Monarch Financial Holdings, Inc. - FORM 10-Q

Monarch Financial Holdings, Inc. - FORM 10-Q - May 13, 2011

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EX-31.2 - EXHIBIT 31.2 - Monarch Financial Holdings, Inc.	dex312.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

x	QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarterly Period Ended: March 31, 2011

¨	TRANSITION REPORT UNDER SECTIONS 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-34565

MONARCH FINANCIAL HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

VIRGINIA

6022

20-4985388

(State of other jurisdiction of

Incorporation or organization)

(Primary Standard Industrial

Classification Code Number)

(I.R.S. Employer

Identification No.)

1435 Crossways Blvd.

Chesapeake, Virginia 23320

(757) 389-5111

(Name, address, including zip code, and telephone number, including area code, of agent for service)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” and “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 ¨ No x

The number of shares of common stock outstanding as of May 5, 2011 was 5,965,339.

(This page intentionally left blank.)

MONARCH FINANCIAL HOLDINGS, INC.

FORM 10-Q

MARCH 31, 2011

INDEX


PART I.		FINANCIAL INFORMATION

	ITEM 1.	Consolidated Statements of Condition as of March 31, 2011 and December 31, 2010	4

		Consolidated Statements of Income for the three months ended March 31, 2011 and March 31, 2010	5

		Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the periods ended March 31, 2011 and March 31, 2010	6

		Consolidated Statements of Cash Flows for the periods ended March 31, 2011 and March 31, 2010	8

		Notes to Consolidated Financial Statements	9

	ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30

	ITEM 3.	Quantitative and Qualitative Disclosures about Market Risk	52

	ITEM 4.	Controls and Procedures	53

PART II.		OTHER INFORMATION

	Item 1.	Legal Proceedings	54

	Item 1A.	Risk Factors	54

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	54

	Item 3.	Defaults Upon Senior Securities	54

	Item 4.	(Removed and Reserved)	54

	Item 5.	Other Information	54

	Item 6.	Exhibits	55

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CONDITION


	Unaudited March 31, 2011			December 31, 2010
ASSETS:
Cash and due from banks	$	14,650,078		$	14,733,974
Interest bearing bank balances		1,088,175			10,150,773
Federal funds sold		35,397,867			2,491,000

Total cash and cash equivalents		51,136,120			27,375,747
Investment securities available-for-sale, at fair value		43,541,652			17,601,718
Loans held for sale		95,306,471			175,388,356
Loans held for investment, net of unearned income		566,455,752			558,868,227
Less: allowance for loan losses		(9,503,000	)		(9,037,800	)

Loans, net		556,952,752			549,830,427
Property and equipment, net		22,560,559			20,841,486
Restricted equity securities		8,858,900			8,692,450
Bank owned life insurance		7,403,188			7,335,473
Goodwill		775,000			775,000
Intangible assets, net		595,240			639,883
Other real estate owned		2,175,818			1,744,700
Other assets		12,002,692			15,357,505

Total assets	$	801,308,392		$	825,582,745

LIABILITIES:
Deposits:
Demand deposits - non-interest bearing	$	103,433,994		$	97,654,595
Demand deposits - interest bearing		33,368,767			32,346,048
Savings deposits		19,772,043			19,348,291
Money market deposits		298,134,192			283,271,306
Time deposits		215,118,486			273,041,337

Total deposits		669,827,482			705,661,577
Borrowings:
Trust preferred subordinated debt		10,000,000			10,000,000
Federal Home Loan Bank advances		41,450,399			30,282,201

Total borrowings		51,450,399			40,282,201
Other liabilities		7,176,290			7,905,470

Total liabilities		728,454,171			753,849,248

STOCKHOLDERS’ EQUITY:
Preferred stock, $5 par value, 1,185,300 shares authorized; none issued		—			—
Noncumulative perpetual preferred stock, series B, liquidation value of $20.0 million, $5 par; 800,000 shares authorized, issued and outstanding		4,000,000			4,000,000
Common stock, $5 par value; 20,000,000 shares authorized; issued and outstanding - 5,965,339 and 5,969,039 shares, respectively		29,826,695			29,845,195
Additional paid-in capital		22,251,601			22,131,351
Retained earnings		16,908,363			15,925,106
Accumulated other comprehensive loss		(286,615	)		(333,247	)

Total Monarch Financial Holdings, Inc. stockholders’ equity		72,700,044			71,568,405
Noncontrolling interests		154,177			165,092

Total equity		72,854,221			71,733,497

Total liabilities and stockholders’ equity	$	801,308,392		$	825,582,745

The accompanying notes are an integral part of the consolidated financial statements.

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)


	3 Months Ended March 31,
	2011			2010
Interest income:
Interest and fees on loans	$	9,443,210		$	8,470,927
Interest on investment securities		40,551			54,546
Interest on federal funds sold		27,041			8,377
Dividends on equity securities		32,515			18,165
Interest on other bank accounts		1,075			376

Total interest income		9,544,392			8,552,391

Interest expense:
Interest on deposits		1,757,675			1,861,365
Interest on trust preferred subordinated debt		121,500			121,500
Interest on borrowings		22,985			182,698

Total interest expense		1,902,160			2,165,563

Net interest income		7,642,232			6,386,828
Provision for loan losses		1,001,454			1,327,870

Net interest income after provision for loan losses		6,640,778			5,058,958

Non-interest income:
Mortgage banking income		9,004,237			7,675,152
Investment and insurance commissions		86,400			74,320
Service charges and fees		386,320			394,331
Other		217,549			182,800

Total noninterest income		9,694,506			8,326,603

Non-interest expenses:
Salaries and employee benefits		5,357,145			4,464,207
Commissions and incentives		3,893,359			3,460,339
Loan expense		1,355,423			1,001,184
Occupancy expenses		927,002			692,476
Furniture and equipment expenses		460,031			375,949
FDIC insurance		315,334			248,836
Marketing expense		273,756			211,741
Data processing		305,833			195,536
Other		1,237,872			1,032,511

Total noninterest expenses		14,125,755			11,682,779

Income before income taxes		2,209,529			1,702,782
Income tax provision		(699,474	)		(569,700	)

Net income		1,510,055			1,133,082
Less: Net income attributable to noncontrolling interests		(136,798	)		(13,265	)

Net income attributable to Monarch Financial Holdings, Inc.	$	1,373,257		$	1,119,817
Preferred stock dividend and accretion of discount		(390,000	)		(390,000	)

Net income available to common stockholders	$	983,257		$	729,817

Basic net income per share	$	0.16		$	0.13
Diluted net income per share	$	0.16		$	0.13

The accompanying notes are an integral part of the consolidated financial statements.

ITEM 1. FINANCIAL STATEMENTS (Continued)

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

(unaudited)


							Additional Paid-In Capital			Preferred Stock
	Common Stock
	Shares			Amount
Balance - December 31, 2009		5,865,534		$	29,327,670		$	22,383,274		$	4,000,000
Comprehensive income:
Net income for three months ended March 31, 2010
Unrealized loss on interest rate swap, net of income taxes
Unrealized gain on securities available-for-sale, net of reclassification adjustment and income taxes
Total comprehensive income
Stock-based compensation expense, net of forfeitures and income taxes		11,000			55,000			42,275
Cash dividend declared on series B noncumulative perpetual preferred stock (7.8%)
Redemption of warrants on series A cumulative perpetual preferred stock								(260,000	)
Contributions from noncontrolling interests
Distributions to noncontrolling interests

Balance - March 31, 2010		5,876,534		$	29,382,670		$	22,165,549		$	4,000,000

Balance - December 31, 2010		5,969,039		$	29,845,195		$	22,131,351		$	4,000,000
Comprehensive income:
Net income for three months ended March 31, 2011
Unrealized gain on interest rate swap, net of income taxes
Unrealized loss on securities available-for-sale, net of reclassification adjustment and income taxes
Total comprehensive income
Stock-based compensation expense, net of forfeitures and income taxes		(3,700	)		(18,500	)		120,250
Cash dividend declared on series B noncumulative perpetual preferred stock (7.8%)
Distributions to noncontrolling interests

Balance - March 31, 2011		5,965,339		$	29,826,695		$	22,251,601		$	4,000,000

The accompanying notes are an integral part of the consolidated financial statements.

ITEM 1. FINANCIAL STATEMENTS (Continued)

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME (Continued)

(unaudited)


Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Noncontrolling Interest			Total
$	12,360,292		$	(162,939	)	$	106,857		$	68,015,154

	1,119,817						13,265			1,133,082
				(154,113	)					(154,113	)

				16,999						16,999

										995,968

										97,275

	(390,000	)								(390,000	)

										(260,000	)
							36,750			36,750
							(40,554	)		(40,554	)

$	13,090,109		$	(300,053	)	$	116,318		$	68,454,593

$	15,925,106		$	(333,247	)	$	165,092		$	71,733,497
	1,373,257						136,798			1,510,055
				66,511						66,511
				(19,879	)					(19,879	)


										1,556,687

										101,750
	(390,000	)								(390,000	)


							(147,713	)		(147,713	)

$	16,908,363		$	(286,615	)	$	154,177		$	72,854,221

The accompanying notes are an integral part of the consolidated financial statements.

ITEM 1. FINANCIAL STATEMENTS (Continued)

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	3 Months Ended March 31,
	2011			2010
Operating activities:
Net income	$	1,510,055		$	1,133,082
Adjustments to reconcile to net cash from operating activities:
Provision for loan losses		1,001,454			1,327,870
Depreciation		378,188			265,999
Accretion of discounts and amortization of premiums, net		6,604			3,747
Deferral of loan costs, net of deferred fees		(20,988	)		156,101
Amortization of intangible assets		44,643			44,643
Stock-based compensation		101,750			97,275
Appreciation of bank-owned life insurance		(67,715	)		(70,281	)
Loss (income) from rate lock commitments		125,847			(24,472	)
Net loss on disposition of property and equipment		—			777
Net loss on on sale of other real estate		—			49,022
Amortization of deferred gain		(40,863	)		(40,863	)
Changes in:
Loans held for sale		80,081,885			(3,666,675	)
Interest receivable		(27,447	)		(342,468	)
Other assets		3,222,209			1,898,958
Other liabilities		(577,361	)		(438,843	)

Net cash from operating activities		85,738,261			393,872

Investing activities:
Purchases of available-for-sale securities		(36,503,183	)		(1,749,619	)
Proceeds from sales and maturities of available-for-sale securities		10,526,525			548,569
Proceeds from sale of other real estate		656,482			738,085
Purchases of premises and equipment		(2,097,261	)		(491,549	)
Purchase of restricted equity securities, net of redemptions		(166,450	)		—
Loan originations, net of principal repayments		(9,190,391	)		(20,726,601	)

Net cash from investing activities		(36,774,278	)		(21,681,115	)

Financing activities:
Net increase in noninterest-bearing deposits		5,779,399			17,402,364
Net (decrease) increase in interest-bearing deposits		(41,613,494	)		21,663,197
Cash dividends paid on preferred stock		(390,000	)		(390,000	)
Net increase (decrease) of FHLB advances and federal funds purchased		11,168,198			(24,070,831	)
Contributions from noncontrolling interests		—			36,750
Distributions to noncontrolling interests		(147,713	)		(40,554	)
Redemption of stock warrants		—			(260,000	)

Net cash from financing activities		(25,203,610	)		14,340,926

CHANGE IN CASH AND CASH EQUIVALENTS		23,760,373			(6,946,317	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR		27,375,747			34,351,240

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	51,136,120		$	27,404,923

SUPPLEMENTAL SCHEDULES AND CASH FLOW INFORMATION
Cash paid for:
Interest on deposits and other borrowings	$	1,886,036		$	2,176,039
Income taxes	$	7,600		$	33,700
Loans transferred to foreclosed real estate during the year	$	1,087,600		$	243,750
Loans to facilitate sale of real estate	$	—		$	735,057
Unrealized gain (loss) on securities available for sale, net	$	(19,879	)	$	16,999
Unrealized gain (loss) on interest rate swap, net	$	66,511		$	(154,113	)

The accompanying notes are an integral part of the consolidated financial statements.

MONARCH FINANCIAL HOLDINGS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments consisting of normal recurring accruals necessary to present fairly Monarch Financial Holdings, Inc.’s financial position as of March 31, 2011; the consolidated statements of income for the three months ended March 31, 2011 and 2010; the consolidated statements of changes in stockholders’ equity and comprehensive income for the three months ended March 31, 2011 and 2010; and the consolidated statements of cash flows for the three months ended March 31, 2011 and 2010. These financial statements have been prepared in accordance with the instructions to Form 10-Q and therefore, do not include all of the disclosures and notes required by generally accepted accounting principles. The financial statements include the accounts of Monarch Financial Holdings, Inc. and its subsidiaries, and all significant intercompany accounts and transactions have been eliminated. Operating results for the three month periods ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ended December 31, 2011. Certain prior year amounts have been reclassified to conform to current year presentations.

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (FASB) issued ASU 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures will be required for periods beginning on or after December 15, 2010. We have included the required disclosures in our consolidated financial statements.

In December 2010, the FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations.” The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of the new guidance did not have a material impact our consolidated financial statements.

In December 2010, the FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

The Securities Exchange Commission (SEC) has issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting”, which requires companies to submit financial statements in XBRL (extensible business reporting language) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011.

In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In April 2011, the FASB issued ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty. The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. We are currently assessing the impact that ASU 2011-02 will have on our consolidated financial statements.

NOTE 2. GENERAL

We are a Virginia-chartered bank holding company engaged in business and consumer banking, investment and insurance sales, and mortgage origination and brokerage. We were created on June 1, 2006 through a reorganization plan, under the laws of the Commonwealth of Virginia, in which Monarch Bank became our wholly-owned subsidiary. Monarch Bank was incorporated on May 1, 1998, and opened for business on April 14, 1999. Our corporate office and main office are located in the Greenbrier area of Chesapeake. In addition we have eight other Virginia banking offices – in the Great Bridge area in Chesapeake, the Lynnhaven area, the Town Center area, the Oceanfront, the Kempsville area, and the Hilltop area in Virginia Beach, and the Ghent area and in the downtown area in Norfolk. Our North Carolina banking division operates as OBX Bank through two offices in Kitty Hawk and Nags Head.

In August 2001, we formed Monarch Investment, LLC, to enable us to offer additional services to our clients. We own 100% of Monarch Investment, LLC. As Monarch Investment, LLC, we invested in the formation of Bankers Investment Group, LLC, the parent company of BI Investments, LLC; a registered brokerage firm and investment advisor. On April 30, 2008, Bankers Investment Group, LLC, and BI Investments, LLC, were merged into Infinex Financial Group (Infinex), a broker-dealer headquartered in Meriden, Connecticut, with Monarch Investment, LLC, now holding a 5.62% ownership interest in Infinex. In June of 2008, investment clients began using Infinex as their broker-dealer. Infinex sells non-deposit investment products in over 200 community banks throughout the country. Monarch Investment, LLC, provides non-deposit investment services under the name of Monarch Investments.

