UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

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

Commission file number: 000-21671

THE NATIONAL BANK OF INDIANAPOLIS CORPORATION

(Exact name of registrant as specified in its charter)

Indiana		35-1887991
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
107 North Pennsylvania Street
Indianapolis, Indiana		46204
(Address of principal executive offices)		(Zip Code)

(317) 261-9000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).

Yes o No o

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

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

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

Common Stock		Outstanding at November 6 , 2009
[Common Stock, no par value per share]		2,306,267

 

 

Table of Contents
The National Bank of Indianapolis Corporation

Report on Form 10-Q
for Quarter Ended
September 30, 2009

PART I — FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets — September 30, 2009 and December 31, 2008			1
Consolidated Statements of Income — Three Months ended September 30, 2009 and 2008			2
Consolidated Statements of Income — Nine Months ended September 30, 2009 and 2008			3
Consolidated Statements of Cash Flows — Nine Months ended September 30, 2009 and 2008			4
Consolidated Statements of Shareholders’ Equity — Nine Months ended September 30, 2009 and 2008			5
Notes to Consolidated Financial Statements			6-17
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			18-34
Item 3. Quantitative and Qualitative Disclosures about Market Risk			34-35
Item 4. Controls and Procedures			35-36
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			37
Item 1A. Risk Factors			37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			37
Item 3. Defaults Upon Senior Securities			37
Item 4. Submission of Matters to a Vote of Security Holders			38
Item 5. Other Information			38
Item 6. Exhibits			38-39
Signatures			40
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Part I — Financial Information

Item 1. Financial Statements

The National Bank of Indianapolis Corporation

		September 30, 2009				December 31, 2008
		(Unaudited)				(Note)
		(Dollars in thousands)
Assets
Cash and cash equivalents
Cash and due from banks		$	149,661			$	29,819
Reverse repurchase agreements			1,000				1,000
Federal funds sold			1,857				601
Total cash and cash equivalents			152,518				31,420
Investment securities
Available-for-sale securities			62,635				56,977
Held-to-maturity securities (Fair value of $101,492 at September 30, 2009, and $82,971 at December 31, 2008)			99,043				83,567
Total investment securities			161,678				140,544
Loans			881,808				904,207
Less: Allowance for loan losses			(16,886	)			(12,847	)
Net loans			864,922				891,360
Premises and equipment			23,501				22,818
Deferred tax asset			8,249				5,749
Accrued interest			4,414				4,855
Federal Reserve and FHLB stock			3,150				3,150
Other assets			22,257				17,888
Total assets		$	1,240,689			$	1,117,784
Liabilities and shareholders’ equity
Deposits:
Noninterest-bearing demand deposits		$	224,841			$	178,656
Money market and savings deposits			639,722				573,679
Time deposits over $100,000			137,836				136,814
Other time deposits			78,786				76,817
Total deposits			1,081,185				965,966
Other short term borrowings			54,609				51,146
Revolving line of credit			4,200				4,200
Subordinated debt			5,000				5,000
Junior subordinated debentures owed to unconsolidated subsidiary trust			13,918				13,918
Other liabilities			8,629				5,342
Total liabilities			1,167,541				1,045,572
Shareholders’ equity:
Preferred stock, no par value — authorized 5,000,000 shares			—				—
Common stock, no par value — authorized 15,000,000 shares issued 2,835,582 shares at September 30, 2009, and 2,778,311 shares at December 31, 2008			34,298				33,136
Treasury stock, at cost; 529,314 shares at September 30, 2009, and 484,130 shares at December 31, 2008			(20,194	)			(18,481	)
Additional paid in capital			10,288				8,766
Retained earnings			48,671				47,955
Accumulated other comprehensive income			85				836
Total shareholders’ equity			73,148				72,212
Total liabilities and shareholders’ equity		$	1,240,689			$	1,117,784

Note: The balance sheet at December 31, 2008, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation

