424B1 1 d424b1.htm RULE 424(B)(1) FILING Rule 424(b)(1) Filing
Table of Contents

Filed Pursuant to Rule 424(b)(1)
Registration No. 333-162473

PROSPECTUS

700,000 Shares

LOGO

7.80% Series B

Noncumulative Convertible Perpetual Preferred Stock

 

 

We are offering 700,000 shares of our 7.80% Series B Noncumulative Convertible Perpetual Preferred Stock, which we refer to in this prospectus as the “Series B Preferred Stock.” The annual dividend on each share of our Series B Preferred Stock is $1.95 and is payable quarterly in cash, when, as and if declared, on the last day of March, June, September and December, commencing December 31, 2009. If our board of directors does not declare a dividend or we fail to pay a dividend declared by our board for any quarterly dividend period, you will not be entitled to receive any dividend for that quarterly dividend period and the undeclared or unpaid dividend will not accumulate.

Each share of our Series B Preferred Stock will be convertible at your option at any time, unless previously redeemed, into 3.125 shares of our Common Stock, reflecting an initial conversion price of $8.00 per share of Common Stock, which may be adjusted as described in this prospectus. The shares of Series B Preferred Stock are also convertible at our option, in whole or in part, into shares of our Common Stock at the conversion price, if the closing price of our Common Stock equals or exceeds 130% of the conversion price for at least 20 trading days within any period of 30 consecutive trading days. Cash will be paid in lieu of issuing any fractional share interest.

The Series B Preferred Stock is also redeemable by us, in whole or in part, at any time on and after the third anniversary of the issue date for the liquidation amount of $25.00 per share of Series B Preferred Stock, plus any declared and unpaid dividends.

All shares of our Common Stock issued upon conversion of the Series B Preferred Stock will be freely tradable without restriction under the Securities Act of 1933, as amended, except for shares purchased by our “affiliates.”

The Series B Preferred Stock has been approved for quotation on the NASDAQ Capital Market under the symbol “MNRKP.” Our Common Stock is currently quoted and traded on the NASDAQ Capital Market under the symbol “MNRK.” On November 27, 2009, the last reported sale price of our Common Stock was $6.75 per share.

 

 

Investing in our Series B Preferred Stock involves risks. See “Risk Factors” beginning on page 11 to read about factors you should consider before making your investment decision.

 

     Per
Share
   Total

Price to public

   $ 25.00    $ 17,500,000

Underwriting discount (1)

   $ 1.50    $ 1,018,750

Proceeds, before expenses, to us (1)

   $ 23.50    $ 16,481,250

 

(1) Scott & Stringfellow, LLC has agreed that the underwriting discount will be $0.875 per share for shares purchased by our directors, executive officers and others. The total underwriting discount and commissions and total proceeds assume the purchase of 50,000 shares by such persons.

We have granted Scott & Stringfellow, LLC, the underwriter for this offering, an option to purchase up to 100,000 additional shares of our Series B Preferred Stock from us at the public offering price, less the underwriting discount and commission, within 30 days from the date of the underwriting agreement.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful and complete. Any representation to the contrary is a criminal offense.

These securities are not savings accounts, deposits or other obligations of any bank and are not insured or guaranteed by the Federal Deposit Insurance Corporation, the Deposit Insurance Fund or any other governmental agency.

The underwriter expects to deliver the shares of Series B Preferred Stock to purchasers on or about December 3, 2009, subject to customary closing conditions.

 

 

Scott & Stringfellow

The date of this prospectus is November 30, 2009


Table of Contents

LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page

About this Prospectus

   ii

Prospectus Summary

   1

Summary Financial Information

   10

Risk Factors

   11

Caution about Forward-Looking Statements

   25

Use of Proceeds

   26

Ratio of Earnings to Fixed Charges and Preferred Dividends and Distributions

   26

Capitalization

   27

Market for Common Stock

   28

Dividend Policy

   29

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   30

Quantitative and Qualitative Disclosures about Market Risk

   67

Business

   69

Supervision and Regulation

   81

Management

   86

Security Ownership

   89

Executive Compensation

   90

Description of the Series B Preferred Stock

   101

Description of Other Capital Stock

   112

Certain United States Tax Considerations

   121

Underwriting

   126

Legal Matters

   129

Experts

   129

Where You Can Find More Information

   129

Financial Statements

   F-1

 

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ABOUT THIS PROSPECTUS

It is important for you to read and consider all of the information contained in this prospectus before making your investment decision. You should rely only on the information contained in this prospectus and any related free writing prospectus that we file with the Securities and Exchange Commission (the “SEC”). We have not, and the underwriter has not, authorized any other person to provide you with additional or different information. If anyone provides you with additional or different information, you should not rely on it. We are not, and the underwriter is not, making an offer to sell our Series B Preferred Stock in any jurisdiction in which the offer or sale is not permitted. You should assume that the information contained in this prospectus is accurate only as of the date on the front cover page of this prospectus, regardless of the time of delivery of this prospectus or any sale of our Series B Preferred Stock. Our business, financial condition and results of operations may have changed since that time.

In this prospectus we rely on and refer to information and statistics regarding the banking industry and banking markets in Virginia and North Carolina. We obtained this market data from independent publications or other publicly available information. Although we believe these sources are reliable, we have not independently verified and do not guarantee the accuracy and completeness of this information. In addition, the sources of the demographic information that we have included in our discussion of our market area in this prospectus include United States Census Bureau, Environmental Systems Research Institute, Inc., economic development authorities and chamber of commerce materials.

No action is being taken in any jurisdiction outside the United States to permit a public offering of our Series B Preferred Stock or possession or distribution of this prospectus in that jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus applicable to those jurisdictions.

In this prospectus, we frequently use the terms “we”, “our”, “us” and the “Company” to refer to Monarch Financial Holdings, Inc., Monarch Bank and other subsidiaries which we own as a combined entity, except where it is clear that the terms mean only Monarch Financial Holdings, Inc. To understand the offering fully and for a more complete description of the offering you should read this entire document carefully, including particularly the “Risk Factors” section beginning on page 11.

 

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. Because this is a summary, it may not contain all of the information that may be important to you. Therefore, you should read this entire prospectus carefully before making a decision to invest in our Series B Preferred Stock, including the risks discussed under the “Risk Factors” section and our financial statements and related notes.

The Company

Monarch Financial Holdings, Inc. is a Virginia-chartered bank holding company headquartered in Chesapeake, Virginia engaged in commercial and retail banking, investment and insurance sales, and mortgage origination and brokerage. We conduct our operations through our wholly-owned subsidiary, Monarch Bank, and its two wholly-owned subsidiaries, Monarch Investment, LLC and Monarch Capital, LLC. We also do business in some markets as OBX Bank, Monarch Mortgage and under various names via joint ventures with other partners.

Monarch Bank serves the needs of local businesses, professionals, corporate executives and individuals in the South Hampton Roads area of Southeastern Virginia and the Outer Banks region of Northeastern North Carolina. We operate eight banking offices, five residential mortgage offices and one investment services office in the cities of Chesapeake, Norfolk, Suffolk and Virginia Beach, Virginia. Our ninth full-service banking office operates under the name “OBX Bank” in the Outer Banks region of Northeastern North Carolina in the town of Kitty Hawk. We also operate twelve additional residential mortgage offices outside of our primary market areas.

Monarch Mortgage, a division of Monarch Bank, was formed in May 2007 when we hired a group of approximately 70 experienced mortgage professionals to staff the division. At that time our employment of these individuals increased the size of our mortgage group from approximately 10 to approximately 80 mortgage professionals. Monarch Mortgage is a residential mortgage lender with offices in Virginia, Maryland, North Carolina and South Carolina. We sell 99% of the mortgages we originate on a loan by loan basis to a large number of national banks, mortgage companies, and directly to certain governmental agencies. By maintaining correspondent and broker relationships with a number of companies, and by monitoring the financial condition of those companies, we believe we can limit the risk of our correspondents not purchasing loans we originate. We originate and sell primarily long-term fixed rate mortgage loans and all loans we originate are considered prime loans. We do not securitize pools of loans.

Mortgage originations and sales have become a major source of revenue and net income for the company since the formation of Monarch Mortgage in 2007, with significant growth in both 2008 and 2009 due to a low interest rate environment coupled with recent government stimulus to the mortgage marketplace. We currently manage our interest rate risks by locking in the interest rate for each mortgage loan with our correspondents and borrowers at the same time.

We offer a wide range of commercial and consumer credit, deposit, mortgage, cash management and private banking services. Through our subsidiaries, we provide full-service investment services through licensed representatives as well as title insurance and commercial mortgage brokerage. We are a community oriented, locally owned and operated financial services company.

Monarch Bank was incorporated on May 1, 1998, and opened for business on April 14, 1999. To better serve our clients and more efficiently manage our business operations, in June 2006 we reorganized as a bank

 

 

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holding company with Monarch Bank becoming the banking subsidiary of Monarch Financial Holdings, Inc. We have grown through de novo expansion, acquisition and the hiring of seasoned banking professionals in our target markets. While we have grown rapidly over the past five years, our strategy has been to do so profitably and without compromising our asset quality. Our growth highlights over the last five years include:

 

   

increasing our total assets from $226.9 million as of December 31, 2004 to $651.7 million as of September 30, 2009;

 

   

increasing our total loans held for investment from $177.1 million as of December 31, 2004 to $512.8 million as of September 30, 2009; and

 

   

increasing our total deposits from $171.4 million as of December 31, 2004 to $540.1 million as of September 30, 2009.

Over the past two years our markets have experienced a slowdown in the development, construction, and sale of residential properties, as well as declines in real estate values. The decline in sales has created diminished cash flows for many of our borrowers, and at times left some borrowers unable to properly service their loan obligations. The rise in unemployment has also affected the ability of consumers to properly service their debt obligations. Management has been aggressive during this period in the recognition, provisioning and charging off of non-performing loans, and this has had an impact on the net income of our commercial and other banking segment. During 2008, our commercial and other banking segment experienced a decline in net income before income taxes and noncontrolling interests primarily due to higher provision for loan loss expense related to the general decline in market conditions. However, growth in our mortgage banking operations during 2008 helped offset the decline in our commercial and other banking segment. For the nine months ended September 30, 2009, the impact of adverse conditions on our commercial and other banking segment moderated, with improvements noted in both segments when compared to the first nine months of 2008.

Net Income before Income Taxes

and Noncontrolling Interest

 

      For the Nine Months
Ended September 30,
    For the Year Ended
December 31,
 
     2009     2008     2008     2007  

Commercial and Other Banking

   $ 5,565,204      $ 4,148,133      $ 1,890,990      $ 4,978,893   

Mortgage Banking Operations

     1,776,256        1,649,987        1,799,724        (1,149,772

Intersegment Eliminations

     (1,706,913     (1,544,622     (1,772,101     1,026,944   
                                

Total

   $ 5,634,547      $ 4,253,498      $ 1,918,613      $ 4,856,065   
                                

 

 

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Management Team

Our senior management team consists of 14 officers who have 370 years of combined experience, with an average of 26 years experience each in the financial services industry. The table below identifies our key senior managers.

 

Name

  

  Position  

   Years of
Experience

William F. Rountree, Jr.

   President & Chief Executive Officer    42

Brad E. Schwartz

  

Executive Vice President – Chief Operating/Financial Officer

Chief Executive Officer, Monarch Bank

   25

E. Neal Crawford

   President – Monarch Bank    24

E. Ted Yoder

   President – Monarch Mortgage    16

James K. Ferber

   President – Real Estate & Construction Group    27

Barry A. Mathias

   Market President – Chesapeake    38

David W. McGlaughon

   Market President – OBX Bank    29

Donald F. Price

   Market President – Norfolk    32

W. Craig Reilly

   Market President – Virginia Beach    11

Barbara N. Lane

   Executive Vice President – Operations    39

Andrew N. Lock

   Executive Vice President – Chief Credit Officer    17

William T. Morrison

   Executive Vice President – Chief Operating Officer, Monarch Mortgage    23

Nancy B. Porter

   Executive Vice President – Sales and Marketing    19

Lynette P. Harris

   Senior Vice President – Chief Financial Officer, Monarch Bank    28

Mr. Rountree turned 65 in July 2009. As part of our management transition plan, Mr. Rountree retained the title of President and Chief Executive Officer of Monarch Financial Holdings, Inc., and stepped down as Chief Executive Officer and President of Monarch Bank in May 2009. At that time Mr. Brad E. Schwartz was named Chief Executive Officer of Monarch Bank and Mr. E. Neal Crawford was named President of Monarch Bank. Previous to that time Mr. Schwartz served as Executive Vice President and Chief Operating and Financial Officer of Monarch Financial Holdings, Inc. and Monarch Bank, and Mr. Crawford served as Market President-Norfolk for Monarch Bank. Mr. Crawford, Mr. Rountree, and Mr. Schwartz all currently serve as members of the board of directors of Monarch Financial Holdings, Inc. and Monarch Bank. The transition plan is expected to continue and it is expected that Mr. Rountree will step down as Chief Executive Officer in 2010 but will continue to serve as part of Monarch’s executive management team for at least the next three years.

We utilize a “Market President” approach to deliver products and services in each of our primary markets. We hire experienced bankers to serve in these leadership roles, and each Market President is responsible for building a strong team of bankers in their respective markets, developing and managing an advisory board of directors, managing sales and service delivery, and integrating our other lines of business in their communities. We believe this approach allows us to expand into new markets with fewer banking office locations and achieve profitability earlier than by utilizing the traditional banking model of opening a banking office and then looking for bankers to staff the location.

Our Market Areas

We operate in the Virginia Beach-Norfolk-Newport News, VA-NC Metropolitan Statistical Area (“MSA”), more commonly known as Greater Hampton Roads. The Greater Hampton Roads area includes the cities of Virginia Beach, Norfolk, Newport News, Chesapeake, Hampton, Portsmouth and Suffolk, and is the 2nd largest MSA in Virginia and the 5th largest MSA in the Southeast with a population of approximately 1.7 million people

 

 

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as of July 2009. The Greater Hampton Roads has a diversified economy that includes military, tourism, government, education, shipping, healthcare and professional services which has resulted in lower unemployment rates when compared to the overall United States.

As of September 2009, the unemployment rate for the Greater Hampton Roads area was 6.7% compared to 9.8% for the U.S. As of September 2008, the unemployment rate for the Greater Hampton Roads area was 4.3%. The labor pool in Hampton Roads has grown in the past year, with 788 thousand working and 35 thousand unemployed in September 2008 compared to 775 thousand working and 56 thousand unemployed in September 2009. The September 2009 numbers are preliminary estimates of the U.S. Bureau of Labor Statistics.

Our primary market areas are South Hampton Roads, which includes the cities of Virginia Beach, Norfolk, Chesapeake, Portsmouth and Suffolk, Virginia, and the Outer Banks region of Northeastern North Carolina, which is comprised of Currituck and Dare counties. We believe the economic conditions encountered in South Hampton Roads, including the level of home purchases and sales, are consistent with those encountered in Greater Hampton Roads as a whole.

South Hampton Roads, with a population of over one million people as of July 2009, has experienced steady growth in recent years and is one of the largest metropolitan areas in Virginia. The area has a significant military base presence with all of the U.S. armed forces represented in the area. The most notable military base is Naval Station Norfolk, the largest naval installation in the world. Norfolk is also the home of the Port of Hampton Roads, the third largest volume port on the East Coast in terms of general cargo. The presence of the military and port provide stability to the market and help the area weather market downturns in other sectors of the local economy. The area’s economy is also supported by a diverse private sector, including a strong manufacturing base and other significant employers. Leading private sector employers include Stihl, Inc. (chain saws), Sumitomo Machinery Corporation of America (industrial motor drives), Canon Virginia, Inc. (copiers, laser printers and suppliers), Dollar Tree Stores, Inc. (retail), Norfolk Southern Corporation (transportation), and Mitsubishi Corporation (various manufacturing operations). We currently concentrate our operations and have banking offices in Chesapeake, Virginia Beach and Norfolk, Virginia.

The Outer Banks region primarily consists of Currituck and Dare counties on North Carolina’s northeast coast and is a natural extension of our South Hampton Roads market. Currituck County is a part of the Virginia Beach-Norfolk-Newport News, VA-NC MSA. We operate a banking office under the name “OBX Bank” in the town of Kitty Hawk with a second OBX Bank office opening in December 2009 in Nags Head, North Carolina.

Business Strategy

Our overall strategic goal is to continue building the area’s top community-based financial services company. We plan to continue to grow both our core banking business as well as our non-interest income lines of business. Specifically, we plan to:

Continue to Penetrate the Greater Hampton Roads Market

Most of our offices are located in the cities of Chesapeake, Virginia Beach and Norfolk, Virginia, and we are continuously looking for additional banking locations in these existing markets that will help support our loan and deposit growth goals. In October 2009, we announced our intention to open our fifth banking office in Virginia Beach, which we expect to open in the first quarter of 2010. Logical extensions of our footprint include the cities of Suffolk, Portsmouth, Newport News and Hampton, Virginia and other markets adjacent to Greater Hampton Roads. We believe our Market President approach to market delivery positions us to successfully expand into new markets. Successful expansion into new markets means we must locate, attract and retain the best talent in our businesses. We will not enter a new market without the right person in the Market President leadership role. This approach may delay our market expansion, but it is our experience that with the right

 

 

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leadership we are able to attract complementary banking professionals and grow loans and deposits more quickly, thus minimizing the short term dilutive effects of de novo branching on our overall profitability.

We believe the Greater Hampton Roads banking market is experiencing a significant amount of market disruption created by the acquisition of Wachovia by Wells Fargo, which held the largest deposit market share at June 30, 2009 representing 19.4% of deposits in the MSA. Other area banks have also been impacted negatively by the recent financial markets downturn. These disruptions create an opportunity for us to acquire both seasoned banking professionals and new clients that are seeking to join a stable and growing franchise in the Greater Hampton Roads marketplace. In August 2009, we announced the hiring of four seasoned banking professionals from regional and local bank competitors in our market. These professionals all have significant client relationships and loan and deposit books of business that we expect to be a source of future growth. The hiring of seasoned bankers and banking teams in our existing and contiguous markets will continue to be a strategy for us as we grow our market share.

Expand OBX Bank

In May 2007, we opened our first full-service banking office in Kitty Hawk, North Carolina under the name “OBX Bank, a Monarch Bank division.” While there have been a number of banks entering this growing market over the past 10 years, most of the banks have out-of-market headquarters and decision-making. Consistent with our strategy, we identified our Market President and developed a local advisory board of directors that have significant experience and deep local ties that we believe will provide us with a competitive advantage in the Outer Banks market. We are also building strong support among local businesses, professionals and consumers, as well as reaching targeted non-residents with residential construction and mortgage loans. We plan to open our second OBX Bank office in the town of Nags Head, North Carolina during December 2009.