In January 2003, Monarch Investment, LLC, purchased a noncontrolling interest in Bankers Insurance, LLC, in a joint venture with the Virginia Bankers Association and many other community banks. Bankers Insurance, LLC, is a full service property/casualty and life/health agency that ranks as one of the largest agencies in Virginia. Bankers Insurance, LLC, provides insurance to our customers and to the general public.

In February 2004, we formed Monarch Capital, LLC, for the purpose of engaging in the commercial real estate brokerage business. We own a 100% interest in Monarch Capital, LLC.

In May 2007, we expanded banking operations into northeastern North Carolina with the opening of a banking office in the town of Kitty Hawk, under the name of OBX Bank (OBX). We opened a second office in the town of Nags Head in December 2009. OBX Bank, which operates as our division, is led by a local management team and a local advisory board of directors.

In June 2007, we announced the expansion of our mortgage operations through the acquisition of a team of experienced mortgage bankers, and our mortgage division began operating as Monarch Mortgage (MM). MM originates and sells conventional, FHA, VA and VHDA residential loans and offers additional mortgage products such as construction-permanent loans for Monarch Bank’s loan portfolio. Their primary office is in Virginia Beach with additional offices in Chesapeake, Norfolk, Richmond, Midlothian, Manassas, Fairfax, Fredericksburg, Woodbridge, Oakton and Reston, Virginia, Rockville, Waldorf, Crofton, Bowie, Towson, Gaithersburg and Greenbelt, Maryland and Kitty Hawk, Wilmington and Charlotte, North Carolina, and Greenwood, South Carolina.

In July 2007, Monarch Investment, LLC, purchased a 51% ownership in Coastal Home Mortgage, LLC, from another bank. This joint venture provides residential loan services through Monarch Mortgage. The 49% ownership is shared by four individuals involved in commercial and residential construction in the Hampton Roads area.

In October 2007, Monarch Investment, LLC, formed a title insurance company, Real Estate Security Agency, LLC (RESA), along with TitleVentures, LLC. Monarch Investment, LLC, owns 75% of RESA and TitleVentures, LLC, owns 25%. RESA offers residential and commercial title insurance to the clients of Monarch Mortgage and Monarch Bank.

In March 2008, Monarch Investment, LLC, formed Home Mortgage Solutions, Inc., in the Richmond area of Virginia. Monarch Investment, LLC, owned 51% with BPRP Funding, LLC, a builder/developer, owning 49%. The primary goal of Home Mortgage Solutions, Inc. was to provide mortgages to the clients of BPRP Funding, LLC. In January 2010, we closed our Home Mortgage Solutions, Inc. operations.

In March 2010, Monarch Investment, LLC, formed Regional Home Mortgage, LLC, in Chesapeake, Virginia. Monarch Investment, LLC, owns 51% of the company and TREG Funding, LLC, owns 49%, which was formed for the primary purpose of providing residential mortgages to clients of TREG Funding, LLC. TREG Funding, LLC is associated with The Real Estate Group, a leading realty firm in Chespeake and Virginia Beach, Virginia.

In September 2010, Monarch Investment, LLC, formed Monarch Home funding, LLC, in Norfolk, Virginia. The primary purpose of the company, of which Monarch Investment, LLC, owns 51% and Danaus, LLC, owns 49%, is to provide residential mortgages to clients of Danaus, LLC. Danaus, LLC is associated with Nancy Chandler Associates, a leading realty firm with offices in Norfolk and Chesapeake, Virginia.

NOTE 3. EARNINGS PER SHARE (“EPS”)

Basic earnings per share (EPS) exclude dilution and are computed by dividing income available to common shareholders by the weighted-average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised, converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations.


	3 months ended March 31,
	2011			2010
Net income	$	1,373,257		$	1,119,817
Less: non-cumulative perpetual preferred dividend		(390,000	)		(390,000	)

Net income (numerator, basic )		983,257			729,817
Weighted average shares outstanding (denominator)		5,969,717			5,700,238

Income per common share - basic	$	0.16		$	0.13

Net income	$	1,373,257		$	1,119,817
Less: non-cumulative perpetual preferred dividend		—			(390,000	)

Net income (numerator, diluted )	$	1,373,257			729,817
Weighted average shares - diluted (denominator)		8,490,328			5,753,067

Income per common share - diluted	$	0.16		$	0.13

Dilutive effect- average number of common shares		20,611			52,829
Dilutive effect- average number of convertible non-cumulative perpetual preferred, if converted		2,500,000			—

Dilutive effect- average number of shares		2,520,611			52,829

For the three months ended March 31, 2011 and 2010, average options to purchase 121,198 and 155,056 shares, respectively, were not included in the computation of earnings per common share, because they were anti-dilutive. 800,000 shares of non-cumulative perpetual preferred stock, which are each convertible to 3.125 shares of common stock, are included in the denominator of our diluted earnings per share calculation at the converted value of 2,500,000 shares. For the three months ended March 31, 2011, the non-cumulative perpetual preferred dividend paid on our preferred shares has been excluded from the numerator.

NOTE 4. INVESTMENT SECURITIES

Securities available-for-sale consists of the following:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
March 31, 2010
U.S. government agency obligations	$	42,075,408	$	63,971	$	(10,693	)	$	42,128,686
Mortgage-backed securities		376,412		16,989		—			393,401
Municipal securities		503,071		6,127		(4,718	)		504,480
Corporate debt securities		500,000		15,085		—			515,085

	$	43,454,891	$	102,172	$	(15,411	)	$	43,541,652


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2010
U.S. government agency obligations	$	16,581,900	$	85,272	$	—		$	16,667,172
Mortgage-backed securities		402,937		16,404		—			419,341
Municipal securities		—		—		—			—
Corporate debt securities		500,000		15,205		—			515,205

	$	17,484,837	$	116,881	$	—		$	17,601,718

No held-to-maturity securities existed at March 31, 2011 or December 31, 2010.

The amortized cost and fair value of securities by contractual maturity date at March 31, 2011 are as follows:

Securities available-for-sale:


	Amortized Cost		Fair Value
Due in one year or less	$	36,007,809	$	36,026,150
Due from one to five years		6,720,977		6,775,371
Due from five to ten years		—		—
Due after ten years		726,105		740,131

Total	$	43,454,891	$	43,541,652

There are no investments in our securities portfolio that have been in a continuous unrealized loss position for more than 12 months. We have the ability to carry unrealized losses in our securities portfolio to the final maturity of the instruments. Other-than-temporarily impaired (“OTTI”) guidance for investments state that an impairment is other-than-temporary if any of the following conditions exists: the entity intends to sell the security; it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis; or, the entity does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). If a credit loss exists, but an entity does not intend to sell the impaired debt security and is not more likely than not to be required to sell before recovery, the impairment is other-than-temporary and should be separated into a credit portion to be recognized in earnings and the remaining amount relating to all other factors recognized as other comprehensive loss. Based on this guidance, there were no securities considered OTTI at March 31, 2011 or December 31, 2010 and there were no losses related to OTTI recognized in accumulated other comprehensive income at March 31, 2011 or December 31, 2010.

NOTE 5. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSS

The following table provides a breakdown, by class or segment of our loans held for investment at March 31, 2011 and December 31, 2010.

Loans held for Investment


	March 31, 2011			December 31, 2010
Commercial	$	82,972,379		$	86,633,856
Real estate
Construction		129,970,770			119,881,034
Residential (1-4 family)		84,950,550			84,822,652
Home equity lines		80,118,245			81,013,642
Multifamily		19,810,668			20,959,832
Commercial		165,438,666			162,541,959

Real estate subtotal		480,288,899			469,219,119

Consumers
Consumer and installment loans		3,101,365			2,937,347
Overdraft protection loans		60,863			66,647

Loans to individuals subtotal		3,162,228			3,003,994

Total gross loans		566,423,506			558,856,969
Allowance for loan losses		(9,503,000	)		(9,037,800	)

Loans net of allowance for loan losses		556,920,506			549,819,169

Unamortized loan costs, net of deferred fees		32,246			11,258

Total net loans	$	556,952,752		$	549,830,427

We have certain lending policies and procedures in place that are designed to balance loan growth and income with an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, credit concentrations, policy exceptions, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, we examine current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and normally incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation or sale of the income producing property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing our commercial real estate portfolio are diverse in terms of type. This diversity helps reduce our exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on purpose, collateral, geography, cash flow, loan to value and risk grade criteria. As a general rule, we avoid financing special purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At March 31, 2011 and December 31, 2010, approximately 58% of the outstanding principal balance of our commercial real estate loans portfolio was secured by owner-occupied properties.

With respect to loans to developers and builders that are secured by non-owner occupied properties that we may originate from time to time, we generally require the borrower to have an existing relationship with the Company and a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, supply and demand, government regulation of real property, general economic conditions and the availability of long-term financing.

Consumer and residential loan originations utilize analytics to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. This monitoring, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend, sensitivity analysis, shock analysis and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity

loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

We perform periodic reviews on various segments of our loan portfolio in addition to presenting the majority of our loan relationships for loan committee review. We utilize an independent company to perform a periodic review to evaluate and validate our credit risk program. Results of these reviews are presented to management and our board. Additionally, we are subject to annual examination by our regulators. We were most recently examined by the Federal Reserve Bank of Richmond in the fourth quarter of 2010. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures.

We have an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. Loans within our portfolio are divided into three classes; commercial, real estate, and consumer. Loans within the commercial and real estate classes are evaluated on an individual or relationship basis and assigned a risk grade based on the characteristics of the loan or relationship. Loans within the consumer class are assigned risk grades and evaluated as a pool, unless specifically identified through delinquency or other signs of credit deterioration, at which time the identified loan would be individually evaluated.

There are nine numerical risk grades which are assigned to loans. These numeric designations represent, from best to worst: minimal, modest, average, acceptable, acceptable with care, special mention, substandard, doubtful and loss. These risk grades are defined as follows:

Minimal – A loan to a borrower of unquestionable financial strength.

Modest – A loan to a borrower with a favorable track record and solid financial condition.

Average – A loan to a borrower exhibiting mostly favorable characteristics, but may be moderately leveraged, moderately liquid or presents an inconsistent operating performance.

Acceptable – A loan to a borrower exhibiting mostly favorable characteristics, but requires closer monitoring because of complexity, information deficiencies, emerging signs of weakness or non-standard terms.

Acceptable with care – A loan to a borrower who is performing favorably but displays a potential weakness that constitutes an undue credit risk.

Special mention – A loan to a borrower who has the capacity to perform but has certain characteristics that require continual supervision and attention from the lender.

Substandard – A loan with a well defined weakness which jeopardizes the orderly liquidation of debt.

Doubtful – A loan with a well defined weakness that renders full liquidation of the debt improbable.

Loss – A loan that is considered uncollectible and of such limited market value that the continued maintenance of the loan as an asset of the Bank is not warranted.

A loan risk graded as loss is generally charged-off when identified. A loan risk graded as doubtful is considered “watch list” and classified as nonaccrual. We did not have any loans in our portfolio classified as doubtful or loss on March 31, 2011 or December 31, 2010. Special mention and substandard loans are considered watch list risk grades and may or may not be classified as nonaccrual, based on current performance. Watch list graded loans or relationships are evaluated individually to determine if all, or a portion of our investment in the borrower, is at risk. If a risk is quantified, a specific loss allowance will be assigned to the identified loan or relationship. We evaluate our investment in the

borrower using either the present value of expected future cash flows, discounted at the historical effective interest rate of the loan, or for a collateral-dependent loan, the fair value of the underlying collateral. Special mention loans, which do not appear to be impaired, are included in the “satisfactory” risk grade groups.

“Satisfactory” loans with a risk rating of modest to acceptable with care, along with the special mention loans having lower risk profiles, are assigned an expected loss factor. This loss factor, which is multiplied by the outstanding principal within each risk grade to arrive at an overall loss estimate, is based on a three-year moving average “look-back” at our historical losses.

Additional metrics, in the form of environmental risk factors, may be applied to a specific class or risk grade of loans within the portfolio based on local or national trends, identifiable events or other economic factors. At March 31, 2011 and December 31, 2010, four environmental factors were applied to the general risk grade groups. The first environmental factor was applied to our real estate construction loans due to the concentration in our portfolio. The second environmental factor was applied to our home equity lines based on delinquency rates. The third environmental factor was applied to all “satisfactory” loans based on economic conditions, including local unemployment and gross regional product. The final environmental factor was applied to all “satisfactory” loans based on trends in our nonperforming assets. The assumptions used to determine the allowance are reviewed to ensure that their theoretical foundation, data integrity, computational processes, and reporting practices are appropriate and properly documented.

We utilize various sources in assessing the economic conditions in our target markets and areas of concentration. We track unemployment trends in both Hampton Roads and Virginia compared to the national average. We monitor trends in our industry and among our peers through reports such as the Uniform Bank Performance Report which are made available to us through the Federal Financial Institutions Examination Council. Additionally, we utilize various industry sources that include information published by CB Richard Ellis, an international firm specializing in commercial real estate reporting and CoStar Group, a provider of commercial real estate information and analytics to monitor local, state and national trends.

We evaluate the adequacy of our allowance for loan losses monthly. A degree of imprecision or uncertainty is inherent in our allowance estimates because it requires that we incorporate a range of probable outcomes which may change from period to period. It requires that we exercise judgment as to the risks inherent in our portfolios, economic uncertainties, historical loss and other subjective factors, including industry trends. No single statistic or measurement determines the adequacy of the allowance for loan loss. Changes in the allowance for loan loss and the related provision expense can materially affect net income.

The following table delineates our loan portfolio by class and risk grade for March 31, 2011 and December 31, 2010.


