Monarch Financial Holdings, Inc. - FORM 10-Q

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EX-31.2 - EXHIBIT 31.2 - Monarch Financial Holdings, Inc.	mnrk-03312015xex312.htm
EX-31.1 - EXHIBIT 31.1 - Monarch Financial Holdings, Inc.	mnrk-03312015xex311.htm
EX-32.1 - EXHIBIT 32.1 - Monarch Financial Holdings, Inc.	mnrk-03312015xex321.htm
EXCEL - IDEA: XBRL DOCUMENT - Monarch Financial Holdings, Inc.	Financial_Report.xls

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

_______________________________________________________

FORM 10-Q

_______________________________________________________



ý	QUARTERLY REPORT UNDER SECTION 13 0R 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarterly Period Ended: March 31, 2015



¨	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	20-4985388
(State of other jurisdiction of Incorporation or organization)	(I.R.S. Employer Identification No.)

1435 Crossways Blvd.

Chesapeake, Virginia 23320

(Address of Principal Executive Offices, Zip Code)

(757) 389-5111

(Registrant's 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 ý 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 ý 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.



Large accelerated filer	¨	Accelerated filer	ý
Non-accelerated filer	¨	Smaller reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý

The number of shares of common stock outstanding as of May 1, 2015 was 10,765,607.

Table of Contents

MONARCH FINANCIAL HOLDINGS, INC.

FORM 10-Q

March 31, 2015

INDEX



PART I.	FINANCIAL INFORMATION
	ITEM 1.	Financial Statements
		Consolidated Statements of Condition as of March 31, 2015 and December 31, 2014	4
		Consolidated Statements of Income for the three months ended March 31, 2015 and March 31, 2014	5
		Consolidated Statements of Comprehensive Income for the three months ended March 31, 2015 and March 31, 2014	6
		Consolidated Statements of Stockholders' Equity for the three months ended March 31, 2015 and March 31, 2014	7
		Consolidated Statements of Cash Flows for the three months ended March 31, 2015 and March 31, 2014	8
		Notes to Unaudited Consolidated Financial Statements	9
	ITEM 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	31
	ITEM 3.	Quantitative and Qualitative Disclosures about Market Risk	54
	ITEM 4.	Controls and Procedures	56
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	57
	Item 1A.	Risk Factors	57
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	57
	Item 3.	Defaults Upon Senior Securities	57
	Item 4.	Mine Safety Disclosures	57
	Item 5.	Other Information	57
	Item 6.	Exhibits	58

Table of Contents

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CONDITION



	(Unaudited)
	March 31, 2015			December 31, 2014
ASSETS:
Cash and due from banks	$	13,869,742		$	14,503,072
Interest bearing bank balances	73,237,427			49,790,751
Federal funds sold	63,311,101			1,135,151
Total cash and cash equivalents	150,418,270			65,428,974
Investment securities available-for-sale, at fair value	20,282,758			23,725,362
Mortgage loans held for sale, net at fair value	159,898,666			147,690,276
Loans held for investment, net of unearned income	787,002,953			772,589,535
Less: allowance for loan losses	(8,643,553		)	(8,948,837		)
Loans, net	778,359,400			763,640,698
Property and equipment, net	30,050,294			30,247,464
Restricted equity securities	3,242,900			3,632,500
Bank owned life insurance	9,949,757			9,656,803
Goodwill	775,000			775,000
Other real estate owned, net of valuation allowance	100,000			144,000
Other assets	25,303,216			21,795,897
Total assets	$	1,178,380,261		$	1,066,736,974
LIABILITIES:
Deposits:
Demand deposits—non-interest bearing	$	270,446,261		$	235,301,171
Demand deposits—interest bearing	58,724,612			66,681,905
Savings deposits	19,518,970			20,003,086
Money market savings	417,328,654			369,221,343
Time deposits	271,120,568			228,206,408
Total deposits	1,037,139,065			919,413,913
Borrowings:
Trust preferred subordinated debt	10,000,000			10,000,000
Federal Home Loan Bank advances	1,050,499			11,075,497
Total borrowings	11,050,499			21,075,497
Other liabilities	19,653,436			18,710,247
Total liabilities	1,067,843,000			959,199,657
STOCKHOLDERS’ EQUITY:
Preferred stock, $5 par value, 1,185,300 shares authorized; none issued	—			—
Common stock, $5 par value; 20,000,000 shares authorized; issued and outstanding - 10,646,873 shares (includes non-vested shares of 299,910) at March 31, 2015 and 10,652,475 shares (includes non-vested shares of 229,750) at December 31, 2014	51,949,985			51,863,625
Additional paid-in capital	8,554,967			8,335,538
Retained earnings	49,957,353			47,354,407
Accumulated other comprehensive loss	(14,424		)	(102,237		)
Total Monarch Financial Holdings, Inc. stockholders’ equity	110,447,881			107,451,333
Non-controlling interest	89,380			85,984
Total equity	110,537,261			107,537,317
Total liabilities and stockholders’ equity	$	1,178,380,261		$	1,066,736,974

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

Table of Contents

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)