Grow Core Deposits

Growing low cost core deposits has been and will continue to be vital to funding our loan growth and preserving our net interest margin. In recent years, we have been successful in growing overall deposits in our target markets. From 2003 to 2008, we opened one banking center per year, increasing our deposit market share penetration in Greater Hampton Roads from 0.98% in 2003 to 2.54% in 2009. Total deposits were $540.1 million at September 30, 2009, an increase of $41.4 million or 8.3% over September 30, 2008. We generate core deposits by offering our clients technology on par with our large bank competitors, including remote deposit capture, sophisticated online internet-based cash management system, and the use of our internal core deposit generating sweep services that allow businesses to earn interest on their excess funds. Our Private Banking Group drives core deposit generation by tailoring the packaging and sales of these services to meet the needs of our retail and commercial clients. At June 30, 2009, we were ranked 9th in deposit market share with 2.54% of the deposits in the Greater Hampton Roads market.

The top four banks in our market control 60.0% of the total deposits in the Greater Hampton Roads market as of June 30, 2009, providing us with ample opportunity to continue to grow our market share.

Grow Non-Interest Income Lines of Business

Our strategy involves building and maintaining sustainable revenue and net income sources incremental to our bank’s spread income (the difference between asset yields and funding costs). Through our subsidiaries and joint ventures, our goal is to provide a full array of products and services, including residential mortgage, investment advisory, title insurance and commercial mortgage brokerage to our clients to meet their financial needs. These ancillary products drive non-interest income, adding diversity to our revenue base and increasing our overall profitability. Over the past several years, we have successfully grown our non-interest income lines of

 

 

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businesses, increasing our non-interest income to operating revenue to 59.6% for the year ended December 31, 2008 compared to 28.0% for the year ended December 31, 2004. We expect that, in the absence of non-organic growth, we will continue to earn non-interest income attributable to our mortgage banking operations at current levels until interest rates rise to rates that discourage residential sales and refinancing by existing homeowners. We operate the following companies that generate non-interest income:

 

   

Monarch Mortgage – a division of Monarch Bank formed in 2007, Monarch Mortgage and our affiliate mortgage companies (Coastal Home Mortgage, LLC and Home Mortgage Solutions, LLC) underwrite permanent residential mortgage loans to be sold in the secondary market. Monarch Mortgage is headquartered in Virginia Beach, Virginia and operates seventeen additional offices in Chesapeake, Norfolk, Virginia Beach, Suffolk, Richmond, and Fredericksburg, Virginia; Rockville, Bowie, Crofton, Gaithersburg, Waldorf, and Green Belt, Maryland; Kitty Hawk, Charlotte, and Wilmington, North Carolina; and Greenwood, South Carolina. We have been successful in hiring seasoned mortgage originators since opening and continue to evaluate expansion opportunities to hire individual loan officers, entire production groups and offices within our current mortgage market areas.

 

   

Monarch Investment, LLC – a wholly-owned subsidiary of Monarch Bank formed in 2003, delivers retail and commercial investment and insurance services to our clients.

 

   

Monarch Capital, LLC – a wholly-owned subsidiary of Monarch Bank formed in 2004, provides structured financing and commercial mortgage brokerage services in the placement of primarily long-term, fixed-rate, non-recourse debt for the commercial, hospitality, and multi-family housing markets.

 

   

Real Estate Security Agency, LLC – a majority-owned joint venture formed in 2007, offers residential and commercial title and settlement services to our banking and mortgage clients.

Maintain Financial Discipline

We are committed to being a high performing financial services company and will continue to expand our banking office network and grow our loan portfolio, but will only do so in a disciplined manner. We will expand only when we have the appropriate local banking officers retained and will not reduce our credit standards or pricing to generate new loans. Our focus on credit risk management has enabled us to successfully grow our balance sheet while generally maintaining strong asset quality through our conservative underwriting practices despite the recent adverse economic climate. We believe that maintaining our financial discipline will generate strong long-term stockholder value.

 

 

Our principal executive offices are located at 1101 Executive Boulevard, Chesapeake, Virginia 23320, and our telephone number is (757) 389-5112. Our primary internet address is www.monarchbank.com. The information contained on our web site is not part of this prospectus.

Participation in the Capital Purchase Program

On December 19, 2008 we issued $14.7 million of our Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) to the United States Department of the Treasury (the “Treasury”) pursuant to the Treasury’s Capital Purchase Program (the “CPP”), together with a warrant to purchase up to 264,706 shares of our Common Stock at an initial exercise price of $8.33 per share (the “Warrant”). If this offering and any other qualified equity offerings that we may make prior to December 31, 2009 result in aggregate gross proceeds of at least $14.7 million, the number of shares of our Common Stock underlying the Warrant then held by the Treasury will be reduced by 50% to 132,353 shares.

 

 

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The Offering

 

Issuer

Monarch Financial Holdings, Inc.

 

Securities Offered

700,000 shares of Series B Preferred Stock (800,000 shares if the underwriter exercises its over-allotment option in full).

 

Offering Price per Share

$25.00

 

Liquidation Preference

$25.00 per share of Series B Preferred Stock, plus an amount equal to the sum of all declared, accrued and unpaid dividends.

 

Maturity

Perpetual.

 

Dividends

7.80% per annum, which is equivalent to $1.95 per annum per share. Dividends are payable quarterly, when, as and if declared, on the last day of March, June, September and December of each year, commencing December 31, 2009.

In order for the Series B Preferred Stock to qualify for Tier 1 capital treatment, dividends are noncumulative and are payable if, when and as authorized and declared by our board of directors. If for any reason the board of directors does not authorize full cash dividends for a dividend period, we will have no obligation to pay any dividends for that period, whether or not our board of directors authorizes and declares dividends on the Series B Preferred Stock for any subsequent dividend period.

Notwithstanding the foregoing, holders of the Series B Preferred Stock have a priority on the receipt of dividends relative to the holders of our junior securities, including the Common Stock. If we have not declared and paid or set aside for full payment of the quarterly dividends on the Series B Preferred Stock for a particular dividend period, we may not declare or pay dividends on, or redeem or purchase, shares of securities junior to the Series B Preferred Stock during the next succeeding dividend period.

 

Conversion by Holder

Each share of Series B Preferred Stock will be convertible at the option of the holder into 3.125 shares of our Common Stock (which reflects an initial conversion price of $8.00 per share of Common Stock), subject to certain adjustments. See “Description of the Series B Preferred Stock – Optional Conversion Right.”

 

Conversion by Us

We may, at our option, at any time or from time to time cause some or all of the Series B Preferred Stock to be converted into shares of our Common Stock at the then applicable conversion rate. We may exercise our conversion right if, for 20 trading days within any period of 30 consecutive trading days, the closing price of our Common Stock exceeds 130% of the then applicable conversion price of the Series B Preferred Stock. See “Description of the Series B Preferred Stock – Mandatory Conversion at Our Option.”

 

 

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Redemption

Subject to prior approval by the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Series B Preferred Stock is redeemable at our option at any time, in whole or in part, on and after the third anniversary of the issue date, at $25.00 per share, plus declared and unpaid dividends, if any, for the prior and the then current dividend periods.

 

Ranking

The Series B Preferred Stock will be, with respect to dividends and upon liquidation, dissolution or winding-up: (i) junior to all our existing and future debt obligations; (ii) junior to each class of capital stock or series of preferred stock, the terms of which expressly provide that it ranks senior to the Series B Preferred Stock; (iii) on a parity with the Series A Preferred Stock, and any future class of capital stock or preferred stock expressly state that such class ranks on parity with the Series B Preferred Stock; and (iv) senior to all classes of our Common Stock or series of preferred stock, the terms of which do not expressly provide that it ranks senior to or on a parity with the Series B Preferred Stock.

As of the consummation of this offering, the Series B Preferred Stock will not rank junior to any of our securities; will rank on a parity with the Series A Preferred Stock; and will rank senior to our trust preferred securities and Common Stock. “Description of the Series B Preferred Stock – Ranking.”

 

Voting

Except as required by law and our articles of incorporation, which will include the terms of the Series B Preferred Stock, the holders of Series B Preferred Stock will have no voting rights.

 

Use of Proceeds

We expect to receive net proceeds from this offering of approximately $16.2 million, after deducting underwriting discounts and commissions and other estimated expenses (or approximately $18.6 million if the underwriter exercises its over-allotment option in full). We intend to use the proceeds of the offering for general corporate purposes, including funding organic growth and opportunistic acquisitions that meet our investment criteria, and, including, if approved, the redemption of our Series A Preferred Stock and Warrant issued to the Treasury through the CPP. See “Use of Proceeds.”

 

Tax Consequences

Material U.S. federal tax considerations relevant to the purchase, ownership and disposition of our Series B Preferred Stock and Common Stock issued upon its conversion are described in “Material Federal U.S. Income Tax Considerations.” Prospective investors are advised to consult with their own tax advisors regarding the tax consequences of acquiring, holding or disposing of our Series B Preferred Stock and Common Stock issued upon its conversion in light of current tax laws, their particular personal investment circumstances and the application of state, local and other tax laws.

 

 

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Shares Outstanding After this Offering (1)

5,792,914 shares of Common Stock.

14,700 shares of Series A Preferred Stock.

700,000 shares of Series B Preferred Stock (800,000 shares if the underwriter exercises its over-allotment option in full).

 

Risk Factors

Before investing, you should carefully review the information contained under “Risk Factors” beginning at page 11 for a discussion of the risks related to an investment in our Series B Preferred Stock.

 

Proposed NASDAQ Symbol

The Series B Preferred Stock has been approved for quotation on the NASDAQ Capital Market under the symbol “MNRKP.”

 

 

(1) The number of shares of Common Stock outstanding excludes 301,437 shares of Common Stock issuable upon exercise of outstanding stock options as of September 30, 2009, with a weighted average exercise price of $7.78 per share, and the Warrant for 264,706 shares of Common Stock with an initial exercise price of $8.33 per share held by the Treasury.

 

 

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SUMMARY FINANCIAL INFORMATION

The following consolidated summary sets forth our selected financial data for the periods and at the dates indicated. The selected financial data have been derived from our audited financial statements for each of the five years that ended December 31, 2008, 2007, 2006, 2005 and 2004 and from our unaudited financial statements for the nine months ended September 30, 2009 and 2008. You should read the detailed information and the financial statements included elsewhere in the prospectus. The operating data for the nine months ended September 30, 2009 are not necessarily indicative of the results that might be expected for the full year.

 

    At or For the Nine Months
Ended September 30,
    At or For the Years Ended December 31,  
            2009                     2008             2008     2007     2006     2005     2004  
                (in thousands, except ratios and per share amounts)  

Balance Sheet Data:

             

Assets

  $ 651,744      $ 594,835      $ 597,198      $ 503,164      $ 407,720      $ 331,174      $ 226,858   

Loans, held for investment (HFI), net of unearned income

    512,784        496,061        496,666        415,177        318,028        260,581        177,141   

Deposits

    540,092        498,704        496,086        389,704        314,113        273,073        171,376   

Total common stockholders’ equity

    48,346        46,294        45,077        36,548        34,009        29,796        21,103   

Total shareholders’ equity

    63,046        46,294        59,777        36,548        34,009        29,796        21,103   

Average shares outstanding, basic (1)

    5,650,780        5,088,633        5,213,096        4,814,738        4,759,448        4,388,720        3,943,054   

Average shares outstanding, diluted (1)

    5,704,082        5,250,089        5,292,232        5,019,221        5,026,364        4,583,951        4,112,396   

Results of Operations:

             

Interest income

  $ 24,047      $ 23,435      $ 29,258      $ 30,752      $ 25,110      $ 15,527      $ 9,392   

Interest expense

    8,220        11,129        14,716        14,487        10,861        5,507        3,232   

Net interest income

    15,827        12,306        14,542        16,265        14,249        10,020        6,160   

Provision for loan losses

    4,085        1,245        5,014        976        559        915        305   

Net interest income after provision for loan losses

    11,742        11,061        9,528        15,289        13,690        9,105        5,855   

Non-interest income

    26,526        14,641        21,469        8,379        3,615        3,161        2,412   

Securities gains (losses)

    —          10        (56     —          (29     (11     (16

Non-interest expenses

    32,633        21,459        29,023        18,812        11,870        9,088        7,113   

Income before income taxes

    5,635        4,253        1,918        4,856        5,406        3,167        1,138   

Income tax expense

    1,834        1,328        505        1,533        1,786        1,065        374   

Net income

    3,801        2,925        1,413        3,323        3,620        2,102        764   

Net income attributable to noncontrolling interests

    (168     (258     (281     (165     6        —          (7

Net income attributable to Monarch Financial Holdings, Inc.

    3,633        2,667        1,132        3,158        3,626        2,102        757   

Amortization of warrants

    29        —          —          —          —          —          —     

Dividend on preferred stock

    558        —          25        —          —          —          —     

Net income available to common shareholders

    3,046        2,667        1,107        3,158        3,626        2,102        757   

Per Share Data:

             

Net income, basic

  $ 0.54      $ 0.52      $ 0.21      $ 0.66      $ 0.76      $ 0.48      $ 0.19   

Net income, diluted

    0.53        0.51        0.21        0.63        0.72        0.46        0.18   

Book value at period end

    8.35        8.14        7.86        7.57        7.02        6.31        5.33   

Tangible book value at period end

    8.06        7.82        7.55        7.17        7.02        6.30        5.33   

Asset Quality Ratios:

             

Non-performing assets to total assets

    1.34     0.89     1.35     0.08     0.02     0.00     0.00

Non-performing loans to period end loans

    1.47     0.98     1.49     0.10     0.03     0.00     0.00

Net charge-offs to average loans

    0.50     0.05     0.20     0.06     0.00     0.01     0.00

Allowance for loan losses to period-end loans, HFI

    1.83     1.00     1.59     0.95     1.01     1.02     1.01

Allowance for loan losses to nonperforming loans

    124.22     101.92     107.19     958.07     3267.68     N/A        N/A   

Selected Ratios:

             

Return on average assets

    0.75     0.65     0.20     0.76     1.05     0.82     0.39

Return on average equity

    7.84     8.79     2.66     8.86     11.38     8.14     3.68

Efficiency (2)

    76.80     79.10     80.20     76.33     66.55     69.01     83.13

Noninterest income to operating revenue (3)

    62.63     54.35     59.55     34.00     20.10     23.92     28.00

Net interest margin

    3.52     3.21     3.00     4.25     4.43     4.15     3.35

Equity to assets

    9.67     7.78     10.01     7.26     8.34     9.00     9.30

Tangible common shareholders’ equity to tangible assets

    7.18     7.50     7.27     6.90     8.34     9.00     9.30

Tier 1 risk-based capital

    12.64     11.09     13.53     9.22     12.18     9.86     9.92

Total risk-based capital

    13.89     12.11     14.79     10.05     13.07     10.74     10.76

Leverage

    11.17     9.42     11.76     9.56     12.21     9.96     10.28

 

(1) Amounts have been adjusted to reflect a 6 for 5 stock split in 2003, a 6 for 5 stock split in 2004, an 11 for 10 stock dividend in 2005, a 5 for 4 stock split in 2006, and a 6 for 5 stock split in 2007.
(2) The efficiency ratio is a key performance indicator in our industry. We monitor this ratio in tandem with other key indicators for signals of potential trends that should be considered when making decisions regarding strategies related to such areas as asset liability management, business line development, and growth and expansion planning. The ratio is computed by dividing non-interest expense by the sum of net interest income on a tax equivalent basis and non-interest income, net of any securities gains or losses. It is a measure of the relationship between operating expenses and earnings.
(3) Operating revenue is defined as net interest income plus noninterest income.

 

 

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RISK FACTORS

An investment in our Series B Preferred Stock involves risk, and you should not invest in our stock unless you can afford to lose some or all of your investment. You should carefully read the risks described below before you decide to buy any of our Series B Preferred Stock. Our business, prospects, financial condition and results of operations could be harmed by any of the following risks.

Risk Factors Related to this Offering

Our Series B Preferred Stock is subordinated to our obligations to our creditors and will rank junior to all of our and our subsidiaries’ liabilities in the event of a bankruptcy, liquidation or winding-up of our assets.

The Series B Preferred Stock is subordinated to our obligations to our creditors, including our depositors. If we are in default to these creditors, you may not receive principal and interest payments on the Series B Preferred Stock. In the event of bankruptcy, liquidation or winding-up, our assets will be available to pay the liquidation preference of our Series B Preferred Stock only after all of our liabilities have been paid. In addition, our Series B Preferred Stock will effectively rank junior to all existing and future liabilities of our subsidiaries and the capital stock of our subsidiaries held by third parties. The rights of holders of our Series B Preferred Stock to participate in the assets of our subsidiaries upon any liquidation or reorganization of any subsidiary will rank junior to the prior claims of that subsidiary’s creditors and minority equity holders. In the event of bankruptcy, liquidation or winding-up, there may not be sufficient assets remaining, after paying our and our subsidiaries’ liabilities, to pay amounts due on any or all of our Series B Preferred Stock then outstanding. The Series B Preferred Stock ranks equally in seniority to the Series A Preferred Stock, which has a liquidation value of $14.7 million. The Series B Preferred Stock will not rank junior to any of our securities, however the terms of our outstanding junior subordinated debt securities relating to certain issuances of trust preferred securities prohibit us from making a liquidation payment on the Series B Preferred Stock if we are in default or have given notice of our election to defer interest payments on the junior subordinated debt securities.

We may not have sufficient cash flow to make payments on the Series B Preferred Stock and our other debt.

Our ability to pay dividends on the Series A Preferred Stock and the Series B Preferred Stock, principal and interest on our debt and to fund our planned capital expenditures, depends on our future operating performance. Our future operating performance is subject to a number of risks and uncertainties that are often beyond our control, including general economic conditions and financial, competitive, and regulatory factors. For a discussion of some of these risks and uncertainties, please see “— Risk Factors Relating to Our Company.” Consequently, we cannot assure you that we will have sufficient cash flow to meet our liquidity needs, including making payments on our indebtedness.

If our cash flow and capital resources are insufficient to allow us to make scheduled payments on the Series B Preferred Stock or our other debt, we may have to sell assets, seek additional capital or restructure or refinance our debt. If we cannot make scheduled payments on our debt, we could be forced into receivership or liquidation and you could lose all or part of your investment in the Series B Preferred Stock.

You may not receive dividends on our Series B Preferred Stock or our Common Stock.