	March 31, 2011
	Satisfactory
	Minimal Risk Grade 1		Modest Risk Grade 2		Average Risk Grade 3		Acceptable Risk Grade 4		Acceptable with Care Risk Grade 5
Commercial	$	228,012	$	805,000	$	15,335,352	$	46,901,856	$	9,243,959
Real estate
Construction		—		3,846,886		34,607,274		53,425,012		13,392,210
Residential (1-4 family)		—		—		3,026,756		56,974,643		8,723,252
Home equity lines		—		—		6,597,329		60,687,508		7,293,173
Multifamily		—		—		13,449,432		2,424,839		408,459
Commercial		—		6,214,628		27,586,106		101,032,787		23,498,363

Real estate subtotal		—		10,061,514		85,266,897		274,544,789		53,315,457

Consumers
Consumer and installment loans		—		—		824,891		1,921,738		142,794
Overdraft protection loans		—		—		11,789		24,802		15,322

Loans to individuals subtotal		—		—		836,680		1,946,540		158,116

Total gross loans	$	228,012	$	10,866,514	$	101,438,929	$	323,393,185	$	62,717,532


	Watchlist						Total		Weighted Average Risk Grade
	Special Mention Risk Grade 6		Substandard Risk Grade 7				Total		Weighted Average Risk Grade
Commercial	$	8,715,754	$	1,742,446			$	82,972,379		4.17
Real estate
Construction		6,283,017		18,416,371				129,970,770		4.30
Residential (1-4 family)		6,235,765		9,990,134				84,950,550		4.57
Home equity lines		1,925,304		3,614,931				80,118,245		4.19
Multifamily		3,527,938		—				19,810,668		3.70
Commercial		4,198,286		2,908,496				165,438,666		4.00

Real estate subtotal		22,170,310		34,929,932				480,288,899		4.20

Consumers
Consumer and installment loans		49,299		162,643				3,101,365		3.97
Overdraft protection loans		1,940		7,010				60,863		4.47

Loans to individuals subtotal		51,239		169,653				3,162,228		3.98

Total gross loans	$	30,937,303	$	36,842,031			$	566,423,506		4.20


	December 31, 2010
	Satisfactory
	Minimal Risk Grade 1		Modest Risk Grade 2		Average Risk Grade 3		Acceptable Risk Grade 4		Acceptable with Care Risk Grade 5
Commercial	$	232,110	$	731,667	$	14,771,833	$	53,992,867	$	7,023,210
Real estate
Construction		—		1,225,329		32,697,778		47,661,653		13,651,344
Residential (1-4 family)		—		—		4,579,850		54,014,031		9,590,337
Home equity lines		—		—		6,764,301		61,480,769		7,225,278
Multifamily		—		—		14,820,350		2,166,220		416,693
Commercial		—		6,220,892		32,511,650		95,506,961		23,663,549

Real estate subtotal		—		7,446,221		91,373,929		260,829,634		54,547,201

Consumers
Consumer and installment loans		—		—		656,918		1,902,223		147,654
Overdraft protection loans		—		—		19,896		33,738		6,003

Loans to individuals subtotal		—		—		676,814		1,935,961		153,657

Total gross loans	$	232,110	$	8,177,888	$	106,822,576	$	316,758,462	$	61,724,068



	Watchlist				Total		Weighted Average Risk Grade
	Special Mention Risk Grade 6		Substandard Risk Grade 7		Total		Weighted Average Risk Grade
Commercial	$	8,038,429	$	1,843,740	$	86,633,856		4.14
Real estate
Construction		5,643,773		19,001,157		119,881,034		4.39
Residential (1-4 family)		5,946,666		10,691,768		84,822,652		4.58
Home equity lines		1,830,661		3,712,633		81,013,642		4.19
Multifamily		3,556,569		—		20,959,832		3.65
Commercial		3,444,500		1,194,407		162,541,959		3.93

Real estate subtotal		20,422,169		34,599,965		469,219,119		4.20

Consumers
Consumer and installment loans		62,182		168,370		2,937,347		4.04
Overdraft protection loans		7,010		—		66,647		4.00

Loans to individuals subtotal		69,192		168,370		3,003,994		4.04

Total gross loans	$	28,529,790	$	36,612,075	$	558,856,969		4.19

An aging of our loan portfolio by class as of March 31, 2011 and December 31, 2010 is as follows:


			Age Analysis of Past Due Loans
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Recorded Investment > 90 days and Accruing		Recorded Investment Nonaccrual Loans
March 31, 2011
Commercial	$	39,591	$	162,000	$	1,014,581	$	1,216,172	$	81,756,207	$	—	$	1,246,582
Real estate
Construction		138,131		926,000		928,510		1,992,641		127,978,129		—		1,854,510
Residential (1-4 family)		885,787		343,753		1,044,828		2,274,368		82,676,182		—		2,795,380
Home equity lines		424,998		311,824		1,316,960		2,053,782		78,064,463		429,992		1,587,068
Multifamily		—		—		—		—		19,810,668		—		—
Commercial		375,667		—		—		375,667		165,062,999		—		—

Real estate subtotal		1,824,583		1,581,577		3,290,298		6,696,458		473,592,441		429,992		6,236,958

Consumers
Consumer and installment loans		87,852		18,571		—		106,423		2,994,942		—		—
Overdraft protection loans		—		7,010		—		7,010		53,853		—		7,010

Loans to individuals subtotal		87,852		25,581		—		113,433		3,048,795		—		7,010

Total gross loans		1,952,026		1,769,158		4,304,879		8,026,063		558,397,443		429,992		7,490,550


December 31, 2010
Commercial:	$	231,500	$	446,484	$	1,284,790	$	1,962,774	$	84,671,082	$	270,728	$	1,575,207
Real estate
Construction		—		—		1,998,424		1,998,424		117,882,610		240,672		1,757,752
Residential (1-4 family)		333,562		—		2,274,052		2,607,614		82,215,038		418,608		3,620,443
Home equity lines		265,139		1,477,353		437,542		2,180,034		78,833,608		179,992		757,585
Multifamily		—		—		—		—		20,959,832		—		—
Commercial		114,925		—		—		114,925		162,427,034		—		178,941

Real estate subtotal		713,626		1,477,353		4,710,018		6,900,997		462,318,122		839,272		6,314,721

Consumers
Consumer and installment loans		159,755		—		20,816		180,571		2,756,776		20,816		—
Overdraft protection loans		—		—		—		—		66,647		—		—

Loans to individuals subtotal		159,755		—		20,816		180,571		2,823,423		20,816		—

Total gross loans		1,104,881		1,923,837		6,015,624		9,044,342		549,812,627		1,130,816		7,889,928

The column “recorded investment in nonaccrual loans”, in the Age Analysis table above, includes nonaccrual loans totaling $7,191,566 and $7,583,305, and restructured loans totaling $298,984 and $306,623 at March 31, 2011 and December 31, 2010, respectively.

Non-performing assets as of March 31, 2011 and December 31, 2010 are as follows:


	NON-PERFORMING ASSETS
	Non-Performing Loans
	Over 90 Days and Accruing		Nonaccrual Loans		Restructured Loans		Non-Performing Loans		Other Real Estate Owned		Total Non-Peforming Assets
March 31, 2011
Commercial	$	—	$	1,064,582	$	182,000	$	1,246,582	$	—	$	1,246,582
Real estate
Construction		—		1,854,510		—		1,854,510		533,518		2,388,028
Residential (1-4 family)		—		2,678,396		116,984		2,795,380		1,642,300		4,437,680
Home equity lines		429,992		1,587,068		—		2,017,060		—		2,017,060
Multifamily		—		—		—		—		—		—
Commercial		—		—		—		—		—		—
Consumers
Consumer and installment loans		—		—		—		—		—		—
Overdraft protection loans		—		7,010		—		7,010		—		7,010

Total	$	429,992	$	7,191,566	$	298,984	$	7,920,542	$	2,175,818	$	10,096,360

December 31, 2010
Commercial	$	270,728	$	1,393,207	$	182,000	$	1,845,935	$	—	$	1,845,935
Real estate
Construction		240,672		1,757,752		—		1,998,424		1,190,000		3,188,424
Residential (1-4 family)		418,608		3,495,820		124,623		4,039,051		554,700		4,593,751
Home equity lines		179,992		757,585		—		937,577		—		937,577
Multifamily		—		—		—		—		—		—
Commercial		—		178,941		—		178,941		—		178,941
Consumers
Consumer and installment loans		20,816		—		—		20,816		—		20,816
Overdraft protection loans		—		—		—		—		—		—

Total	$	1,130,816	$	7,583,305	$	306,623	$	9,020,744	$	1,744,700	$	10,765,444



	March 31, 2011			December 31, 2010
Asset Quality Ratios:
Nonperforming loans to period end loans		1.40	%		1.61	%
Nonperforming assets to period end assets		1.26	%		1.30	%
Allowance for loan losses to nonperforming loans		119.98	%		100.19	%

A summary of the activity in the allowance for loan losses account is as follows:


Allocation of the Allowance for Loan Losses
			Real Estate
March 31, 2011	Commercial		Construction			Residential			Home Equity			Multifamily			Commercial
Allowance for credit losses:
Beginning balance	$	919,774	$	1,931,797		$	2,114,094		$	2,443,275		$	146,923		$	1,308,073
Charge-offs		—		(38,623	)		(141,624	)		(417,064	)		—			—
Recoveries		4,206		734			10,226			45,356			—			—
Provision		467,457		374,729			(191,078	)		194,571			(1,939	)		67,545

Ending balance	$	1,391,437	$	2,268,637		$	1,791,618		$	2,266,138		$	144,984		$	1,375,618

Ending balance
Individually evaluated for impairment	$	801,371	$	1,388,814		$	1,249,606		$	1,664,694		$	—		$	193,033
Collectively evaluated for impairment		590,066		879,823			542,012			601,444			144,984			1,182,585
Loan acquired with detriorated credit quality		—		—			—			—			—			—
Financing receivables:
Ending balance	$	82,972,379	$	129,970,770		$	84,950,550		$	80,118,245		$	19,810,668		$	165,438,666
Ending balance: individually evaluated for impairment		2,172,828		18,416,371			9,986,435			4,476,749			—			3,302,548
Ending balance: collectively evaluated for impairment		80,799,551		111,554,399			74,964,115			75,641,496			19,810,668			162,136,118


	Consumers
	Consumer and Installment loans			Overdraft Protection		Unallocated		Total
Allowance for credit losses:
Beginning balance	$	84,384		$	466	$	89,014	$	9,037,800
Charge-offs		—			—		—		(597,311	)
Recoveries		205			330		—		61,057
Provision		(5,190	)		3,240		92,119		1,001,454

Ending balance	$	79,399		$	4,036	$	181,133	$	9,503,000

Ending balance
Individually evaluated for impairment	$	61,580		$	—	$	—	$	5,359,098
Collectively evaluated for impairment		17,819			4,036		181,133		4,143,902
Loan acquired with detriorated credit quality		—			—		—		—
Financing receivables:
Ending balance	$	3,101,365		$	60,863	$	—	$	566,423,506
Ending balance: individually evaluated for impairment		162,643			7,010		—		38,524,584
Ending balance: collectively evaluated for impairment		2,938,722			53,853		—		527,898,922


				Real Estate
December 31, 2010	Commercial			Construction			Residential			Home Equity			Multifamily		Commercial
Allowance for credit losses:
Beginning balance	$	742,206		$	3,623,237		$	1,746,390		$	2,521,078		$	37,047	$	607,279
Charge-offs		(303,881	)		(3,903,040	)		(1,842,885	)		(2,887,006	)		—		(195,000	)
Recoveries		74,386			11,225			10,256			142,308			—		29,427
Provision		407,063			2,200,375			2,200,333			2,666,895			109,876		866,367

Ending balance	$	919,774		$	1,931,797		$	2,114,094		$	2,443,275		$	146,923	$	1,308,073

Ending balance
Individually evaluated for impairment	$	352,200		$	1,200,197		$	1,615,621		$	1,859,370		$	—	$	220,726
Collectively evaluated for impairment		567,574			731,600			498,473			583,905			146,923		1,087,347
Loan acquired with detriorated credit quality		—			—			—			—			—		—

Financing receivables:
Ending balance	$	86,633,856		$	119,881,034		$	84,822,652		$	81,013,642		$	20,959,832	$	162,541,959

Ending balance: individually evaluated for impairment		2,439,251			23,808,720			13,132,292			3,974,969			—		3,293,837
Ending balance: collectively evaluated for impairment		84,194,605			96,072,314			71,690,360			77,038,673			20,959,832		159,248,122

	Consumers
	Consumer and Installment loans			Overdraft Protection			Unallocated			Total
Allowance for credit losses:
Beginning balance
Charge-offs	$	22,579		$	184		$	—		$	9,300,000
Recoveries		(38,221	)		(1,000	)		—			(9,171,033	)
Provision		575			1,364			—			269,541
Ending balance		99,451			(82	)		89,014			8,639,292

	$	84,384		$	466		$	89,014		$	9,037,800

Ending balance
Individually evaluated for impairment	$	65,061		$	—					$	5,313,175
Collectively evaluated for impairment		19,323			466			89,014			3,724,625
Loan acquired with detriorated credit quality		—			—			—			—

Financing receivables:
Ending balance	$	2,937,347		$	66,647		$	—		$	558,856,969

Ending balance: individually evaluated for impairment		179,994			—			—			46,829,063
Ending balance: collectively evaluated for impairment		2,757,353			66,647						512,027,906

A loan is considered impaired when, based on current information and events; it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. In addition to loans 90 days past due and still accruing, nonaccrual loans and restructured loans, all loans risk graded doubtful or substandard qualify, by definition, as impaired. The following table sets forth our impaired loans at March 31, 2011 and December 31, 2010.


Impaired Loans
	With No Related Allowance
	Recorded Investment		Unpaid Principal Balance		Average Recorded Investment		Interest Income Recognized
March 31, 2011
Commercial	$	495,578	$	546,160	$	375,447	$	2,172
Real estate
Construction		11,517,942		13,072,942		11,384,131		154,816
Residential (1-4 family)		2,504,226		3,057,950		2,552,471		5,539
Home equity lines		877,363		1,174,854		922,369		10,193
Multifamily		—		—		—		—
Commercial		1,900,227		1,945,227		1,911,045		37,654
Consumers
Consumer and installment loans		18,571		18,571		19,694		541
Overdraft protection loans		7,010		7,010		7,010		—

Total	$	17,320,917	$	19,822,714	$	17,172,167	$	210,915


December 31, 2010
Commercial	$	1,376,790	$	1,447,373	$	731,937	$	51,131
Real estate
Construction		2,522,200		4,152,564		5,198,112		234,684
Residential (1-4 family)		3,516,555		4,185,054		2,537,481		112,580
Home equity lines		437,442		644,992		807,606		13,786
Multifamily		—		—		—		—
Commercial		178,941		223,941		267,766		20,170
Consumers
Consumer and installment loans		20,816		20,816		14,210		1,941
Overdraft protection loans		—		—		—		—

Total	$	8,052,744	$	10,674,740	$	9,557,112	$	434,292


	With Related Allowance
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
March 31, 2011
Commercial	$	1,677,250	$	1,677,250	$	801,371	$	1,690,347	$	24,864
Real estate
Construction		6,898,429		6,938,429		1,388,814		6,900,430		102,524
Residential (1-4 family)		7,482,209		7,482,209		1,249,606		7,501,577		106,128
Home equity lines		3,599,386		3,619,386		1,664,694		3,599,640		32,510
Multifamily		—		—		—		—		—
Commercial		1,402,321		1,402,321		193,033		1,406,768		104,533
Consumers
Consumer and installment loans		144,072		144,072		61,580		145,813		2,539
Overdraft protection loans		—		—		—		—		—

Total	$	21,203,667	$	21,263,667	$	5,359,098	$	21,244,575	$	373,098


December 31, 2010
Commercial	$	965,144	$	969,144	$	352,200	$	588,758	$	79,435
Real estate
Construction		7,291,850		7,410,900		1,200,197		7,589,440		427,378
Residential (1-4 family)		8,887,047		8,887,047		1,615,621		8,661,283		453,452
Home equity lines		3,327,535		3,347,535		1,859,370		3,084,212		106,631
Multifamily		—		—		—		—		—
Commercial		1,411,215		1,411,215		220,726		1,421,195		393,647
Consumers
Consumer and installment loans		147,554		147,554		65,061		73,777		905
Overdraft protection loans		—		—		—		—		—

Total	$	22,030,345	$	22,173,395	$	5,313,175	$	21,418,665	$	1,461,448

NOTE 6. FAIR VALUE ACCOUNTING

Fair Value Hierarchy and Fair Value Measurement

We group our assets and liabilities that are recorded at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

•

Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

•

Level 2 – Valuations based on quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.