		Three months ended
		September 30,
		2009				2008
		(Dollars in thousands, except per share amounts)
Interest income:
Interest and fees on loans		$	10,866			$	12,149
Interest on investment securities taxable			806				970
Interest on investment securities nontaxable			513				527
Interest on federal funds sold			—				138
Interest on reverse repurchase agreements			—				4
Total interest income			12,185				13,788
Interest expense:
Interest on deposits			2,300				3,999
Interest on other short term borrowings			49				84
Interest on FHLB advances and overnight borrowings			—				50
Interest on short term debt			22				3
Interest on long term debt			392				420
Total interest expense			2,763				4,556
Net interest income			9,422				9,232
Provision for loan losses			3,955				1,800
Net interest income after provision for loan losses			5,467				7,432
Other operating income:
Wealth management fees			1,226				1,207
Rental income			66				143
Service charges and fees on deposit accounts			792				622
Mortgage banking income			188				220
Interchange income			268				236
Other			451				498
Total other operating income			2,991				2,926
Other operating expenses:
Salaries, wages and employee benefits			5,102				4,340
Occupancy			631				512
Furniture and equipment			331				352
Professional services			472				525
Data processing			521				492
Business development			448				430
FDIC Insurance			411				155
Non performing assets			135				14
Other			1,077				1,097
Total other operating expenses			9,128				7,917
Net income (loss) before tax			(670	)			2,441
Federal and state income tax (benefit)			(462	)			798
Net income (loss) after tax		$	(208	)		$	1,643
Basic earnings per share		$	(0.09	)		$	0.71
Diluted earnings per share		$	(0.09	)		$	0.69

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation

		Nine months ended
		September 30,
		2009				2008
		(Dollars in thousands, except per share amounts)
Interest income:
Interest and fees on loans		$	31,542			$	37,489
Interest on investment securities taxable			2,543				3,588
Interest on investment securities nontaxable			1,557				1,522
Interest on federal funds sold			3				644
Interest on reverse repurchase agreements			—				147
Total interest income			35,645				43,390
Interest expense:
Interest on deposits			7,362				14,126
Interest on other short term borrowings			134				479
Interest on FHLB advances and overnight borrowings			—				157
Interest on short term debt			64				3
Interest on long term debt			1,194				1,284
Total interest expense			8,754				16,049
Net interest income			26,891				27,341
Provision for loan losses			7,855				4,975
Net interest income after provision for loan losses			19,036				22,366
Other operating income:
Wealth management fees			3,647				3,821
Rental income			251				435
Service charges and fees on deposit accounts			2,316				1,764
Mortgage banking income			1,137				127
Interchange income			721				641
Other			1,491				1,599
Total other operating income			9,563				8,387
Other operating expenses:
Salaries, wages and employee benefits			15,859				14,210
Occupancy			1,863				1,554
Furniture and equipment			1,031				1,058
Professional services			1,404				1,499
Data processing			1,654				1,522
Business development			1,274				1,175
FDIC Insurance			1,708				438
Non performing assets			420				58
Other			3,185				4,504
Total other operating expenses			28,398				26,018
Net income before tax			201				4,735
Federal and state income tax (benefit)			(515	)			1,336
Net income after tax		$	716			$	3,399
Basic earnings per share		$	0.31			$	1.47
Diluted earnings per share		$	0.31			$	1.42

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation

		Nine months ended
		September 30,
		2009				2008
		(Dollars in thousands)
Operating Activities
Net Income		$	716			$	3,399
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Provision for loan losses			7,855				4,975
Proceeds from sale of loans			57,752				24,537
Origination of loans held for sale			(56,783	)			(23,086	)
Depreciation and amortization			1,146				1,151
Fair value adjustment on mortgage servicing rights			347				410
Gain on sale of loans			(1,230	)			(333	)
Net increase in deferred income taxes			(2,019	)			(1,280	)
Net increase in bank owned life insurance			(308	)			(338	)
Excess tax benefit from deferred stock compensation			(399	)			(227	)
Stock compensation			100				100
Net accretion of discounts and amortization of premiums on investments			190				166
Compensation expense related to restricted stock and options			1,128				891
(Increase) decrease in:
Accrued interest receivable			441				627
Other assets			(4,407	)			(2,633	)
Increase (decrease) in:
Other liabilities			3,686				(1,399	)
Net cash provided by operating activities			8,215				6,960
Investing Activities
Proceeds from maturities of investment securities held to maturity			15,855				12,106
Proceeds from maturities of investment securities available for sale			51,000				21,503
Purchases of investment securities held to maturity			(31,426	)			(28,392	)
Purchases of investment securities available for sale			(57,986	)			(17,180	)
Net (increase) decrease in loans			18,844				(46,464	)
Purchases of bank premises and equipment			(1,829	)			(5,941	)
Net cash used by investing activities			(5,542	)			(64,368	)
Financing Activities
Net increase (decrease) in deposits			115,219				(68,404	)
Net increase in short term borrowings			3,463				656
Net change in FHLB borrowings			—				20,000
Net change in revolving line of credit			—				1,300
Income tax benefit from deferred stock compensation (ASC 718)			399				227
Proceeds from issuance of stock			1,057				591
Repurchase of stock			(1,713	)			(2,910	)
Net cash provided (used) by financing activities			118,425				(48,540	)
Increase (decrease) in cash and cash equivalents			121,098				(105,948	)
Cash and cash equivalents at beginning of year			31,420				162,323
Cash and cash equivalents at end of period		$	152,518			$	56,375
Interest paid		$	9,100			$	17,012
Income taxes paid		$	78			$	2,308

