Loans are evaluated for impairment in accordance with the Company’s portfolio monitoring and ongoing risk assessment proceduresManagement considers the financial condition of the borrower, cash flow of the borrower, payment status of the loan, and the value of the collateral, if any, securing the loan. Generally, impaired loans do not include large groups of smaller balance homogeneous loans such as residential real estate and consumer type loans which loans are evaluated collectively for impairment and are generally placed on nonaccrual when the loan becomes 90 days past due as to principal or interest. Loans specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (ninety days or less) provided eventual collection of all amounts due is expected.  The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided solely by the collateral.  In appropriate circumstances, interest income on impaired loans may be recognized on the cash basis.

Higher Risk Lending – Revenue Recognition

The Company has occasionally made higher risk acquisition, development, and construction (“ADC”) loans that entail higher risks than ADC loans made following normal underwriting practices (“higher risk loan transactions”). These higher risk loan transactions are currently made through the Company’s subsidiary, ECV. This activity is limited as to individual transaction amount and total exposure amounts based on capital levels and is carefully monitored. The loans are carried on the balance sheet at amounts outstanding and meet the loan classification requirements of the Accounting Standards Executive Committee (“AcSEC”) guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No. 1). Additional interest earned on these higher risk loan transactions (as defined in the individual loan agreements) is recognized as realized under the provisions contained in  AcSEC’s guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No.1) and Staff Accounting Bulletin No. 101 (Revenue Recognition in Financial Statements). The additional interest is included as a component of noninterest income. ECV recorded no additional interest on higher risk transactions during 2011 and 2010 (although normal interest income was recorded) and had one higher risk lending transaction outstanding as of March 31, 2011 and December 31, 2010, amounting to $1.3 million at the end of each period.

Allowance for Credit Losses

The allowance for credit losses represents an amount which, in management’s judgment, is adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible.  The adequacy of the allowance for credit losses is determined through careful and continuous review and evaluation of the loan portfolio and involves the balancing of a number of factors to establish a prudent level of allowance.  Among the factors considered in evaluating the adequacy of the allowance for credit losses are lending risks associated with growth and entry into new markets, loss allocations for specific credits, the level of the allowance to nonperforming loans, historical loss experience, economic conditions, portfolio trends and credit concentrations, changes in the size and character of the loan portfolio, and management’s judgment with respect to current and expected economic conditions and their impact on the existing loan portfolio.  Allowances for impaired loans are generally determined based on collateral values. Loans or any portion thereof deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance.  Management adjusts the level of the allowance through the provision for credit losses, which is recorded as a current period operating expense.  The allowance for credit losses consists of allocated and unallocated components.
 
9

 
The components of the allowance for credit losses represent an estimation done pursuant to Accounting Standards Codification (“ASC”) Topic 450, “Contingencies,” or ASC Topic 310, “Receivables.” Specific allowances are established in cases where management has identified significant conditions or circumstances related to a specific credit that management believes indicate the probability that a loss may be incurred. For potential problem credits for which specific allowance amounts have not been determined, the Company establishes allowances according to the application of credit risk factors.  These factors are set by management and approved by the appropriate Board Committee to reflect its assessment of the relative level of risk inherent in each risk grade.  A third component of the allowance computation, termed a nonspecific or environmental factors allowance, is based upon management’s evaluation of various environmental conditions that are not directly measured in the determination of either the specific allowance or formula allowance.  Such conditions include general economic and business conditions affecting key lending areas, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, specific industry conditions within portfolio categories, recent loss experience in particular loan categories, duration of the current business cycle, bank regulatory examination results, findings of outside review consultants, and management’s judgment with respect to various other conditions including credit administration and management and the quality of risk identification systems. Executive management reviews these environmental conditions quarterly, and documents the rationale for all changes.

