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

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 August 6, 2010
[Common Stock, no par value per share]		2,318,367

 

 

Table of Contents
The National Bank of Indianapolis Corporation

Report on Form 10-Q
for Quarter Ended
June 30, 2010

PART I — FINANCIAL INFORMATION
Item 1.				Consolidated Financial Statements (Unaudited)
				Consolidated Balance Sheets — June 30, 2010 and December 31, 2009			1
				Consolidated Statements of Income — Three Months ended June 30, 2010 and 2009			2
				Six Months ended June 30, 2010 and 2009			3
				Consolidated Statements of Cash Flows — Six Months ended June 30, 2010 and 2009			4
				Consolidated Statements of Shareholders’ Equity — Six Months ended June 30, 2010 and 2009			5
				Notes to Consolidated Financial Statements			6
Item 2.				Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
Item 3.				Quantitative and Qualitative Disclosures about Market Risk			29
Item 4.				Controls and Procedures			30
PART II — OTHER INFORMATION
Item 1.				Legal Proceedings			30
Item 1A.				Risk Factors			30
Item 2.				Unregistered Sales of Equity Securities and Use of Proceeds			31
Item 3.				Defaults Upon Senior Securities			32
Item 4.				(Removed and Reserved)			32
Item 5.				Other Information			32
Item 6.				Exhibits			32
				Signatures			34
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
Consolidated Balance Sheets
(Unaudited, Dollars in thousands except share data)

		June 30, 2010				December 31, 2009
Assets
Cash and cash equivalents
Cash and due from banks		$	166,140			$	149,375
Reverse repurchase agreements			1,000				1,000
Federal funds sold			13,631				1,242
Total cash and cash equivalents			180,771				151,617
Investment securities
Available-for-sale securities			74,758				67,296
Held-to-maturity securities (Fair value of $100,031 at June 30, 2010 and $96,588 at December 31, 2009)			97,009				94,922
Total investment securities			171,767				162,218
Loans held for sale			10,337				884
Loans			878,583				863,838
Less: Allowance for loan losses			(15,523	)			(13,716	)
Net loans			863,060				850,122
Premises and equipment			24,122				24,532
Deferred tax asset			7,909				7,133
Accrued interest			4,126				4,199
Federal Reserve and FHLB stock			3,150				3,150
Other real estate owned			6,370				8,432
Other assets			21,108				21,343
Total assets		$	1,292,720			$	1,233,630
Liabilities and shareholders’ equity
Deposits:
Noninterest-bearing demand deposits		$	197,208			$	192,705
Money market and savings deposits			704,277				650,353
Time deposits over $100,000			126,135				131,938
Other time deposits			79,581				77,069
Total deposits			1,107,201				1,052,065
Other short term borrowings			80,258				81,314
FHLB advances			—				—
Short term debt			4,013				4,138
Subordinated debt			5,000				5,000
Junior subordinated debentures owed to unconsolidated subsidiary trust			13,918				13,918
Other liabilities			6,425				4,164
Total liabilities			1,216,815				1,160,599
Shareholders’ equity:
Preferred stock, no par value — authorized 5,000,000 shares			—				—
Common stock, no par value — authorized 15,000,000 shares issued 2,858,994 shares at June 30, 2010 and 2,840,382 shares at December 31, 2009			35,021				34,440
Treasury stock, at cost; 543,174 shares at June 30, 2010 and 533,204 shares at December 31, 2009			(20,726	)			(20,346	)
Additional paid in capital			11,700				10,873
Retained earnings			49,525				48,067
Accumulated other comprehensive income (loss)			385				(3	)
Total shareholders’ equity			75,905				73,031
Total liabilities and shareholders’ equity		$	1,292,720			$	1,233,630

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation
Consolidated Statements of Income
(Unaudited, Dollars in thousands except per share data)