Dividends on the Series B Preferred Stock are noncumulative. If our board of directors fails to declare a dividend or we fail to pay a dividend declared by our board of directors on the Series B Preferred Stock for a dividend period, then the holders of the Series B Preferred Stock will have no right to receive a dividend related to that dividend period, and we will have no obligation to pay a dividend for the related dividend period or to pay any interest, whether or not dividends on the Series B Preferred Stock are declared for any future dividend period. See “Description of the Series B Preferred Stock – Dividend Rights.”

Holders of our Series B Preferred Stock and our Common Stock are only entitled to receive such dividends as our board of directors may declare out of funds legally available for such payments. Furthermore, our

 

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Common Stockholders are subject to the prior dividend rights of any holders of our preferred stock or depositary shares representing such preferred stock then outstanding. As of September 30, 2009, there were 14,700 shares of our Series A Preferred Stock, with a liquidation amount of $1,000 per share, issued and outstanding. Under the terms of the Series A Preferred Stock, our ability to declare and pay dividends on or repurchase our Common Stock will be subject to restrictions in the event we fail to declare and pay (or set aside for payment) full dividends on the Series A Preferred Stock.

We have never declared a cash dividend on our Common Stock in the past and we may not do so in the future. Our ability to declare and pay cash dividends will be dependent upon, among other things, restrictions imposed by the reserve and capital requirements of Virginia and federal banking regulations, our income and financial condition, tax considerations and general business conditions. Furthermore, as long as the Series A Preferred Stock is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including our Common Stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions. In addition, prior to December 19, 2011, unless we have redeemed all of the Series A Preferred Stock or the Treasury has transferred all of the Series A Preferred Stock to third parties, the consent of the Treasury will be required for us to, among other things, pay a Common Stock dividend. Under the terms of our Series A Preferred Stock, our ability to declare or pay dividends on or repurchase our Common Stock or other equity or capital securities will be subject to restrictions in the event that we fail to declare and pay (or set aside for payment) full dividends on the Series A Preferred Stock. This could adversely affect the market price of our Common Stock. Also, we are a bank holding company and our ability to declare and pay dividends is dependent on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.

In addition, the terms of our outstanding junior subordinated debt securities relating to certain issuances of trust preferred securities prohibit us from declaring or paying any dividends or distributions on our capital stock, including our Series B Preferred Stock and our Common Stock, or purchasing, acquiring, or making a liquidation payment on such stock, if we are in default or have given notice of our election to defer interest payments.

We are a holding company and depend on our subsidiaries for dividends, distributions and other payments.

We are a legal entity separate and distinct from our banking and other subsidiaries. Our principal source of cash flow, including cash flow to pay dividends to our stockholders and principal and interest on our outstanding debt, is dividends from our banking subsidiary, Monarch Bank. There are statutory and regulatory limitations on the payment of dividends by Monarch Bank to us, as well as by us to our stockholders. Regulations of both the Federal Reserve and the Virginia State Corporation Commission affect the ability of Monarch Bank to pay dividends and other distributions to us and to make loans to us. If Monarch Bank is unable to make dividend payments to us and sufficient capital is not otherwise available, we may not be able to make dividend payments to holders of our Series B Preferred Stock or our Common Stock.

In addition, our right to participate in any distribution of assets of any of our subsidiaries upon the subsidiary’s liquidation or otherwise, and thus your ability as a holder of our Series B Preferred Stock or our Common Stock to benefit indirectly from such distribution, will be subject to the prior claims of creditors of that subsidiary, except to the extent that any of our claims as a creditor of such subsidiary may be recognized. As a result, shares of our Common Stock are effectively subordinated to all existing and future liabilities and obligations of our subsidiaries.

Periods of rising interest rates will adversely affect the market price of the Series B Preferred Stock.

As of the date of this prospectus, interest rates are at historically low levels. In periods of rising interest rates, holders of fixed dividend securities like the Series B Preferred Stock should expect to see the market price of the fixed rate security go down.

 

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There is currently no established public market for the Series B Preferred Stock, which could limit their market price or the ability to sell them for an amount equal to or higher than their initial offering price.

There is no established public trading market for the Series B Preferred Stock. We intend to have the Series B Preferred Stock quoted on the NASDAQ Capital Market as soon as practicable after the completion of the offering. However, we cannot assure you that an active trading market for the Series B Preferred Stock will develop or be sustained after the completion of the offering. If a trading market does not develop or is not maintained, holders of the Series B Preferred Stock may experience difficulty in reselling, or an inability to sell, the Series B Preferred Stock. If a market for the Series B Preferred Stock develops, any such market may be discontinued at any time. If a public trading market develops for the Series B Preferred Stock, future trading prices of the Series B Preferred Stock will depend on many factors, including, among other things, the price of our Common Stock into which the Series B Preferred Stock is convertible, prevailing interest rates, our operating results and the market for similar securities. Depending on the price of our Common Stock into which the Series B Preferred Stock is convertible, prevailing interest rates, the market for similar securities and other factors, including our financial condition, the Series B Preferred Stock may trade at a discount from their principal amount.

The market for our Common Stock is limited and historically has experienced significant price and volume fluctuations, which may make it difficult for you to resell the Series B Preferred Stock or the shares of Common Stock into which the Series B Preferred Stock is convertible.

The Series B Preferred Stock will be convertible into shares of our Common Stock. Our Common Stock is currently listed on the NASDAQ Capital Market under the symbol “MNRK.” The volume of trading activity in our stock is relatively limited. Even if a more active market develops, there can be no assurance that such market will continue, or that you will be able to sell your shares at or above the offering price.

Further, the market for our Common Stock historically has experienced and may continue to experience significant price and volume fluctuations similar to those experienced by the broader stock market in recent years. Generally, the fluctuations experienced by the broader stock market have affected the market prices of securities issued by many companies for reasons unrelated to their operating performance and may adversely affect the price of our Common Stock. In addition, our announcements of our quarterly operating results, changes in general conditions in the economy or the financial markets and other developments affecting us, our affiliates or our competitors could cause the market price of our Common Stock to fluctuate substantially. The trading price of the Series B Preferred Stock is expected to be affected significantly by the price of our Common Stock.

You may suffer dilution of the Common Stock issuable upon conversion of your Series B Preferred Stock.

The number of shares of our Common Stock issuable upon conversion of your Series B Preferred Stock is subject to adjustment only for stock splits and combinations, stock dividends and certain other specified transactions. See “Description of the Series B Preferred Stock—Conversion Rights.” The number of shares of our Common Stock issuable upon conversion of your Series B Preferred Stock is not subject to adjustment for other events, including the following:

 

   

the issuance of shares of our Common Stock for cash or in connection with acquisitions or other transactions, including in exchange for other of our outstanding securities;

 

   

the issuance of any shares of our Common Stock pursuant to any present or future plan providing for the reinvestment of dividends or interest payable on our securities and the investment of additional optional amounts in shares of our Common Stock under any plan;

 

   

the issuance of any shares of our Common Stock or options or rights to purchase those shares pursuant to any present or future employee, director or consultant benefit plan or program of or assumed by us or any of our subsidiaries; or

 

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the issuance of any shares of our Common Stock pursuant to any option, warrant, right or exercisable, exchangeable or convertible security outstanding as of the date the Series B Preferred Stock were first issued.

The terms of the Series B Preferred Stock do not restrict our ability to offer shares of our Common Stock in the future or to engage in other transactions that could dilute our Common Stock. We have no obligation to consider the interests of the holders of the Series B Preferred Stock in engaging in any such offering or transaction. If we issue additional shares of our Common Stock, that issuance may materially and adversely affect the price of our Common Stock and, because of the relationship of the number of shares of our Common Stock you are to receive on conversion to the price of our Common Stock, such other events may adversely affect the trading price of the Series B Preferred Stock.

If you hold Series B Preferred Stock, you are not entitled to any rights with respect to our Common Stock, but you are subject to all changes made with respect to our Common Stock.

If you hold Series B Preferred Stock, you are not entitled to any rights with respect to our Common Stock (including, without limitation, voting rights and rights to receive any dividends or other distributions on our Common Stock), but you are subject to all changes affecting the Common Stock. You will only be entitled to rights on the Common Stock if and when we deliver shares of Common Stock to you in exchange for your Series B Preferred Stock. For example, if an amendment is proposed to our articles of incorporation or bylaws requiring stockholder approval and the record date for determining the stockholders of record entitled to vote on the amendment occurs prior to delivery to you of the shares of Common Stock, you will not be entitled to vote on the amendment, although you will nevertheless be subject to any changes in the powers, preferences or special rights of our Common Stock.

The trading volume in our Common Stock is lower than that of other large financial services companies.

Subject to certain conditions, the Series B Preferred Stock will be convertible into shares of our Common Stock. Although our Common Stock is traded on the NASDAQ Capital Market, the trading volume in our Common Stock is lower than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our Common Stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our Common Stock, significant sales of our Common Stock, or the expectation of these sales, could cause our stock price to fall.

Risk Factors Relating to Our Company

Changes in interest rates may impact our net interest margin and profitability.

Our profitability depends in substantial part on our net interest margin, which is the difference between the rates we receive on loans and investments and the rates we pay for deposits and other sources of funds. Our net interest margin depends on many factors that are partly or completely outside of our control, including competition, monetary and fiscal policies, and economic conditions generally. Our net interest margin is positively impacted when the Federal Reserve lowers rates and negatively impacted when it increases rates, due to our large portfolio of floating rate loans with floor or minimum rates established above the floating rate equivalent. We anticipate that our profitability will continue to hold in the current rate environment by our ability to control the costs of deposits and other borrowings which are used to fund our loans. We try to minimize our exposure to interest rate risk, but we are unable to completely eliminate this risk.

Our profitability depends significantly on economic conditions in our market area.

Our success depends to a large degree on the general economic conditions in Greater Hampton Roads, Virginia. Our market has experienced a downturn in which we have seen falling home prices, rising foreclosures,

 

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reduced economic activity, increased unemployment and an increased level of commercial and consumer delinquencies. The economic climate has created diminished cash flows for many of our borrowers, and at times left some borrowers unable to properly service their loan obligations. The rise in unemployment has also affected the ability of consumers to properly service their debt obligations. Management has been aggressive during this period in the recognition, provisioning and charging off of non-performing loans, and this has had an impact on the net income of our commercial and other banking segment. If economic conditions in our market do not improve or deteriorate further, we could experience any of the following consequences, each of which could further adversely affect our business:

 

   

demand for our products and services could decline;

 

   

loan delinquencies may continue to increase; and

 

   

problem assets and foreclosures may continue to increase.

We could experience further adverse consequences in the event of a prolonged economic downturn in our market due to our exposure to commercial loans across various lines of business. A prolonged economic downturn could impact collateral values or cash flows of the borrowing businesses, and as a result our primary source of repayment could be insufficient to service the debt. In addition, adverse consequences to us in the event of a prolonged economic downturn in our market could be compounded by the fact that many of our commercial and real estate loans are secured by real estate located in our market area. A further significant decline in real estate values in our market would mean that the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral would be diminished. In addition, a number of our loans are dependent on successful completion of real estate projects and demand for homes, both of which could be affected adversely by a decline in the real estate markets.

Future economic conditions in our market will depend on factors outside of our control such as political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government, military and fiscal policies and inflation. Adverse changes in economic conditions in our market would likely impair our ability to collect loans and could otherwise have a negative effect on our financial condition.

If we experience greater loan losses than anticipated, it will have an adverse effect on our net income and our ability to fund our growth strategy.

While the risk of nonpayment of loans is inherent in banking, if we experience greater nonpayment levels than we anticipate, our earnings and overall financial condition, as well as the value of our Common Stock, could be adversely affected. We cannot assure you that our monitoring, procedures and policies will reduce certain lending risks or that our allowance for loan losses will be adequate to cover actual losses. In addition, as a result of the growth in our loan portfolio, loan losses may be greater than management’s estimates of the appropriate level for the allowance. Loan losses can cause insolvency and failure of a financial institution and, in such an event, our stockholders could lose their entire investment. In addition, future provisions for loan losses could materially and adversely affect our profitability. Any loan losses will reduce the loan loss allowance. A reduction in the loan loss allowance will be restored by an increase in our provision for loan losses. This would reduce our earnings, which could have an adverse effect on our stock price.

Our profitability depends on our ability to manage our balance sheet to minimize the effects of interest rate fluctuation on our net interest margin.

Our results of operations depend on the stability of our net interest margin, which is the difference between the rates we receive on loans and investments and the rates we pay for deposits and other sources of funds. Interest rates, because they are influenced by, among other things, expectations about future events, including the level of economic activity, federal monetary and fiscal policy and geo-political stability, are not predictable or

 

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controllable. In addition, the interest rates we can earn on our loan and investment portfolios and the interest rates we pay on our deposits are heavily influenced by competitive factors. Community banks are often at a competitive disadvantage in managing their cost of funds compared to the large regional, super-regional or national banks that have access to the national and international capital markets. These factors influence our ability to maintain a stable net interest margin.

Our long-term goal is to maintain a neutral position in terms of the volume of assets and liabilities that mature or re-price during any period so that we may reasonably predict our net interest margin; however, interest rate fluctuations, loan prepayments, loan production and deposit flows are constantly changing and influence our ability to maintain this neutral position. Generally speaking, our earnings will be more sensitive to fluctuations in interest rates the greater the variance in the volume of assets and liabilities that mature or re-price in any period. The extent and duration of the sensitivity will depend on the cumulative variance over time, the velocity and direction of interest rates, and whether we are more asset sensitive or liability sensitive. Accordingly, we may not be successful in maintaining this neutral position and, as a result, our net interest margin may suffer, which will negatively impact our earnings. Based on our asset and liability position at September 30, 2009, a rise or decline in interest rates would have limited impact on our net interest income in the short term.

We rely heavily on our management team and the unexpected loss of any of those personnel could adversely affect our operations; we depend on our ability to attract and retain key personnel.

We are a client-focused and relationship-driven organization. We expect our future growth to be driven in a large part by the relationships maintained with our clients by our executive and senior lending officers. We have entered into an employment agreement with Mr. Rountree, President and Chief Executive Officer, Mr. Schwartz, Executive Vice President and Chief Operating and Financial Officer of the Company and Chief Executive Officer of Monarch Bank, E. Neal Crawford, Jr., Executive Vice President of the Company and President of Monarch Bank, and Edward O. Yoder, President of Monarch Mortgage. The existence of such agreements, however, does not necessarily ensure that we will be able to continue to retain their services. The other members of management do not currently have employment agreements to retain their services. The unexpected loss of key employees could have a material adverse effect on our business and possibly result in reduced revenues and earnings. Mr. Rountree has been treated for the past 18 years for various types of cancer, and he continues treatment and monitoring.

Also, our anticipated growth and success, in large part, will be due to the services provided by our mortgage banking officers and the employees of our residential mortgage division. The loss of services of one or more of these persons could have a material adverse effect on our operations, and our business could suffer. With the exception of Mr. Yoder, our mortgage loan originators are not a party to any employment agreement with us, and they could terminate their employment with us at any time and for any reason.

The implementation of our business strategy will also require us to continue to attract, hire, motivate and retain skilled personnel to develop new client relationships as well as new financial products and services. Many experienced banking professionals employed by our competitors are covered by agreements not to compete or solicit their existing clients if they were to leave their current employment. These agreements make the recruitment of these professionals more difficult. The market for these people is competitive, and we cannot assure you that we will be successful in attracting, hiring, motivating or retaining them.

Revenue from our mortgage banking operations are sensitive to changes in economic conditions, decreased economic activity, a slowdown in the housing market, higher interest rates or new legislation and may adversely impact our profits.

Our mortgage banking division, Monarch Mortgage, has provided a significant portion of our consolidated revenue and maintaining our revenue stream in this segment is dependent upon our ability to originate loans and sell them to investors. For the nine months ended September 30, 2009, our mortgage banking operations

 

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produced approximately $1.8 million in net income before taxes and non-controlling interest. Mortgage loan production levels are sensitive to changes in economic conditions and can suffer from decreased economic activity, a slowdown in the housing market or higher interest rates. Generally, any sustained period of decreased economic activity or higher interest rates could adversely affect Monarch Mortgage’s mortgage originations and, consequently, reduce its income from mortgage lending activities. In addition, new legislation, including proposed legislation that would require Monarch Mortgage to retain five percent of the credit risk of securitized exposures, could adversely affect its operations.

Deteriorating economic conditions may also cause home buyers to default on their mortgages. In certain of these cases where Monarch Mortgage has originated loans and sold them to investors, it may be required to repurchase loans or provide a financial settlement to investors if it is proven that the borrower failed to provide 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. Such repurchases or settlements would also adversely affect our net income.

Periods of rising interest rates will adversely affect our income from our mortgage division.

In periods of rising interest rates, consumer demand for new mortgages and re-financings decreases, which in turn adversely impacts our mortgage banking division. Currently, as a result of government actions and other economic factors related to the economic downturn and disruptions in the credit market, interest rates are at historically low levels. It is unknown how long interest rates will remain at these historically low levels and to the extent that market interest rates increase in the future, we will likely experience reductions in our mortgage banking income. Because interest rates depend on factors outside of our control, we cannot eliminate the interest rate risk associated with our mortgage operations.

Our concentration in loans secured by real estate may increase our credit losses, which would negatively affect our financial results.

We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. As of September 30, 2009, $455.6 million, or 87.1% of our loans held for investment were secured by real estate (both residential and commercial). A major change in the real estate market, such as deterioration in the value of this collateral, or in the local or national economy, could adversely affect our clients’ ability to pay these loans, which in turn could negatively impact us. Risk of loan defaults and foreclosures are unavoidable in the banking industry, and we try to limit our exposure to this risk by monitoring our extensions of credit carefully. We cannot fully eliminate credit risk, and as a result credit losses may occur in the future.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results.

Effective internal controls are necessary for us to provide reliable financial reports. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Any failure to maintain an effective system of internal controls could harm our operating results or cause us to fail to meet our reporting obligations.

We may not be able to successfully manage our growth or implement our growth strategies, which may adversely affect our results of operations and financial condition.

A key aspect of our business strategy is our continued growth and expansion. Our ability to continue to grow depends, in part, upon our ability to:

 

   

open new banking offices;

 

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attract deposits to those locations; and

 

   

identify attractive loan and investment opportunities.

We may not be able to successfully implement our growth strategy if we are unable to identify attractive markets, locations or opportunities to expand in the future. Our ability to manage our growth successfully also will depend on whether we can maintain capital levels adequate to support our growth, maintain cost controls and asset quality and successfully integrate any new banking offices into our organization.