Management believes that the allowance for credit losses is adequate; however, determination of the allowance is inherently subjective and requires significant estimates. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Evaluation of the potential effects of these factors on estimated losses involves a high degree of uncertainty, including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Bank periodically review the Bank’s loan portfolio and allowance for credit losses. Such review may result in recognition of additions to the allowance based on their judgments of information available to them at the time of their examination.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation and amortization computed using the straight-line method for financial reporting purposes.  Premises and equipment are depreciated over the useful lives of the assets, which generally range from seven years for furniture, fixtures and equipment, three to five years for computer software and hardware, and ten to forty years for buildings and building improvements.  Leasehold improvements are amortized over the terms of the respective leases, which may include renewal options where management has the positive intent to exercise such options, or the estimated useful lives of the improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary maintenance and repairs are expensed as incurred. These costs are included as a component of premises and equipment expenses on the Consolidated Statements of Operations.

Other Real Estate Owned (OREO)

Assets acquired through loan foreclosure are held for sale and are initially recorded at the lower of cost or fair value less estimated selling costs when acquired, establishing a new cost basis. The new basis is supported by recent appraisals. Costs after acquisition are generally expensed. If the fair value of the asset declines, a write-down is recorded through expense. The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in economic conditions or review by regulatory examiners.

Goodwill and Other Intangible Assets

Goodwill and other intangible assets are subject to impairment testing at least annually, or when events or changes in circumstances indicate the assets might be impaired.  Intangible assets (other than goodwill) are amortized to expense using accelerated or straight-line methods over their respective estimated useful lives.  The Company’s testing of potential goodwill impairment (which is required annually) at December 31, 2010, resulted in no impairment being recorded.
 
10

 
Customer Repurchase Agreements

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

Marketing and Advertising

Marketing and advertising costs are generally expensed as incurred.

Income Taxes

The Company employs the liability method of accounting for income taxes as required by ASC Topic 740, “Income Taxes.” Under the liability method, deferred-tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary timing differences) and are measured at the enacted rates that will be in effect when these differences reverse. The Company utilizes statutory requirements for its income tax accounting, and avoids risks associated with potentially problematic tax positions that may incur challenge upon audit, where an adverse outcome is more likely than not. Therefore, no provisions are made for either uncertain tax positions nor accompanying potential tax penalties and interest for underpayments of income taxes in the Company’s tax reserves. In accordance with ASC Topic 740, the Company may establish a reserve against deferred tax assets in those cases where realization is less than certain.

Transfer of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered.  Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. In certain cases, the recourse to the Bank to repurchase assets may exist but is deemed immaterial based on the specific facts and circumstances.

Earnings per Common Share

Basic net income per common share is derived by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period measured.  Diluted earnings per common share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period measured including the potential dilutive effects of common stock equivalents. Earnings per common share have been adjusted to give retroactive effect to all stock splits and stock dividends.

Stock-Based Compensation

 In accordance with ASC Topic 718, “Compensation,” the Company records as  compensation expense an amount equal to the amortization (over the remaining service period) of the fair value (computed at the date of option grant) of any outstanding fixed stock option grants and restricted stock awards which vest subsequent to December 31, 2005. Compensation expense on variable stock option grants (i.e. performance based grants) is recorded based on the probability of achievement of the goals underlying the performance grant. Refer to Note 6 for a description of stock-based compensation awards, activity and expense.
 
11

 
New Authoritative Accounting Guidance

ASU No. 2010-20, “Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a roll forward of the allowance for credit losses as well as information about modified, impaired, nonaccrual and past due loans and credit quality indicators. ASU 2010-20 became effective for the Corporation’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period became effective for the Corporation’s financial statements beginning on January 1, 2011. ASU 2011-01, “Receivables (Topic 310) - Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,” temporarily deferred the effective date for disclosures related to troubled debt restructurings to coincide with the effective date of the then proposed ASU 2011-02, “Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” which is further discussed below.

ASU No. 2010-28, “Intangibles - Goodwill and Other (Topic 350) - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist such as if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. ASU 2010-28 became effective for the Company on January 1, 2011 and did not have a significant impact on the Company’s financial statements.

ASU No. 2011-02, “Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” ASU 2011-02 clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-02, that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. ASU 2011-02 will be effective for the Company on July 1, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011. Adoption of ASU 2011-02 is not expected have a significant impact on the Company’s financial statements.