		Three months ended
		June 30,
		2010				2009
Interest income:
Interest and fees on loans		$	10,529			$	10,431
Interest on investment securities taxable			536				789
Interest on investment securities nontaxable			527				521
Interest on federal funds sold			4				1
Interest on due from banks			90				53
Total interest income			11,686				11,795
Interest expense:
Interest on deposits			1,808				2,359
Interest on other short term borrowings			73				55
Interest on short term debt			47				21
Interest on long term debt			388				399
Total interest expense			2,316				2,834
Net interest income			9,370				8,961
Provision for loan losses			1,234				2,650
Net interest income after provision for loan losses			8,136				6,311
Other operating income:
Wealth management fees			1,467				1,336
Rental income			76				79
Service charges and fees on deposit accounts			749				756
Mortgage banking income			268				647
Interchange income			314				243
Net loss on sale of securities			(5	)			—
Other			438				508
Total other operating income			3,307				3,569
Other operating expenses:
Salaries, wages and employee benefits			6,179				5,403
Occupancy			647				641
Furniture and equipment			330				355
Professional services			554				427
Data processing			802				689
Business development			459				417
FDIC Insurance			501				942
Non performing assets			147				264
Other			845				922
Total other operating expenses			10,464				10,060
Income before tax			979				(180	)
Federal and state income tax (benefit)			143				(259	)
Net income		$	836			$	79
Basic earnings per share		$	0.36			$	0.03
Diluted earnings per share		$	0.35			$	0.03

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation
Consolidated Statements of Income
(Unaudited, Dollars in thousands except per share data)

		Six months ended
		June 30,
		2010				2009
Interest income:
Interest and fees on loans		$	20,986			$	20,676
Interest on investment securities taxable			1,119				1,661
Interest on investment securities nontaxable			1,015				1,044
Interest on federal funds sold			5				3
Interest on due from banks			176				76
Total interest income			23,301				23,460
Interest expense:
Interest on deposits			3,696				5,062
Interest on other short term borrowings			144				85
Interest on short term debt			94				42
Interest on long term debt			776				802
Total interest expense			4,710				5,991
Net interest income			18,591				17,469
Provision for loan losses			2,469				3,900
Net interest income after provision for loan losses			16,122				13,569
Other operating income:
Wealth management fees			2,671				2,421
Rental income			145				185
Service charges and fees on deposit accounts			1,518				1,524
Mortgage banking income			480				949
Interchange income			598				453
Net loss on sale of securities			(5	)			—
Other			833				1,040
Total other operating income			6,240				6,572
Other operating expenses:
Salaries, wages and employee benefits			12,113				10,757
Occupancy			1,288				1,232
Furniture and equipment			659				700
Professional services			1,143				932
Data processing			1,527				1,399
Business development			890				826
FDIC Insurance			1,035				1,297
Non performing assets			304				285
Other			1,727				1,842
Total other operating expenses			20,686				19,270
Income before tax			1,676				871
Federal and state income tax (benefit)			218				(53	)
Net income		$	1,458			$	924
Basic earnings per share		$	0.63			$	0.40
Diluted earnings per share		$	0.62			$	0.40

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation
Consolidated Statements of Cash Flows
(Unaudited, Dollars in thousands)

		Six months ended
		June 30,
		2010				2009
Operating Activities
Net Income		$	1,458			$	924
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Provision for loan losses			2,469				3,900
Proceeds from sale of loans			25,325				40,107
Origination of loans held for sale			(17,972	)			(39,138	)
Depreciation and amortization			757				770
Fair value adjustment on mortgage servicing rights			438				141
Loss on sales of investment securities available for sale			5				—
Gain on sale of loans			(714	)			(927	)
Net gain on sales and writedowns of other real estate and repossessions			(75	)			74
Net increase in deferred income taxes			(1,031	)			(778	)
Net increase in bank owned life insurance			(194	)			(211	)
Excess tax benefit from deferred stock compensation			(50	)			(400	)
Net accretion of discounts and amortization of premiums on investments			568				110
Compensation expense related to restricted stock and options			866				705
Changes in:
Accrued interest receivable			73				201
Other assets			(8	)			(1,979	)
Changes in:
Other liabilities			2,311				4,516
Net cash provided provided by operating activities			14,226				8,015
Investing Activities
Proceeds from maturities of investment securities held to maturity			13,292				11,077
Proceeds from maturities of investment securities available for sale			5,500				10,000
Proceeds from sales of investment securities held to maturity			477				—
Purchases of investment securities held to maturity			(16,057	)			—
Purchases of investment securities available for sale			(12,692	)			(15,601	)
Net increase in loans			(32,321	)			(5,628	)
Proceeds from sales of other real estate and repossessions			2,959				1,170
Purchases of bank premises and equipment			(347	)			(1,097	)
Net cash used by investing activities			(39,189	)			(79	)
Financing Activities
Net increase in deposits			55,136				61,428
Net increase (decrease) in short term borrowings			(1,056	)			19,744
Net change in revolving line of credit			(125	)			—
Income tax benefit from deferred stock compensation			50				400
Proceeds from issuance of stock			492				1,057
Repurchase of stock			(380	)			(1,713	)
Net cash provided by financing activities			54,117				80,916
Increase in cash and cash equivalents			29,154				88,852
Cash and cash equivalents at beginning of year			151,617				31,420
Cash and cash equivalents at end of year		$	180,771			$	120,272
Interest paid		$	4,835			$	5,851
Income taxes paid		$	837			$	26