As we continue to implement our growth strategy by opening new banking and mortgage offices, we expect to incur construction costs and increased personnel, occupancy and other operating expenses. We generally must absorb those higher expenses while we continue to generate new deposits, and there is a further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding earning assets. Thus, our plans to grow could depress our earnings in the short run, even if we efficiently execute this growth.

Difficult market conditions have adversely affected our industry.

Dramatic declines in the housing market over the past year, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of all types of loans and resulted in significant write-downs of asset values by financial institutions. These write-downs, initially of asset-backed securities but spreading to other securities and loans, have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Many lenders and institutional investors have reduced or ceased providing funding to borrowers. This tightening of credit has led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets have adversely affected our business and results of operations. Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.

Current levels of market volatility are unprecedented.

The capital and credit markets have experienced volatility and disruption. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.

The soundness of other financial institutions could adversely affect us.

Our ability to engage in routine funding transactions could be affected adversely by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty and other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices insufficient to recover the full amount of the financial instrument exposure due to us. There is no assurance that any such losses would not materially and adversely affect our results of operations.

 

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Recent legislative regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system.

The Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008 to restore liquidity and stability to the financial system of the United States. The EESA authorizes the Treasury to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies, under the Troubled Asset Relief Program (“TARP”). The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. The Treasury has allocated $250 billion towards the CPP. Under the CPP, the Treasury is purchasing equity securities from participating institutions, and in December 2008 we issued our Series A Preferred Stock to the Treasury pursuant to the CPP. EESA also increased federal deposit insurance on most deposit accounts from $100 thousand to $250 thousand. This increase is in place until the end of 2013 and is not covered by deposit insurance premiums paid by the banking industry. On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted as a sweeping economic recovery package intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. There can be no assurance as to the actual impact that EESA or its programs, including the CPP, and ARRA or its programs, will have on the national economy or financial markets. The failure of these significant legislative measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our financial condition, results of operation, liquidity or stock price.

The EESA and ARRA have been followed by numerous actions by the Federal Reserve, the U.S. Congress, Treasury, the Federal Deposit Insurance Corporation (the “FDIC”), the SEC and others to address the current liquidity and credit crisis that has followed the sub-prime meltdown that commenced in 2007. These measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. The purpose of these legislative and regulatory actions is to stabilize the U.S. banking system. The EESA, ARRA, and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition, and results of operations could be materially and adversely affected.

The impact on us of recently enacted legislation, in particular the Emergency Economic Stabilization Act of 2008 and American Recovery and Reinvestment Act of 2009 and their implementing regulations, and actions by the FDIC, cannot be predicted at this time.

The programs established or to be established under EESA, ARRA and TARP may have adverse effects upon us. We may face increased regulation of our industry. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities. Also, participation in specific programs may subject us to additional restrictions. Similarly, programs established by the FDIC under the systemic risk exception to the Federal Deposit Act, whether we participate or not, may have an adverse effect on us. Participation in the FDIC Temporary Liquidity Guarantee Program likely will require the payment of additional insurance premiums to the FDIC. We may be required to pay significantly higher FDIC premiums even if we do not participate in the FDIC Temporary Liquidity Guarantee Program because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. The FDIC released a notice of proposed rulemaking on September 29, 2009 that, if made final, would require all insured institutions, including Monarch Bank, to prepay their FDIC premiums for the fourth quarter of 2009 and all of 2010 through 2012. The FDIC also approved an increase of assessment rates by three basis points effective January 2011. The effects of participating or not participating in any such programs and the extent of our participation in such programs cannot reliably be determined at this time.

 

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Current and future increases in FDIC insurance premiums, including the FDIC special assessment imposed on all FDIC-insured institutions, will decrease our earnings.

EESA, as amended by the Helping Families Save Their Homes Act of 2009, temporarily increased the limit on FDIC coverage to $250 thousand for all accounts through December 31, 2013. In addition, in May 2009, the FDIC announced that it had voted to levy a special assessment on insured institutions in order to facilitate the rebuilding of the Deposit Insurance Fund. The assessment is equal to five basis points of our total assets minus Tier 1 capital as of June 30, 2009. This represented a charge of approximately $309 thousand, which was recorded as a pre-tax charge during the second quarter of 2009. The FDIC released a notice of proposed rulemaking on September 29, 2009 that, if made final, would require all insured institutions, including Monarch Bank, to prepay their FDIC premiums for the fourth quarter of 2009 and all of 2010 through 2012. The FDIC also approved an increase of assessment rates by three basis points effective January 2011. Any such prepayment will decrease our earnings and could have a material adverse effect on the value of, or market for, our Common Stock.

Our preferred stock reduces net income available to holders of our Common Stock and earnings per common share and the Warrant may be dilutive to holders of our Common Stock.

The cash dividends declared on each series of our preferred stock will reduce any net income available to holders of Common Stock and our earnings per common shares. The preferred stock will also receive preferential treatment in the event of sale, merger, liquidation, dissolution or winding-up of our company. Additionally, the ownership interest of holders of our Common Stock will be diluted to the extent the Warrant is exercised.

Because of our participation in TARP, we are subject to several restrictions including restrictions on compensation paid to our executives.

Pursuant to the terms of TARP, we adopted certain standards for executive compensation and corporate governance for the period during which the Treasury holds an investment in us. These standards generally apply to certain of our senior executive officers. The standards include, among other things, ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; a required clawback of any bonus or incentive compensation paid to our top twenty most highly compensated employees based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; a prohibition on making golden parachute payments to senior executives; an agreement not to deduct for tax purposes annual compensation in excess of $500 thousand for each senior executive; and a limitation on bonuses.

Additionally, the Treasury released an interim final rule on standards for compensation and corporate governance on June 10, 2009, which implemented and further expanded the limitations and restrictions imposed on executive compensation and corporate governance by the CPP and ARRA. The new Treasury interim final rules, which became effective on June 15, 2009, also prohibit any tax gross-up payments to senior executive officers and the next 20 highest paid executives. The rule further authorizes the Treasury to establish the Office of the Special Master for TARP Executive Compensation with broad powers to review compensation plans and corporate governance matters of TARP recipients.

If we are unable to redeem the Series A Preferred Stock issued to Treasury after five years, the cost of this capital to us will increase substantially.

If we are unable to redeem the Series A Preferred Stock issued to Treasury prior to February 15, 2014, the cost of this capital to us will increase substantially on that date, from 5.0% per annum to 9.0% per annum. Depending on our financial condition at the time, this increase in the annual dividend rate on the Series A Preferred Stock could have a material negative effect on our liquidity.

 

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Our directors and executive officers own our Common Stock, and their interests may conflict with those of our other stockholders.

As of September 30, 2009, our directors and executive officers beneficially owned approximately 983,337 shares or 16.2% of our Common Stock. Accordingly, such persons will be in a position to exercise substantial influence over our affairs and may impede the acquisition of control by a third party. We cannot assure investors that the interests of our directors and executive officers will always align precisely with the interests of the other holders of our Common Stock.

Our future success will depend on our ability to compete effectively in the highly competitive financial services industry.

The banking business is highly competitive, and we face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive financial services environment. Some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies and federally insured state-chartered banks, national banks and federal savings institutions. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services. Some of these competitors are subject to similar regulation but have the advantages of larger established client bases, higher lending limits, extensive banking office networks, numerous ATMs, greater advertising-marketing budgets and other factors.

Competition in our target market area for loans to businesses, professionals and consumers is very strong. Most of our competitors have substantially greater resources and lending limits than us and offer certain services, such as extensive and established banking office networks and trust services that we cannot provide. Moreover, larger institutions operating in South Hampton Roads have access to borrowed funds at lower cost than is available to us. Several community banks are headquartered in our trade areas. Several regional and super-regional banks, as well as a number of large credit unions, also have banking offices in our market area. Competition among institutions for checking and saving deposits in the area is intense.

Our legal lending limit may limit our growth.

We are limited in the amount we can lend to a single borrower by the amount of our capital. Generally, under current law, we may lend up to 15% of our unimpaired capital and surplus to any one borrower. As of September 30, 2009, we were allowed to lend approximately $9.5 million to any one borrower, and maintained an in-house limit of $9.0 million to any one borrower. This amount is significantly less than that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our legal lending limit from doing business with us. Our legal lending limit also impacts the efficiency of our lending operation because it tends to lower our average loan size, which means we have to generate a higher number of transactions to achieve the same portfolio volume. We can accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy is not efficient or always available. We may not be able to attract or maintain clients seeking larger loans or may not be able to sell participations in such loans on terms we consider favorable.

If our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.

We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses in our loan portfolio. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of our clients relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed our

 

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current estimates. Rapidly growing loan portfolios are, by their nature, unseasoned. As a result, estimating loan loss allowances is more difficult, and may be more affected by changes in estimates, and by losses exceeding estimates, than more seasoned portfolios. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in our loan portfolio, we cannot fully predict such losses or that our loan loss allowance will be adequate in the future. Excessive loan losses could have a material and adverse impact on our financial performance. Because of our growth strategy, we expect that our earnings will be negatively impacted by loan growth, which requires additions to our allowance for loan losses. Consistent with our loan loss reserve methodology, we expect to make additions to our loan loss reserve levels as a result of our growth strategy, which may affect our short-term earnings.

Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in the amount of our provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.

Our ability to operate profitably may depend on our ability to implement various technologies into our operations.

The market for financial services, including banking services and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, internet-based banking and telebanking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. If we are not able to afford such technologies, properly or timely anticipate or implement such technologies, or properly train our staff to use such technologies, our business, financial condition or operating results could be adversely affected.

If we need additional capital in the future to continue our growth, we may not be able to obtain it on terms that are favorable. This could negatively affect our performance and the value of our Common Stock.

Our business strategy calls for continued growth. We anticipate that we will be able to support this growth through the generation of additional deposits at new banking locations as well as investment opportunities. However, we may need to raise additional capital in the future to support our continued growth and to maintain our capital levels. Our ability to raise capital through the sale of additional securities will depend primarily upon our financial condition and the condition of financial markets at that time. We may not be able to obtain additional capital in the amounts or on terms satisfactory to us. Our growth may be constrained if we are unable to raise additional capital as needed.

We may in the future issue additional stock, any or all of which will dilute your percentage ownership and, possibly, the value of your shares.

Our board of directors has the authority to issue all or part of any authorized but unissued Common Stock without prior stockholder approval and without allowing the stockholders the right to purchase their pro rata portion of such shares of Common Stock. This includes shares authorized to be issued under our stock compensation plans. The issuance of any new shares of Common Stock will dilute your percentage ownership on an as converted basis and could dilute the value of your Series B Preferred Stock.

Our management will have discretion in allocating all of the proceeds of the offering, and it could delay the achievement of our strategic goals.

We will use the net proceeds from this offering for general corporate purposes and as further described in the section entitled “Use of Proceeds.” General corporate purposes include using the net proceeds to provide additional equity capital to Monarch Bank to support the growth of our operations. We may also use a portion of the net proceeds of this offering to redeem all or a portion of the Series A Preferred Stock and the Warrant.

 

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Subject to the requirements of safe and sound banking practices, however, our management will have discretion in determining specific uses of the offering proceeds. The discretion of management to allocate the proceeds of the offering may result in the use of the net proceeds for non-banking activities that are permitted for bank holding companies, but that are not otherwise specifically identified in this prospectus. While we do not anticipate that these proceeds will be used for other purposes, to the extent that they are, it may take us longer to grow our business and operations and otherwise achieve our strategic goals.

Continued growth may require raising additional capital which may dilute current stockholders’ ownership percentage.

In order to meet applicable regulatory capital requirements, we may, from time to time, need to raise additional capital to support continued growth. If selling our equity securities raises additional funds, the relative ownership interests of our existing stockholders would likely be diluted.

Our need to comply with extensive and complex government regulation could have an adverse effect on our business.

The banking industry is subject to extensive regulation by state and federal banking authorities. Many of the banking regulations we are governed by are intended to protect depositors, the public or the insurance funds maintained by the FDIC, not stockholders. Banking regulations affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. These requirements may constrain our rate of growth and changes in regulations could adversely affect us. The burden imposed by these federal and state regulations may place banks in general, and us specifically, at a competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to reduce losses or operate profitably.

In addition, because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal regulation of financial institutions may change in the future nor the impact those changes may have on our operations. Although the U.S. Congress in recent years has sought to reduce the regulatory burden on financial institutions with respect to the approval of specific transactions, we fully expect that the financial institution industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted further regulating specific banking practices.

The costs of being a public company are proportionately higher for small companies like us due to the requirements of the Sarbanes-Oxley Act.

The Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated by the SEC have increased the scope, complexity, and cost of corporate governance, reporting, and disclosure practices. These regulations are applicable to us. We expect to experience increasing compliance costs, including costs related to internal controls and the requirement that our auditors attest to and report on management’s assessment of our internal controls, as a result of the Sarbanes-Oxley Act. The regulations apply to us in 2010. These necessary costs are proportionately higher for a company of our size and will affect our profitability more than that of some of our larger competitors.

Virginia law and the provisions of our articles of incorporation and bylaws could deter or prevent takeover attempts by a potential purchaser of our Common Stock that would be willing to pay you a premium for your shares of our Common Stock.

Our articles of incorporation and bylaws contain provisions that may be deemed to have the effect of discouraging or delaying uninvited attempts by third parties to gain control of us. These provisions include the division of our board of directors into classes with staggered terms, the ability of our board of directors to set the price, term and rights of, and to issue, one or more series of our preferred stock and the ability of our board of

 

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directors, in evaluating a proposed business combination or other fundamental change transaction, to consider the effect of the business combination on us and our stockholders, employees, customers and the communities which we serve. Similarly, the Virginia Stock Corporation Act contains provisions designed to protect Virginia corporations and employees from the adverse effects of hostile corporate takeovers. See “Description of Other Capital Stock.” These provisions reduce the possibility that a third party could effect a change in control without the support of our incumbent directors. These provisions may also strengthen the position of current management by restricting the ability of stockholders to change the composition of the board of directors, to affect its policies generally and to benefit from actions which are opposed by the current board of directors.

 

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CAUTION ABOUT FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of us. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of our management and on information available at the time these statements and disclosures were prepared.

This prospectus includes and incorporates by reference forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are included throughout this prospectus, and in the documents incorporated by reference in this prospectus, and relate to, among other things, projections of revenues, earnings, earnings per share, cash flows, capital expenditures, or other financial items, expectations regarding acquisitions, discussions of estimated future revenue enhancements, potential dispositions, and changes in interest rates. These statements also relate to our business strategy, goals and expectations concerning our market position, future operations, margins, profitability, liquidity, and capital resources. The words “believe”, “anticipate”, “could”, “estimate”, “expect”, “intend”, “may”, “plan”, “predict”, “project”, “will”, and similar terms and phrases identify forward-looking statements in this prospectus and in the documents incorporated by reference in this prospectus.

Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. Our operations involve risks and uncertainties, many of which are outside our control, and any one of which, or a combination of which, could materially affect our results of operations and whether the forward-looking statements ultimately prove to be correct.

Actual results and trends in the future may differ materially from those suggested or implied by the forward-looking statements depending on a number of factors. Factors that may cause actual results to differ materially from those expected include the following:

 

   

changes in interest rates;

 

   

changes in economic conditions in our market area;

 

   

greater loan losses than anticipated;

 

   

the effect on us and our industry of difficult market conditions, unprecedented volatility and the soundness of other financial institutions;

 

   

the effect of recent legislative regulatory initiatives;

 

   

our ability to compete effectively in the highly competitive financial services industry;

 

   

the effect of our concentration in loans secured by real estate;

 

   

the adequacy of our allowance for loan losses;

 

   

our ability to obtain additional capital in the future on terms that are favorable;

 

   

other factors described under “Risk Factors” above.

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. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We will not update the forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking statements.

 

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USE OF PROCEEDS

We estimate that the net proceeds of this offering, after deducting underwriting discounts, commissions and the estimated expenses of this offering payable by us, will be approximately $16.2 million, or approximately $18.6 million if the underwriter’s over-allotment option is exercised in full. We intend to use the proceeds of the offering for general corporate purposes, including funding organic growth and opportunistic acquisitions that meet our investment criteria. We may also use a portion of the net proceeds of this offering to redeem all or a portion of the Series A Preferred Stock and the Warrant issued to the Treasury.

RATIO OF EARNINGS TO FIXED CHARGES

AND PREFERRED DIVIDENDS AND DISTRIBUTIONS

Our ratio of earnings to fixed charges and preferred dividends and distributions for the nine month period ended September 30, 2009 and for each of the five years in the period ended December 31, 2008 were as follows:

 

     Nine Months
Ended
September 30, 2009
    Year Ended December 31,  
       2008     2007     2006     2005     2004  

Ratio of earnings to fixed charges and preferred dividends and distributions

   1.55   1.11   1.32   1.50   1.58   1.35

For the purposes of the above calculations, “earnings” consist of income from continuing operations before adjustments for income taxes plus fixed charges. “Fixed charges” consist of interest costs, the interest component of rental expense and amortization of debt issuance costs. Prior to this offering, we had 14,700 shares of the Series A Preferred Stock outstanding. We have computed the ratios of earnings to fixed charges and preferred dividends and distributions by dividing earnings by fixed charges plus preferred dividends and distributions.

 

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CAPITALIZATION

The following table sets forth our unaudited consolidated capitalization as of September 30, 2009. Our capitalization is presented on an actual basis and on an as-adjusted basis to give effect to the sale of 700,000 shares of Series B Preferred Stock, based on an assumed public offering of $25.00 per share, as if the offering had been completed as of September 30, 2009 and assuming:

 

   

the net proceeds of the offering are $16.2 million, after deducting the estimated underwriting discount and estimated offering expenses of $250 thousand;

 

   

the underwriter’s over-allotment option is not exercised; and

 

   

the application of the net proceeds of this offering to the uses described in “Use of Proceeds.”