 2. Cash and Due from Banks

Regulation D of the Federal Reserve Act requires that banks maintain noninterest reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. During 2011, the Bank maintained balances at the Federal Reserve (in addition to vault cash) to meet the reserve requirements as well as balances to partially compensate for services.  Late in 2008, the Federal Reserve in connection with the Emergency Economic Stabilization Act of 2008 began paying a nominal amount of interest on balances held. Additionally, the Bank maintains interest bearing balances with the Federal Home Loan Bank of Atlanta and noninterest bearing balances with six domestic correspondents as compensation for services they provide to the Bank.
 
 
12

 
3. Investment Securities Available for Sale

Amortized cost and estimated fair value of securities available for sale are summarized as follows:
 
         
Gross
   
Gross
   
Estimated
 
 
 
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
March 31, 2011
 
Cost
   
Gains
   
Losses
   
Value
 
(dollars in thousands)
                       
U. S. Government agency securities
  $ 70,441     $ 971     $ 192     $ 71,220  
Residential mortgage backed securities
    104,373       2,761       444       106,690  
Municipal bonds
    49,423       1,209       425       50,207  
Other equity investments
    445       -       55       390  
    $ 224,682     $ 4,941     $ 1,116     $ 228,507  
                                 
           
Gross
   
Gross
   
Estimated
 
 
 
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
December 31, 2010
 
Cost
   
Gains
   
Losses
   
Value
 
(dollars in thousands)
                               
U. S. Government agency securities
  $ 67,288     $ 1,253     $ 143     $ 68,398  
Residential mortgage backed securities
    107,425       2,903       419       109,909  
Municipal bonds
    49,459       658       749       49,368  
Other equity investments
    445       -       72       373  
    $ 224,617     $ 4,814     $ 1,383     $ 228,048  
 
Gross unrealized losses and fair value by length of time that the individual available for sale securities have been in a continuous unrealized loss position are as follows:
 
   
Less than
   
12 Months
             
   
12 Months
   
or Greater
   
Total
 
   
Estimated
         
Estimated
         
Estimated
       
 
 
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
March 31, 2011
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
(dollars in thousands)
                                   
U. S. Government agency securities
  $ 17,622     $ 192     $ -     $ -     $ 17,622     $ 192  
Residential mortgage backed securities
    30,638       444       -       -       30,638       444  
Municipal bonds
    12,808       425       -       -       12,808       425  
Other equity investments
    -       -       123       55       123       55  
    $ 61,068     $ 1,061     $ 123     $ 55     $ 61,191     $ 1,116  
                                                 
   
Less than
   
12 Months
                 
   
12 Months
   
or Greater
   
Total
 
   
Estimated
           
Estimated
           
Estimated
         
 
 
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
December 31, 2010
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
(dollars in thousands)
                                               
U. S. Government agency securities
  $ 7,122     $ 143     $ -     $ -     $ 7,122     $ 143  
Residential mortgage backed securities
    31,605       419       -       -       31,605       419  
Municipal bonds
    21,874       749       -       -       21,874       749  
Other equity investments
    -       -       105       72       105       72  
    $ 60,601     $ 1,311     $ 105     $ 72     $ 60,706     $ 1,383  
 
 
13

 
The unrealized losses that exist are generally the result of changes in market interest rates and spread relationships since original purchases. The weighted average duration of debt securities, which comprise 99.8% of total investment securities, is relatively short at 3.7 years. The gross unrealized loss on other equity investments represents common stock of one local banking company owned by the Company, and traded on a broker “bulletin board” exchange. The estimated fair value is determined by broker quoted prices. The unrealized loss is deemed a result of generally weak valuations for many smaller community bank stocks. The individual banking company is profitable and has a satisfactory capital position. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. The Company does not believe that the investment securities that were in an unrealized loss position as of March 31, 2011 represent an other-than-temporary impairment for the reasons noted. The Company does not intend to sell the investments and it is more likely than not that the Company will not have to sell the securities before recovery of its amortized cost basis, which may be maturity. In addition, at March 31, 2011, the Company held $10.4 million in equity securities in a combination of Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) stocks which are required to be held for regulatory purposes and are not marketable.