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation
Consolidated Statement of Shareholders’ Equity
(Unaudited, Dollars in thousands except share data)

																		Accumulated
										Additional								Other
		Common				Treasury				Paid In				Retained				Comprehensive
		Stock				Stock				Capital				Earnings				Income				TOTAL
Balance at December 31, 2008		$	33,136			$	(18,481	)		$	8,766			$	47,955			$	836			$	72,212
Comprehensive income:
Net income			—				—				—				924				—				924
Other comprehensive income
Net unrealized loss on investments, net of tax of $355			—				—				—				—				(551	)			(551	)
Total comprehensive income																							373
Income tax benefit from deferred stock compensation			—				—				400				—				—				400
Issuance of stock 54,700 shares of common stock under stock-based compensation plans			1,062				—				(5	)			—				—				1,057
Repurchase of stock 45,184 shares of common stock			—				(1,713	)			—				—				—				(1,713	)
Stock based compensation earned			—				—				705				—				—				705
Balance at June 30, 2009		$	34,198			$	(20,194	)		$	9,866			$	48,879			$	285			$	73,034
Balance at December 31, 2009		$	34,440			$	(20,346	)		$	10,873			$	48,067			$	(3	)		$	73,031
Comprehensive income:
Net income			—				—				—				1,458				—				1,458
Other comprehensive income
Net unrealized gain on investments, net of tax of $255			—				—				—				—				388				388
Total comprehensive income																							1,846
Income tax benefit from deferred stock compensation			—				—				50				—				—				50
Issuance of 18,611 shares of common stock under stock-based compensation plans			581				—				(89	)			—				—				492
Repurchase of 9,969 shares of common stock			—				(380	)			—				—				—				(380	)
Stock based compensation earned			—				—				866				—				—				866
Balance at June 30, 2010		$	35,021			$	(20,726	)		$	11,700			$	49,525			$	385			$	75,905

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

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 six month period ended June 30, 2010, are not necessarily indicative of the results that may be expected for the year ended December 31, 2010. 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, 2009.

Note 2: Investment Securities

The following is a summary of available-for-sale and held-to-maturity securities:

						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gain				Loss				Value
June 30, 2010
Available-for-sale
U.S. Treasury securities		$	7,696			$	2			$	—			$	7,698
U.S. Government agencies			66,424				636				—				67,060
Total available-for-sale		$	74,120			$	638			$	—			$	74,758
Held-to-maturity
Municipal securities		$	60,315			$	2,380			$	86			$	62,609
Collateralized mortgage obligations, residential			32,764				705				32				33,437
Mortgage backed securities, residential			3,780				55				—				3,835
Other securities			150				—				—				150
Total Held-to-maturity		$	97,009			$	3,140			$	118			$	100,031

						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gain				Loss				Value
December 31, 2009
Available-for-sale
U.S. Treasury securities		$	506			$	—			$	—			$	506
U.S. Government agencies			66,795				97				102				66,790
Total available-for-sale		$	67,301			$	97			$	102			$	67,296
Held-to-maturity
Municipal securities		$	54,913			$	1,805			$	47			$	56,671
Collateralized mortgage obligations, residential			30,124				29				232				29,921
Mortgage backed securities, residential			9,735				111				—				9,846
Other securities			150				—				—				150
Total Held-to-maturity		$	94,922			$	1,945			$	279			$	96,588

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

The fair value of debt securities and carrying amount, if different, at June 30, 2010, by contractual maturity were as follows. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. There was one sale of a held-to-maturity municipal security with a net carrying amount of $483 thousand that was sold for a loss of $5 thousand during the six month period ending June 30, 2010. Since the security had a non-rated issuer, a credit review of the municipality was conducted. As a result of the review, it was determined that the investment was no longer considered a pass asset and thus below investment grade. Per investment policy, the Corporation is prohibited from holding any securities below investment grade.