The following data should be read together with our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

     September 30, 2009  
     Actual     As Adjusted  

Long-term Indebtedness:

    

Junior subordinated debentures (1)

   $ 10,000,000      $ 10,000,000   

Shareholders’ Equity:

    

Preferred stock, 2,000,000 shares authorized:

    

Series A cumulative, non-convertible, perpetual preferred stock, $1,000 liquidation value, 14,700 shares issued and outstanding

   $ 14,510,815      $ 14,510,815   

Series B noncumulative, convertible, perpetual preferred stock, $25 liquidation value, 0 shares issued and outstanding, 700,000 shares issued and outstanding on as adjusted basis

     —          16,231,250   

Common stock, par value $5.00 per share, 20,000,000 shares authorized; 5,792,914 shares issued and outstanding

     28,964,570        28,964,570   

Capital surplus

     8,229,998        8,229,998   

Retained earnings

     11,603,364        11,603,364   

Accumulated other comprehensive income, net

     (263,138     (263,138
                

Total shareholders’ equity

   $ 63,045,609      $ 79,276,859   
                

Total capitalization (2)

   $ 73,045,609      $ 89,276,859   
                

Book value per common share

   $ 8.35      $ 8.35 (3) 
                

Tangible book value per common share

   $ 8.06        7.89 (4) 
                

Capital Ratios:

    

Leverage ratio

     11.17     13.36

Tier 1 risk-based capital ratio (5)

     12.64     15.07

Total risk-based capital ratio (5)

     13.89     16.29

 

(1) Consists of debt associated with trust preferred securities in the aggregate amount of $10 million.
(2) Includes total shareholders’ equity and junior subordinated debentures, net of estimated offering costs of $1.4 million related to this Series B Preferred Stock offering.
(3) The calculation to determine as adjusted book value per common share does not include $14.7 million of net proceeds from the sale of the Series A Preferred Stock or $16.2 million of net proceeds from the sale of the Series B Preferred Stock.
(4) The calculation to determine as adjusted tangible book value per common share does include the $16.2 million of net proceeds from the sale of the Series B Preferred Stock and assumes a conversion price of $8.00 per share.
(5) As adjusted assumes net proceeds from the offering are invested in assets with a 100% risk-weighting.

 

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MARKET FOR COMMON STOCK

Our Series B Preferred Stock is a new issue for which there is no existing market. The Series B Preferred Stock has been approved for listing and quotation on the NASDAQ Capital Market under the symbol “MNRKP.”

Our Common Stock is listed on the NASDAQ Capital Market under the symbol “MNRK.” The table below presents the high and low sales prices for our Common Stock for each completed quarter of 2007 and 2008 and 2009 through November 27, 2009. Market values are shown per share and are based on the shares outstanding, on a split adjusted basis, for 2008 and 2007.

 

2009

   High    Low

Fourth Quarter (through November 27)

   $ 7.59    $ 6.00

Third Quarter

     8.99      6.40

Second Quarter

     9.00      4.00

First Quarter

     7.85      4.01

2008

   High    Low

Fourth Quarter

   $ 9.50    $ 6.33

Third Quarter

     10.30      6.50

Second Quarter

     11.25      9.25

First Quarter

     11.00      9.10

2007

   High    Low

Fourth Quarter

   $ 13.91    $ 9.17

Third Quarter

     11.56      9.81

Second Quarter

     12.85      10.42

First Quarter

     12.37      10.56

The closing sales price for our Common Stock on November 27, 2009, as reported on the NASDAQ Capital Market, was $6.75 per share. As of October 9, 2009, the most recent date records were available, there were 1,998 stockholders of record. As of November 13, 2009, the most recent date records were available, there were 566,143 shares of Common Stock subject to outstanding options or warrants to purchase, or securities convertible into our Common Stock and 774,110 shares that could be sold pursuant to Rule 144 of the Securities Act of 1933, as amended (the “Securities Act”), or that we have agreed to register under the Securities Act for sale by security holders.

 

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DIVIDEND POLICY

Dividends on the Series B Preferred Stock are noncumulative. While it is our current intent to pay dividends on the Series B Preferred Stock as scheduled, there is no guarantee that we will do so. If our board of directors fails to declare a dividend on the Series B Preferred Stock for any dividend period, then the holders of the Series B Preferred Stock will have no right to receive a dividend related to that dividend period, and we will have no obligation to pay a dividend for the related dividend period or to pay any interest, whether or not dividends on the Series B Preferred Stock are declared for any future dividend period. See “Description of the Series B Preferred Stock – Dividend Rights.”

We have never declared a cash dividend on our Common Stock. The final determination of the timing, amount and payment of dividends on our Series B Preferred Stock and our Common Stock is at the discretion of our board of directors and will depend upon our and our subsidiaries’ earnings, principally Monarch Bank, our financial condition and other factors, including general economic conditions and applicable governmental regulations and policies as discussed in the section entitled “Supervision and Regulation.”

We are organized under the Virginia Stock Corporation Act, which prohibits the payment of a dividend if, after giving it effect, a corporation would not be able to pay its debts as they become due in the usual course of business or if the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved, to satisfy the preferential rights upon dissolution of any preferred stockholders.

We are a legal entity separate and distinct from our subsidiaries. Our ability to distribute cash dividends will depend primarily on the ability of Monarch Bank to pay dividends to us, and Monarch Bank is subject to laws and regulations that limit the amount of dividends that it can pay. As a state member bank, Monarch Bank is subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. Under Virginia law, a bank may not declare a dividend in excess of total bank profits from current as well as prior years that have neither been distributed to shareholders as dividends nor transferred to surplus. Additionally, Monarch Bank may not declare a dividend if the total amount of all dividends, including the proposed dividend, declared by it in any calendar year exceeds the total of its retained net income of that year to date, combined with its retained net income of the two preceding years, unless the dividend is approved by the Federal Reserve.

The Federal Reserve and the Virginia Bureau of Financial Institutions have the general authority to limit the dividends paid by insured banks if the payment is deemed an unsafe and unsound practice. Both the Virginia Bureau of Financial Institutions and the Federal Reserve have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsound and unsafe banking practice. Monarch Bank may not declare or pay a dividend without the approval of its board and two-thirds of its stockholders if the dividend would exceed its undivided profits as reported to the Federal Reserve. The Federal Reserve has indicated that a bank holding company should generally pay dividends only if its net income available to common stockholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition.

We are also subject to certain restrictions imposed by the reserve and capital requirements of federal banking statutes and regulations. In addition, as a result of our participation in the CPP, we must obtain the Treasury’s consent to commence payment of dividends on our Common Stock.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The following discussion provides information about the major components of our results of operations and financial condition, liquidity and capital resources. This discussion and analysis should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this prospectus.

We generate a significant amount of our income from the net interest income earned by Monarch Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. Monarch Bank’s cost of money is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on non-accrual loans and the amount of additions to the allowance for loan losses.

We also generate income from non-interest sources. Non-interest income sources include bank related service charges, fee income from residential and commercial mortgage sales, fee income from the sale of investment and insurance services, income from bank owned life insurance (“BOLI”) policies, as well as gains or losses from the sale of investment securities.

Analysis of Operating Results

Net Income

We reported year-to-date net income of $3.6 million for the first nine months of 2009 compared to $2.7 million for the same period in 2008, an increase of 36.2% or $965 thousand. Basic earnings per share of Common Stock were $0.54 for the first nine months of 2009 compared to $0.52 for the same period in 2008 and diluted earnings per share were $0.53 for the first nine months of 2009 compared to $0.51 for the same period in 2008.

We reported net income of $1.1 million for the year ended December 31, 2008 compared to $3.2 million and $3.6 million for the years ended December 31, 2007 and 2006, respectively. For the year ended December 31, 2008, the basic and diluted earnings per share were both $0.21. Our basic and diluted earnings per share were $0.66 and $0.63, respectively, for the year ended December 31, 2007, and $0.76 and $0.72, respectively, for the year ended December 31, 2006.

Two important and commonly used measures of profitability are return on assets (net income as a percentage of average total assets) and return on stockholders’ equity (net income as a percentage of average common stockholders’ equity). Our annualized return on average assets was 0.74% for the nine months ended September 30, 2009 compared to 0.65% for the nine months ended September 30, 2008. Our annualized return on average equity for the first nine months of 2009 was 7.84% compared to 8.79% for the first nine months of 2008. Our returns on average assets were 0.20%, 0.76% and 1.05% for the years ended December 31, 2008, 2007 and 2006, respectively. The returns on average stockholders’ equity were 2.66%, 8.86% and 11.38% for the same time periods.

The improvements, year over year, in net income were due to growth in both net interest income and non-interest income. The impact of this growth was partially offset by slower growth in non-interest expense and a greater provision for loan losses expense.

Net interest income increased $3.5 million and non-interest income increased $11.9 million, for the first nine months of 2009 compared to the same period in 2008. Lower interest costs associated with our deposits is a

 

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primary contributor to the improvement in net interest income and increased production from our mortgage division is the source of the increase in non-interest income.

Non-interest expense increased $11.2 million for the first nine months of 2009 compared to the same period in 2008. The areas of greatest non-interest expense growth were salaries and benefits, loan origination expense, and FDIC insurance expense. Our provision for loan losses increased $2.8 million for the nine month period ended September 30, 2009 compared to the same period in 2008. This growth was due to higher loss experience and an increase in watch-list loans.

Net income was down for the year ended December 31, 2008 compared to the year ended December 31, 2007 by $2.0 million or 64.1%, and net income declined $468 thousand or 12.9% for the year ended December 31, 2007 compared to the year ended December 31, 2006. A declining net interest margin coupled with a significantly higher provision for loan losses were the primary contributors to this decline.

For the year ended December 31, 2008, net interest income declined 10.6% or $1.7 million compared to the year ended December 31, 2007, which had increased $2.0 million or 14.1% over the year ended December 31, 2006. Provision for loan losses increased 413% or $4.0 million for the year ended December 31, 2008 compared to the year ended December 31, 2007, which had increased 74.6% or $417 thousand over the year ended December 31, 2006. This was due to a combination of factors which included a severe downturn in the economy and increased provision for loan losses expense.

Non-interest income increased $13.0 million or 155.6% for the year ended December 31, 2008 compared to the year ended December 31, 2007 and $4.8 million or 133.7% for the year ended December 31, 2007 compared to the year ended December 31, 2006. The source of this growth trend was increased production from our mortgage operations. Non-interest expenses increased 54.3% or $10.2 million for a total of $29.0 million for the year ended December 31, 2008 and $6.9 million or 58.5% for a total of $18.8 million in 2007, compared to a total of $11.9 million for the year ended December 31, 2006. The majority of the increases were in salaries and benefits, occupancy expenses and loan origination expenses.

Net non-interest income or loss, which represents non-interest income minus non-interest expense, has improved dramatically with the growth of our non-interest income lines of business. A lower net non-interest income number can enhance profitability, and we focus more closely on this number than on the industry standard efficiency ratio. For the nine months ended September 30, 2009, our net non-interest loss was $6.1 million compared to $6.8 million for the same period in 2008, an improvement of 10.3%. For the year ended December 31, 2008, our net non-interest loss was $7.6 million compared to $10.4 million in the year ended December 31, 2007, a 27.1% improvement. For the year ended December 31, 2007, this number grew $2.1 million or 25.9% when compared to $8.3 million in the year ended December 31, 2006 due to the startup of our mortgage operations.

Net Interest Income

Net interest income, a significant source of our revenue, is the excess of interest income over interest expense. Net interest income is influenced by a number of factors, including the volume of interest-earning assets and interest bearing liabilities, the mix of interest-earning assets and interest bearing liabilities, the interest rates earned on earning assets, and the interest rates paid to obtain funding to support the assets. For analytical purposes, net interest income is adjusted to a taxable equivalent basis to recognize the income tax savings on tax-exempt assets, such as BOLI and state and municipal securities. A tax rate of 34% was used in adjusting interest on BOLI, tax-exempt securities and loans to a fully taxable equivalent basis. The difference between rates earned on interest-earning assets (with an adjustment made to tax-exempt income to provide comparability with taxable income, i.e. the “FTE” adjustment) and the cost of the supporting funds is measured by the net interest margin.

 

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Nine months ended September 30, 2009 compared to nine months ended September 30, 2008

Net interest income showed marked improvement in the first nine months of 2009 due to repricing opportunities of both assets and liabilities in a low, but stable, rate environment. Interest rates have remained at a record low since December 2008, which has allowed us to realign our longer term liability costs with that of our assets. Historically, we have been an asset sensitive company with the majority of our loan portfolio indexed to the Wall Street Journal Prime Rate (“WSJ”) and set to re-price quickly. Our net interest income is negatively impacted when rates decline because repricing of our liabilities lags behind that of our assets. Over the past year, we have renegotiated the majority of our commercial and mortgage loans to include rate “floors” which limits how low a rate can go, despite of how a loan is indexed. In addition, we have repriced deposits as they mature to lower market rates.

The federal funds rate that is set by the Federal Reserve’s Federal Open Market Committee was 0.25% at September 30, 2009 compared to 2.00% at September 30, 2008. For comparable periods, the WSJ, which generally moves with the federal funds rate, was 3.25% compared to 5.00%. A stable, though lower, rate environment has allowed us to renegotiate the pricing of our interest bearing liabilities and assets to terms which should be more favorable to us in the future when rates begin to rise.

Net interest income was $15.8 million for the first nine months of 2009 compared to net interest income of $12.3 million for the first nine months of 2008. Despite a 175bp decline in our primary pricing index, interest income increased $611 thousand for the first nine months of 2009 compared to 2008. Growth in loan volume coupled with the addition of rate floors have kept interest income level with prior periods, while falling rates have resulted in lower interest expense for an overall improvement in net interest income.

Establishing rate floors, which are the contractually defined minimum rate that can be charged on variable rate loans, is one of the ways a traditionally asset sensitive lender can neutralize that sensitivity and buffer the impact of falling rates. Interest and fees on loans are the largest component of our interest income. At September 30, 2009, $214.4 million, or 89% of our commercial and real estate loans had average floors of 5.68% compared to 37%, or $104.7 million, at an average rate of 5.21% at September 30, 2008. The addition of floors coupled with loan growth have kept interest earnings level in spite of steep rate declines in an $86 million segment of our consumer loan portfolio, home equity loans, that do not have floors and carry rates at or near WSJ.

Concurrent with the addition of loan floors, we have replaced the majority of our longer term, higher cost, liabilities with lower cost liabilities. At September 30, 2009, the blended cost on our time deposits had declined 108 basis points when compared to the first nine months of 2008. Total interest expense declined $2.9 million in the first nine months of 2009 when compared to 2008.

Our net interest rate spread on a tax-equivalent basis increased 45 basis points to 3.12% for first nine months of 2009 when compared to 2.67% for the same period in 2008. Yield on earning assets decreased 75 basis points to 5.31% in 2009 compared to 6.06% for the first nine months of 2008, while the cost of interest bearing liabilities decreased 120 basis points to 2.19% from 3.39%, respectively, for the same period.

Year ended December 31, 2008 compared to year ended December 31, 2007 and year ended December 31, 2007 compared to year ended December 31, 2006

Net interest income declined $1.7 million to $14.5 million in 2008 compared to $16.3 million in 2007. Net interest income growth in 2007 was $2.0 million or 14.1% over 2006. During 2008, we had an asset sensitive balance sheet with the majority of our earning assets set to reprice within a one year time frame and many of our loans repricing on a daily basis based on market indexes. When comparing the components of net interest income in 2007 to 2006 our total interest costs increased $3.6 million or 33.4% to $14.5 million on average volume growth of $60.1 million while total interest income increased $5.6 million or 22.5% to $30.8 million on average

 

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volume growth of $61.1 million. The same comparison of 2008 to 2007 shows that our total interest costs only increased $229 thousand or 1.6% to $14.7 million on average volume growth of $123.8 million while total interest income declined $1.5 million or 4.9% to $29.3 million on average volume growth of $106.6 million.

As stated previously, we have historically been asset sensitive and the economic environment created challenges in 2008 that began in late 2007. A majority of our loan portfolio is tied to the WSJ which has moved in tandem with the changes in the federal funds rate. The Federal Reserve’s Open Market Committee, which sets the federal funds rate, decreased the target funds rate five times in 2008 for a total of 400 basis points, which resulted in a historically low federal funds rate of 0.25%. In 2007, they decreased rates three times for a total of 100 basis points between September and December.

Our net yield on earning assets or net interest margin, which is calculated by dividing net interest income by average earning assets, was 3.00% in 2008 compared to 4.25% and 4.43% in 2007 and 2006, respectively. Our earning asset yield decreased 201 basis points in 2008 to 5.95% compared to a 24 basis point increase to 7.96% in 2007 over the 2006 rate of 7.72%. During the same periods, liability costs declined 121 basis points to 3.32% compared to a 35 basis point increase to 4.53% in 2007 over 4.18% in 2006. The result of these changes is a 80 basis point margin compression in 2008 to a spread of 2.63% compared to 3.43% in 2007 and 3.54% in 2006. Comparing the basis point decrease in our earning asset yield to the decrease in the index reveals that we were able to soften the effect of the economic change through management strategies. With 75% of all loans repricing due to maturity or contractual repricing (to the prime rate or another market index) in 2008 and 79% in 2007, we negotiated floors on the majority of our commercial and mortgage loan portfolio, which prevented further declines in asset earnings. On the cost side, we promoted funding growth that is short term, with 93% of interest bearing liabilities set to reprice within twelve months of December 31, 2008.

BOLI has been included in interest-earning assets. We purchased $6.0 million in BOLI during the fourth quarter of 2005. The income on BOLI is not subject to federal income tax, giving it a tax-effective yield of 5.68% for the first nine months of 2009 compared to 5.50% for the same period in 2008.

In July 2006, we added additional capital through the issuance of $10.0 million in trust preferred securities. These securities are treated as subordinated debt and have been included in other borrowings. The cost on trust preferred securities decreased to an average of 2.95% from 5.36% in the first nine months of 2009 compared to the same period of 2008.

 

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The following table is an analysis of net interest income, on a taxable basis, depicting interest income on average earning assets and related yields, interest expense on average interest bearing liabilities and related rates paid for the periods indicated.