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation

																		Accumulated
										Additional								Other
		Common				Treasury				Paid In				Retained				Comprehensive
(Dollars in thousands)		Stock				Stock				Capital				Earnings				Income				TOTAL
Balance at December 31, 2007		$	32,105			$	(14,979	)		$	7,181			$	44,171			$	460			$	68,938
Comprehensive income:
Net income			—				—				—				3,399				—				3,399
Other comprehensive income
Net unrealized loss on investments, net of tax of $50			—				—				—				—				(76	)			(76	)
Total comprehensive income			—				—				—				—				—				3,323
Income tax benefit from deferred stock compensation			—				—				227				—				—				227
Issuance of stock 26,473 shares of common stock under stock-based compensation plans			782				—				(91	)											691
Repurchase of stock 56,086 shares of common stock			—				(2,910	)			—				—				—				(2,910	)
Stock based compensation earned			—				—				891				—				—				891
Balance at September 30, 2008		$	32,887			$	(17,889	)		$	8,208			$	47,570			$	384			$	71,160
Balance at December 31, 2008		$	33,136			$	(18,481	)		$	8,766			$	47,955			$	836			$	72,212
Comprehensive income:
Net income			—				—				—				716				—				716
Other comprehensive income
Net unrealized loss on investments, net of tax of $482			—				—				—				—				(751	)			(751	)
Total comprehensive income																							(35	)
Income tax benefit from deferred stock compensation			—				—				399				—				—				399
Issuance of 57,271 shares of common stock under stock-based compensation plans			1,162				—				(5	)			—				—				1,157
Repurchase of 45,184 shares of common stock			—				(1,713	)			—				—				—				(1,713	)
Stock based compensation earned			—				—				1,128				—				—				1,128
Balance at September 30, 2009		$	34,298			$	(20,194	)		$	10,288			$	48,671			$	85			$	73,148

See notes to consolidated financial statements.

The National Bank of Indianapolis
Corporation

Notes to Consolidated Financial Statements
September 30, 2009

Note 1: Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of The National Bank of Indianapolis Corporation (“Corporation”) and its wholly-owned subsidiary, The National Bank of Indianapolis (“Bank”). All intercompany transactions between the Corporation and its subsidiary have been properly eliminated. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine month period ended September 30, 2009, are not necessarily indicative of the results that may be expected for the year ended December 31, 2009. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation’s Form 10-K for the year ended December 31, 2008.

Note 2: Investment Securities

The securities available-for-sale and held-to-maturity are summarized as follows:

		Available-for-Sale Securities
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
(Dollars in thousands)		Cost				Gain				Loss				Value
September 30, 2009
U.S. Treasury securities		$	508			$	—			$	—			$	508
U.S. Government agencies			61,986				161				20			$	62,127
		$	62,494			$	161			$	20			$	62,635
December 31, 2008
U.S. Treasury securities		$	494			$	5			$	—			$	499
U.S. Government agencies			55,109				1,369				—				56,478
		$	55,603			$	1,374			$	—			$	56,977

		Held-to-Maturity Securities
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
(Dollars in thousands)		Cost				Gain				Loss				Value
September 30, 2009
Municipals		$	55,397			$	2,225			$	23			$	57,599
Collateralized mortgage obligations			32,024				103				10			$	32,117
Mortgage backed securities			11,447				154				—			$	11,601
Other securities			175				—				—			$	175
		$	99,043			$	2,482			$	33			$	101,492
December 31, 2008
Municipals		$	56,874			$	213			$	800			$	56,287
Collateralized mortgage obligations			8,825				12				—				8,837
Mortgage backed securities			17,693				45				66				17,672
Other securities			175				—				—				175
		$	83,567			$	270			$	866			$	82,971

The fair value of debt securities and carrying amount, if different, at September 30, 2009, by contractual maturity were as follows. Securities not due at a single maturity date, primarily mortgage-backed securities are shown separately.