		June 30, 2010
		Amortized				Fair
		Cost				Value
Available-for-sale
Due in one year or less		$	12,703			$	12,710
Due from one to five years			61,417				62,048
Total		$	74,120			$	74,758
Held-to-maturity
Due in one year or less		$	8,454			$	8,524
Due from one to five years			6,172				6,497
Due from five to ten years			37,425				39,313
Due after ten years			8,414				8,424
CMO/Mortgage-backed, residential			36,544				37,273
Total		$	97,009			$	100,031

Investment securities with a carrying value of approximately $89 million and $83 million were pledged as collateral for Wealth Management accounts and securities sold under agreements to repurchase at June 30, 2010, and December 31, 2009, respectively.

Securities with unrealized losses at June 30, 2010, and December 31, 2009, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

		Less Than 12 Months								12 Months or Longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Loss				Value				Loss				Value				Loss
June 30, 2010
Available-for-sale
None		$	—			$	—			$	—			$	—			$	—			$	—
Held-to-maturity
Collateralized mortgage obligations, residential		$	4,130			$	32			$	—			$	—			$	4,130			$	32
Municipal securities			6,415				86				—				—				6,415				86
Total Held-to-maturity		$	10,545			$	118			$	—			$	—			$	10,545			$	118
December 31, 2009
Available-for-sale
U.S. Government agencies		$	36,515			$	102			$	—			$	—			$	36,515			$	102
Total available-for-sale		$	36,515			$	102			$	—			$	—			$	36,515			$	102
Held-to-maturity
Collateralized mortgage obligations, residential		$	24,851			$	232			$	—			$	—			$	24,851			$	232
Municipal securities			1,796				10				1,424				37				3,220				47
Total Held-to-maturity		$	26,647			$	242			$	1,424			$	37			$	28,071			$	279

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

In determining other-than-temporary-impairment (“OTTI”) for debt securities, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary-impairment exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

As of June 30, 2010, the Corporation held 19 investments in which the amortized cost was greater than fair value. The Corporation has no securities in which OTTI has been recorded.

The unrealized losses for investments classified as held-to-maturity are attributable to changes in interest rates and/or economic environment and individually were 3.42% or less of their respective amortized costs. The unrealized losses relate primarily to residential collateralized mortgage obligations and securities issued by various municipalities. The residential collateralized mortgage obligations were purchased in September 2009. Prepayments have increased due to a decrease in long-term interest rates from the time of the investment purchase and June 30, 2010, which affects the fair value of residential collateralized mortgage obligations. All residential collateralized mortgage obligations are backed by the U.S. Government and its agencies and represent minimal credit risk at this time. The unrealized losses on securities issued by various municipalities were mainly purchased during the second quarter of 2010. 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 June 30, 2010, all but four of the municipal debt securities were rated BBB or better (as a result of insurance of the underlying rating on the bond). The four 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.

Note 3: Loans

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

		June 30, 2010				December 31, 2009
Residential loans secured by real estate		$	266,532			$	254,722
Commercial loans secured by real estate			267,681				232,841
Construction loans			49,887				75,615
Other commercial and industrial loans			273,586				273,117
Consumer loans			31,234				28,427
Total loans			888,920				864,722
Less allowance for loan losses			(15,523	)			(13,716	)
Total loans, net		$	873,397			$	851,006

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

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.

There were no loans pledged as collateral for FHLB advances as of June 30, 2010, and December 31, 2009.