NET INTEREST INCOME ANALYSIS

 

    For Periods Ended September 30,  
    2009     2008  
    Average
Balance
    Income/
Expense
  Yield
Rate (1)
    Average
Balance (5)
    Income/
Expense (5)
  Yield
Rate (1)
 

ASSETS

           

Securities, at amortized cost

  $ 6,260,901      $ 181,539   3.88   $ 12,290,979      $ 367,649   4.00

Loans, net

    585,918,470        23,772,474   5.42     494,676,533        22,822,737   6.16

Federal funds sold

    5,340,746        9,987   0.25     1,051,275        17,444   2.22

Dividend-earning restricted equity securities

    6,112,856        80,553   1.76     4,332,645        162,206   5.00

Deposits in other banks

    2,470,322        1,902   0.10     3,798,859        65,040   2.29

Bank owned life insurance (2)

    6,879,653        292,230   5.68     6,630,381        273,274   5.51
                                       

Total earning assets

    612,982,948        24,338,685   5.31     522,780,672        23,708,350   6.06
                               

Less: Allowance for loan losses

    (8,560,372         (4,378,100    

Nonaccrual loans

    6,767,652            600,506       

Total nonearning assets

    28,960,333            28,475,918       
                       

Total assets

  $ 640,150,561          $ 547,478,996       
                       

LIABILITIES and STOCKHOLDERS’ EQUITY

           

Interest-bearing deposits:

           

Checking

  $ 16,395,957      $ 50,504   0.41   $ 16,710,550      $ 121,729   0.97

Regular savings

    29,889,357        291,155   1.30     6,228,006        29,540   0.63

Money market savings

    117,604,995        1,119,478   1.27     128,880,070        2,708,259   2.81

Certificates of deposit

           

$100,000 and over

    95,324,826        1,455,647   2.04     126,529,066        3,008,377   3.18

Under $100,000

    175,835,490        4,232,934   3.22     101,206,992        3,603,853   4.76
                                       

Total interest-bearing deposits

    435,050,625        7,149,718   2.20     379,554,684        9,471,758   3.33

Borrowings

    66,245,972        1,070,214   2.16     59,109,988        1,657,240   3.75
                                       

Total interest-bearing liabilities

    501,296,597      $ 8,219,932   2.19     438,664,672      $ 11,128,998   3.39

Noninterest-bearing liabilities

           

Demand deposits

    71,839,085            62,816,450       

Other noninterest-bearing liabilities

    5,047,719            5,481,517       
                       

Total liabilities

    578,183,401            506,962,639       

Stockholders’ equity

    61,967,160            40,516,357       
                       

Total liabilities and stockholders’ equity

  $ 640,150,561          $ 547,478,996       
                       

Net interest income (2)

    $ 16,118,753       $ 12,579,352  
                   

Interest rate spread (2)(3)

      3.12       2.67
                   

Net interest margin (2)(4)

      3.52       3.21
                   

 

(1) Yields are annualized and based on average daily balances.
(2) Income and yields are reported on a taxable equivalent basis assuming a federal tax rate of 34%, with a $99,358 adjustment for 2009 and a $92,913 adjustment for 2008.
(3) Represents the differences between the yield on total average earning assets and the cost of total interest-bearing liabilities.
(4) Represents the ratio of net interest-earnings to the average balance of interest-earning assets.
(5) Loans held for sale of $26,815,990 and interim interest income of $1,211,085 have been reclassified from mortgage banking income to interest income and fees on loans for September 30, 2008 to be consistent with the presentation for September 30, 2009.

 

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NET INTEREST INCOME ANALYSIS

(In thousands)

 

    For the Years Ended December 31,  
    2008     2007     2006  
    Average
Balance
    Income/
Expense
  Yield/
Rate (1)
    Average
Balance
    Income/
Expense
  Yield/
Rate
    Average
Balance
    Income/
Expense
  Yield/
Rate (1)
 

Assets

                 

Loans:

                 

Commercial

  $ 207,492      $ 14,700   7.08   $ 156,567      $ 12,798   8.17   $ 116,782      $ 9,336   7.99

Mortgage

    152,759        9,398   6.15     139,038        11,527   8.29     116,425        9,739   8.37

Consumer

    109,527        4,397   4.01     70,022        5,546   7.92     58,462        4,576   7.83
                                                           

Total loans

    469,778        28,495   6.07     365,627        29,871   8.17     291,669        23,651   8.11
                                                           

Securities:

                 

Federal agencies

    10,013        383   3.83     10,043        439   4.37     11,404        436   3.82

Mortgage-backed

    906        38   4.19     1,380        56   4.06     4,950        252   5.09

State and municipal

    —          —     0.00     —          —     0.00     281        13   4.63

Other securities

    1,659        63   3.80     2,091        76   3.63     2,137        77   3.60
                                                           

Total securities

    12,578        484   3.85     13,514        571   4.23     18,772        778   4.14
                                                           

Restricted stock and deposits in other banks

    8,639        279   3.23     5,524        310   5.61     13,325        681   5.11
                                                           

Bank owned life insurance

    6,661        370   5.55     6,417        374   5.83     6,171        365   5.91

Total interest-earning assets

    497,656        29,628   5.95     391,082        31,126   7.96     329,937        25,475   7.72
                                         

Less: Allowance for loan losses

    (4,526         (3,546         (3,177    

Other non-earning assets

    60,942            26,844            18,047       
                                   

Total assets

  $ 554,072          $ 414,380          $ 344,807       
                                   

Liabilities and Stockholders’ Equity

                 

Deposits:

                 

Demand

  $ 16,364        152   0.93   $ 10,549        25   0.24   $ 9,561        20   0.21

Money market

    123,542        3,203   2.59     144,964        6,363   4.39     154,176        6,837   4.43

Savings

    9,509        115   1.21     5,982        35   0.59     7,751        49   0.63

Time

    240,648        9,203   3.82     120,352        5,913   4.91     70,217        3,026   4.31
                                                           

Total deposits

    390,063        12,673   3.25     281,847        12,336   4.38     241,705        9,932   4.11

Other borrowings

    53,556        2,043   3.81     37,927        2,150   5.67     17,995        928   5.16
                                                           

Total interest-bearing liabilities

    443,619        14,716   3.32     319,774        14,486   4.53     259,700        10,860   4.18
                                                           

Demand deposits

    65,607            58,104            51,685       

Other liabilities

    2,234            861            1,550       

Stockholders’ equity

    42,612            35,641            31,872       
                                   

Total liabilities and stockholders’ equity

  $ 554,072          $ 414,380          $ 344,807       
                                   

Interest rate spread (2)

      2.63       3.43       3.54
                             

Net yield on earning assets

      3.00       4.25       4.43
                             

Reconcilement to GAAP:

                 

Net interest income tax equivalent

      14,912         16,640         14,615  

Less: Taxable equivalent adjustment

      126         127         124  

Less: BOLI interest income

      244         247         241  
                             
    $ 14,542       $ 16,266       $ 14,250  
                             

 

(1) Yields are annualized and based on average daily balances.
(2) Represents the differences between the yield on total average earning assets and the cost of total interest-bearing liabilities.

 

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Rate/Volume Analysis

The goal of a rate/volume analysis is to compare two or more periods to determine whether the difference between those periods is the result of changes in rate, or volume, or some combination of the two. This is achieved through a “what if” analysis. We calculate what the potential income would have been in the new period if the prior period rate would have remained unchanged, and compare that result to what the potential income would have been in the prior period if the current rates were in effect. Through the analysis of these income potentials, we are able to determine how much of the change between periods is due to the impact of differing rates and how much is volume driven.

For discussion purposes, our “Rate/Volume Analysis” and “Net Interest Income Analysis” tables include tax equivalent income on BOLI that is not in compliance with generally accepted accounting principles (“GAAP”). The following table is a reconciliation of our income statement presentation to these tables.

RECONCILIATION OF NET INTEREST INCOME TO TAX EQUIVALENT NET INTEREST INCOME

 

     Nine Months Ended September 30,   For the Years Ended December 31,

Non-GAAP

            2009                       2008             2008   2007   2006

Interest income

         

Total interest income

  $ 24,046,455   $ 23,435,076   $ 29,258,204   $ 30,752,514   $ 25,110,447

Bank owned life insurance

    192,872     180,361     244,035     246,513     240,603

Tax equivalent adjustment (34% tax rate)

    99,358     92,913     125,715     126,992     123,947
                             

Adjusted income on earning assets

    24,338,685     23,708,350     29,627,954     31,126,019     25,474,997
                             

Interest expense

         

Total interest expense

    8,219,932     11,128,998     14,715,983     14,486,625     10,860,686
                             

Net interest income-adjusted

  $ 16,118,753   $ 12,579,352   $ 14,911,971   $ 16,639,394   $ 14,614,311
                             

Adjusted income on earning assets increased $630 thousand in the first nine months of 2009 compared to 2008 because our growth in earning assets offset reduced yields. Income from loans, which is the largest component of earning assets, increased $949 thousand, in spite of an earnings potential from growth of $3.5 million. During the same period, interest income from securities declined $186 thousand; $168 thousand due to a smaller portfolio and $18 thousand due to lower rates. Interest on federal funds sold declined $8 thousand and BOLI increased $19 thousand in the first nine months of 2009 compared to the same period in 2008.

Loans, net of unearned income, and loans held for sale grew a combined $56.2 million, to $593.6 million at September 30, 2009 compared to $537.4 million at September 30, 2008. Had interest rates in 2009 remained level with 2008 at this increase in volume, the year over year earnings potential from loans was $3.5 million. Consumer loans, which include home equity products and loans held for sale, had a growth related earnings potential of $2.6 million, or 74.3% of the total category, but only yielded $1.1 million due to the negative impact of much lower rates. Commercial loans had an earnings potential of $645 thousand and mortgage loans, $259 thousand. However, lower yields reduced this potential by $711 and $376 thousand for net losses of $66 thousand in commercial loans and $117 thousand in mortgage loans.

Investment income declined in the first nine months of 2009 compared to 2008. In the first nine months of 2009, investment income has decreased $185 thousand due to both volume and rate reductions. A significant portion of our Federal Agency securities have been called in the past year as market rates fell below the rate on these investments. Securities purchased to replace those called have a much lower yield than the original bonds.

 

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Interest on federal funds sold and other bank accounts as well as income on restricted securities decreased a combined total of $153 thousand for the first nine months of 2009 compared to 2008. Income on restricted equity securities has declined, despite higher average balances, because the Federal Home Loan Bank of Atlanta (“FHLB”) modified its stock release policy. In addition, the FHLB paid no dividends until August of this year, at which time they declared a lower yielding dividend.

Year to date interest expense through September 30, 2009 has decreased $2.9 million compared to 2008. Interest on deposits has been the primary source, contributing $2.3 million; other borrowings and federal funds purchased added expense savings of $574 and $13 thousand, respectively.

On average, interest bearing deposits increased $55.5 million to $435.1 million through September 30, 2009 compared to $379.6 million through September 30, 2008 while the average cost of those deposits has dropped from 3.33% to 2.20%. Our deposit composition has changed along with rates, which should contribute to cost savings in the future.

Money market accounts contributed $1.6 million to our interest savings during the first nine months of 2009 compared to the same period in 2008. The blended average rate on these deposits has decreased from 2.81% to 1.27%. Based on the Rate/Volume Analysis table below, $1.4 million of interest savings is due to rate and $219 thousand is attributable to volume, which is inconsistent with the period end growth noted. For clarification purposes, both the Net Interest Income and the Rate/Volume Analysis tables utilize average balances for calculation purposes because an average takes into account both the level and duration of a balance, creating a more accurate picture in most cases. The results then would indicate that money market accounts, on average, had declined over time. Although this has been the case, in mid-September 2009 we opened a $30.0 million brokered money market account which carries a low indexed interest rate. Given its relative size, this account should provide interest savings benefits going forward.

Interest cost on time deposits (“CDs”) declined $923 thousand in the first nine months of 2009 compared to the same period in 2008. Interest cost savings of $2.0 million associated with rate were partially offset by $1.1 million in additional interest costs associated with growth. The composition of our CD portfolio has shifted over time to lower cost CDs. On average, Jumbo CDs, time deposits in excess of $100 thousand, represented 55.6% or our total CDs at September 30, 2008 compared to 35.2% at September 30, 2009. Management has focused, through two retail CD campaigns, on our local market. The first of these campaigns was offered in the fall of 2008, with the majority of those CDs maturing from August to October 2009, when we ran a second campaign. The short duration of the CDs offered has allowed us to manage the decline in rates over time more efficiently.

Savings interest cost for the first nine months of 2009 increased $261 thousand over the same period in 2008. We introduced a new higher cost savings product in 2008 that has produced average year over year growth of $23.7 million.

Our borrowing costs declined $574 thousand in the first nine months of 2009 due to lower rates, partially offset by higher balances.

Changes in Net Interest Income (Rate/Volume Analysis)

Net interest income is the product of the volume of average earning assets and the average rates earned, less the volume of average interest bearing liabilities and the average rates paid. The portion of change relating to both rate and volume is allocated to each of the rate and volume changes based on the relative change in each category. The following table analyzes the changes in both rate and volume components of net interest income on a tax equivalent basis.

 

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RATE / VOLUME ANALYSIS

(in thousands)

 

    For the Nine Months Ended
September 30,
    For the Years Ended December 31,  
    2009 vs 2008     2008 vs 2007     2007 vs 2006  
    Interest
Increase

(Decrease)
    Change
Attributable to
    Interest
Increase

(Decrease)
    Change
Attributable to
    Interest
Increase

(Decrease)
    Change
Attributable to
 
      Rate     Volume       Rate     Volume       Rate     Volume  

Interest income

                 

Loans:

                 

Commercial

  $ (66   $ (711   $ 645      $ 1,902      $ (1,867   $ 3,769      $ 3,462      $ 214      $ 3,248   

Mortgage

    (117     (376     259        (2,129     (3,185     1,056        1,788        (87     1,875   

Consumer

    1,132        (1,424     2,556        (1,149     (3,455     2,306        970        55        915   
                                                                       

Total loans

    949        (2,511     3,460        (1,376     (8,507     7,131        6,220        182        6,038   
                                                                       

Securities:

                 

Federal agencies

    (182     (47     (135     (56     (55     (1     3        58        (55

Mortgage-backed

    11        14        (3     (18     2        20        (196     (43     (153

State and municipal

    —          —          —          —          —          —          (13     (6     (7

Other securities

    (14     15        (29     (13     3        (16     (1     1        (2
                                                                       

Total securities

    (185     (18     (167     (87     (50     (37     (207     10        (217
                                                                       

Deposits in other banks

    (145     (157     12        (31     (163     132        (371     61        (432

Bank owned life insurance and Federal Funds sold

    11        (19     30        (4     (18     14        6        (4     10   
                                                                       

Total interest income

  $ 630      $ (2,705   $ 3,335      $ (1,498   $ (8,378   $ 7,240      $ 5,648      $ 249      $ 5,399   
                                                                       

Interest expense

                 

Deposits:

                 

Demand

  $ (71   $ (69   $ (2   $ 127      $ 107      $ 20      $ 5      $ 3      $ 2   

Money market

    (1,589     (1,370     (219     (3,160     (2,322     (838     (474     (69     (405

Savings

    261        55        206        80        52        28        (14     (3     (11

Time

    (923     (2,041     1,118        3,290        (1,548     4,838        2,887        473        2,414   
                                                                       

Total deposits

    (2,322     (3,425     1,103        337        (3,711     4,048        2,404        404        2,000   

Other borrowings and repurchase agreements

    (587     (772     185        (107     (831     724        1,221        99        1,122   
                                                                       

Total interest expense

    (2,909     (4,197     1,288        230        (4,542     4,772        3,625        503        3,122   
                                                                       

Net interest income

  $ 3,539      $ 1,492      $ 2,047      $ (1,728   $ (4,196   $ 2,468      $ 2,023      $ (254   $ 2,277   
                                                                       

Market Risk Management

We spend a great deal of time focusing on the management of the balance sheet to maximize net interest income. Our primary component of market risk is interest rate volatility, and our primary objectives for managing interest rate volatility are to identify opportunities to maximize net interest income while ensuring adequate liquidity and carefully managing interest rate risk. The Asset/Liability Management Committee (“ALCO”), which is composed of certain of our executive officers, is responsible for:

 

   

monitoring corporate financial performance;

 

   

meeting liquidity requirements;

 

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establishing interest rate parameters, indices, and terms for loan and deposit products;

 

   

assessing and evaluating the competitive rate environment; and

 

   

monitoring and measuring interest rate risk.

Interest rate risk refers to the exposure of our earnings and market value of portfolio equity (“MVE”) to changes in interest rates. The magnitude of the change in earnings and MVE resulting from interest rate changes is impacted by the time remaining to maturity on fixed-rate obligations, the contractual ability to adjust rates prior to maturity, competition, and the general level of interest rates and customer actions.

There are several common sources of interest rate risk that must be effectively managed if there is to be minimal impact on our earnings and capital. Repricing risk arises largely from timing differences in the pricing of assets and liabilities. Reinvestment risk refers to the reinvestment of cash flows from interest payments and maturing assets at lower or higher rates. Basis risk exists when different yield curves or pricing indices do not change at precisely the same time or in the same magnitude such that assets and liabilities with the same maturity are not all affected equally. Yield curve risk refers to unequal movements in interest rates across a full range of maturities.

In determining the appropriate level of interest rate risk, ALCO reviews the changes in net interest income and MVE given various changes in interest rates. We also consider the most likely interest rate scenarios, local economics, liquidity needs, business strategies, and other factors in determining the appropriate levels of interest rate risk. To effectively measure and manage interest rate risk, simulation analysis is used to determine the impact on net interest income and MVE from changes in interest rates.

Interest rate sensitivity analysis presents the amount of assets and liabilities that are estimated to reprice through specified periods if there are no changes in balance sheet mix. The interest rate sensitivity analysis in the following table reflects our assets and liabilities at September 30, 2009 and December 31, 2008 that will either be repriced in accordance with market rates, mature or are estimated to mature early or prepay within the periods indicated. This is a one-day position that is continually changing and is not necessarily indicative of our position at any other time. Interest bearing demand deposits and money market balances are considered interest sensitive for 50% of the outstanding balances. Management believes this structure makes for a more accurate and meaningful view of our interest sensitivity position.

As illustrated in the table, we were asset sensitive as of December 31, 2008, primarily due to our adjustable rate loan portfolio. The majority of these loans are indexed to the WSJ and can adjust either daily or monthly. To match this, we have also kept the maturities of most of our borrowings short, either maturing or repricing within one month. As of September 30, 2009, our cumulative interest sensitivity gap was near neutral for most maturities, due to short term repricing on liabilities and the use of floors on new and repriced loans.