		Held to Maturity								Available for Sale
		Carrying				Fair				Amortized				Fair
		Amount				Value				Cost				Value
		(Dollars in thousands)
Due in one year or less		$	7,350			$	7,448			$	10,593			$	10,681
Due from one to five years			10,059				10,377				51,901				51,954
Due from five to ten years			37,972				39,746				—				—
Due after ten years			191				203				—				—
CMO/Mortgage-backed			43,471				43,718				—				—
Total		$	99,043			$	101,492			$	62,494			$	62,635

Securities with unrealized losses at September 30, 2009, and December 31, 2008, aggregated by investment category and length of time that individuals securities have been in a continuous unrealized loss position are as follows:

		Less Than 12 Months								12 Months or More								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(Dollars in thousands)		Value				Loss				Value				Loss				Value				Loss
September 30, 2009
U.S. Government agencies		$	17,176			$	20			$	—			$	—			$	17,176			$	20
U.S. Treasury securities			508				—												508				—
Collateralized mortgage obligations			5,776				10				—				—				5,776				10
Municipal bonds			—				—				1,438				23				1,438				23
Other securities			—				—				25				—				25				—
Total temporarily impaired		$	23,460			$	30			$	1,463			$	23			$	24,923			$	53
December 31, 2008
Collateralized mortgage obligations		$	—			$	—			$	2,783			$	—			$	2,783			$	—
Mortgage backed securities			14,035				66				—				—				14,035				66
Municipal bonds			7,981				21				33,281				778				41,261				800
Other securities			—				—				25				—				25				—
Total temporarily impaired		$	22,016			$	87			$	36,089			$	778			$	58,104			$	866

As of September 30, 2009, the Corporation held 12 investments in which the amortized cost was greater than fair value.

The unrealized loss for investments classified as available-for-sale is attributable to changes in interest rates and individually is 0.27% or less of its respective amortized cost. The unrealized loss relates to one security issued by the Federal Home Loan Bank (“FHLB”). Given this investment is backed by the U.S. Government and its agencies, there is no credit risk.

The unrealized losses for investments classified as held-to-maturity are attributable to changes in interest rates and/or economic environment and individually were 4.03% or less of their respective amortized costs. The unrealized losses relate primarily to securities issued by various municipalities. The majority of these investment securities were purchased during 2005 and first quarter of 2006 when rates were lower. The largest unrealized loss relates to one municipal that was purchased February 2006. The credit rating of the individual municipalities is assessed monthly. As of September 30, 2009, all but five of the municipal debt securities were rated BBB or better (as a result of insurance or the underlying rating on the bond). The five municipal debt securities have no underlying rating. Credit reviews of the municipalities have been conducted. As a result, we have determined that all of our non-rated debt securities would be rated a “pass” asset and thus classified as an investment grade security. All interest payments are current for all municipal securities and management expects all to be collected in accordance with contractual terms.

There were no sales of securities during the nine month period ending September 30, 2009 and 2008.

Investment securities with a carrying value of approximately $60 million and $51 million were pledged as collateral for Wealth Management accounts and securities sold under agreements to repurchase at September 30, 2009, and December 31, 2008, respectively.

Note 3: Loans

Loans, including net unamortized deferred fees and costs, consist of the following:

		September 30, 2009				December 31, 2008
		(Dollars in thousands)
Residential loans secured by real estate		$	252,961			$	260,354
Commercial loans secured by real estate			235,381				217,445
Construction loans			79,441				83,822
Other commercial and industrial loans			284,360				307,409
Consumer loans			29,665				35,177
Total loans			881,808				904,207
Less allowance for loan losses			(16,886	)			(12,847	)
Total loans, net		$	864,922			$	891,360

The Corporation periodically sells residential mortgage loans it originates based on the overall loan demand of the Corporation and outstanding balances of the residential mortgage portfolio. As of September 30, 2009, and December 31, 2008, loans held for sale totaled $315 thousand and $969 thousand, respectively, and are included in the totals above.

There were no loans pledged as collateral for FHLB advances as of September 30, 2009, and December 31, 2008.

Activity in the allowance for loan losses was as follows:

		Three months ended								Nine months ended
		September 30,								September 30,
		2009				2008				2009				2008
		(Dollars in thousands)
Beginning balance		$	14,077			$	10,582			$	12,847			$	9,453
Loan charge offs			(1,171	)			(687	)			(3,903	)			(2,937	)
Recoveries			25				173				87				377
Provision for loan losses			3,955				1,800				7,855				4,975
Ending balance		$	16,886			$	11,868			$	16,886			$	11,868

Note 4: Mortgage Banking Activities

The unpaid principal balances of mortgage loans serviced for others were $149.2 million and $125.4 million at September 30, 2009, and December 31, 2008, respectively.