Activity in the allowance for loan losses was as follows:

		Three months ended								Six months ended
		June 30,								June 30,
		2010				2009				2010				2009
Beginning balance		$	14,759			$	12,471			$	13,716			$	12,847
Loan charge offs			(509	)			(1,061	)			(717	)			(2,732	)
Recoveries			39				17				55				62
Provision for loan losses			1,234				2,650				2,469				3,900
Ending balance		$	15,523			$	14,077			$	15,523			$	14,077

Note 4: Real Estate Owned

Activity in real estate owned was as follows:

		Six months ended				Twelve months ended
		June 30, 2010				December 31, 2009
Balance at beginning of period		$	8,432			$	3,418
Additions			822				7,614
Write downs			(46	)			(905	)
Sales			(2,838	)			(1,695	)
Balance at end of period		$	6,370			$	8,432

Expenses related to real estate owned include:

		Three months ended								Six months ended
		June 30,								June 30,
		2010				2009				2010				2009
Net gain on sales		$	(65	)		$	(6	)		$	(121	)		$	(34	)
Write downs			27				108				46				108
Operating expenses, net of rental income			159				153				295				202
		$	121			$	255			$	220			$	276

Note 5: Mortgage Banking Activities

The unpaid principal balances of mortgage loans serviced for others were $164.8 million and $154.3 million at June 30, 2010, and December 31, 2009, respectively.

Custodial escrow balances maintained in connection with serviced loans were $434 thousand and $1.2 million at June 30, 2010, and December 31, 2009, respectively.

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

The following table includes activity for mortgage servicing rights:

		Six months ended				Twelve months ended
		June 30, 2010				December 31, 2009
Balance at beginning of period		$	1,459			$	1,070
Plus additions			215				723
Fair value adjustments			(438	)			(334	)
Balance at end of period		$	1,236			$	1,459

Mortgage servicing rights are carried at fair value at June 30, 2010, and December 31, 2009. Fair value at June 30, 2010, was determined using discount rates ranging from 10.7% to 16.0%, prepayment speeds ranging from 8.08% to 24.24%, depending on the stratification of the specific right, and a weighted average default rate of 0.33%. Fair value at December 31, 2009, was determined using discount rates ranging from 11.0% to 17.0%, prepayment speeds ranging from 8.68% to 28.92%, depending on the stratification of the specific right, and a weighted average default rate of 0.41%.

Note 6: 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 June 30, 2010. Interest payments are due quarterly.

On June 29, 2007, the Corporation entered into a $5.0 million revolving loan agreement with U.S. Bank, which matured on June 27, 2009, and was renewed and matured on August 31, 2009. The revolving 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 $4.0 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 pays prime plus 1.25% which equated to 4.50% at June 30, 2010.

Under the terms of the revolving loan agreement, the Corporation paid prime minus 1.25% which equated to 2.00% through August 31, 2009, and interest payments were due quarterly. Beginning September 1, 2009, the Corporation pays prime plus 1.25% which equated to 4.50% at June 30, 2010. In addition, beginning October 1, 2009, U.S. Bank assessed a 0.25% fee on the unused portion of the revolving line of credit.

The loan agreements contain various financial and non-financial covenants. One of the covenants requires the Bank to maintain a loan loss reserve to non-performing loans at a minimum of 100%. The Bank was in violation of this covenant as of June 30, 2010, as the loan loss reserve to non-performing loans was 98.17%. The Bank was in compliance with all other covenants.

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 and is currently discussing a waiver for this covenant violation with U.S. Bank.

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

Note 7: Trust Preferred Securities

In September 2000, the Corporation established the 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, and the Corporation owns all of the common securities 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.

The Corporation does not have the power to direct the activities of the trust, therefore, the trust is not consolidated in the Corporation’s 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 June 30, 2010, and December 31, 2009. 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 8: Stock Based Compensation

During the first quarter of 2010, four officers of the Corporation exercised options to purchase 5,300 common shares in aggregate. The weighted average exercise price was $24.68 and the weighted average fair market value of the stock was $37.44.

During the second quarter of 2010, two directors and one officer of the Corporation exercised options to purchase 5,600 common shares in aggregate. The weighted average exercise price was $24.00 and the weighted average fair market value of the stock was $38.86.