•

Level 3 – Valuations based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Valuations are determined using pricing models and discounted cash flow models and includes management judgment and estimation which may be significant.

The following table presents our assets and liabilities related to continuing operations, which are measured at fair value on a recurring basis for each of the fair value hierarchy levels, as of March 31, 2011 and December 31, 2010:


	Fair Value Measurements at Reporting Date Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Description
Assets at March 31, 2011
Investment securities - available for sale
U.S. government agency obligations	$	42,128,686	$	—	$	42,128,686	$	—
Mortgage-backed securities		393,401		—		393,401		—
Municipal securities		504,480		—		504,480		—
Corporate debt securities		515,085		—		515,085		—
Loans held for sale		95,306,471		—		95,306,471		—
Rate lock commitments, net		424,358		—		46,818		377,540

Total Assets	$	139,272,481	$	—	$	138,894,941	$	377,540

Derivative financial liability	$	521,085	$	—	$	521,085	$	—


Assets at December 31, 2010
Investment securities - available for sale
U.S. government agency obligations	$	16,667,172	$	—	$	16,667,172	$	—
Mortgage-backed securities		419,341		—		419,341		—
Municipal securities		—		—		—		—
Corporate debt securities		515,205		—		515,205		—
Loans held for sale		175,388,356		—		175,388,356		—
Rate lock commitments, net		503,386		—		—		503,386

Total Assets	$	193,493,460	$	—	$	192,990,074	$	503,386

Derivative financial liability	$	621,800	$	—	$	621,800	$	—

The changes in rate lock commitments (Level 3 assets) measured at fair value on a recurring basis are summarized below as:


	2011			2010
Balance, January 1	$	503,386		$	804,240
Issuances and settlements, net		(503,386	)		(804,240	)
Unrealized gain included in earnings		377,540			828,712

Balance, March 31	$	377,540		$	828,712

The following table provides quantitative disclosures about the fair value measurements of our assets related to continuing operations which are measured at fair value on a nonrecurring basis as of March 31, 2011 and 2010.


	Fair Value Measurements at Reporting Date Using
Description	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
At March 31, 2011
Real estate owned	$	2,175,818	$	—	$	2,175,818	$	—
Restructured and impaired loans		15,884,569		—		15,884,569		—
At December 31, 2010
Real estate owned	$	1,744,700	$	—	$	—	$	1,744,700
Restructured and impaired loans		16,717,170		—		—		16,717,170

For the three months ended March 31, 2011, we had no gains or losses to report on sale of other real estate owned. For the three months ended March 31, 2010, we recorded a loss on the sale of real estate owned of $49,022. Gains or losses on sale of other real estate owned are included in other noninterest expense in the periods indicated.

At the time a loan secured by real estate becomes real estate owned, we record the property at the lower of its carrying amount or fair value. Upon foreclosure and through liquidation, we evaluate the property’s fair value as compared to its carrying amount and record a valuation adjustment when the carrying amount exceeds fair value. Any valuation adjustments at the time a loan becomes real estate owned is charged to the allowance for loan losses. Any subsequent valuation adjustments are applied to earnings in our consolidated statements of income. We recorded a loss of $0 and $51,955 in the three months ended March 31, 2011 and 2010, respectively, due to valuation adjustments on real estate owned in our consolidated statements of income. Adjustments were recorded within the financial statement caption other noninterest income for the respective period.

Valuation Methods

Securities – available-for-sale. Securities – available-for-sale are valued at quoted market prices, if available. For securities for which no quoted market price is available, we estimate the fair value on the basis of quotes for similar instruments or other available information. Investment securities classified as available-for-sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. To the extent that the cost basis of investment securities exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss. The specific identification method is used in computing realized gains or losses.

Loans held for sale. Loans held for sale are recorded at their fair value when originated, based on our expected return from the secondary market.

rates or are accompanied by interest rate lock commitments. A “locked pipeline loan” is a loan where the potential borrower has set the interest rate for the loan by entering into an interest rate lock commitment, or “rate lock commitment,” resulting in interest rate risk to us. Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers net of related costs, if material, are recorded at fair value in derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans.

Restructured loans. Measurement of the value of a restructured loan is generally based on the present value of expected future cash flows discounted at the loan’s effective interest rate, unless in the case of collateral-dependent loans, the observable market price, or the fair value of the collateral can be readily determined. Restructured loans are periodically reevaluated to determine if additional adjustments to the carrying value are necessary.

Impaired Loans – Loans are designated as impaired when, in the judgment of management, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Statements of Operations.

Other Real Estate Owned – Other real estate owned (“OREO”) is measured at fair value based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2). However, if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3.

Derivative financial instruments. Derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both our credit risk and the counterparties’ credit quality in determining the fair value of the derivative. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate (LIBOR) observable market prices for LIBOR swap rates, and three month LIBOR basis spreads at commonly quoted intervals. Our derivative financial liability consists of an interest rate swap that qualifies as a cash flow hedge which had an unrealized loss of $521,085 at March 31, 2011 and $621,800 at December 31, 2010.

Fair Value of Financial Instruments

The following table presents the carrying amounts and fair value of our financial instruments at March 31, 2011 and December 31, 2010. GAAP defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than through a forced or liquidation sale for purposes of this disclosure. The carrying amounts in the table are included in the balance sheet under the indicated captions.


	March 31, 2011				December 31, 2010
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial Assets
Cash and cash equivalents	$	51,136,120	$	51,136,120	$	27,375,747	$	27,375,747
Investment securities		43,541,652		43,541,652		17,601,718		17,601,718
Mortgage loans held for sale		95,306,471		95,306,471		175,388,356		175,388,356
Loans held for investment (net)		556,952,752		570,970,700		549,830,427		566,893,439
Accrued interest receivable		1,907,798		1,907,798		1,880,351		1,880,351
Restricted equity securities		8,858,900		8,858,900		8,692,450		8,692,450
Rate lock commitments, net		424,358		424,358		503,386		503,386

Financial Liabilities
Deposit liabilities	$	669,827,482	$	667,586,006	$	705,661,577	$	670,860,094
Total borrowings		51,450,399		51,292,594		40,282,201		40,145,059
Accrued interest payable		140,677		140,677		124,553		124,553
Derivative financial liability		521,085		521,085		621,800		621,800

The following notes summarize the significant assumptions used in estimating the fair value of financial instruments:

Short-term financial instruments are valued at their carrying amounts included in the Bank’s balance sheet, which are reasonable estimates of fair value due to the relatively short period to maturity of the instruments. This approach applies to cash and cash equivalents and overnight borrowings.

Loans are valued on the basis of estimated future receipts of principal and interest, which are discounted at various rates. Loan prepayments are assumed to occur at the same rate as in previous periods when interest rates were at levels similar to current levels. Future cash flows for homogeneous categories of consumer loans, such as motor vehicle loans, are estimated on a portfolio basis and discounted at current rates offered for similar loan terms to new borrowers with similar credit profiles.

Investment securities. Securities – available-for-sale are valued at quoted market prices, if available. For securities for which no quoted market price is available, we estimate the fair value on the basis of quotes for similar instruments or other available information. Investment securities classified as available-for-sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. To the extent that the cost basis of investment securities exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss. The specific identification method is used in computing realized gains or losses.

Rate lock commitments. Our mortgage loan pipeline consists of mortgage loan applications that have been received but the loan has not yet closed. The interest rates on pipeline loans float with market rates or are accompanied by interest rate lock commitments. A “locked pipeline loan” is a loan where the potential borrower has set the interest rate for the loan by entering into an interest rate lock commitment, or “rate lock commitment,” resulting in interest rate risk to us. Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers net of related costs, if material, are recorded at fair value in derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans.

Restricted equity securities are recorded at cost, which approximates fair value.

The fair value of demand deposits and deposits with no defined maturity is taken to be the amount payable on demand at the reporting date. The fair value of fixed-maturity deposits is estimated using rates currently offered for deposits of similar remaining maturities. The intangible value of long-term relationships with depositors is not taken into account in estimating the fair values disclosed.

The fair value of short-term borrowings is based on discounting expected cash flows at the interest rate of debt with the same or similar remaining maturities and collateral requirements.

The carrying amounts of accrued interest approximate fair value.

The fair value of the derivative financial liability, which relates to our interest rate swap, is based on the income approach using observable market inputs, reflecting market inputs of future interest rates as of the measurement date. Consideration is given to our credit risk as well as the counterparty’s credit quality in determining the fair value of the derivative.

It is not practicable to separately estimate the fair values for off-balance-sheet credit commitments, including standby letters of credit and guarantees written, due to the lack of cost-effective reliable measurement methods for these instruments.

NOTE 7. COMPREHENSIVE INCOME

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and

losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. Components of other comprehensive income are unrealized gains and losses on available-for-sale securities and a derivative financial liability related to an interest rate swap. The following is a detail of comprehensive income for the three months ended March 31, 2011 and 2010:


	Three months ended March 31,
	2011			2010
Net Income	$	1,510,055		$	1,133,082
Change in unrealized gains (losses) on securities available-for-sale, net of tax expense		(19,879	)		16,999
Change in unrealized losses on a derivative financial liability, net of tax		66,511			(154,113	)

Total comprehensive income		1,556,687			995,968
Less: Comprehensive income attributable to noncontrolling interests		(136,798	)		(13,265	)

Comprehensive income attributable to Monarch Financial Holdings, Inc.	$	1,419,889		$	982,703

Unrealized holding gains securities available for sale	$	(30,120	)	$	25,756
Income tax expense		10,241			(8,757	)

Net unrealized gains	$	(19,879	)	$	16,999

NOTE 8. STOCK-BASED COMPENSATION

In May 2006, our stockholders ratified the adoption of a new stock-based compensation plan to succeed the Monarch Bank 1999 Incentive Stock Option Plan. The Monarch Bank 2006 Equity Incentive Plan (“2006EIP”) authorizes the compensation committee to grant options, stock appreciation rights, stock awards, performance stock awards, and stock units to designated directors, officers, key employees, consultants and advisors to the Company and its subsidiaries. The Plan authorizes us to issue up to 630,000 split-adjusted shares of our Common Stock plus the number of shares of our Common Stock outstanding under the 1999 Plan. The Plan also provides that no award may be granted more than 10 years after the May 2006 ratification date.

Since May 2006, we have issued stock awards under the new Plan at a price equal to the stock price on the issue date with vesting periods of up to five years from issue. Total compensation costs are recognized over the service period to vesting.

At March 31, 2011 there were 257,283 options outstanding and exercisable. All options in the plan are fully vested and no additional options were granted in the periods covered. No options have been exercised or forfeited in the first quarter of 2011.

Compensation expense related to our restricted stock totaled $96,209 during the first quarter of 2011. Non-vested shares in restricted stock totaled 205,340 at March 31, 2011. These shares, which typically vest over a 60 month period, have remaining vesting periods of between 9 and 58 months with unrecognized remaining compensation expense of $1,011,395. We issued 500 shares of restricted stock in the first quarter of 2011, and 9,000 shares were vested. Additionally, 2,000 shares issued at December 31, 2010 were canceled, and 2,200 shares were forfeited.

NOTE 9. SEGMENT REPORTING

Reportable segments include community banking and retail mortgage banking services. Community banking involves making loans to and generating deposits from individuals and businesses in the markets where we have offices. Retail mortgage banking originates residential loans and subsequently sells them to investors. Our mortgage banking segment is a strategic business unit that offers different products and services. It is managed separately because the segment appeals to different markets and, accordingly, requires different technology and marketing strategies. The segment’s most significant revenue and expense is non-interest income and non-interest expense, respectively. We do not have other reportable operating segments. (The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1 of our annual 10-K.) All intersegment sales prices are market based. The assets and liabilities and operating results of our other wholly owned subsidiary, Monarch Capital, LLC, are included in the mortgage banking segment. Monarch Capital, LLC, provides commercial mortgage brokerage services.

Segment information for the three months ended March 31, 2011 and 2010 is shown in the following table.

Selected Financial Information


	Commercial and Other Banking			Mortgage Banking Operations			Intersegment Eliminations			Total
Three Months Ended March 31, 2011
Net interest income after provision for loan losses	$	6,485,415		$	155,363		$	—		$	6,640,778
Noninterest income		864,855			8,871,641			(41,990	)		9,694,506
Noninterest expenses		(4,821,615	)		(9,346,130	)		41,990			(14,125,755	)

Net income (loss) before income taxes and noncontrolling interest	$	2,528,655		$	(319,126	)	$	—		$	2,209,529

Three Months Ended March 31, 2010
Net interest income after provision for loan losses	$	5,058,958		$	458,550		$	(458,550	)	$	5,058,958
Noninterest income		628,690			8,061,228			(363,315	)		8,326,603
Noninterest expenses		(3,838,855	)		(7,940,396	)		96,472			(11,682,779	)

Net income before income taxes and noncontrolling interest	$	1,848,793		$	579,382		$	(725,393	)	$	1,702,782

Segment Assets
March 31, 2011	$	803,860,870		$	103,541,558		$	(106,094,036	)	$	801,308,392
December 31, 2010	$	650,645,549		$	185,530,329		$	(10,593,133	)	$	825,582,745

NOTE 10. GOODWILL AND INTANGIBLE ASSETS

Goodwill and intangible assets with indefinite lives are recorded at cost and are reviewed at least annually for impairment based on evidence of certain impairment indicators. Intangible assets with identifiable lives are amortized over their estimated useful lives. The intangible assets have a weighted-average useful life of seven years.

Information concerning goodwill and intangible assets is presented in the following table:


	March 31, 2011			December 31, 2010
Amortizable intangible assets	$	1,250,000		$	1,250,000
Accumulated amortization - intangible assets		(654,760	)		(610,117	)

Amortizable intangible assets, net	$	595,240		$	639,883

Goodwill	$	775,000		$	775,000

Amortization expense for intangible assets totaled $44,643 for each of the three month periods, ending March 31, 2011 and 2010.