Custodial escrow balances maintained in connection with serviced loans were $1.7 million and $1.2 million at September 30, 2009, and December 31, 2008, respectively.

The following table includes activity for mortgage servicing rights:

		Nine months ended				Twelve months ended
		September 30, 2009				December 31, 2008
		(Dollars in thousands)
Balance at January 1		$	1,070			$	1,348
Plus additions		$	608			$	437
Fair value adjustments		$	(347	)		$	(715	)
Net ending balance		$	1,331			$	1,070

Mortgage servicing rights are carried at fair value at September 30, 2009, and December 31, 2008. Fair value at September 30, 2009, was determined using discount rates ranging from 11.0% to 17.0%, prepayment speeds ranging from 11.9% to 26.8%, depending on the stratification of the specific right, and a weighted average default rate of 0.38%. Fair value at December 31, 2008, was determined using discount rates ranging from 11.0% to 17.0%, prepayment speeds ranging from 11.0% to 29.7%, depending on the stratification of the specific right, and a weighted average default rate of 0.54%.

Note 5: Subordinated Term Loan Agreement/Revolving Line of Credit

On June 29, 2007, the Bank entered into a Subordinated Debenture Purchase Agreement with U.S. Bank in the amount of $5.0 million, which will mature on June 28, 2017. Under the terms of the Subordinated Debenture Purchase Agreement, the Bank pays 3-month LIBOR plus 1.20% which equated to 1.51% at September 30, 2009. Interest payments are due quarterly.

On June 29, 2007, the Corporation entered into a $5.0 million loan agreement with U.S. Bank, which matured on June 27, 2009, and was renewed and matured on August 31, 2009. The loan agreement was used to provide additional liquidity support to the Corporation, if needed. On September 5, 2008, and December 11, 2008, the Corporation drew $1.3 million and $2.9 million, respectively, on the revolving loan agreement with U.S. Bank.

On August 31, 2009, U.S. Bank renewed the revolving loan agreement which will mature on August 31, 2010. As part of the renewal of the revolving loan agreement, U.S. Bank reduced the revolving loan amount from $5.0 million to $2.0 million. Of the $4.2 million outstanding, $3.0 million was moved to a separate one-year term facility with principal payments of $62.5 thousand and interest payments due quarterly. Under the terms of the one-year term facility, the Corporation paid prime plus 1.25% which equates to 4.50% at September 30, 2009.

Under the terms of the revolving loan agreement, the Corporation paid prime minus 1.25% which equates to 2.00% through August 31, 2009 and interest payments were due quarterly. Beginning September 1, 2009, the Corporation paid prime plus 1.25% which equates to 4.50% at September 30, 2009. In addition, beginning October 1, 2009, U.S. Bank will assess a 0.25% fee on the unused portion of the revolving line of credit.

The revolving loan agreement contains various financial and non-financial covenants. One of these covenants requires the Bank to maintain a return on assets of at least 0.30%. The Bank was in violation of this covenant as of September 30, 2009, as its return on assets was 0.27%. At this time, U.S. Bank has not indicated an intention to exercise any of its remedies available under the credit facility as a result of the Corporation’s covenant violation. The remedies available to U.S. Bank are: make the note immediately due and payable; termination of the obligation to extend further credit; and/or invoke default interest rate of 3.0% over current interest rate. Management does not believe the impact of any of these remedies would have a material impact on the Corporation’s results of operation or financial position.

Note 6: Trust Preferred Securities

In September 2000, the Corporation established the NBIN Statutory Trust I (“Trust”), a Connecticut statutory business trust, which subsequently issued $13.5 million of company obligated mandatorily redeemable capital securities and $418 thousand of common securities. The proceeds from the issuance of both the capital and common securities were used by the Trust to purchase from the Corporation $13.9 million fixed rate junior subordinated debentures. The capital securities and debentures mature September 7, 2030, or upon earlier redemption as provided by the Indenture. The Corporation has the right to redeem the capital securities, in whole or in part, but in all cases, in a principal amount with integral multiples of a thousand dollars on any March 7 or September 7 on or after September 7, 2010, at a premium, declining ratably to par on September 7, 2020. The capital securities and the debentures have a fixed interest rate of 10.60%, and are guaranteed by the Bank. The subordinated debentures are the sole assets of the Trust. The net proceeds received by the Corporation from the sale of capital securities were used for general corporate purposes. The indenture, dated September 7, 2000, requires compliance with certain non-financial covenants.