Due to the exercise of these options and the vesting of restricted stock for the six months ended June 30, 2010, 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. The Corporation recorded an income tax benefit of $50 thousand as additional paid in capital for the six months ended June 30, 2010, as per guidance issued by the Financial Accounting Standards Board (FASB) on stock compensation.

Note 9: Earnings per Share

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

		Three months ended								Six months ended
		June 30,								June 30,
		2010				2009				2010				2009
Basic average shares outstanding			2,311,055				2,298,755				2,309,206				2,296,914
Net income		$	836			$	79			$	1,458			$	924
Basic net income per common share		$	0.36			$	0.03			$	0.63			$	0.40
Diluted
Average shares outstanding			2,311,055				2,298,755				2,309,206				2,296,914
Nonvested restricted stock			44,998				12,772				40,168				8,906
Net effect of the assumed exercise of stock options			21,184				30,824				20,713				32,193
Diluted average shares			2,377,237				2,342,351				2,370,087				2,338,013
Net income		$	836			$	79			$	1,458			$	924
Diluted net income per common share		$	0.35			$	0.03			$	0.62			$	0.40

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

For the three month period ending June 30, 2010, options to purchase 183,800 shares and 0 restricted shares were outstanding but not included in the computation of diluted earnings per share because they were antidilutive.

For the six month period ending June 30, 2010, options to purchase 183,800 shares and 4,325 restricted shares were outstanding but not included in the computation of diluted earnings per share because they were antidilutive.

For the three month period ending June 30, 2009, options to purchase 192,200 and 70,850 restricted shares were outstanding but not included in the computation of diluted earnings per share because they were antidilutive

For the six month period ending June 30, 2009, options to purchase 192,200 and 70,850 restricted shares were outstanding but not included in the computation of diluted earnings per share because they were antidilutive

Note 10: Comprehensive Income

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available-for-sale. Following is a summary of other comprehensive income (loss):

		Three months ended								Six months ended
		June 30,								June 30,
		2010				2009				2010				2009
Net Income		$	836			$	79			$	1,458			$	924
Other comprehensive income (loss)
Change in securities available for sale:
Net unrealized gains (loss) during the period			347				(421	)			643				(906	)
Tax effect			(138	)			165				(255	)			355
Total other comprehensive income (loss)			209				(256	)			388				(551	)
Comprehensive income (loss)		$	1,045			$	(177	)		$	1,846			$	373

Note 11: 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. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated.

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

		June 30, 2010				December 31, 2009
Unused commercial credit lines		$	204,151			$	198,815
Unused revolving home equity and credit card lines			103,152				99,629
Standby letters of credit			8,033				24,338
Demand deposit account lines of credit			2,565				2,499
		$	317,901			$	325,281

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 has been named as a defendant in one lawsuit. Based upon information presently available, we believe that the total amount, if any, that will ultimately be paid arising from this lawsuit will not have a material adverse effect on our consolidated results of operation or financial position.

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

Note 12: Fair Value

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

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 Corporation used the following methods and significant assumptions to estimate the fair value of each type of asset or liability carried at fair value:

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).

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 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 usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value less costs to sell, an impairment loss is recognized.

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

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 Using:
						Quoted Prices
						in Active Markets				Significant				Significant
						for Identical				Other				Unobservable
						Assets				Observable Inputs				Inputs
		Carrying Value				(Level 1)				(Level 2)				(Level 3)
June 30, 2010
Assets:
Available for sale securities		$	74,758			$	—			$	74,758			$	—
Mortgage servicing rights			1,236				—				1,236				—
December 31, 2009
Assets:
Available for sale securities		$	67,296			$	—			$	67,296			$	—
Mortgage servicing rights			1,459				—				1,459				—

A detailed breakdown of the fair value for the available-for-sale investment securities is provided in the Investment Securities note.

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 Using:
						Quoted Prices
						in Active Markets				Significant				Significant
						for Identical				Other				Unobservable
						Assets				Observable Inputs				Inputs
		Carrying Value				(Level 1)				(Level 2)				(Level 3)
June 30, 2010
Assets:
Impaired loans		$	5,389			$	—			$	—			$	5,389
Other real estate			607				—				—				607
December 31, 2009
Assets:
Impaired loans		$	6,120			$	—			$	—			$	6,120
Other real estate			2,017				—				—				2,017