REGULATORY MATTERS

6 Months Ended

Jun. 30, 2011

REGULATORY MATTERS

REGULATORY MATTERS

7.  REGULATORY MATTERS

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that could have a direct material effect on the Company’s consolidated financial statements.  Under the capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.  The Company’s and the Bank’s capital amounts and the Bank’s classification are also subject to qualitative judgments by the federal banking regulators about components of capital, risk weightings of assets and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total capital and Tier I capital, as defined in the federal banking regulations, to risk-weighted assets and of Tier I capital to average assets as shown in the following table. Each of the Company’s and the Bank’s capital ratios exceeds applicable regulatory capital requirements and the Bank meets the requisite capital ratios to be well-capitalized as of June 30, 2011 and December 31, 2010. There are no subsequent conditions or events that management believes have changed the Company’s or the Bank’s capital adequacy. The Company’s and the Bank’s capital amounts and ratios are as follows (dollars in thousands):

					For Capital				To Be Considered
	Actual				Adequacy Purposes				Well-Capitalized
	Amount		Ratio		Amount		Ratio		Amount		Ratio
As of June 30, 2011:
Tier I Capital to Total Adjusted
Average Assets (Leverage):
The Company	$	162,270	10.07	%	$	64,467	4.00	%	N/A		N/A
The Bank	$	159,696	9.91	%	$	64,443	4.00	%	$	80,554	5.00	%
Tier I Capital to Risk-Weighted Assets:
The Company	$	162,270	12.74	%	$	50,942	4.00	%	N/A		N/A
The Bank	$	159,696	12.54	%	$	50,942	4.00	%	$	76,412	6.00	%
Total Capital to Risk-Weighted Assets:
The Company	$	178,335	14.00	%	$	101,883	8.00	%	N/A		N/A
The Bank	$	175,761	13.80	%	$	101,883	8.00	%	$	127,354	10.00	%
As of December 31, 2010:
Tier I Capital to Total Adjusted
Average Assets (Leverage):
The Company	$	153,261	9.53	%	$	64,294	4.00	%	N/A		N/A
The Bank	$	152,608	9.50	%	$	64,269	4.00	%	$	80,336	5.00	%
Tier I Capital to Risk-Weighted Assets:
The Company	$	153,261	12.29	%	$	49,895	4.00	%	N/A		N/A
The Bank	$	152,608	12.23	%	$	49,930	4.00	%	$	74,896	6.00	%
Total Capital to Risk-Weighted Assets:
The Company	$	169,069	13.55	%	$	99,791	8.00	%	N/A		N/A
The Bank	$	168,427	13.49	%	$	99,861	8.00	%	$	124,826	10.00	%

Generally, for regulatory capital purposes, deferred tax assets that are dependent upon future taxable income are limited to the lesser of: (i) the amount of deferred tax assets that a financial institution expects to realize within one year of the calendar quarter-end date based on its projected future taxable income or (ii) 10% of the amount of an institution’s Tier I capital. Based on these restrictions, at June 30, 2011, $15 million of the Company’s net deferred tax assets were deducted from Tier I capital and risk-weighted assets compared to $18 million at December 31, 2010. The Company anticipates that the amount of its net deferred tax assets disallowed for regulatory capital purposes will gradually decline in coming quarters as it anticipates future taxable income.

State banking regulations limit, absent regulatory approval, the Bank’s dividends to the Company to the lesser of the Bank’s undivided profits and the Bank’s retained net income for the current year plus its retained net income for the preceding two years (less any required transfers to capital surplus) up to the date of any dividend declaration in the current calendar year.  As of June 30, 2011, $4 million was available for payment of dividends to the Company from the Bank according to these limitations without seeking regulatory approval.

The preferred stock, purchased by the U.S. Treasury in December 2008, qualifies as Tier I capital for regulatory reporting purposes. The U.S. Treasury also received a warrant to purchase 465,569 shares of the Company’s common stock with an exercise price of $11.87 per share representing an aggregate market price of $6 million or 15% of the preferred stock investment. The warrant is immediately exercisable and expires ten years from the date of issuance, or December 2018. The Company allocated $1 million of the proceeds from the issuance of the preferred stock to the value of the warrant representing an unamortized discount on preferred stock. The discount is being amortized to preferred stock using an effective yield method over a five-year period. Through June 30, 2011, $581 thousand of the discount has been accreted to preferred stock.

The proceeds from the issuance to the U.S. Treasury were allocated based on the relative fair value of the warrant as compared to the fair value of the preferred stock. The fair value of the warrant was determined using a Black-Scholes valuation model. The assumptions used in the warrant valuation were a dividend yield of 3.8%, stock price volatility of 34% and a risk-free interest rate of 2.7%. The fair value of the preferred stock was determined using a discounted cash flow analysis based on assumptions regarding the market rate for preferred stock, which was estimated to be approximately 9% at the date of issuance.

The Reform Act requires the federal bank regulatory agencies to establish consolidated risk-based and leverage capital requirements for insured depository institutions, depository institution holding companies and systemically important nonbank financial companies.  These requirements must be no less than those to which insured depository institutions are currently subject.  Thus, it is likely that we will become subject to capital requirements that are higher than those to which we are currently subject, although it is unknown at this time what these requirements will be.  The new requirements will also eliminate the use of trust preferred securities issued after May 19, 2010 as a component of Tier 1 capital for depository institution holding companies of our size, although because we had less than $15 billion of consolidated assets as of December 31, 2009, we will continue to be permitted to include our $20 million of trust preferred securities, all of which were issued before May 19, 2010, as an element of Tier 1 capital.