In accordance with accounting standards, the Corporation does not consolidate the Trust in its financial statements. The junior subordinated debt obligation issued to the Trust of $13.9 million is reflected in the Corporation’s consolidated balance sheets at September 30, 2009, and December 31, 2008. The junior subordinated debentures owed to the Trust and held by the Corporation qualify as Tier 1 capital for the Corporation under Federal Reserve Board guidelines.

Interest payments made on the junior subordinated debentures are reported as a component of interest expense on long-term debt.

Note 7: Stock Based Compensation

During the first quarter of 2009, nine officers of the Corporation exercised options to purchase 24,600 common shares in aggregate. The weighted average exercise price was $19.15 and the weighted average fair market value of the stock was $37.04.

During the second quarter of 2009, two directors and nine officers of the Corporation exercised options to purchase 30,100 common shares in aggregate. The weighted average exercise price was $19.47 and the weighted average fair market value of the stock was $38.82.

During the third quarter of 2009 no directors or officers of the Corporation exercised options to purchase common shares.

Due to the exercise of these options and the vesting of restricted stock for the nine months ended September 30, 2009, the Corporation will receive a deduction for tax purposes for the difference between the fair value of the stock at the date of grant and the date of exercise. In accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 718, guidance on Stock Compensation, the Corporation has recorded the income tax benefit of $399 thousand as additional paid in capital for the nine months ended September 30, 2009.

Note 8: Earnings per Share

The following table sets forth the computation of basic and diluted earnings per share:

		Three months ended								Nine months ended
		September 30,								September 30,
		2009				2008				2009				2008
		(in thousands, except per share amounts)
Basic average shares outstanding (in thousands)			2,306				2,306				2,300				2,316
Net income		$	(208	)		$	1,643			$	716			$	3,399
Basic net income per common share		$	(0.09	)		$	0.71			$	0.31			$	1.47
Diluted
Average shares outstanding			2,306				2,306				2,300				2,316
Nonvested restricted stock			26				17				12				14
Net effect of the assumed exercise of stock options			25				64				30				67
Diluted average shares			2,357				2,387				2,342				2,397
Net income		$	(208	)		$	1,643			$	716			$	3,399
Diluted net income per common share		$	(0.09	)		$	0.69			$	0.31			$	1.42

For the three and nine month period ending September 30, 2009, options to purchase 192 thousand and 190 thousand shares respectively, and 4 thousand and 47 thousand restricted shares, respectively, were outstanding but not included in the computation of diluted earnings per share because they were antidilutive.

For the three and nine month period ending September 30, 2008, there were no antidilutive options or restricted stock.

Note 9: Comprehensive Income

The following is a summary of activity in accumulated other comprehensive income:

		Three months ended								Nine months ended
		September 30,								September 30,
		2009				2008				2009				2008
		(Dollars in thousands)
Accumulated other comprehensive income beginning of period, net of tax		$	285			$	515			$	836			$	460
Net unrealized gain (loss) for period			(327	)			(218	)			(1,233	)			(126	)
Tax effect			127				87				482				50
Accumulated other comprehensive income at end of period, net of tax		$	85			$	384			$	85			$	384

Note 10: Commitments and Contingencies

Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used and the total commitment amounts do not necessarily represent future cash-flow requirements.

Stand by letter of credit agreements are conditional commitments issued to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party.

Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at origination of the commitment.

The contractual amount of financial instruments with off-balance sheet risk was as follows:

		September 30, 2009				December 31, 2008
		(Dollars in thousands)
Unused commercial credit lines		$	213,783			$	231,795
Unused revolving home equity and credit card lines			99,971				98,925
Standby letters of credit			23,397				24,224
Demand deposit account lines of credit			2,492				2,917
		$	339,643			$	357,861

The majority of commitments to fund loans are variable rate. The demand deposit account lines of credit are a fixed rate at 18% with no maturity.

The credit risk associated with loan commitments and standby letters of credit is essentially the same as that involved in extending loans to customers and is subject to normal credit policies. Collateral may be obtained based on management’s credit assessment of the customer.

The Corporation is party to various lawsuits and proceedings arising in the ordinary course of business. In addition, many of these proceedings are pending in jurisdictions that permit damage awards disproportionate to the actual economic damages alleged to have been incurred. Based upon information presently available, we believe that the total amounts, if any, that will ultimately be paid arising from these lawsuits and proceedings will not have a material adverse effect on our consolidated results of operations or financial position.

Note 11: Fair Value

FASB ASC 820, Fair Value, establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

FASB ASC 820 describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair value of available-for-sale securities are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on securities’ relationship to other benchmark quoted securities (Level 2 inputs).