The amortized cost and estimated fair value of investments available for sale by contractual maturity are shown in the table below.  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

   
March 31, 2011
   
December 31, 2010
 
   
Amortized
   
Estimated
   
Amortized
   
Estimated
 
(dollars in thousands)
 
Cost
   
Fair Value
   
Cost
   
Fair Value
 
U. S. Government agency securities maturing:
                       
One year or less
  $ 850     $ 880     $ -     $ -  
After one year through five years
    66,745       67,523       60,175       61,398  
After five years through ten years
    2,846       2,817       7,113       7,000  
Residential mortgage backed securities
    104,373       106,690       107,425       109,909  
Municipal bonds maturing:
                               
Five years through ten years
    9,868       10,145       7,250       7,356  
After ten years
    39,555       40,062       42,209       42,012  
Other equity investments
    445       390       445       373  
    $ 224,682     $ 228,507     $ 224,617     $ 228,048  

The carrying value of securities pledged as collateral for certain government deposits, securities sold under agreements to repurchase, and certain lines of credit with correspondent banks at March 31, 2011 was $177.9 million. As of March 31, 2011 and December 31, 2010, there were no holdings of securities of any one issuer, other than the U.S. Government and U.S. Government agency securities that exceeded ten percent of shareholders’ equity.

4.  Loans and Allowance for Credit Losses

The Bank makes loans to customers primarily in the Washington, D.C. metropolitan statistical area and surrounding communities. A substantial portion of the Bank’s loan portfolio consists of loans to businesses secured by real estate and other business assets.

Loans, net of unamortized net deferred fees, at March 31, 2011 and December 31, 2010 are summarized by type as follows:
 
14

 
 
   
March 31, 2011
   
December 31, 2010
 
                         
(dollars in thousands)
 
Amount
   
%
   
Amount
   
%
 
Commercial
  $ 443,251       25 %   $ 411,744       26 %
Investment - commercial real estate
    671,859       37 %     619,714       37 %
Owner occupied - commercial real estate
    226,321       13 %     223,986       13 %
Real estate mortgage - residential
    19,661       1 %     15,977       1 %
Construction - commercial and residential (1)
    334,661       19 %     308,081       18 %
Home equity
    88,551       5 %     89,885       5 %
Other consumer
    5,780       -       6,113       -  
    Total loans
    1,790,084       100 %     1,675,500       100 %
Less: Allowance for Credit Losses
    (25,582 )             (24,754 )        
   Net loans
  $ 1,764,502             $ 1,650,746          
                                 
(1) Includes loans for land acquisition and development.
                         

Unamortized net deferred fees amounted to $5.2 million and $4.1 million at March 31, 2011 and December 31, 2010, of which $147 thousand and $484 thousand, at March 31, 2011 and December 31, 2010, respectively, represented net deferred costs on home equity loans.
 
As of March 31, 2011 and December 31, 2010, the Bank serviced $25.5 million and $28.1 million, respectively, of SBA loans participations which are not reflected as loan balances on the Consolidated Balance Sheets.

Loan Origination / Risk Management

The Bank’s goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include; carefully enforcing loan policies and procedures, evaluating each borrower’s business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation. Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations.

The composition of the Bank’s loan portfolio is heavily weighted toward commercial real estate, both owner occupied and investment real estate. At March 31, 2011, real estate commercial, real estate residential and real estate construction combined represented approximately 70% of the loan portfolio. These loans are underwritten to mitigate lending risks typical of this type of loan such as declines in real estate values, changes in borrower cash flow and general economic conditions. The Bank typically requires a maximum loan to value of 80% or less and minimum cash flow debt service coverage of 1.15 to 1.0. Personal guarantees are generally required, but may be limited.  In making real estate commercial mortgage loans, the Bank generally requires that interest rates adjust not less frequently than five years.

The Bank is also an active traditional commercial lender providing loans for a variety of purposes, including cash flow, equipment and account receivable financing. This loan category represents approximately 25% of the loan portfolio at March 31, 2011 and is generally variable or adjustable rate. Commercial loans meet reasonable underwriting standards, including appropriate collateral, and cash flow necessary to support debt service. Personal guarantees are generally required, but may be limited. SBA loans represent 2% of the commercial loan category of loans. In originating SBA loans, the Company assumes the risk of non-payment on the uninsured portion of the credit. The Company generally sells the insured portion of the loan generating noninterest income from the gains on sale, as well as servicing income on the portion participated. SBA loans are subject to the same cash flow analyses as other commercial loans. SBA loans and the Section 7A lending program in particular, are subject to a maximum loan size established by the SBA.
 