Estimated Amortization Expense:
For the remaining months of the year ended 12/31/11		133,929
For the year ended 12/31/12		178,572
For the year ended 12/31/13		178,572
For the year ended 12/31/14		104,167

	$	595,240

NOTE 11. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

We entered into an interest rate swap agreement with PNC Bank (PNC) of Pittsburgh, PA on July 29, 2009, for our $10 million Trust preferred borrowing, which carries a floating interest rate of 90 day London Interbank Offered Rate (LIBOR) plus 160 basis points. The terms of this hedge allows us to mitigate our exposure to interest-rate fluctuations by swapping our floating rate obligation for a fixed rate obligation. The notional amount of the swap agreement is $10 million, and has an expiration date of September 30, 2014. Under the terms of our agreement, at the end of each quarter we will swap our floating rate for a fixed rate of 3.26%. Including the additional 160 basis points, the effective fixed rate of interest cost will be 4.86% on our $10 million Trust Preferred borrowing for five years.

The fixed-rate payment feature of this swap is structured to mirror the provisions of the hedged borrowing agreement. This swap qualifies as a cash flow hedge and the underlying liability is carried at fair value in other liabilities, with the changes in fair value of the instrument included in Stockholders’ Equity in accumulated other comprehensive income.

Our credit exposure, if any, on the interest rate swap is limited to the net favorable value (net of any collateral pledged) and interest payments of the swap by the counterparty. Conversely, when an interest rate swap is in a liability position we are required to post collateral to PNC which is evaluated monthly and adjusted based on the fair value of the hedge on the last day of the month. The fair value of this swap instrument was a liability of $521 thousand at March 31, 2011 for which our collateral requirement on March 31, 2011, was $550 thousand.

On June 15, 2010, we began participating in a mandatory delivery program for mortgage loans. Under the mandatory delivery program we commit to deliver a block of loans to an investor at a preset

cost prior to the close of such loans. This differs from a best efforts delivery which sets the cost to the investor on a loan by loan basis at the close of the loan. Mandatory delivery creates a higher level of risk for us but is not binding to the client. Our client could decide, at any time between the time of the rate lock and the actual closing on their mortgage loan, not to proceed with the commitment. There is a higher occurrence of this during periods of volatility.

To mitigate this risk, we pair the rate lock commitment with the sale of a notional security bearing similar attributes. At the time the loan is delivered to the investor, matched securities are repurchased. Any gains or losses associated with this pairing are recorded in mortgage banking income on our income statement as incurred. Our board approved mandatory delivery policy will only allow us to commit $50.0 million to the program at any given time. We utilize the services of Capital Markets Cooperative (CMC) of Ponte Vedra Beach, Florida to help monitor and manage our rate lock activities in this program. At March 31, 2011 we had gross loans of $19,494,729 paired with notional securities of $17,500,000 for net position of $1,994,729. We reported income related to our mandatory delivery program of $63 thousand during the first quarter of 2011.

ITEM 2.

MONARCH FINANCIAL HOLDINGS, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The purpose of this discussion is to focus on important factors affecting our financial condition and results of operations. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and supplemental financial data.

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

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

This report contains forward-looking statements with respect to our financial condition, results of operations and business. These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward-looking statements.

These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of our management and on information available at the time these statements and disclosures were prepared. Factors that may cause actual results to differ materially from those expected include the following:

•

General economic conditions may deteriorate and negatively impact the ability of borrowers to repay loans and depositors to maintain balances.

•

Changes in interest rates could reduce income.

•

Competitive pressures among financial institutions may increase.

•

The businesses that we are engaged in may be adversely affected by legislative or regulatory changes, including changes in accounting standards.

•

New products developed or new methods of delivering products could result in a reduction in our business and income.

•

Adverse changes may occur in the securities market.

•

Other factors described from time to time in our reports with the Securities and Exchange Commission.

This section should be read in conjunction with the description of our “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010.

Net Income

Net income for the quarter ended March 31, 2011 was $1.5 million compared to $1.1 million at March 31, 2010, an increase of $377 thousand or 33.3%. Basic earnings per share for the first quarter of 2011 and 2010 were $0.17 and $0.13, respectively, while diluted earnings per share were $0.16 and $0.13 for the same periods, respectively.

Two important and commonly used measures of profitability are return on assets (net income as a percentage of average total assets) and return on equity (net income as a percentage of average stockholders’ equity). Our annualized return on assets (“ROA”) was 0.71% and 0.67% for the three month periods ended March 31, 2011 and March 31, 2010. Our annualized return on equity (“ROE”) for the first quarter of 2011 was 7.74% compared to 6.68% in 2010. Growth in both net interest income and noninterest income contributed to our improvement in ROE.

Net interest income increased $1.3 million and non-interest income increased $1.4 million in the first quarter of 2011 compared to 2010. Higher loan yield coupled with lower interest costs on deposits contributed to improvement in our net interest income. Our mortgage division was the source of the increase in non-interest income.

Our provision for loan losses declined $326 thousand in the first quarter of 2011 compared to 2010. Non-interest expense increased $2.5 million for the quarter, with the areas of greatest non-interest expense growth in salaries and benefits, commissions and incentives, and loan expense.

Net Interest Income

Net interest income, the excess of interest income over interest expense, is a significant source of our revenue. A number of factors influence net interest income, including the interest rates earned on earning assets, and the interest rates paid to obtain funding to support the assets, the volume of interest-earning assets and interest bearing liabilities, and the mix of interest-earning assets and interest bearing liabilities.

Interest rates have remained at a record low for an extended period. The federal funds rate that is set by the Federal Reserve Bank’s Federal Open Market Committee has been 0.25% since December 2008. For comparable periods, the Wall Street Journal Prime Rate (“WSJ”), which generally moves with the federal funds rate, was 3.25%. This extended stable, though low, rate environment has allowed us to position our balance sheet to respond quickly in the future when rates begin to rise and to buffer the potential impact of those rising rates.

Net interest income increased $1.3 million in the first quarter of 2011, compared to 2010. Interest income has increased $992 thousand or 11.6% while interest expense has decreased $263 thousand or 12.2% over the prior year. Interest and fees on loans are the largest component of our interest income and the main contributor to interest income growth. The yield on our loan portfolio increased 6 basis points to 5.79% in 2011 compared to 2010, on higher average volume.

Our loan portfolio is comprised of two major classifications of loans: loans held for sale and loans held for investment. Loans held for sale, which are residential mortgages originated by our mortgage division and sold to investors, earn interest while on our books but are currently at rates lower than our held for investment portfolio. The normal holding period for these loans is approximately 35 to 45 days, and outstanding balances have increased $35.1 million, year-over-year, while the yield on these balances has declined. Loans held for investment, which are primarily commercial and real estate loans, have grown $9.7 million over March 31, 2010. The average yield on loans held for investment was 5.99% for the first quarter of 2011 compared to 5.76% for the first quarter of 2010.

At March 31, 2011, the blended cost of deposits declined 40 basis points when compared to 2010. The cost of our money market deposits declined 37 basis points, despite $14.8 million in growth. Time deposits decreased 21 basis points which, coupled with a $57.9 million decline in outstanding balances contributed $240 thousand in interest expense savings. Total interest expense on deposits declined $104 thousand year-over-year. Borrowing costs also declined $160 thousand due to lower average borrowings in the first quarter of 2011 compared to 2010.

For analytical purposes, net interest income is adjusted to a taxable equivalent basis to recognize the income tax savings on tax-exempt assets, such as bank owned life insurance (“BOLI”) and state and municipal securities. A tax rate of 34% was used in adjusting interest on BOLI, tax-exempt securities and loans to a fully taxable equivalent basis. The difference between rates earned on interest-earning assets (with an adjustment made to tax-exempt income to provide comparability with taxable income, i.e. the “FTE” adjustment) and the cost of the supporting funds is measured by net interest margin.

Our net interest rate spread on a tax-equivalent basis increased 22 basis points to 4.05% for first quarter of 2011, when compared to 3.83% for the same period in 2010. Yield on earning assets decreased 19 basis points to 5.32% from 5.51%, quarter over quarter, for the first three months of 2011 compared to 2010 and the cost of interest bearing liabilities decreased 41 basis points in the same comparative periods for an increase in our net interest margin of 14 basis points to 4.27%.

Bank Owned Life Insurance (BOLI) has been included in interest earning assets. We purchased $6,000,000 in BOLI during the fourth quarter of 2005. The income on BOLI is not subject to Federal Income tax, giving it a tax-effective yield of 5.65% for the first quarter of 2011 compared to 6.10% for the same period in 2010.

In July, 2006, we added additional capital through the issuance of $10,000,000 in trust preferred securities. These securities are treated as subordinated debt and have been included in other borrowings. The cost on trust preferred securities is fixed at 4.86%.

The following tables set forth average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders’ equity and the related income, expense and corresponding weighted average yields and costs.

The following is an analysis of net interest income, on a taxable equivalent basis.

NET INTEREST INCOME ANALYSIS

For Three Months Period Ended

March 31, 2011

Average
Balance

Income/
Expense

Yield
Rate(1)

ASSETS

Securities, at amortized cost (2)

9,348,054

41,674

1.81

Loans, held for investment, net

562,218,841

8,308,749

5.99

Loans, held for sale

107,148,421

1,134,461

4.29

Federal funds sold

44,813,967

27,041

0.24

Dividend-earning restricted equity securities

8,705,271

32,515

1.51

Deposits in other banks

3,567,740

1,075

0.12

Bank owned life insurance (2)

7,359,504

102,598

5.65

Total earning assets

743,161,798

9,648,113

5.27

Less: Allowance for loan losses

(8,894,949

)

Nonperforming loans

7,576,059

Total nonearning assets

53,484,656

Total assets

795,327,564

LIABILITIES and STOCKHOLDERS’ EQUITY

Interest-bearing deposits:

Checking

31,844,194

26,319

0.34

Regular savings

19,090,820

27,039

0.57

Money market savings

295,871,978

634,119

0.87

Certificates of deposit

246,411,418

1,070,198

1.76

Total interest-bearing deposits

593,218,410

1,757,675

1.20

Borrowings

13,773,078

144,485

4.25

Total interest-bearing liabilities

606,991,488

1,902,160

1.27

Noninterest-bearing liabilities

Demand deposits

95,635,486

Other noninterest-bearing liabilities

13,195,706

Total liabilities

715,822,680

Stockholders’ equity

71,928,826

Total liabilities and stockholders’ equity

787,751,506

Net interest income (2)

7,745,953

Interest rate spread (2)(3)

3.99

Net interest margin (2)(4)

4.23

(1)	Yields are annualized and based on average daily balances.

(2)	Income and yields are reported on a taxable equivalent basis assuming a federal tax rate of 34%, with a $36,006 adjustment for 2011.

(3)	Represents the differences between the yield on total average earning assets and the cost of total interest-bearing liabilities.

(4)	Represents the ratio of net interest-earnings to the average balance of interest-earning assets.

NET INTEREST INCOME ANALYSIS (continued)


	For Three Months Period Ended
	March 31, 2010
	Average Balance			Income/ Expense		Yield Rate(1)
	Average Balance			Income/ Expense		Yield Rate(1)
ASSETS
Securities, at amortized cost	$	8,037,953		$	54,546		2.75	%
Loans, net		544,497,023			7,730,963		5.76	%
Loans, held for sale		63,432,391			739,964		4.73	%
Federal funds sold		13,101,462			8,377		0.26	%
Dividend-earning restricted equity securities		7,019,700			18,165		1.05	%
Deposits in other banks		2,719,221			376		0.06	%
Bank owned life insurance (2)		7,078,127			106,484		6.10	%

Total earning assets		645,885,877			8,658,875		5.44	%

Less: Allowance for loan losses		(9,418,064	)
Nonperforming loans		8,438,496
Total nonearning assets		39,986,896

Total assets	$	684,893,205

LIABILITIES and STOCKHOLDERS’ EQUITY
Interest-bearing deposits:
Checking	$	19,006,338		$	17,615		0.38	%
Regular savings		23,056,521			45,982		0.81	%
Money market savings		159,592,985			487,496		1.24	%
Certificates of deposit		269,560,657			1,310,272		1.97	%

Total interest-bearing deposits		471,216,501			1,861,365		1.60	%
Borrowings		51,470,984			304,198		2.40	%

Total interest-bearing liabilities		522,687,485		$	2,165,563		1.68	%
Noninterest-bearing liabilities
Demand deposits		77,468,686
Other noninterest-bearing liabilities		8,320,790

Total liabilities		608,476,961
Stockholders’ equity		67,977,750

Total liabilities and stockholders’ equity	$	676,454,711

Net interest income (2)				$	6,493,312

Interest rate spread (2)(3)							3.76	%

Net interest margin (2)(4)							4.08	%

(1)	Yields are annualized and based on average daily balances.

(2)	Income and yields are reported on a taxable equivalent basis assuming a federal tax rate of 34%, with a $36,204 adjustment for 2010.

(3)	Represents the differences between the yield on total average earning assets and the cost of total interest-bearing liabilities.

(4)	Represents the ratio of net interest-earnings to the average balance of interest-earning assets.

Rate/Volume Analysis

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

For discussion purposes, our “Rate/Volume Analysis” and “Net Interest Income Analysis” tables include tax equivalent income on bank owned life insurance (BOLI) and municipal securities that is not in compliance with Generally Accepted Accounting Principals (GAAP). The following table is a reconciliation of our income statement presentation to these tables.

RECONCILIATION OF NET INTEREST INCOME

TO TAX EQUIVALENT INTEREST INCOME


Non-GAAP	3 Months Ended March 31,
	2011		2010
Interest income:
Total interest income	$	9,544,392	$	8,552,391
Bank owned life insurance		67,715		70,280
Tax equivalent adjustment (34% tax rate)
Bank owned life insurance		34,883		36,204
Municipal securities		1,123		—

Adjusted income on earning assets		9,648,113		8,658,875

Interest expense:
Total interest expense		1,902,160		2,165,563

Net interest income - adjusted	$	7,745,953	$	6,493,312

Net interest income increased $1.3 million, quarter over quarter, driven primarily by growth. The overall impact of growth was an increase to net interest income of $935 thousand while changes in rates contributed an additional $318 thousand.

Loan growth provided $813 thousand while higher rates contributed an additional $159 thousand to interest income. Lower yields on agency securities and lower earnings on BOLI reduced the increased interest income provided by federal funds sold and dividend-earning restricted equity securities to an additional, volume driven, contribution of $17 thousand.

Reduction in the cost of interest bearing deposits provided a savings in deposit costs of $326 thousand which was partially offset by deposit growth for a net deposit cost savings of $105 thousand. Average borrowings declined for a benefit of $307 thousand which was reduced $148 thousand due to higher rates.