 

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INTEREST RATE SENSITIVITY ANALYSIS

(In thousands)

 

    September 30, 2009
    3 Months
or Less
    > 3 Months
to 1 Year
    > 1 Year
to 3 Years
    > 3 Years
to 5 Years
    > 5 Years     Total

Interest sensitive assets:

           

Interest bearing deposits and Federal funds sold

  $ 7,749      $ —        $ —        $ —        $ —        $ 7,749

Securities

    500        —          1,571        3,887        304        6,262

Loans

    220,821        128,258        92,466        62,852        17,937        522,334

Bank Owned Life Insurance

    —          —          —          —          6,981        6,981
                                             

Total interest sensitive assets

    229,070        128,258        94,037        66,739        25,222        543,326
                                             

Interest sensitive liabilities:

           

NOW and savings deposits

    23,428        —          —          —          23,428        46,856

Money market deposits

    69,558        —          —          —          69,557        139,115

Time deposits

    106,608        119,992        42,707        425        —          269,732

Other borrowings

    21,826        75        10,200        9,881        1,100        43,082
                                             

Total interest sensitive liabilities

    221,420        120,067        52,907        10,306        94,085        498,785
                                             

Interest sensitivity gap

  $ 7,650      $ 8,191      $ 41,130      $ 56,433      $ (68,863   $ 44,541
                                             

Cumulative interest sensitivity gap

  $ 7,650      $ 15,841      $ 56,971      $ 113,404      $ 44,541     
                                         

Percentage cumulative gap to total interest sensitive assets

    1.4     2.9     10.5     20.9     8.2  
    December 31, 2008
    3 Months
or Less
    > 3 Months
to 1 Year
    > 1 Year
to 3 Years
    > 3 Years
to 5 Years
    > 5 Years     Total

Interest sensitive assets:

           

Interest bearing deposits and Federal funds sold

  $ 66      $ —        $ —        $ —        $ —        $ 66

Securities

    —          500        1,593        3,643        611        6,347

Loans

    247,796        106,619        60,127        67,990        22,180        504,712

Bank Owned Life Insurance

    —          —          —          —          6,787        6,787
                                             

Total interest sensitive assets

    247,862        107,119        61,720        71,633        29,578        517,912
                                             

Interest sensitive liabilities:

           

NOW and savings deposits

    17,903        —          —          —          17,904        35,807

Money market deposits

    64,643        —          —          —          64,644        129,287

Time deposits

    75,091        166,294        9,910        803        —          252,098

Other borrowings

    6,410        10,075        10,200        10,200        1,175        38,060
                                             

Total interest sensitive liabilities

    164,047        176,369        20,110        11,003        83,723        455,252
                                             

Interest sensitivity gap

  $ 83,815      $ (69,250   $ 41,610      $ 60,630      $ (54,145   $ 62,660
                                             

Cumulative interest sensitivity gap

  $ 83,815      $ 14,565      $ 56,175      $ 116,805      $ 62,660     
                                         

Percentage cumulative gap to total interest sensitive assets

    16.2     2.8     10.8     22.6     12.1  

 

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Because of inherent limitations in interest rate sensitivity analysis, ALCO uses more sophisticated interest rate risk measurement techniques. Simulation analysis is used to subject the current repricing conditions to rising and falling interest rates in increments and decrements of 1%, 2% and 3% to determine how such changes in the rate environment could affect net interest income. ALCO also measures the effects of changes in interest rates on Market Value of Portfolio Equity (“MVE”) by discounting future cash flows of deposits and loans using new rates at which deposits and loans would be made to similar depositors and borrowers. Market value changes in the investment portfolio are estimated by discounting future cash flows and using duration analysis. Loan and investment security prepayments are estimated using current market information. Simulation analysis presents a more accurate picture since certain rate indices that affect liabilities do not change with the same magnitude over the same period of time as changes in the prime rate or other indices that reprice loans and investment securities. The table below shows the estimated impact of changes in interest rates up and down 1%, 2% and 3% on net interest income and on MVE as of September 30, 2009 and December 31, 2008.

The projected changes in net interest income to changes in interest rates at September 30, 2009 were in compliance with internal guidelines. The projected changes in net interest income to changes in interest rates at December 31, 2008 were in compliance with established guidelines for increases and decreases in rate of 3% but were not in compliance for changes of 1% and 2%. The projected changes in MVE to changes in interest rates at December 31, 2008 were in compliance with established policy guidelines for increases and decreases in rate of 2% and 3%, as well as, decreases in rate of 1%. The projected changes in MVE to changes in interest rates at September 30, 2009 were in compliance with established policy guidelines for increases and decreases in rate of 3%, as well as, increases in rate of 1% and 2%. However, the projected changes in MVE were not in compliance at September 30, 2009 for a decrease in rate of 1% and 2% and at December 31, 2008 for an increase of 1%. These projected changes in the model are based on numerous assumptions of growth and changes in the mix of assets or liabilities. We exceeded established policy guidelines under certain rate scenarios at December 31, 2008 and September 30, 2009 due to the inability to drop deposit rates below zero.

The results of our net interest income simulation as of September 30, 2009 and December 31, 2008 were notably different. Our September 30, 2009 results indicate that an increase in rates of 1% or 2% would result in a nominal decrease in net interest income while our December 31, 2008 simulation indicates that an increase in rates would improve net interest income. This is consistent with our expectations. Changes in our loan and deposit composition between December and September combined with a higher percentage of loans with floors have enhanced our 2009 net interest-earnings. Conversely, the variable loan floors that are bolstering earnings in 2009 are higher than the indexed rate on the loans and, therefore, would not increase as rates increased, resulting in some income compression. This impact on earnings has declined over the past two quarters due to management action in repricing deposits and loans.

 

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CHANGES IN NET INTEREST INCOME AND MARKET VALUE OF PORTFOLIO EQUITY

(In thousands)

 

     September 30, 2009  

Change in

Interest
Rates (1)

   Changes in
Net Interest Income (2)
    Changes in Market Value
of Portfolio Equity (3)
 
   Amount     Percent     Amount     Percent  

Up 3%

   $ 782      2.73   $ 4,495      6.00

Up 2%

     (113   (0.39     2,783      3.71   

Up 1%

     (124   (0.43     1,319      1.76   

Down 1%

     312      1.09        (7,247   (9.67

Down 2%

     (231   (0.81     (9,487   (12.66

Down 3%

     (590   (2.06     (10,101   (13.48
     December 31, 2008  

Change in
Interest

Rates (1)

   Changes in
Net Interest Income (2)
    Changes in Market Value
of Portfolio Equity (3)
 
   Amount     Percent     Amount     Percent  

Up 3%

   $ 2,467      11.26   $ 4,886      7.54

Up 2%

     2,582      11.79        4,516      6.97   

Up 1%

     1,472      6.72        3,264      5.04   

Down 1%

     (1,292   (5.89     (3,138   (4.85

Down 2%

     (2,386   (10.89     (5,295   (8.18

Down 3%

     (2,275   (10.38     (3,672   (5.67

 

(1) Monarch Bank’s simulation model makes assumptions including, among others the slope and timing of rate increases, the rates that drive certain financial instruments, and prepayment assumption.
(2) Represents the difference between estimated net interest income for the next 12 months in the current rate environment.
(3) Represents the difference between market value of portfolio equity in the current interest rate environment.

Non-Interest Income

In the first nine months of 2009, non-interest income totaled $26.5 million compared to $14.7 million for the same period in 2008. This $11.8 million increase was fueled by $11.9 million in mortgage banking income, and combined gains on the sale of assets and other real estate of $391 thousand, offset by a $314 thousand decrease in investment and insurance income and a $209 thousand decrease in other income. Non-interest income totaled $21.4 million in 2008, an increase of $13.0 million or 155.6% over 2007, which was $4.8 million or 133.7% higher than 2006. The following table lists the major components of non-interest income for the nine months ended September 30, 2009 and 2008, and for the years ended December 31, 2008, 2007 and 2006.

 

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NON-INTEREST INCOME

 

    For the Nine Months Ended September 30,     For the Years Ended December 31,  
                2009                           2008                 2008     2007   2006  

Mortgage banking income

  $ 23,902,036   $ 11,995,944      $ 18,080,469      $ 5,151,974   $ 2,060,700   

Investment and insurance commissions

    677,433     991,095        1,277,608        1,130,594     204,386   

Service charges and fees

    1,052,808     1,021,517        1,370,229        1,159,253     924,449   

Security gains (losses), net

    —       10,801        (56,428     —       (29,139

Gain (loss) on sale of other real estate, net

    111,366     (1,586     (31,244     —       —     

Bank owned life insurance

    192,872     180,361        244,035        246,513     240,603   

Title company income

    248,067     179,545        230,214        61,466     48,466   

Gain on sale of assets, net

    302,269     24,410        16,192        586,234     —     

Gain on early extinguishment of debt

    —       —          —          —       138,000   

Other

    39,441     248,891        282,238        43,025     (1,707
                                   
  $ 26,526,292   $ 14,650,978      $ 21,413,313      $ 8,379,059   $ 3,585,758   
                                   

Nine months ended September 30, 2009 compared to nine months ended September 30, 2008

Mortgage banking income represents fees from originating and selling residential mortgage loans as well as commercial mortgages through Monarch Mortgage and our wholly owned commercial mortgage banking subsidiary, Monarch Capital, LLC. In the first nine months of 2009 our residential mortgage operations have closed 3,470 loans totaling $904.0 million compared to 1,650 loans totaling $431.4 million in 2008. In terms of both dollar volume and loans, our residential mortgage division has exceeded their total production for 2008 of 2,208 loans totaling $577.0 million. The current low mortgage rate environment, coupled with first time home buyer incentives, has contributed to the growth in this area. We believe our gross mortgage banking income will continue at the same pace until interest rates begin to rise to levels that could discourage residential sales and would likely discourage refinancing by existing homeowners.

Investment and insurance commissions declined $314 thousand or 31.6% for the first nine months of 2009 compared to the same period of 2008. Excluding nonrecurring income of $125 thousand related to retrospective insurance adjustments, which is included in the first nine months for 2008, investment and insurance income decreased $189 thousand or 21.8%, due to lower production and investment balances.

Service charges and fees on deposit accounts increased $31 thousand in the first nine months of 2009 when compared to the same period in 2008. The primary components of service charges and fees are nonsufficient fund and overdraft fees, and ATM transaction fees. In April 2009, we modified our deposit service fees. In addition, we have an agreement with a third-party vendor to brand ATMs in Food Lion grocery stores in southeast Virginia and northeast North Carolina. In return for supplying the cash for the machines and paying the machines’ cash servicing fees, we receive a portion of the transaction surcharge, and our customers can withdraw cash from the machines without a fee or transaction surcharge. We have 9 ATMs located at our banking center sites. Combined with our third-party vendor relationship, our network includes over 50 active branded ATMs.

There were no security gains or losses in the first nine months of 2009. We have sold six properties in other real estate, net of valuation adjustments for net gains of $111 thousand in the first nine months of 2009 compared to one property, net of valuation adjustments for a net loss of $2 thousand in 2008.

BOLI is included in the net interest income calculation for yield analysis. We purchased $6.0 million in BOLI during the fourth quarter of 2005. The income from BOLI, which is not subject to tax, increased

 

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$13 thousand in the first nine months of 2009 compared to 2008. The tax-effective income earnings are $292 thousand for the first nine months of 2009 compared to $273 thousand for the same period in 2008.

Through Monarch Investment, LLC, we own a 75% interest in a title company, Real Estate Security Agency, LLC (“RESA”), which is being treated as a consolidated entity for accounting purposes, and showed an increase in the first nine months of 2009 of $69 thousand when compared to 2008, the year it was formed. RESA, which provides title insurance on residential and commercial real estate, has benefited from the overall increased activity in the residential mortgage industry.

In June 2009, we sold two parcels of land on Hanbury Road, attached to our Great Bridge office for a gain of $302,269. We have one vacant parcel of land remaining. A one-time gain for $217 thousand related to a change in ownership by Monarch Investment, LLC, resulting from the merger of BI Investments, LLC into Infinex Financial Group is included in other income for the first nine months of 2008.

Year ended December 31, 2008 compared to year ended December 31, 2007 and year ended December 31, 2007 compared to December 31, 2006

Monarch Mortgage, our mortgage division, was reorganized and expanded in June 2007, making 2008 its first full year of operations. Our mortgage operations closed 2,208 loans in 2008 compared to 826 in 2007 and 301 in 2006. The dollar volume closed in 2008 was $577.0 million compared to $196.9 million in 2007 and $67.3 million in 2006. Net interim interest income on loans closed but unfunded is shown as a component of mortgage banking income in all years presented.

Investment and insurance commissions showed some increase in a difficult year for investment activity. On October 1, 2006, we formed a subsidiary, Virginia Asset Group, LLC (“VAG”), of which we owned 51% while the remaining 49% was held by an investment professional. VAG was formed to sell insurance and non-deposit investment products. Income in 2007 was significantly higher than 2006 because of the formation of VAG. We sold our 51% ownership in VAG to the minority partner effective August 31, 2009. With the sale of VAG, we expect our gross investment and insurance commissions to be reduced but for the net revenue to the Company from investment and insurance commissions to remain in line with previous periods.

Service charges continued to grow with deposits during 2008. The fees charged in connection with our overdraft/NSF program, which allows retail clients to overdraw their accounts without the negative stigma associated with a returned check, also increased. This program was initiated in 2004 with broad customer acceptance. As noted above, the primary reason for the increase was deposit growth coupled with our overdraft/NSF program, which began in 2004. Service charge pricing on deposit accounts is typically reevaluated annually to reflect current costs and competition.

Net security losses in 2008 were related primarily to the sale of a poorly performing security in the fourth quarter which carried a loss of $71 thousand. Gains related to rate calls on discounted securities totaled $15 thousand in 2008. Securities losses of $29 thousand in 2006 were due to the sale of lower yielding investment securities. In 2006, management sold lower yielding mortgage-backed securities.

In 2008, we sold three foreclosed properties for a net loss of $31 thousand. There were no gains or losses to report in either 2007 or 2006. The first year we had foreclosed properties was 2008.

Title income increased notably in 2008 due to our newly formed title company, Real Estate Security Agency, LLC, which provides title insurance on residential real estate, and which has benefited from the increased activity in the residential mortgage industry. RESA is being treated as a consolidated entity for accounting purposes. Our wholly owned subsidiary, Monarch Investment, LLC, owns 75% of this new company with 25% owned by an un-affiliated third party, TitleVentures, LLC. Prior years’ title income was from our

 

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minority interest in Bankers Title of Central Virginia, LLC, a joint venture with the Virginia Bankers’ Association and many other community banks in Virginia that we sold in 2007.

The $6.0 million in BOLI that we purchased in 2008 has resulted in income and commissions in each of the three years presented in the table above. In 2007, the Company entered into a sale-leaseback agreement on its Lynnhaven banking office that resulted in a total gain of $1.4 million. In compliance with GAAP, $817 thousand of that gain was deferred and is being amortized over the life of the lease. The reportable gain has been included in non-interest income for 2007. In 2006, other income included a one- time gain from early repayment on a FHLB borrowing in the amount of $138 thousand.

Other income represents a variety of nominal recurring and non-recurring activities and transactions that have occurred throughout the year.

Non-Interest Expense

The following table summarizes our non-interest expense for the periods indicated.

NON-INTEREST EXPENSE

 

    For the Nine Months Ended September 30,   For the Years Ended December 31,
    2009   2008   2008   2007   2006

Salaries and employee benefits

  $ 22,354,849   $ 14,222,938   $ 19,008,912   $ 12,483,022   $ 7,018,828

Occupancy expenses

    1,817,821     1,593,265     2,119,648     1,386,630     1,016,671

Loan origination expenses

    2,540,723     1,311,311     1,922,651     725,655     443,635

Furniture and equipment expense

    975,298     951,103     1,281,804     802,203     533,215

Data processing services

    600,581     489,318     669,135     628,839     562,684

Professional fees

    352,241     247,481     453,998     410,575     270,052

Telephone

    327,442     297,641     399,894     264,690     147,865

Stationary and supplies

    332,878     275,222     376,266     340,591     203,971

Marketing expense

    194,483     253,847     350,163     297,877     323,212

Virginia Franchise Tax

    328,166     220,164     316,104     268,495     322,041

FDIC Insurance

    1,085,755     211,210     298,019     166,848     26,143

ATM expense

    189,128     169,859     237,801     202,196     180,397

Postage

    188,475     146,812     202,649     112,137     84,940

Amortization of intangible assets

    133,929     133,929     178,572     74,401     —  

Other

    1,211,563     934,845     1,207,229     648,246     735,938
                             
  $ 32,633,332   $ 21,458,945   $ 29,022,845   $ 18,812,405   $ 11,869,592
                             

Nine months ended September 30, 2009 compared to nine months ended September 30, 2008

Total non-interest expenses increased $11.2 million for the first nine months of 2009, an increase of 52.1% over the same period in 2008. Salaries and employee benefits represent an approximate average of 67% of non-interest expense in the periods presented above. Our full time equivalent employees, at the end of nine months of 2009 totaled 351, compared to 273 in 2008. The primary source of our salary and benefits growth was in mortgage operations and increased production, as banking segment salaries and benefits are level with 2008. Fifty-five percent of our mortgage employees are paid commissions based on their production levels, which have increased significantly. Secondary increases are attributable to the following factors: (1) an increase in loan origination expense related to increased production by Monarch Mortgage; (2) an increase in FDIC insurance expense due to notably higher assessment rates and a one-time special assessment to cover the shortage created by failed banks; (3) growth and inflation-related increases in occupancy expenses; and (4) increase in data processing services due to costs associated with updated technology and the establishment of a co-location processing site for disaster recovery purposes.

 

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The following summary identifies, in descending order, non-interest expenses with the most significant year-over-year increase.

 

     Increase
For the Nine Months Ended
September 30,
 
     Dollars    Percentage  

Salaries and employee benefits

   $ 8,131,911    57.2

Loan origination expenses

     1,229,412    93.8

FDIC Insurance

     874,545    414.1

Occupancy expenses

     224,556    14.1

Data processing services

     111,263    22.7

Year ended December 31, 2008 compared to year ended December 31, 2007 and year ended December 31, 2007 compared to year ended December 31, 2006

Expenses that had the highest dollar increase year-over year are broken out by dollar increase and percentage change below.

 

     Year Ended December 31,  
     2008 vs 2007     2007 vs 2006  
     Dollars    Percentage     Dollars    Percentage  

Salaries and employee benefits

   $ 6,525,890    52.3   $ 5,464,194    77.9

Loan origination expenses

     1,196,996    165.0     282,020    63.6

Occupancy expenses

     733,018    52.9     369,959    39.4

Furniture and equipment expenses

     479,601    59.8     268,988    50.4

Telephone

     135,204    51.1     116,825    79.0

Regulatory Assessment

     131,171    78.6     140,705    538.2

Postage

     90,512    80.7     27,197    32.0

In all periods presented, the majority of the increase in expense growth was due to increased staffing and higher benefits costs. The information for 2008 represents a full year of salary expense related to our 2007 expansion in mortgage operations as well as increases related to two additional banking offices, additional lenders and support staffing which has more than doubled the number of our employees since January 1, 2007. At December 31, 2008, we employed a total of 295 full and part-time employees compared to 254 and 126 at December 31, 2007 and 2006, respectively. In addition, higher production related incentives, and higher health insurance costs and other benefits such as social security taxes, Medicare taxes, and 401(k) contribution expenses, have contributed to the increase.