Mortgage servicing rights are carried at fair value as permitted by FASB ASC 860, Transfers and Servicing. The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. The Corporation is able to compare the valuation model inputs and results to widely available published industry data for reasonableness.

The fair value of impaired loans with specific allocations of the allowance for loan losses and other real estate is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:

						Fair Value Measurements at Reporting Date Using:
						Quoted Prices in
						Active Markets				Significant Other				Significant
						for Identical Assets				Observable Inputs				Unobservable Inputs
(Dollars in thousands)		September 30, 2009				(Level 1)				(Level 2)				(Level 3)
Assets:
Available for sale securities		$	62,635			$	—			$	62,635			$	—
Mortgage servicing rights			1,331				—				1,331				—
		December 31, 2008
Assets:
Available for sale securities		$	56,977			$	—			$	56,977			$	—
Mortgage servicing rights			1,070				—				1,070				—

A detailed break down of the fair value for the available-for-sale investment securities is provided in Note 2 Investment Securities.

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

						Fair Value Measurements at Reporting Date Using:
						Quoted Prices in
						Active Markets				Significant Other				Significant
						for Identical Assets				Observable Inputs				Unobservable Inputs
(Dollars in thousands)		September 30, 2009				(Level 1)				(Level 2)				(Level 3)
Assets:
Impaired loans		$	7,861			$	—			$	—			$	7,861
Other real estate			6,521				—				—				6,521
		December 31, 2008
Assets:
Impaired loans		$	4,522			$	—			$	—			$	4,522
Other real estate			3,414				—				—				3,414

Impaired loans had a carrying amount of $14.0 million, with a valuation allowance of $6.1 million, resulting in an additional provision for loan losses of $7.6 million for the nine month period ending September 30, 2009.

Impaired loans had a carrying amount of $6.2 million, with a valuation allowance of $1.7 million, resulting in an additional provision for loan losses of $4.6 million for the twelve month period ending December 31, 2008.

Other real estate is carried at lower of cost or fair value and was written down to a fair value of $6.5 million resulting in a charge of $157 thousand to earnings for the nine month period ending September 30, 2009.

Other real estate is carried at lower of cost or fair value and was written down to a fair value of $3.4 million resulting in a charge of $76 thousand to earnings for the twelve month period ending December 31, 2008.

The estimated fair value of the Corporation’s financial instruments is as follows:

		September 30, 2009								December 31, 2008
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
		(Dollars in thousands)
Assets
Cash and due from banks		$	149,661			$	149,661			$	29,819			$	29,819
Federal funds sold			1,857				1,857				601				601
Reverse repurchase agreements			1,000				1,000				1,000				1,000
Investment securities available-for-sale			62,635				62,635				56,977				56,977
Investment securities held-to-maturity			99,043				101,492				83,567				82,971
Net loans			864,922				864,488				891,360				904,043
Federal Reserve and FHLB stock			3,150				N/A				3,150				N/A
Accrued interest receivable			4,414				4,414				4,855				4,855
Liabilities
Deposits			1,081,185				1,083,551				965,966				967,071
Security repurchase agreements			54,609				54,609				51,146				51,146
Revolving line of credit			4,200				4,200				4,200				4,200
Subordinated debt			5,000				5,000				5,000				4,997
Junior subordinated debentures			13,918				10,067				13,918				9,962
Accrued interest payable			1,876				1,876				2,222				2,222

The following methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments not recorded at fair value:

Carrying amount is the estimated fair value for cash and short-term investments, interest bearing deposits, accrued interest receivable and payable, demand deposits, borrowings under repurchase agreements, variable rate loans or deposits that reprice frequently and fully. Fair values for available-for-sale and held-to-maturity investment securities are determined as previously described. For fixed rate loans or deposits or for variable rate loans or deposits with infrequent pricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. It was not practicable to determine the fair value of Federal Reserve or FHLB stock due to restrictions placed on its transferability. The fair value of the revolving line of credit, subordinated debt and junior subordinated debentures are based upon discounted cash flows using rates for similar securities with the same maturities. The fair value of off-balance-sheet items is not considered material.

Note 12: Adoption of New Accounting Standards

FASB ASC 805 - In December 2007, the FASB issued an update to FASB ASC 805, Business Combinations, which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. This update is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption was prohibited. The adoption of this standard did not have a material effect on the Corporation’s results of operations or financial position and will apply to any business combinations prospectively.