15

 
Approximately 5% of the loan portfolio at March 31, 2011 consists of home equity loans and lines of credit and other consumer loans. These credits, while making up a smaller portion of the loan portfolio, demand the same emphasis on underwriting and credit evaluation as other types of loans advanced by the Bank.

From time to time the Company may make loans for its own portfolio or through its higher risk loan affiliate, ECV, which under its operating agreement conducts lending only to real estate projects, where the Company’s directors or lending officers have significant expertise. Such loans, which are made to finance projects (which may also be financed at the Bank level), may have higher risk characteristics than loans made by the Bank, such as lower priority interests and/or higher loan to value ratios. The Company seeks an overall financial return on these transactions commensurate with the risks and structure of each individual loan. Certain transactions bear current interest at a rate with a significant premium to normal market rates. Other loan transactions carry a standard rate of current interest, and may also earn additional interest based on a percentage of the profits of the underlying project.

Loans are secured primarily by duly recorded first deeds of trust. In some cases, the Bank may accept a recorded second trust position.  In general, borrowers will have a proven ability to build, lease, manage and/or sell a commercial or residential project and demonstrate satisfactory financial condition.  Additionally, an equity contribution toward the project is customarily required.

Construction loans require that the financial condition and experience of the general contractor and major subcontractors be satisfactory to the Bank.  Guaranteed, fixed price contracts are required whenever appropriate, along with payment and performance bonds or completion bonds for larger scale projects.

Loans intended for residential land acquisition, lot development and construction are made on the premise that the land: 1) is or will be developed for building sites for residential structures, and; 2) will ultimately be utilized for construction or improvement of residential zoned real properties, including the creation of housing.  Residential development and construction loans will finance projects such as single family subdivisions, planned unit developments, townhouses, and condominiums.  Residential land acquisition, development and construction loans generally are underwritten with a maximum term of 36 months, including extensions approved at origination.

Commercial land acquisition and construction loans are secured by real property where loan funds will be used to acquire land and to construct or improve appropriately zoned real property for the creation of income producing or owner user commercial properties.  Borrowers are generally required to put equity into each project at levels determined by the appropriate Loan Committee.  Commercial land acquisition and construction loans generally are underwritten with a maximum term of 24 months.

All construction draw requests must be presented in writing on American Institute of Architects documents and certified by the contractor, the borrower and the borrower’s architect.  Each draw request shall also include the borrower’s soft cost breakdown certified by the borrower or its Chief Financial Officer.  Prior to an advance, the Bank or its contractor inspects the project to determine that the work has been completed, to justify the draw requisition.

Commercial permanent loans are secured by improved real property which is generating income in the normal course of operation.  Debt service coverage, assuming stabilized occupancy, must be satisfactory to support a permanent loan.  The debt service coverage ratio is ordinarily at least 1.15:1.  As part of the underwriting process, debt service coverage ratios are stress tested assuming a 200 basis point increase in interest rates from their current levels.

Commercial permanent loans generally are underwritten with a term not greater than 10 years or the remaining useful life of the property, whichever is lower.  The preferred term is between 5 to 7 years, with amortization to a maximum of 25 years.

Personal guarantees are generally received from the principals, and only in instances where the loan-to-value is sufficiently low and the debt service is sufficiently high is consideration given to either limiting or not requiring personal recourse.
 