The following table sets forth an analysis of the impact of changes in rate and volume on our interest bearing assets and liabilities for the first quarter of 2011 compared to 2010.

Changes in Net Interest Income (Rate/Volume Analysis)

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


	RATE / VOLUME ANALYSIS
	(in thousands)
	For the Three Months Ended March 31, 2011 vs 2010
	Interest Increase (Decrease)			Change Attributable to
	Interest Increase (Decrease)			Rate			Volume
Interest income
Loans:
Commercial	$	520		$	131		$	389
Real Estate		144			123			21
Consumer		(86	)		(21	)		(65	)
Loans held for sale		394			(74	)		468

Total loans		972			159			813

Securities:
Federal agencies		(14	)		(21	)		7
Mortgage-backed		(1	)		1			(2	)
Municipal securities		3			—			3
Other securities		—			—			—

Total securities		(12	)		(20	)		8

Federal funds sold		19			—			19
Dividend-earning restricted equity securities		15			10			5
Deposits in other banks		—			—			—
Bank owned life insurance		(5	)		(9	)		4

Total interest income	$	989		$	140		$	849

Interest expense
Deposits:
Demand	$	8			(3	)		11
Money market		146			(178	)		324
Savings		(19	)		(12	)		(7	)
Time		(240	)		(133	)		(107	)

Total deposits		(105	)		(326	)		221
Borrowings		(159	)		148			(307	)

Total interest expense		(264	)		(178	)		(86	)

Net interest income	$	1,253		$	318		$	935

Non-Interest Income

Non-interest income was $9.7 million for the first quarter of 2011, an increase of $1.4 million or 16.4% over the same period in 2010. Mortgage banking income continues to be the driver in non-interest income growth. Non-interest income is broken out into more detail in the following table:

NON-INTEREST INCOME


	For the Three Months Ended March 31,
	2011		2010
Mortgage banking income	$	9,004,237	$	7,675,152
Investment and insurance commissions		86,400		74,320
Service charges and fees		386,320		394,331
Bank owned life insurance income		67,715		70,280
Title company income		137,968		91,569
Other		11,866		20,951

	$	9,694,506	$	8,326,603

Mortgage banking income represents fees from originating and selling residential mortgage loans as well as commercial mortgages through Monarch Mortgage and our wholly owned commercial mortgage banking subsidiary, Monarch Capital, LLC. The overwhelming majority of this growth has been in the area of residential mortgages. Gross mortgage banking income increased in first quarter of 2011 compared to 2010 due to higher production. In the first quarter of 2011 Monarch Mortgage originated 1,320 loans totaling $300.0 million, compared to 979 loan originations totaling $233.9 million for the same period in 2010. Although rates have increased in recent months, residential mortgage rates remain low.

Service charges and fees on deposit accounts declined $8 thousand in the first quarter of 2011 compared to 2010. The primary components of service charges and fees are nonsufficient fund and overdraft fees and ATM transaction fees. Despite, year-over-year growth in deposits of $90.7 million, recent regulatory changes on the charging of fees on certain transactions have adversely impacted fee income. We have an agreement with a third-party vendor to brand ATMs in Food Lion grocery stores in southeast Virginia and northeast North Carolina. In return for supplying the cash for the machines and paying the machines’ cash servicing fees, we receive a portion of the transaction surcharge, and our customers can withdraw cash from the machines without a fee or transaction surcharge. We have 11 ATMs located at our banking center sites. Combined with our third-party vendor relationship, our network includes over 55 active branded ATMs.

Investment and insurance commissions increased $12 thousand, quarter over quarter. There were no security gains or losses in either 2011 or 2010.

BOLI is included in the net interest income calculation for yield analysis. We purchased $6.0 million in BOLI during the fourth quarter of 2005. The income from BOLI, which is not subject to tax, decreased $3 thousand quarter-over-quarter, in 2011 compared to 2010. The tax-effective income earnings are $102 for the first quarter of 2011 compared to $106 for the same period in 2010.

Through Monarch Investment, LLC, we own a 75% interest in a title company, Real Estate Security Agency, LLC (RESA), which is being treated as a consolidated entity for accounting purposes. RESA showed an increase of income for the first quarter of 2011 when compared to 2010 of $46 thousand.

Non-interest Expense

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

NON-INTEREST EXPENSE


	For the Three Months Ended March 31,
	2011		2010
Salaries and employee benefits	$	5,357,145	$	4,464,207
Commissions and incentives		3,893,359		3,460,339
Loan expense		1,355,423		1,001,184
Occupancy expenses		927,002		692,476
Furniture and equipment expense		460,031		375,949
FDIC Insurance		315,334		248,836
Marketing expense		273,756		211,741
Data processing services		305,833		195,536
Professional fees		168,928		132,307
Stationary and supplies		179,819		152,875
Telephone		151,634		122,661
Virginia Franchise Tax		126,905		116,113
Postage and shipping		112,133		86,262
Loss on sale of other real estate, net		—		49,023
ATM expense		53,392		49,862
Amortization of intangibles		44,643		44,643
Other		400,418		278,765

	$	14,125,755	$	11,682,779

Total non-interest expenses increased $2.5 million in the first quarter of 2011, an increase of 21.4% over the same period in 2010. Excluding salaries and employee benefits, and commissions and incentives, non-interest expense increased $1.1 million or 31.4% in the first quarter of 2011 compared to 2010.

Employee compensation; in the form of salaries, benefits, commissions and incentives, represent an approximate 65% of non-interest expense in first quarter of 2011 compared to 68% for the same period in 2010. Our full time equivalent employees, at March 31, 2011 totaled 531, compared to 434 in 2010. Employee compensation growth was primarily in salaries and benefits, which increased $893 thousand or 20% in the first quarter of 2011 compared to 2010. Commissions and incentives increased $433 thousand or 13% for the same period. Expansion in both our mortgage operations and the Bank’s sales team and branch staff were the source of the increases. We opened a new banking office in the Hilltop area of Virginia Beach in June 2010, relocated our corporate headquarters in the third quarter of 2010, after a substantial renovation of a building purchased in the second quarter 2010. Over fifty-five percent of our mortgage employees are paid commissions based on their production levels. Secondary increases are attributable to first, an increase in loan origination expense related to higher production by the bank and higher vendor expenses for Monarch Mortgage; and second growth related increases in occupancy, equipment, data service expenses and FDIC insurance.

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


	Increase For the Three Months Ended March 31,
	Dollars		Percentage
Salaries and employee benefits	$	892,938		20.0	%
Commissions and incentives		433,020		12.5	%
Loan origination expenses		354,239		35.4	%
Occupancy expenses		234,526		33.9	%
Data processing services		110,297		56.4	%

One property in other real estate was sold during the first quarter of 2011 at book value, with no gain or loss to report. In the first quarter of 2010 we sold four properties in other real estate and recorded losses, net of valuation adjustments of $49 thousand.

Income Taxes

Our income tax provision was $699 thousand for the quarter compared to $570 thousand for the same period in 2010. Included in first quarter 2011 taxes are state taxes for Maryland, North Carolina and South Carolina of $81 thousand. The effective tax rate for the quarter was 31.7% compared to 33.5% for the same period in 2010.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

GENERAL

Total assets were $801.3 million at March 31, 2011, a $24.3 million or 2.9% decrease compared to assets of $825.6 million at December 31, 2010. On an annual basis total assets increased $96.6 million, a 13.7% increase when compared to assets of $704.7 million at March 31, 2010. Decreases in loans held for sale of $80.1 million or 45.7% were the source of the decline from December 31, 2010. This decrease was partially offset by growth during the quarter in investment securities of $25.9 million, total cash and cash equivalents of $23.8 million and loans held for investment of $7.6 million.

On an annual basis, investment securities increased $35.1 million or 417.6% compared to $8.4 million at March 31, 2010 and total cash and cash equivalents increased $23.7 million or 86.6% compared to $27.4 million at March 31, 2010. Loans held for sale increased $12.6 million or 15.3% over the March 31, 2010 balance of $82.7 million. On an annual basis, total loans held for investment increased $9.7 million, or 1.7%, from $556.8 million in March 2010. Property and equipment increased $13.4 million or 145.3% to $22.6 million at March 31, 2011 compared to $9.2 million at March 31, 2010.

Loans held for sale represent mortgage loans that have been closed and are awaiting investor purchase. A majority of our mortgage loans are pre-sold and remain on our books for thirty to forty-five days. Outstanding balances are dependent on the current mortgage market and may fluctuate significantly between periods. The decline noted at March 31, 2011 compared to year-end 2010 is a product of seasonality coupled with rate volatility. The increase on an annual basis is a product of a higher level of production in 2011 coupled with seasonality created by a particularly difficult winter in 2010.

In April 2010, we purchased a building in Chesapeake, Virginia, which was renovated and in September 2010 became our new corporate headquarters. Also in April 2010, we purchased a piece of land in the Ghent section of Norfolk, Virginia. We are currently in the construction phase of that project which, when complete, will be the new home of our existing Ghent banking office and Norfolk Monarch Mortgage headquarters. In May 2010, we began construction on our new Kitty Hawk branch, located in

Kitty Hawk, North Carolina on property for which we have a land lease. Both of these construction projects, which are relocations of existing store front branches, were completed and opened in April 2011. In June 2010 we opened a new office in the Hilltop area of Virginia Beach, Virginia, which is a leased location. These purchases and the renovation and furnishing of our leased location were the primary source of the increase in property and equipment.

Total liabilities were $728.5 million at March 31, 2011, a decrease of $25.3 million or 3.4% from year-end 2010 liabilities of $753.8 million. Year over year total liabilities increased $92.3 million or 14.5% over $636.2 million at March 31, 2010. The primary source of the changes in our liabilities in comparative periods is fluctuations in our deposits. Total deposits decreased $35.9 million or 5.1% to $669.8 million at March 31, 2011, when compared to $705.7 million at year-end 2010 and increased $90.7 million or 15.7% compared to $579.1 million, one year prior. Total borrowings increased $11.2 million to $51.5 million at March 31, 2011, a 27.7% increase from $40.3 million at December 31, 2010 and declined $638 thousand or 1.2% from $52.1 million at March 31, 2010.

Non-interest bearing demand deposits increased $5.7 million over December 2010 to $103.4 million and on an annual basis $9.8 million over March 31, 2010. Interest bearing demand deposits were $33.4 million, an increase of $1.1 million and $13.4 million when compared to December 31, 2010 and March 31, 2010 totals of $32.3 million and $20.0 million, respectively. We are primarily a business bank and, as such, have focused our efforts on obtaining company operating and escrow accounts, which are demand deposit accounts. Escrow accounts ordinarily house real estate funds, which makes them sensitive to the growth of the current mortgage environment. Our focus on the business sector, coupled with the growth in business operating and escrow accounts, has resulted in continued growth in demand deposits.

Our interest bearing deposits are comprised of savings accounts, money market accounts and time deposits or certificates of deposits (“CDs”). Savings accounts have increased compared to year end 2010 but declined, on an annual basis. CDs declined at March 31, 2011, compared to year-end 2010, and prior year. Money market accounts continue to grow and have shown marked growth in 2011 compared to the prior year.

Savings deposits are $424 thousand or 2.2% higher at March 31, 2011 compared to $19.3 million at December 31, 2010, but $3.9 million or 16.6% lower on an annual basis from $23.7 at March 31, 2010. The year-over-year decline is the result of a change in pricing. In early 2010 we began lowering the rates on our tiered savings product and the decline, year over year, is attributable to the rate sensitivity of those clients who have migrated to our higher yield money market product.

Total money market balances were $298.1 million at March 31, 2011, an increase of $14.8 million compared to $283.3 million at December 31, 2010. On an annual basis, money market accounts have increased $128.6 million compared to $169.5 million at March 31, 2010. Our multi-tiered money market product offers attractive rates and is highly competitive in the market.

CDs were $215.1 million at March 31, 2011, a decrease of $57.9 million or 21.2% from $273.0 million at December 31, 2010 and a decrease $57.3 million or 21.0% from $272.4 million at March 31, 2010. Rates remain at historically low levels. At December 31, 2010 fluctuations in our loans held for investment created excess liquidity, which we sold overnight at extremely low rates. In order to reduce this excess liquidity, during the first quarter of 2011, we allowed $34.3 million in, out of market, brokered deposits to mature and reduced our core CD portfolio renewals through pricing. The goal of most CD clients is a higher rate of return on their deposit to offset the time they are required to tie up funds they would otherwise have available for use. We have focused on relationship pricing for CDs coupled with lower rates for non-clients to reduce excess liquidity.

Stockholders’ equity was $72.7 million at March 31, 2011, compared to $71.6 million at December 31, 2010. Components of the change in stockholders’ equity include net income of $1.4 million, decrease in unrealized losses in other comprehensive income of $47 thousand, stock based compensation totaling $102 thousand, and a preferred stock dividend payment of $390 thousand.

Loans Held for Investment

Our lending activities are our principal source of income. Loans held for investment, net of unearned income, increased $7.6 million or 1.4% in the first quarter of 2011 compared to year end 2010.

The following table provides a breakdown, by class or segment of our loans held for investment at March 31, 2011 and December 31, 2010.

Loans held for Investment


	March 31, 2011			December 31, 2010
Commercial	$	82,972,379		$	86,633,856
Real estate
Construction		129,970,770			119,881,034
Residential (1-4 family)		84,950,550			84,822,652
Home equity lines		80,118,245			81,013,642
Multifamily		19,810,668			20,959,832
Commercial		165,438,666			162,541,959

Real estate subtotal		480,288,899			469,219,119

Consumers
Consumer and installment loans		3,101,365			2,937,347
Overdraft protection loans		60,863			66,647

Loans to individuals subtotal		3,162,228			3,003,994

Total gross loans		566,423,506			558,856,969
Allowance for loan losses		(9,503,000	)		(9,037,800	)

Loans net of allowance for loan losses		556,920,506			549,819,169

Unamortized loan costs, net of deferred fees		32,246			11,258

Total net loans	$	556,952,752		$	549,830,427

Allowance and Provision for Loan Losses

We have certain lending policies and procedures in place that are designed to balance loan growth and income with an acceptable level of risk, which management reviews and approves on a regular basis. Our review process is supported by a series of reports related to loan production, loan quality, credit concentrations, policy exceptions, loan delinquencies and non-performing and potential problem loans. We also utilize diversification in our loan portfolio as a means of managing risk.

Our allowance for loan losses is to provide for losses inherent in the loan portfolio. Management is responsible for determining the level of the allowance for loan losses, subject to review by our Board of Directors. Among other factors, we consider on a monthly basis our historical loss experience, the size and composition of our loan portfolio, the value and adequacy of collateral and guarantors, non-performing credits including impaired loans and our risk-rating-based loan “watch list”, and local and national economic conditions. The economy of our trade area is well diversified. There are additional risks of future loan losses that cannot be precisely quantified or attributed to particular loans or classes of loans. Since those factors include general economic trends as well as conditions affecting individual borrowers, the allowance for loan losses is an estimate.