The expansion of our mortgage operations has been the major contributor to the growth in loan origination expenses. Costs associated with underwriting and processing mortgage loans at our current volume are significant. Bank related loan expense has also increased due to higher loan volume. Additionally, expense related to the shipping of mortgage loan packages to secondary market investors has had an impact on postage.

Occupancy plus furniture and fixture expense have increased as a result of expansion. We currently have twenty-nine offices, the majority of which we lease. This compares with twenty office locations in 2007 and thirteen in 2006.

Our industry requires that our loan officers be mobile, but accessible to their clients. The telephone is a necessary tool in their daily communication. The growth noted earlier is attributable to both the increase in the number of employees and our volume growth.

The current state of the economy has had a direct impact on our regulatory assessment. The number of bank failures in the past eighteen months has decreased deposit insurance reserves. As such, the remaining banks must

 

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bear the burden of restoring these reserves through the payment of assessments. The FDIC has had to increase its assessments rates in both 2008 and 2007, resulting in a significantly higher expense in both years.

We continue to focus on controlling overhead expenses in relation to income growth. The efficiency ratio, a productivity measure used to determine how well non-interest expense is managed, was 80.2% in 2008 compared to 76.33% in 2007, and 66.55%, in 2006. The “bank only” efficiency ratio was 78.6% in 2008, compared to 68.00% in 2007 and 64.50% in 2006. A lower efficiency ratio indicates more favorable expense efficiency. The efficiency ratio is calculated by dividing non-interest expense by the sum of taxable equivalent net interest income and non-interest income. The expansion of our non-interest income lines of business has negatively impacted this ratio.

Income Taxes

Our income tax provision was $1.8 million for the first nine months of 2009 compared to $1.3 million in 2008. The effective tax rate for the first nine months of 2009 was 32.5% compared to 31.2% for the same period in 2008.

In 2008, we recognized federal income tax expense of $505 thousand resulting in an effective tax rate of 30.8%. During 2007, we recognized federal income tax expense of $1.5 million resulting in an effective tax rate of 32.7%, and in 2006, we recognized federal income tax expense of $1.8 million resulting in an effective tax rate of 33.0%. The major difference between the statutory rate and the effective rate results from income that is not taxable for federal income tax purposes. The primary non-taxable income is that of state and municipal securities or loans and BOLI.

Financial Condition, Liquidity and Capital Resources

General

Nine months ended September 30, 2009 compared to year ended December 31, 2008

Total assets were $651.8 million at September 30, 2009, compared to assets of $597.2 million at December 31, 2008, a 9.1% increase. On an annual basis total assets increased 9.6% at September 30, 2009 when compared to assets of $594.8 million at September 30, 2008. Total loans held for investment as of September 30, 2009 were $522.3 million, an increase of $17.6 million, or 3.5%, from $504.7 million at December 31, 2008. On an annual basis, total loans held for investment increased $21.2 million, or 4.2%, from $501.0 million at September 30, 2008. Loans held for sale were $71.2 million, an increase of $16.8 million from $54.4 million at December 31, 2008, and on an annual basis loans held for sale increased $34.8 million from $36.4 million at September 30, 2008 due to increased volume at our mortgage division. Investment securities were $6.2 million at September 30, 2009, down slightly from $6.3 million at December 31, 2008. On an annual basis, investments securities decreased $11.5 million, or 64.8% over September 30, 2008. Cash and cash equivalents were $26.2 million, an increase of $17.6 million, or 204.3% from $8.6 million at December 31, 2008.

Total liabilities were $588.6 at September 30, 2009, compared to $537.3 million at December 31, 2008, an increase of $51.3 million or 9.5 %. Total deposits were $540.1 million at September 30, 2009, an increase of $44.0 million or 8.9% over December 31, 2008 and $41.4 million or 8.3% higher than September 30, 2008. Our deposits have increase in all major categories due to a continued focus on deposit generation, through the offering of attractive products with competitive pricing. Our borrowings have increased $5.0 million to $43.1 million at September 30, 2009, a 13.1% increase over $38.1 million at December 31, 2008.

Stockholders’ equity was $63.5 million at September 30, 2009, compared to $60.0 million at December 31, 2008. Components of the change in stockholders’ equity include net income of $3.6 million, increase in net unrealized gains on available-for-sale securities totaling $29 thousand, stock based compensation totaling $211 thousand, exercised stock options totaling $272 thousand, net of a preferred stock dividend declaration of $557 thousand.

 

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Year ended December 31, 2008 compared to year ended December 31, 2007 and year ended December 31, 2007 compared to year ended December 31, 2006

Our total assets at December 31, 2008 were $597.2 million, an increase of $94.0 million from $503.2 million at December 31, 2007. Net loans outstanding at December 31, 2008 were $496.7 million, reflecting an increase of $81.5 million from $415.1 million at December 31, 2007. The primary source of asset growth in 2008 was in the loan portfolio and loans held for sale, which were loans originated for the secondary market by Monarch Mortgage, that were closed but not yet been funded by the investor.

Our total assets at December 31, 2007 were $503.1 million, an increase of $95.4 million from $407.7 million at December 31, 2006. Net loans outstanding at December 31, 2007 increased $97.1 million from $318.0 million at December 31, 2006. The primary source of asset growth in 2007 has been in the loan portfolio and loans held for sale, which are loans originated for the secondary market by Monarch Mortgage, which have closed but not yet been sold to the investor.

Total liabilities were $537.3 million at December 31, 2008, compared to $466.6 million at December 31, 2007, an increase of $70.7 million or 15.2%. Total deposits increased $106.4 million to $496.1 million during 2008, or 27.3%, compared to $389.7 million at December 31, 2007. This deposit growth was due to our focus on deposit generation, marketing efforts, new office maturation, and providing attractive deposit products and pricing in our markets. Our deposit growth allowed us to reduce FHLB borrowings $35.8 million from $63.5 million at December 31, 2007 to $27.7 million at December 31, 2008. Total stockholders’ equity was $59.8 million at December 31, 2008, compared to $36.5 million at December 31, 2007, an increase of $23.3 million or 63.8%.

Total liabilities grew 24.9% at December 31, 2007, when compared to $373.7 million at December 31, 2006. Total deposits increased $75.6 million or 24.1% during 2007. Total deposits were $389.7 million and $314.1 million at December 31, 2007 and 2006, respectively. Other borrowings increased $15.5 million to help support asset growth. Total stockholders’ equity was $36.5 million at December 31, 2007, compared to $34.0 million at December 31, 2006.

Securities

Our securities portfolio consists primarily of securities for which an active market exists. Our policy is to invest primarily in securities of the U. S. Government and its agencies and in other high grade fixed income securities to minimize credit risk. Our securities portfolio plays a role in the management of interest rate sensitivity and generates additional interest income. In addition, our portfolio serves as a source of liquidity and is used to meet collateral requirements.

Our securities portfolio consists of two components, securities held-to-maturity and securities available-for-sale. Securities are classified as held-to-maturity based on our intent and ability, at the time of purchase, to hold such securities to maturity. These securities are carried at amortized cost (book value). Securities which may be sold in response to changes in market interest rates, changes in securities’ prepayment risk, increases in loan demand, general liquidity needs, and other similar factors are classified as available-for-sale and are carried at estimated fair value (market value).

 

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SECURITIES PORTFOLIO

(In thousands)

 

     As of September 30,    As of December 31,
     2009    2008    2008    2007    2006

Securities available-for-sale, at fair value:

              

U.S. government agency obligations

   $ 4,627    $ 14,996    $ 4,632    $ 5,819    $ 6,642

Mortgage-backed securities

     642      831      760      1,034      2,799

Corporate debt securities

     493      1,463      455      2,021      2,014
                                  
   $ 5,762    $ 17,290    $ 5,847    $ 8,874    $ 11,455
                                  

Securities held-to-maturity, at cost:

              

U.S. government agency obligations

   $ 500    $ 500    $ 500    $ 22,085    $ 38,574
                                  

Total Securities Portfolio

   $ 6,262    $ 17,790    $ 6,347    $ 30,959    $ 50,029
                                  

At September 30, 2009, total investment securities were $6.3 million, compared to $17.8 million at September 30, 2008. At December 31, 2008, total investment securities were $6.3 million, compared to $31.0 million at December 31, 2007. Excluding securities of U.S. agencies, neither the aggregate book value nor the aggregate market value of the securities of any issuer exceeded ten percent of our stockholders’ equity. Additional information on our investment securities portfolio is in Note 2 to our Consolidated Financial Statements for the year ended December 31, 2008.

We had a net unrealized gain of $56 thousand related to the available-for-sale investment portfolio at September 30, 2009 compared to a net unrealized loss of $47 thousand at September 30, 2008. At December 31, 2008, there was a net unrealized gain of $41 thousand related to the available-for-sale investment portfolio compared to a net unrealized loss of $27 thousand at December 31, 2007.

The market value of securities held-to-maturity at September 30, 2009 was $2 thousand over book value and $10 thousand over book value at September 30, 2008. The market value of securities held-to-maturity at December 31, 2008 was $18 thousand over the book value and $4 thousand over the book value at December 31, 2007. Note 2 of our Consolidated Financial Statements for the year ended December 31, 2008 provides details of the amortized cost, unrealized gains and losses, and estimated fair value of each category of the investment portfolio as of December 31, 2008 and 2007.

 

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The following table sets forth the estimated maturities of securities, based on current performance. Contractual maturities may be different.

ESTIMATED MATURITIES OF SECURITIES HELD AS OF PERIOD INDICATED

(In thousands)

 

     September 30, 2009  
     1 Year
or Less
    1 to 5
Years
    5 to 10
Years
    Over 10
Years
    Total  
     (Dollars In thousands)  

US Agency Securities:

          

Amortized cost

   $ 3,000      $ 2,038      $ —        $ —        $ 5,038   

Fair value

   $ 3,037      $ 2,092        —          —        $ 5,129   

Weighted average yield

     3.74     2.70     —          —          3.32

Mortgage Backed Securities and Collateralized Mortgage Obligations:

          

Amortized cost

   $ 256      $ 328      $ —        $ 55      $ 639   

Fair value

   $ 259      $ 338      $ —        $ 45      $ 642   

Weighted average yield

     2.73     4.19     —          4.65     3.64

Corporate Debt Securities:

          

Amortized cost

   $ —        $ 500      $ —        $ —        $ 500   

Fair value

   $ —        $ 493      $ —        $ —        $ 493   

Weighted average yield

     —          4.15     —          —          4.15

Total Securities:

          

Amortized cost

   $ 3,256      $ 2,866      $ —        $ 55      $ 6,177   

Fair value

   $ 3,296      $ 2,923      $ —        $ 45      $ 6,264   

Weighted average yield

     4.30     3.53     4.38     4.98     3.42
     December 31, 2008  

US Agency Securities:

          

Amortized cost

   $ 2,500      $ 2,535      $ —        $ —        $ 5,035   

Fair value

   $ 2,537      $ 2,613        —          —        $ 5,150   

Weighted average yield

     4.36     3.64     —          —          4.00

Mortgage Backed Securities and Collateralized Mortgage Obligations:

          

Amortized cost

   $ 279      $ 147      $ 288      $ 57      $ 771   

Fair value

   $ 274      $ 149      $ 295      $ 42      $ 760   

Weighted average yield

     4.00     3.91     4.42     7.10     4.37

Corporate Debt Securities:

          

Amortized cost

   $ —        $ 500      $ —        $ —        $ 500   

Fair value

   $ —        $ 455      $ —        $ —        $ 455   

Weighted average yield

     —          4.15     —          —          4.15

Total Securities:

          

Amortized cost

   $ 2,779      $ 3,182      $ 288      $ 57      $ 6,306   

Fair value

   $ 2,811      $ 3,217      $ 295      $ 42      $ 6,365   

Weighted average yield

     4.33     3.73     4.42     7.10     4.06

 

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Loan Portfolio

Total loans held for investment at September 30, 2009 were $522.3 million, an increase of $17.6 million, or 3.5%, from $504.7 million at December 31, 2008. On an annual basis total loans increased $21.2 million, or 4.2%, from $501.1 million at September 30, 2008.

Loans, net of unearned income, increased $85.6 million or 20.4% during 2008. Loans held for sale increased 189.3% or $35.6 million to $54.4 million at December 31, 2008 compared to $18.8 million at December 31, 2007. This notable increase in 2008 was due to increases in our mortgage originations and sales coupled with a full year of operation for Monarch Mortgage. In May 2007, we reorganized our mortgage operations and focused on new markets in Maryland and on growing the number of loan officers employed. The discussion below excludes loans held for sale.

Commercial loans and loans secured by real estate should be considered together under the title of commercial when comparing loans outstanding in 2008 to prior years. In May 2008, we evaluated the classification of our loan portfolio as reported on March 31, 2008, with regard to underlying collateral. Based on that evaluation, loans previously classified as commercial were moved to real estate loans – secured by nonfarm, nonresidential properties. Prior years presented have not been reclassified.

Construction and land development, commercial and home equity loans were our primary areas of growth in 2008. Loans secured by real estate comprised 86.3% of our total loan portfolio as of December 31, 2008, and include a diverse product mix. Commercial loans comprised 39.0% of our total loan portfolio as of December 31, 2008 compared to 44.8% as of December 31, 2007. Real estate construction and development loans comprised 25.2% of the loan portfolio as of December 31, 2008 and 17.4% one year prior. Our consumer portfolio, excluding home equity lines of credit and loans included above, comprised 0.7% of total loans as of December 31, 2008, and 0.9% as of December 31, 2007.

We consider our overall loan portfolio diversified as it consists of 34.2% in residential real estate loans including home equity and residential construction loans, 52.1% in other real estate secured loans including commercial real estate, multi-family, farmland and construction and land development loans, 13.0% in commercial, industrial and agricultural loans, and 0.7% in consumer loans as of December 31, 2008, as detailed in the table below, classified by type.

Interest income on consumer, commercial, and real estate mortgage loans was computed on the principal balance outstanding. Most variable rate loans carry an interest rate tied to the WSJ. Note 3 to our Consolidated Financial Statements for the year ended December 31, 2008 provides a schedule of loans by type and other information. We do not participate in highly leveraged lending transactions, as defined by the regulators, and there are no loans of this nature recorded in the loan portfolio. We do not have foreign loans in our portfolio. At December 31, 2008 and June 30, 2009, we had loan concentrations (loans to borrowers engaged in similar activities) which exceeded 10% of total loans in two areas. These areas of concentration are to borrowers who are principally engaged in the acquisition, development and construction of 1-4 single family homes and developments and to residential home owners with equity lines.

 

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LOANS

(In thousands)

 

     September 30,    December 31,
     2009    2008    2008    2007    2006    2005    2004

Real estate loans:

                    

Construction and land development

   $ 134,644    $ 128,624    $ 126,987    $ 72,858    $ 55,121    $ 58,765    $ 31,941

Secured by 1-4 family residential properties

     172,088      204,383      172,648      146,189      116,419      76,344      52,556

Secured by multi-family (5 or more) residential properties

     12,406      4,594      4,587      8,766      4,234      3,017      1,778

Secured by nonfarm, nonresidential properties

     135,499      129,577      131,264      54,581      50,915      30,622      36,158

Commercial and industrial loans

     63,810      30,591      65,663      133,120      91,152      89,412      51,729

Consumer loans

     3,811      3,219      3,490      3,567      3,349      5,025      4,756

Deposit overdrafts

     75      64      73      72      73      81      27
                                                

Loans - net of unearned income

   $ 522,333    $ 501,052    $ 504,712    $ 419,153    $ 321,263    $ 263,266    $ 178,945
                                                

LOAN MATURITIES

(In thousands)

 

     At September 30, 2009  
     Due within
one year
    Due after one year
but within five years
    Due after
five years
    Total  
     Amount    Yield     Amount    Yield     Amount    Yield     Amount    Yield  

Loans:

                    

Construction and land development

   $ 107,778    5.50   $ 25,800    5.83   $ 1,066    7.63   $ 134,644    5.58

Secured by 1-4 family residential properties

     50,025    5.74     26,419    6.73     95,644    3.86     172,088    4.78

Secured by multi-family (5 or more) residential properties

     1,774    5.00     10,632    6.90     —      0.00     12,406    6.63

Secured by nonfarm, nonresidential properties

     50,617    6.09     76,451    6.64     8,431    6.41     135,499    6.42

Commercial and industrial

     48,032    5.69     15,498    5.82     280    7.75     63,810    5.75

Consumer loans

     1,569    5.92     2,111    16.68     131    7.28     3,811    11.87

Deposit overdrafts/lines

     7    12.25     27    16.89     41    20.11     75    18.25
                                    

Total

   $ 259,802    5.69   $ 156,938    6.60   $ 105,593    4.12   $ 522,333    5.63
                                    

 

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     At December 31, 2008  
     Due within
one year
    Due after one year
but within five years
    Due after
five years
    Total  
     Amount    Yield     Amount    Yield     Amount    Yield     Amount    Yield  

Loans:

                    

Construction and land development

   $ 110,381    4.63   $ 15,517    5.21   $ 1,089    7.62   $ 126,987    4.73

Secured by 1-4 family residential properties

     54,662    4.90     23,479    6.61     94,507    4.41     172,648    4.86

Secured by multi-family (5 or more) residential properties

     547    5.84     4,040    7.29     —      0.00     4,587    7.11

Secured by nonfarm, nonresidential properties

     41,193    5.37     74,486    6.74     15,585    6.63     131,264    6.30

Commercial and industrial

     45,431    5.08     18,631    5.63     1,601    5.51     65,663    5.25

Consumer loans

     1,117    6.72     2,229    15.17     144    6.53     3,490    12.13

Deposit overdrafts/lines

     11    18.99     15    13.00     47    18.24     73    18.70
                                    

Total

   $ 253,342    4.90   $ 138,397    6.55   $ 112,973    4.77   $ 504,712    5.33
                                    

Allowance and Provision For Loan Losses

Our allowance for loan losses is to provide for losses inherent in the loan portfolio. Our management is responsible for determining the level of the allowance for loan losses, subject to review by the board of directors. Among other factors, management considers on a quarterly basis our historical loss experience, the size and composition of our loan portfolio, the value and adequacy of collateral and guarantors, non-performing credits including impaired loans and our risk-rating-based loan watch-list, and national and local economic conditions.

The economy of our trade area is well diversified. There are additional risks of future loan losses that cannot be precisely quantified or attributed to particular loans or classes of loans. Since those factors include general economic trends as well as conditions affecting individual borrowers, the allowance for loan losses is an estimate. The sum of these elements is our management’s recommended level for the allowance. The unallocated portion of the allowance is based on loss factors that cannot be associated with specific loans or loan categories. These factors include management’s subjective evaluation of such conditions as credit quality trends, collateral values, portfolio concentrations, speci