16

 
The Company’s loan portfolio includes loans made for real estate Acquisition, Development and Construction (“ADC”) purposes, including both investment and owner occupied projects. ADC loans amounted to $334.7 million at March 31, 2011.  ADC loans containing loan funded interest reserves represent approximately 26% of the outstanding ADC loan portfolio at March 31, 2011.  The decision to establish a loan-funded interest reserve is made upon origination of the ADC loan and is based upon a number of factors considered during underwriting of the credit including (i) the feasibility of the project; (ii) the experience of the sponsor; (iii) the creditworthiness of the borrower and guarantors; (iv) borrower equity contribution; and (v) the level of collateral protection.  When appropriate, an interest reserve provides an effective means of addressing the cash flow characteristics of a properly underwritten ADC loan.  The Company does not significantly utilize interest reserves in other loan products.  The Company recognizes that one of the risks inherent in the use of interest reserves is the potential masking of underlying problems with the project and/or the borrower’s ability to repay the loan.  In order to mitigate this inherent risk, the Company employs a series of reporting and monitoring mechanisms on all ADC loans, whether or not an interest reserve is provided, including (i) construction and development timelines which are monitored on an ongoing basis which track the progress of a given project to the timeline projected at origination; (ii) a construction loan administration department independent of lending function; (iii) third party independent construction loan inspection reports; (iv) monthly interest reserve monitoring reports detailing the balance of the interest reserves approved at origination and the days of interest carry represented by the reserve balances as compared to the then current anticipated time to completion and/or sale of speculative projects; and (v) quarterly commercial real estate construction meetings among senior Company management which includes monitoring of current and projected real estate market conditions. If a project has not performed as expected, it is not the customary practice of the Company to increase loan funded interest reserves.

The following table details activity in the allowance for credit losses by portfolio segment for the period ended March 31, 2011.  Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

         
Investment
   
Owner occupied
   
Real Estate
   
Construction
                   
         
Commercial
   
Commercial
   
Mortgage
   
Commercial and
   
Home
   
Other
       
(dollars in thousands)
 
Commercial
   
Real Estate
   
Real Estate
   
Residential
   
Residential
   
Equity
   
Consumer
   
Total
 
For the Period Ended March 31, 2011
                                               
  Allowance for credit losses:
                                               
    Balance at beginning of period
  $ 8,630     $ 6,668     $ 2,064     $ 115     $ 5,745     $ 1,441     $ 91     $ 24,754  
      Loans charged-off
    (686 )     (32 )     -       -       (741 )     -       -       (1,459 )
      Recoveries of loans previously charged-off
    3       -       -       -       167       1       -       171  
      Net loan charged-off
    (683 )     (32 )     -       -       (574 )     1       -       (1,288 )
      Provision for credit losses
    606       21       125       46       1,307       10       1       2,116  
Balance at end of period
  $ 8,553     $ 6,657     $ 2,189     $ 161     $ 6,478     $ 1,452     $ 92     $ 25,582  
For the Period Ended March 31, 2011
                                                               
  Allowance for credit losses:
                                                               
    Individually evaluated for impairment
  $ 2,404     $ 613     $ 165     $ -     $ 1,045     $ 135     $ -     $ 4,362  
    Collectively evaluated for impairment
    6,149       6,044       2,024       161       5,433       1,317       92       21,220  
Total
  $ 8,553     $ 6,657     $ 2,189     $ 161     $ 6,478     $ 1,452     $ 92     $ 25,582  
Recorded investment in loans:
                                                               
    Individually evaluated for impairment
  $ 21,153     $ 9,193     $ 3,966     $ -     $ 21,582     $ 284     $ -     $ 56,178  
    Collectively evaluated for impairment
    422,098       662,666       222,355       19,661       313,079       88,267       5,780       1,733,906  
Total
  $ 443,251     $ 671,859     $ 226,321     $ 19,661     $ 334,661     $ 88,551     $ 5,780     $ 1,790,084  

At March 31, 2011, the nonperforming loans acquired from Fidelity & Trust Financial Corporation (“Fidelity”) have a carrying value of $5.0 million and an unpaid principal balance of $14.6 million and were evaluated separately in accordance with ASC Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality.”  The various impaired loans were recorded at estimated fair value with any excess being charged-off or treated as a non-accretable discount. Subsequent downward adjustments to the valuation of impaired loans acquired will result in additional loan loss provisions and related allowance for credit losses. Subsequent upward adjustments to the valuation of impaired loans acquired will result in accretable discount. No adjustments have been
 
17

 
made to the fair value amounts of impaired loans subsequent to the allowable period of adjustment from the date of acquisition.
 