To determine the total allowance for loan losses, we estimate the reserves needed for each class or segment of the portfolio, including loans analyzed on both, a pooled basis and individually. Our allowance for loan losses consists of amounts applicable to the following classes or segments: (i) the commercial loan portfolio; (ii) the real estate loan portfolio; (iii) the consumer loan portfolio. In addition, loans within these portfolios are evaluated as a group or on an individual or relationship basis and assigned a risk grade based on the underlying characteristics. Loans are pooled by risk grade within the portfolio segment, and losses are modeled utilizing metrics such as the risk rating, historical experience, other known and inherent risks, and quantitative techniques which management has determined fit the characteristics of that segment.

The commercial loan portfolio includes commercial and industrial loans which are usually secured by the assets being financed or other business assets such as accounts receivable or inventory and normally incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business.

The real estate loan portfolio includes all loans secured by real estate. This segment is further broken down into construction loans, residential 1-4 family loans, home equity lines, multifamily loans, and commercial real estate loans. Construction and multifamily loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the completed project. Residential 1-4 family and home equity loan originations utilize analytics to supplement the underwriting process. Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.

Commercial and real estate portfolio loans are evaluated on an individual or relationship basis and assigned a risk grade at the time the loan is made. Additionally, we perform periodic reviews of the loan or relationship to determine if there have been any changes in the original underwriting which would change the risk grade and/or impact the borrower’s ability to repay the loan.

The consumer loan portfolio includes consumer and installment loans and overdraft protection loans. These loans, which are in relatively small loan amounts, are spread across many individual borrowers. We utilize analytics to supplement general underwriting. Loans within the consumer class are assigned risk grades and evaluated as a pool, unless specifically identified through delinquency or other signs of credit deterioration, at which time the identified loan is individually evaluated. Additionally, loans that have been specifically identified as a credit risk due to circumstances that may affect the ability of the borrower to repay interest and/or principal are analyzed on an individual basis. Adverse circumstances may include loss of repayment source, deterioration in the estimated value of collateral, elevated trends of delinquencies, and charge-offs.

We evaluate the adequacy of the allowance for loan losses monthly in order to maintain the allowance at a level that is sufficient to absorb probable credit losses. Such factors as the level and trend of interest rates and the condition of the national and local economies are also considered. From time to time, events or economic factors may affect the loan portfolio, causing management to provide additional amounts to or release balances from the allowance for loan losses. Our allowance for loan losses is sensitive to risk ratings assigned to individually evaluated loans, economic assumptions, and delinquency trends driving statistically modeled reserves.

There are nine numerical risk grades which are assigned to loans. These risk grades are as follows:


“Satisfactory”		“Watch List”
1 Minimal		6 Special mention
2 Modest		7 Substandard
3 Average		8 Doubtful
4 Acceptable		9 Loss
5 Acceptable with care

The following is a breakdown between Satisfactory and Watch List loans at March 31, 2011 and December 31, 2010. There were no loans risk graded Doubtful (8) or Loss (9) included in our portfolio in either period presented.


	March 31, 2011				December 31, 2010
	Satisfactory		Watchlist		Satisfactory		Watchlist
	Risk Grades 1 - 5		Risk Grades 6-7		Risk Grades 1 - 5		Risk Grades 6-7
Commercial	$	72,514,179	$	10,458,200	$	76,751,687	$	9,882,169
Real estate
Construction		105,271,382		24,699,388		95,236,104		24,644,930
Residential (1-4 family)		68,724,651		16,225,899		68,184,218		16,638,434
Home equity lines		74,578,010		5,540,235		75,470,348		5,543,294
Multifamily		16,282,730		3,527,938		17,403,263		3,556,569
Commercial		158,331,884		7,106,782		157,903,052		4,638,907

Real estate subtotal		423,188,657		57,100,242		414,196,985		55,022,134

Consumers
Consumer and installment loans		2,889,423		211,942		2,706,795		230,552
Overdraft protection loans		51,913		8,950		59,637		7,010

Loans to individuals subtotal		2,941,336		220,892		2,766,432		237,562

Total gross loans	$	498,644,172	$	67,779,334	$	493,715,104	$	65,141,865

We do not have any potential problem loans which have not been evaluated and disclosed at March 31, 2011 or December 31, 2010. No loans on the watchlist meet the definition of a potential problem loan. We evaluate the collectability of both principal and interest when assessing the need for a loss accrual. (For additional discussion on this evaluation refer to Note 1 and Note 3 of our 2010 Annual Report on Form10-K.)

This evaluation includes, but is not limited to, the application of a loss factor which is arrived at by using a three-year moving average “look back” at our historical losses. This loss factor is multiplied by the outstanding principal within a risk grade to arrive at an overall loss estimate. Environmental factors may also be applied to a class or classes of loans based on management’s subjective evaluation of such conditions as credit quality trends, collateral values, portfolio concentrations, specific industry conditions in the regional economy, regulatory examination results, external audit and loan review findings, recent loss experiences in particular portfolio classes, etc. Any unallocated portion of the allowance for loan losses reflects management’s attempt to ensure that the overall reserve appropriately reflects a margin for the imprecision necessarily inherent in estimates of credit losses.

The allowance is subject to regulatory examinations and determination as to adequacy. This examination may take into account such factors as the methodology used to calculate the allowance and the size of the allowance in comparison to peer banks identified by regulatory agencies.

During the quarter ended March 31, 2011, we accrued $1,001,454 in provision for loan losses compared to $1,327,870 in the first quarter of 2010. Based on the current economic environment and the composition of our loan portfolio, the level of our charged-off loans combined with our peer bank loss experience, we considered this provision to be a prudent allocation of funds for our loan loss allowance.

Loans charged off during first quarter of 2011 and 2010 totaled $597,311 and $2,041,948, respectively. Recoveries totaled $60,157 and $64,078 for the same periods, respectively. The ratio of net charge-offs to average outstanding loans was 0.10% in through March 31, 2011 compared to 0.36% in 2010. Specific reserves included in our December 31, 2010 allowance for loans charged off in the first quarter of 2011 totaled $165,472.

In the first quarter of 2011, approximately $141 thousand in loans charged off were related to failed business activities and the remaining $456 thousand were related to residential properties. In the first quarter of 2010, approximately $1.2 million in loans charged off were related to real estate development projects which were adversely impacted by the downturn in the real estate market, $450 thousand was due to failed business activities and an additional $350 thousand in charged-off balances were related to residential properties.

The allowance for loan losses totaled $9,503,000 at March 31, 2011, an increase of $465,200 or 5.1% over December 31, 2010 and $853,000 or 9.9% over March 31, 2010. The ratio of the allowance to loans, less unearned income, was 1.68% at March 31, 2011, 1.62% at December 31, 2010 and 1.55% at

March 31, 2010. We believe that the allowance for loan losses is adequate to absorb any inherent losses on existing loans in our loan portfolio at March 31, 2011. The allowance to loans ratio is supported by the level of non-performing loans, the seasoning of the loan portfolio, and the experience of the lending staff in the market.

LOAN LOSS ALLOWANCE AND LOSS EXPERIENCE


	For the Three Months Ended March 31,
	2011			2010
Balance, beginning of period	$	9,037,800		$	9,300,000
Loans charged-off
Commercial		—			—
Real estate
Construction		(38,623	)		(737,947	)
Residential (1-4 family)		(141,624	)		(586,693	)
Home equity lines		(417,064	)		(707,808	)
Multifamily		—			—
Commercial		—			(9,500	)
Consumers
Consumer and installment loans		—			—
Overdraft protection loans		—			—

		(597,311	)		(2,041,948	)

Recoveries
Commercial		4,206			—
Real estate
Construction		734			4,517
Residential (1-4 family)		10,226			392
Home equity lines		45,356			2,989
Multifamily		—			—
Commercial		—			55,710
Consumers
Consumer and installment loans		205			470
Overdraft protection loans		330			—

		61,057			64,078

Net Charge Offs		(536,254	)		(1,977,870	)
Provisions charged to operations		1,001,454			1,327,870

Balance, end of period	$	9,503,000		$	8,650,000

A summary of our allowance as of March 31, 2011 and December 31, 2010 by classification is as follows:

Allocation of the Allowance for Loan Losses


	March 31, 2011
	Amount			Percentage of loans in each category to total loans
Commercial	$	1,391,437			14.7	%
Real estate
Construction		2,268,637			22.9	%
Residential (1-4 family)		1,791,618			15.0	%
Home equity lines		2,266,138			14.1	%
Multifamily		144,984			3.5	%
Commercial		1,375,618			29.2	%
Consumers
Consumer and installment loans		79,399			0.6	%
Overdraft protection loans		4,036			0.0	%
Unallocated		181,133

	$	9,503,000			100.0	%

Total loans held for investment outstanding *	$	566,455,752
Ratio of allowance for loan losses to total loans held for investment		1.68	%

	December 31, 2010
	Amount			Percentage of loans in each category to total loans
Commercial	$	919,774			15.5	%
Real estate
Construction		1,931,797			21.5	%
Residential (1-4 family)		2,114,094			15.2	%
Home equity lines		2,443,275			14.5	%
Multifamily		146,923			3.7	%
Commercial		1,308,073			29.1	%
Consumers
Consumer and installment loans		84,384			0.5	%
Overdraft protection loans		466			0.0	%
Unallocated		89,014			n/a

	$	9,037,800			100.0	%

Total loans held for investment outstanding *	$	558,868,227
Ratio of allowance for loan losses to total loans held for investment		1.62	%

*	Total loans held for investment outstanding includes unamortized loan costs, net of deferred fees of $32,246 at March 31, 2011 and $11,258 at December 31, 2010.

Asset Quality and Non-Performing Loans

We identify specific credit exposures through periodic analysis of our loan portfolio and monitor general exposures from economic trends, market values and other external factors. We maintain an allowance for loan losses, which is available to absorb losses inherent in the loan portfolio. The allowance is increased by the provision for losses and by recoveries from losses. Charged-off loan balances are

subtracted from the allowance. The adequacy of the allowance for loan losses is determined on a monthly basis. Various factors as defined in the previous section “Allowance and Provision for Loan Losses” are considered in determining the adequacy of the allowance. Loans are generally placed on non-accrual status after they are past due for 90 days.

Non-performing loans include loans on which interest is no longer accrued, accruing loans that are contractually past due 90 days or more as to principal and interest payments, and loans classified as troubled debt restructurings. At March 31, 2011 loans 90 days past due and still accruing totaled $429,992, loans in nonaccrual totaled $7,191,566 and loans classified as troubled debt restructurings totaled $298,984. At December 31, 2010 loans 90 days past due and still accruing totaled $1,130,816 and loans in nonaccrual totaled $7,583,305 and loans classified as troubled debt restructurings totaled $306,623. Total non-performing loans as a percentage of total loans were 1.40% and 1.61% at March 31, 2011 and December 31, 2010, respectively.


	NON-PERFORMING ASSETS										Other Real Estate Owned		Total Non-Peforming Assets
	Non-Performing Loans
	Over 90 Days and Accruing		Nonaccrual Loans			Restructured Loans			Non-Performing Loans
March 31, 2011
Commercial	$	—	$	1,064,582		$	182,000		$	1,246,582	$	—	$	1,246,582
Real estate
Construction		—		1,854,510			—			1,854,510		533,518		2,388,028
Residential (1-4 family)		—		2,678,396			116,984			2,795,380		1,642,300		4,437,680
Home equity lines		429,992		1,587,068			—			2,017,060		—		2,017,060
Multifamily		—		—			—			—		—		—
Commercial		—		—			—			—		—		—
Consumers
Consumer and installment loans		—		—			—			—		—		—
Overdraft protection loans		—		7,010			—			7,010		—		7,010

Total	$	429,992	$	7,191,566		$	298,984		$	7,920,542	$	2,175,818	$	10,096,360

December 31, 2010
Commercial	$	270,728	$	1,393,207		$	182,000		$	1,845,935	$	—	$	1,845,935
Real estate
Construction		240,672		1,757,752			—			1,998,424		1,190,000		3,188,424
Residential (1-4 family)		418,608		3,495,820			124,623			4,039,051		554,700		4,593,751
Home equity lines		179,992		757,585			—			937,577		—		937,577
Multifamily		—		—			—			—		—		—
Commercial		—		178,941			—			178,941		—		178,941
Consumers
Consumer and installment loans		20,816		—			—			20,816		—		20,816
Overdraft protection loans		—		—			—			—		—		—

Total	$	1,130,816	$	7,583,305		$	306,623		$	9,020,744	$	1,744,700	$	10,765,444


			March 31, 2011			December 31, 2010
Asset Quality Ratios:
Nonperforming loans to period end loans				1.40	%		1.61	%
Nonperforming assets to period end assets				1.26	%		1.30	%
Allowance for loan losses to nonperforming loans				119.98	%		100.19	%

Restructured loans are loans for which it has been determined the borrower will not be able to perform under the original terms of the loan agreement and a concession has been made to those terms that would not otherwise have been considered. If the value of a restructured loan is determined to be less than the recorded investment in the loan, a valuation allowance is created with a corresponding charge-off and any collection of interest and principal are recorded as recoveries to the allowance for loan losses until all charged-off balances are fully recovered. Measurement of the value of a restructured loan is generally based on the present value of expected future cash flows discounted at the loan’s effective interest rate, unless in the case of collateral-dependent loans, the observable market price, or the fair value of the collateral can be readily determined. Restructured loans are reevaluated periodically and additional adjustments to the carrying value may be made. In addition, if it is determined the borrower is unable to perform under the modified terms, further steps, such as a full charge-off or foreclosure may be taken. We did not have any commitments to lend additional funds on restructured loans at March 31, 2011 or December 31, 2010.


	Restructured Loans
	Commercial		Residential 1-4 Family		Real Estate Construction		Total
March 31, 2011
Balance beginning of the period	$	182,000	$	124,623	$	—	$	306,623
Investment in restructured loans
Additions during the period		—		(7,639)		—		(7,639)
Charge-off during the period		—		—		—		—
Moved to other real estate		—		—		—		—
Valuation allowance for restructured loans included in charged-off loans		—		—		—		—
Additions during the period		—		—		—		—

Restructured loans included in impaired loans end of the period	$	182,000	$	116,984	$	—	$	298,984


December 31, 2010
Balance beginning of the period	$	182,000	$	—	$	356,000	$	538,000
Investment in restructured loans
Additions during the period		—		124,623		—		124,623
Charge-off during the period		—		—		(41,000)		(41,000)
Valuation allowance for restructured loans included in charged-off loans						(315,000)		(315,000)
Additions during the period
Restructured loans included in impaired loans end of the period		—		—		—		—

	$	182,000	$	124,623	$	—	$	306,623

Recoveries of charged-off balance
March 31, 2011	$	1,545	$	—	$	—	$	1,545
December 31, 2010	$	8,000	$	—	$	9,000	$	17,000

A loan is considered impaired when, based on current information and events; it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. In addition to loans 90 days past due and still accruing, nonaccrual loans and restructured loans, all loans risk graded doubtful or substandard qualify, by definition, as impaired. Approximately $9.3 million in loans, which had been evaluated, and qualified by definition, as impaired at December 31, 2010 have been added to our impaired loans table in the notes for March 31, 2011 due to a change in methodology between the periods.