FASB ASC 810 - In December 2007, the FASB issued an update to FASB ASC 810, Consolidation, related to the guidance on accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity within the consolidated balance sheets. This update is effective as of the beginning of the first fiscal year beginning on or after December 15, 2008. Earlier adoption was prohibited. The adoption of this standard did not have a material impact on the Corporation’s results of operations or financial position.

FASB ASC 815 - In March 2008, the FASB issued an update to FASB ASC 815, Derivatives and Hedging, related to the guidance on qualitative disclosure about objectives and strategies for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements. This update is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. Upon adoption, the Corporation included the required disclosures, as applicable.

FASB ASC 820 - In April 2009, the FASB issued an update to FASB ASC 820, Fair Value Measurements and Disclosures, related to guidance on providing additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. This update also includes guidance on identifying circumstances that indicate a transaction is not orderly. This issue is effective for reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of this standard did not have a material effect on the Corporation’s results of operations or financial position.

FASB ASC 825 - In April 2009, the FASB ASC 825, Financial Instruments, was updated to require disclosures about fair value of financial instruments in interim reporting periods of publicly traded companies that were previously only required to be disclosed in annual financial statements. The update to FASB ASC 825 is effective for the Corporation’s interim period ending on June 30, 2009. The updates to FASB ASC 825 amend only the disclosure requirements about fair value of financial instruments in interim periods. The Corporation included the required disclosures, as applicable.

FASB ASC 320 - In April 2009, the FASB ASC 320, Investments — Debt and Equity, amends current other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This update does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The updates to FASB ASC 320 were effective for the Corporation’s interim period ending on June 30, 2009. The adoption of this standard did not have a material effect on the Corporation’s results of operations or financial position.

FASB ASC 855 - In May 2009, the FASB issued FASB ASC 855, Subsequent Events. FASB ASC 855 establishes the period after the balance sheet date during which management shall evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements and the circumstances under which an entity shall recognize events or transactions that occur after the balance sheet date. FASB ASC 855 also requires disclosure of the date through which subsequent events have been evaluated. The new standard becomes effective for interim and annual periods ending after June 15, 2009. The Corporation adopted this standard for the interim reporting period ending June 30, 2009. The adoption of this statement did not have a material impact on the Corporation’s consolidated financial position or results of operations. These financial statements consider events that occurred through November 6, 2009, the date the financial statements were issued.

FASB ASC 105 - In June 2009, the FASB issued an update to FASB ASC 105, Generally Accepted Accounting Principles. The update is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The FASB Accounting Standards Codification became the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. On the effective date of this Statement, the Codification superseded all then-existing non-SEC accounting and reporting standards and all the contents in the Codification carries the same level of authority. Following this Statement, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. The adoption of this standard did not have a material effect on the Corporation’s results of operations or financial position.

FASB ASC 860 - In June 2009, the FASB issued new guidance impacting FASB ASC 860, Transfers and Servicing. The new guidance amends ASC 860 and removes the concept of a qualifying special-purpose entity and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. The new standard will become effective for the Corporation on January 1, 2010. The Corporation is currently evaluating the impact of adopting the new standard on the consolidated financial statements.

FASB ASC 810-10 - In June 2009, the FASB issued new guidance impacting FASB ASC 810-10, Consolidation (Statement No. 167 — Amendments to FASB Interpretation No. 46(R)). The new guidance amends tests for variable interest entities to determine whether a variable interest entity must be consolidated. FASB ASC 810-10 requires an entity to perform an analysis to determine whether an entity’s variable interest or interests give it a controlling financial interest in a variable interest entity. This standard requires ongoing reassessments of whether an entity is the primary beneficiary of a variable interest entity and enhanced disclosures that provide more transparent information about an entity’s involvement with a variable interest entity. The new guidance will become effective for the Corporation on January 1, 2010 and the Corporation is currently evaluating the impact of adopting the standard on the consolidated financial statements.

FASB ASC 820-05 - In August 2009, the FASB issued new guidance impacting FASB ASC 820, Fair Value Measurements and Disclosures. The update is effective for the first reporting period including interim periods after the issuance. The update reduces potential ambiguity in financial reporting when measuring the fair value of liabilities by providing clarification for circumstances in which a quoted price in an active market for the identical liability is not available. A reporting entity is required to measure fair value using one or more of the following techniques: A valuation technique that uses the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as an asset. Another valuation technique consistent with the principals of FASB ASC 820 would be an income approach such as present value technique or a market approach based on the amount at the measurement date that the reporting entity would pay to transfer the identical liability or would receive to enter into the identical liability. The adoption of this standard did not have a material effect on the Corporation’s results of operations or financial position.

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