Credit Quality Indicators
 
The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company's primary credit quality indicators are to use an internal credit risk rating system that categorizes loans into pass, watch, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans to businesses or individuals in the classes which comprise the commercial portfolio segment. Groups of loans that are underwritten and structured using standardized criteria and characteristics, such as statistical models (e.g., credit scoring or payment performance), are typically risk rated and monitored collectively. These are typically loans to individuals in the classes which comprise the consumer portfolio segment.

The following are the definitions of the Company's credit quality indicators:
 
Pass:
Loans in all classes that comprise the commercial and consumer portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes that there is a low likelihood of loss related to those loans that are considered pass.
 
Watch:
Loan paying as agreed with generally acceptable asset quality; however Borrower’s performance has not met expectations.  Balance sheet and/or income statement has shown deterioration to the point that the company could not sustain any further setbacks.  Credit is expected to be strengthened through improved company performance and/or additional collateral within a reasonable period of time.
 
Special Mention:
Loans in the classes that comprise the commercial portfolio segment that have potential weaknesses that deserve management's close attention. If not addressed, these potential weaknesses may result in deterioration of the repayment prospects for the loan. The special mention credit quality indicator is not used for classes of loans that comprise the consumer portfolio segment. Management believes that there is a moderate likelihood of some loss related to those loans that are considered special mention.
 
 
Classified:
Classified (a) Substandard - Loans inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.  Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual loans classified substandard.
 
 
Classified (b) Doubtful - Loans that have all the weaknesses inherent in a loan classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.  The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the assets, its classification as an estimated loss is deferred until its more exact status may be determined.
 
The Company's credit quality indicators are periodically updated on a case-by-case basis. The following table presents by class and by credit quality indicator, the recorded investment in the Company's loans and leases as of March 31, 2011.

 
18

 
 
                           
Total
 
(dollars in thousands)
 
Pass
   
Watch
   
Substandard
   
Doubtful
   
Loans
 
Commercial
  $ 398,494     $ 23,604     $ 20,268     $ 885     $ 443,251  
Investment - commercial real estate
    651,086       11,580       9,193       -       671,859  
Owner occupied - commercial real estate
    214,503       7,852       3,966       -       226,321  
Real estate mortgage – residential
    19,661       -       -       -       19,661  
Construction - commercial and residential
    299,929       13,150       21,582       -       334,661  
Home equity
    88,267       -       284       -       88,551  
Other consumer
    5,780       -       -       -       5,780  
          Total
  $ 1,677,720     $ 56,186     $ 55,293     $ 885     $ 1,790,084  
 
Nonaccrual and Past Due Loans
 
 Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following presents by class of loan, information related to nonaccrual loans as of the periods ended March 31, 2011 and December 31, 2010:

(dollars in thousands)
 
March 31, 2011
   
December 31, 2010
 
             
Commercial
  $ 5,732     $ 5,137  
Investment - commercial real estate
    4,024       3,913  
Owner occupied - commercial real estate
    295       -  
Real estate mortgage - residential
    1,310       760  
Construction - commercial and residential
    21,520       14,645  
Home equity
    296       297  
Other consumer
    -       535  
Total nonperforming loans (1)(2)
  $ 33,177     $ 25,287  
 
(1)
Excludes TDRs returned to performing status totaling $3.1 million at March 31, 2011. These loans havedemonstrated a period of a least six months of performance under the modified terms.
 
(2)
Gross interest income that would have been recorded in 2011 if nonaccrual loans  shown above had beencurrent and in accordance with their original terms was $649 thousand, no  interest was recorded on such loans. See Note 1 to the Consolidated Financial Statements for a description of the Company's policy for placing loans on nonaccrual status.
 
The following table presents by class, an aging analysis and the recorded investments in loans past due as of March 31, 2011:
 
 
19

 

   
Loans
   
Loans
   
Loans
               
Total Recorded
 
   
30-59 Days
   
60-89 Days
   
90 Days or
   
Total Past
   
Current
   
Investment in
 
(dollars in thousands)
 