Other Real Estate

Other real estate is real estate properties acquired through or in lieu of loan foreclosure. At foreclosure, these properties are recorded at their fair value less estimated selling costs as a nonperforming asset, with any write-downs to the carrying value of our investment charged to the allowance for loan loss. After foreclosure, periodic evaluations are performed to determine if any decrease in the fair value less estimated selling costs has occurred. Further adjustments to this fair value are charged to operations, in noninterest income, when identified. Expenses associated with the maintenance of other real estate are charged to operations, in loan expense, as incurred. When a property is sold, any gain or loss on the sale is recorded as noninterest income.


	March 31, 2011
	Balance		Number
January 1,	$	1,744,700		5
Balance moved into other real estate		1,087,600		4

		2,832,300		9

Write down of property charged to operations
Payments received after foreclosure
Properties sold		(656,482)		(1)

Balance March 31, 2011	$	2,175,818		8

Gross gains of sale of other real estate	$	—
Gross losses on sale of other real estate		—
Write down of property charged to operations		—

Net gain (loss) on other real estate	$	—


	December 31, 2010
	Balance		Number
January 1,	$	2,115,700		8
Balance moved into other real estate		5,617,450		13	*

		7,733,150		21

Write down of property charged to operations		(51,955)
Payments received after foreclosure		(40,665)
Properties sold		(5,895,830)		(16)

Balance December 31, 2010	$	1,744,700		5

Gross gains of sale of other real estate	$	409,566
Gross losses on sale of other real estate		(254,516)
Write down of property charged to operations		(51,955)

Net gain (loss) on other real estate	$	103,095

*	Two units moved to other real estate in 2010 were originally held and reported as one property. During the first quarter of 2011 the property was split into two parcels to be sold separately.

Liquidity

Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale of existing assets or the acquisition of additional funds through short-term borrowings. Our liquidity is provided from cash and amounts due from banks, federal funds sold, interest-bearing deposits in other banks, repayments from loans, increases in deposits, lines of credit from the Federal Home Loan Bank and five correspondent banks, and maturing investments. As a result of our management of liquid assets, and our ability to generate liquidity through liability funding, we believe that we maintain overall liquidity sufficient to satisfy our depositors’ requirements and to meet clients’ credit needs. We also take into account any liquidity needs generated by off-balance sheet transactions such as commitments to extend credit, commitments to purchase securities and standby letters of credit.

We monitor and plan our liquidity position for future periods. Liquidity strategies are implemented and monitored by our Asset/Liability Committee (“ALCO”). The Committee uses a simulation and budget model to assess current and future liquidity needs.

Cash, cash equivalents and federal funds sold totaled $51.1 million as of March 31, 2011 compared to $27.4 million as of December 31, 2010. At March 31, 2011, cash, securities classified as available for sale and federal funds sold were $94.7 million or 11.8% of total earning assets, compared to $45.0 million or 5.4% of total earning assets at December 31, 2010.

In the course of operations, due to fluctuations in loan and deposit levels, we occasionally find it necessary to purchase federal funds on a short-term basis. We maintain unsecured federal funds line arrangements with five other banks, which allow us to purchase funds totaling $34.5 million. These lines mature and re-price daily. At March 31, 2011 and December 31, 2010, we had $0 in federal funds purchased.

We have access to the Federal Reserve Bank of Richmond’s discount window should a liquidity crisis occur. We have not used this facility in the past and consider it a backup source of funds.

We are also members of the Promontory Network and have access to a program through their Certificate of Deposit Account Registry Service^® (“CDARS”) to use their CDARS One Way Buy^SM to purchase cost-effective funding without collateralization (and in lieu of generating funds through “traditional” brokered CDs or the Federal Home Loan Bank). These funds are accessed through a weekly auction. The auction typically takes place on Wednesdays, with next day settlement. There are seven maturities available ranging from 4 weeks to 5 years. If we are allotted funds in the auction, we incur no transaction fees or commissions. Although the process to compete for these deposits is different from the process for traditional brokered CDs, they are still considered brokered for Call Report purposes. These funds which are included in our Jumbo CDs are subject to discretionary limitations on volume that we normally would impose on traditional brokered deposits. Based on our “well capitalized” status, we are able to draw up to $79.1 million from this program. We had $0 on our balance sheet from this program at March 31, 2011 and $10.0 million at December 31, 2010.

We have lines of credit with the Federal Home Loan Bank of Atlanta (“FHLB”) that can equal up to 30% of our assets. Our primary line of credit (Primary) totaled approximately $76.6 million with $29.1 million available at March 31, 2011. This line is currently reduced by $6.0 million, which has been pledged as collateral for public deposits.

In February 2009, we negotiated an additional line of credit with FHLB which is secured by a portion of our loans held for sale (“LHFS”). We pledge these loans, which have been sold to FHLB approved investors, as collateral. In return, we are allowed to borrow up to 70% of these loans for 120 days. The investor remits the proceeds for the purchased loans directly to FHLB, which then releases the collateral pledged. At March 31, 2011, we had assets pledged totaling $52.3 million and advances outstanding totaled $0.

Borrowings outstanding under the combined FHLB lines of credit were $41.5 million at March 31, 2011 and $30.3 million at December 31, 2010. We had the following borrowing advances under our Primary line outstanding as of March 31, 2011, with the following final maturities:


Advance Amount		Expiration Date
	1,450,399	September 2015
	40,000,000	July 31, 2011

$	41,450,399

The advance maturing in 2015 is a principal reducing credit that matures on September 28, 2015. Terms include 39 quarterly principal payments of $25 thousand beginning December 2005, with a final payment of $1.0 million in September 2015. We are utilizing this advance to match-fund several long term fixed rate loans. The interest rate for this advance is fixed at 4.96%.

The advance maturing in July 2011 is from our daily investment account and carries a variable rate that changes daily. The interest rate on March 31, 2011 for this advance was 0.36%.

We have no material commitments or long-term debt for capital expenditures at the report date. The only long-term debt is for funding loans.

Off-Balance Sheet Arrangements

We enter into certain financial transactions in the ordinary course of performing traditional banking services that result in off-balance sheet transactions. The off-balance sheet transactions recognized as of March 31, 2011 and December 31, 2010 were a line of credit to secure public funds and commitments to extend credit and standby letters of credit issued to customers. The line of credit to secure public funds was from the Federal Home Loan Bank for $6 million at March 31, 2011 and December 31, 2010.

We entered into an interest rate swap agreement with PNC Bank of Pittsburgh, PA on July 29, 2009, for our $10 million Trust Preferred borrowings which carries a floating interest rate of 90 day LIBOR plus 160 basis points. Under the terms of this agreement, at the end of each quarter we will swap our floating rate for a fixed rate of 3.26%. The effective date of this swap is March 31, 2010, with an expiration date of September 30, 2014. This swap will fix our interest cost on our $10 million Trust Preferred borrowings of 4.86% for five years.

Commitments to extend credit, which include rate lock commitments, amounted to $439.6 million at March 31, 2011 and $302.2 million at December 31, 2010, represent legally binding agreements to lend to customers with fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being funded, the total commitment amounts do not necessarily represent future liquidity requirements.

We have a commitment to purchase a $250 thousand investment security at March 31, 2011 but did not have any outstanding commitments to purchase securities on December 31, 2010.

Standby letters of credit are conditional commitments we issue guaranteeing the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. We had $7.7 million in outstanding standby letters of credit at March 31, 2011 and $5.8 million at December 31, 2010.

We have thirty non-cancelable leases for premises. The original lease terms are from one to fifty years and have various renewal and option dates.

Capital Resources

We review the adequacy of our capital on an ongoing basis with reference to the size, composition, and quality of our resources and consistent with regulatory requirements and industry standards. We seek to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses.

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 additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, banks must meet specific capital guidelines that involve quantitative measures of the bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators about components (such as interest rate risk), risk weighting, and other factors.

The Bank, as a Virginia banking corporation, may pay dividends only out of retained earnings. In addition, regulatory authorities may limit payment of dividends by any bank, when it is determined that such limitation is in the public interest and necessary to ensure financial soundness of the Bank. Regulatory agencies place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. The amount of dividends the Bank may pay to the Company, without prior approval, is limited to current year earnings plus retained net profits for the two preceding years. At March 31, 2011, the amount available was approximately $9.7 million. We currently pay a quarterly dividend on our series B noncumulative, perpetual preferred stock of 7.8%, or $390,000 per quarter. We paid our first common stock dividends of $0.14 per share in 2010 for total dividends of $824,577.

Common Stock Dividends


Payment Date	Per Share Dividend		Total Dividend
June 15, 2010	$	0.07	$	411,287
November 30, 2010		0.07		413,290

Quantitative measures established by regulation to ensure capital adequacy require that the Bank maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of March 31, 2011, the Bank meets all capital adequacy requirements to which it is subject.

As of March 31, 2011, the Bank was categorized as “well capitalized,” the highest level of capital adequacy. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. The Bank’s actual capital amounts and ratios are also presented in the table as of March 31, 2011 and December 31, 2010.


	Actual				For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective
	Amounts		Ratio		Amounts		Ratio		Amounts		Ratio
	(Dollars in Thousands)
As of March 31, 2011
Total Risk-Based Capital Ratio
Consolidated company	$	89,928		13.53%	$	53,173		8.00%		N/A		N/A
Bank	$	85,918		12.97%	$	52,995		8.00%	$	66,244		10.00%
(Total Risk-Based Capital to Risk-Weighted Assets)

Tier 1 Risk-Based Capital Ratio
Consolidated company	$	81,618		12.28%	$	26,586		4.00%		N/A		N/A
Bank	$	77,623		11.72%	$	26,492		4.00%	$	39,739		6.00%
(Tier 1 Capital to Risk-Weighted Assets)

Tier 1 Leverage Ratio
Consolidated company	$	81,618		10.41%	$	31,363		4.00%		N/A		N/A
Bank	$	77,623		9.90%	$	31,363		4.00%	$	39,204		5.00%
(Tier 1 Capital to Average Assets)

As of December 31, 2010
Total Risk-Based Capital Ratio
Consolidated company	$	89,061		12.99%	$	54,846		8.00%		N/A		N/A
Bank	$	85,075		12.42%	$	54,820		8.00%	$	68,526		10.00%
(Total Risk-Based Capital to Risk-Weighted Assets)

Tier 1 Risk-Based Capital Ratio
Consolidated company	$	80,486		11.74%	$	27,423		4.00%		N/A		N/A
Bank	$	76,503		11.16%	$	27,410		4.00%	$	41,115		6.00%
(Tier 1 Capital to Risk-Weighted Assets)

Tier 1 Leverage Ratio
Consolidated company	$	80,486		9.35%	$	34,424		4.00%		N/A		N/A
Bank	$	76,503		8.89%	$	34,424		4.00%	$	43,030		5.00%
(Tier 1 Capital to Average Assets)

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Our primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an important component of our asset/liability management process, which is governed by policies established by our board of directors that are reviewed and approved annually. Our board of directors delegates responsibility for carrying out asset/liability management policies to the Asset/Liability Management Committee (“ALCO”). In this capacity, this committee develops guidelines and strategies that govern our asset/liability management related activities, based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.

Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with our financial instruments also change, affecting net interest income, the primary component of our earnings. The Asset/Liability Management Committee uses the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While this committee routinely monitors simulated net interest income sensitivity over a rolling 12 month horizon, it also employs additional tools to monitor potential longer-term interest rate risk.

The interest sensitivity position (“gap”) is the difference between interest sensitive assets and interest sensitive liabilities in a specific time interval. The gap can be managed by repricing assets or liabilities, affected by selling securities available-for-sale, by replacing an asset or liability at maturity, or by adjusting the interest rate or the life of an asset or liability. Matching of assets and liabilities repricing in the same interval helps to hedge the risk and minimize the impact on interest income in periods of rising and falling interest rates.

Generally, positive gaps affect net interest margins and earnings negatively in periods of falling rates, and conversely, higher negative gaps adversely impact net interest margin and earnings in periods of rising rates as a higher volume of liabilities will reprice quicker than assets over the period for which the gap is computed.

The impact of changing interest rates on loans and deposits is reflected in our financial statements. We believe that our mortgage banking operation, Monarch Mortgage, provides somewhat of a natural interest rate hedge, in that we are interest rate sensitive to a downward change in the prime rate for short term periods. When loan interest rates decline, our earnings will be negatively impacted in our banking operation, but the mortgage company’s volume should increase as the demand for refinancing and purchase money mortgages increase. The reverse should occur in a rising interest rate environment.

ITEM 4.

CONTROLS AND PROCEDURES

We maintain a system of internal controls and procedures designed to provide reasonable assurance as to the reliability of our published financial statements and other disclosures included in this report. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us (including our consolidated subsidiaries) required to be included in periodic SEC filings. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out our evaluation.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

In the ordinary course of our operations, we become party to various legal proceedings. Currently, we are not party to any material legal proceedings, and no such proceedings are, to management’s knowledge, threatened against us.

Item 1A. Risk Factors

Our operations are subject to many risks that could adversely affect our future financial condition and performance and, therefore, the market value of our securities, including the risk factors that are outlined in our 2010 Annual Report on Form 10-K. There have been no material changes in our risk factors from those disclosed.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. (Removed and Reserved)

Item 5. Other Information

None.

Item 6. Exhibits


11.1	–	Statement regarding computation of per share earnings (included in Note 3 to the Financial Statements).
16.1	–	Letter from Goodman & Company, LLP agreeing to statements with regard to changes in the Company’s certifying accountant attached as Exhibit 16.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on March 24, 2011, incorporated by reference herein.
31.1	–	Certification of CEO pursuant to Rule 13a-14(a).
31.2	–	Certification of Principal Financial Officer pursuant to Rule 13a-14(a).
32.1	–	Certification of CEO and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


MONARCH FINANCIAL HOLDINGS, INC.

/s/ Brad E. Schwartz				Date: May 13, 2011
Brad E. Schwartz
Chief Executive Officer

/s/ Lynette P. Harris.				Date: May 13, 2011
Lynette P. Harris
Executive Vice President & Chief Financial Officer

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Smaller reporting company