Past Due
   
Past Due
   
More Past Due
   
Due Loans
   
Loans
   
Loans
 
                                     
Commercial
  $ 2,094     $ 3,295     $ 5,732     $ 11,121     $ 432,130     $ 443,251  
Investment - commercial real estate
    4,298       3,704       5,149       13,151       658,708       671,859  
Owner occupied - commercial real estate
    256       -       295       551       225,770       226,321  
Real estate mortgage – residential
    107       -       1,310       1,417       18,244       19,661  
Construction - commercial and residential
    1,000       10,171       20,395       31,566       303,095       334,661  
Home equity
    297       423       296       1,016       87,535       88,551  
Other consumer
    91       9       -       100       5,680       5,780  
Total
  $ 8,143     $ 17,602     $ 33,177     $ 58,922     $ 1,731,162     $ 1,790,084  
 
Impaired Loans
 
 Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
 
 
The following table presents by class, information related to impaired loans for the periods ended March 31, 2011 and December 31, 2010:
 
 
20

 
 
   
Unpaid
   
Recorded
   
Recorded
                         
   
Contractual
   
Investment
   
Investment
   
Total
         
Average
   
Interest
 
   
Principal
   
With No
   
With
   
Recorded
   
Related
   
Recorded
   
Income
 
(dollars in thousands)
 
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
   
Investment
   
Recognized
 
Commercial
  $ 5,732     $ 1,998     $ 2,000     $ 3,998     $ 1,734     $ 5,434     $ -  
Investment - commercial real estate
    7,292       4,386       2,163       6,549       743       7,237       -  
Owner occupied - commercial
    295       -       230       230       65       148       -  
Real estate mortgage – residential
    1,310       1,310       -       1,310       -       1,035       -  
Construction - commercial and residential
    21,395       6,595       13,805       20,400       995       18,225       -  
Home equity
    296       12       149       161       135       297       -  
Other consumer
    -       -       -       -       -       -       -  
Total impaired loans at March 31, 2011
  $ 36,320     $ 14,301     $ 18,347     $ 32,648     $ 3,672     $ 32,376     $ -  
                                                         
                                                         
   
Unpaid
   
Recorded
   
Recorded
                                 
   
Contractual
   
Investment
   
Investment
   
Total
           
Average
   
Interest
 
   
Principal
   
With No
   
With
   
Recorded
   
Related
   
Recorded
   
Income
 
(dollars in thousands)
 
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
   
Investment
   
Recognized
 
Commercial
  $ 5,136     $ 1,527     $ 1,995     $ 3,522     $ 1,615     $ 4,480     $ 131  
Investment - commercial real estate
    7,182       2,156       2,188       4,344       695       3,736       87  
Owner occupied - commercial
    -       -       -       -       -       263       -  
Real estate mortgage – residential
    760       760       -       760       -       510       23  
Construction - commercial and residential
    15,055       7,775       5,206       12,981       1,075       19,147       136  
Home equity
    297       112       100       212       85       170       13  
Other consumer
    -       -       -       -       -       4,253       -  
Total impaired loans at December 31, 2010
  $ 28,430     $ 12,330     $ 9,489     $ 21,819     $ 3,470     $ 32,559     $ 390  
 
5. Net Income per Common Share

The calculation of net income per common share for the three months ended March 31 was as follows:
 
   
Three Months Ended
 
   
March 31,
 
(dollars and shares in thousands)
 
2011
   
2010
 
Basic:
           
Net income available to common shareholders
  $ 4,816     $ 3,071  
Average common shares outstanding
    19,717       19,609  
Basic net income per common  share
  $ 0.24     $ 0.16  
                 
Diluted:
               
Net income available to common shareholders
  $ 4,816     $ 3,071  
Average common shares outstanding
    19,717       19,609  
Adjustment for common share equivalents
    498       342  
Average common shares outstanding-diluted
    20,215       19,951  
Diluted net income per common share
  $ 0.24     $ 0.15  
                 
Anti-dilutive shares
    218,647       469,961  
 
6. Stock-Based Compensation
 
The Company maintains the 1998 Stock Option Plan (“1998 Plan”) and the 2006 Stock Plan (“2006 Plan”), and, in connection with the acquisition of Fidelity and its subsidiary Fidelity & Trust Bank (F&T Bank”), assumed
 
21

 
the Fidelity 2004 Long Term Incentive Plan and 2005 Long Term Incentive Plan (the “Fidelity Plans”). No additional options may be granted under the 1998 Plan or the Fidelity Plans.
 
The 2006 Plan provi