	For the Three Months Ended March 31,
	2015			2014
Interest income:
Interest and fees on loans held for investment	$	9,840,336		$	9,478,892
Interest on mortgage loans held for sale	1,307,037			772,732
Interest on investment securities	88,915			76,049
Interest on federal funds sold	8,253			40,378
Dividends on equity securities	39,000			30,000
Interest on other bank accounts	102,029			36,032
Total interest income	11,385,570			10,434,083
Interest expense:
Interest on deposits	668,060			834,413
Interest on trust preferred subordinated debt	46,415			122,337
Interest on borrowings	22,606			14,362
Total interest expense	737,081			971,112
Net interest income	10,648,489			9,462,971
Provision for loan losses	250,000			—
Net interest income after provision for loan losses	10,398,489			9,462,971
Non-interest income:
Mortgage banking income	21,063,679			12,202,162
Service charges and fees	516,554			470,212
Title income	232,771			105,034
Investment and insurance income	344,126			445,472
Gain on sale of asset	35,011			—
Other	74,022			85,771
Total non-interest income	22,266,163			13,308,651
Non-interest expenses:
Salaries and employee benefits	9,594,276			8,271,561
Commissions and incentives	9,445,138			4,010,964
Loan origination expense	2,458,663			1,363,141
Occupancy expense	2,288,508			2,276,703
Marketing expense	746,227			521,841
Data processing expense	629,750			479,278
Telephone	325,746			311,137
Professional fees	258,601			249,839
Foreclosed property expense	53,326			7,139
Other expenses	1,377,597			1,255,030
Total non-interest expenses	27,177,832			18,746,633
Income before income taxes	5,486,820			4,024,989
Income tax provision	(1,993,340		)	(1,471,240		)
Net income	3,493,480			2,553,749
Less: Net income attributable to non-controlling interests	(32,273		)	(16,484		)
Net income attributable to Monarch Financial Holdings, Inc.	$	3,461,207		$	2,537,265
Basic net income per share	$	0.32		$	0.24
Diluted net income per share	$	0.32		$	0.24

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

Table of Contents

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)



	Three Months Ended
	March 31
	2015			2014
Net Income	$	3,493,480		$	2,553,749
Other comprehensive income:
Change in unrealized gain on interest rate swap, net of income taxes	—			46,878
Change in unrealized gain on securities available for sale, net of income taxes	77,526			57,554
Change in unrealized loss on supplemental executive's retirement plan, net of income taxes	3,049			1,287
Change in unrealized gain on mutual fund	7,238			—
Other comprehensive income	87,813			105,719
Total comprehensive income	3,581,293			2,659,468
Less: Comprehensive income attributable to non-controlling interests	(32,273		)	(16,484		)
Comprehensive income attributable to Monarch Financial Holdings, Inc.	$	3,549,020		$	2,642,984

Unrealized gain on interest rate swap	$	—		$	72,120
Income tax expense	—			(25,242		)
Net unrealized gain on interest rate swap	$	—		$	46,878

Unrealized holding gain on securities available for sale	$	119,271		$	88,545
Income tax expense	(41,745		)	(30,991		)
Net unrealized gain on securities available for sale	$	77,526		$	57,554

Unrealized gain on supplemental executive's retirement plan	$	4,691		$	1,980
Income tax expense	(1,642		)	(693		)
Net unrealized gain on supplemental executive's retirement plan	$	3,049		$	1,287

Unrealized gain on mutual fund	$	7,238		$	—
Income tax expense	—			—
Net unrealized gain on mutual fund	$	7,238		$	—

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

Table of Contents

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(unaudited)



	Common Stock			Additional Paid-In Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Non-controlling Interest			Total
	Shares	Amount		Additional Paid-In Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Non-controlling Interest			Total
Balance—December 31, 2013	10,286,363	$	51,431,815	$	7,068,715	$	39,437,119		$	(419,496	)	$	227,445		$	97,745,598
Net income for the three months ended March 31, 2014						2,537,265						16,484			2,553,749
Other comprehensive income									105,719						105,719
Stock-based compensation expense, net of forfeitures and income taxes	—	—		199,150											199,150
Stock options exercised	23,870	119,350		45,164											164,514
Cash dividend declared on common stock ($0.07 per share)						(742,447		)							(742,447		)
Common stock issued through dividend reinvestment	6,501	32,505		43,617											76,122
Cash in lieu of fractional shares				5											5
Distributions to non-controlling interests												(126,218		)	(126,218		)
Balance - March 31, 2014	10,316,734	$	51,583,670	$	7,356,651	$	41,231,937		$	(313,777	)	$	117,711		$	99,976,192

Balance—December 31, 2014	10,372,725	$	51,863,625	$	8,335,538	$	47,354,407		$	(102,237	)	$	85,984		$	107,537,317
Net income for the three months ended March 31, 2015						3,461,207						32,273			3,493,480
Other comprehensive income									87,813						87,813
Stock-based compensation expense, net of forfeitures and income taxes	—	—		171,643											171,643
Stock options exercised	17,272	86,360		47,786											134,146
Cash dividend declared on common stock ($0.08 per share)						(858,261		)							(858,261		)
Distributions to non-controlling interests												(28,877		)	(28,877		)
Balance - March 31, 2015	10,389,997	$	51,949,985	$	8,554,967	$	49,957,353		$	(14,424	)	$	89,380		$	110,537,261

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

Table of Contents

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)



	Three Months Ended March 31,
	2015			2014
Operating activities:
Net income	$	3,493,480		$	2,553,749
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Provision for loan losses	250,000			—
Depreciation	723,205			687,534
Accretion of discounts and amortization of premiums, net	684			1,739
Deferral of loan fees, net of deferred (costs)	147,656			(65,070		)
Amortization of intangible assets	—			44,643
Stock-based compensation	171,643			199,150
Appreciation of bank-owned life insurance	(67,954		)	(57,773		)
Net gain on disposition of property and equipment	(35,011		)	—
Net loss on sale of other real estate	38,879			—
Deferred income tax expense	334,565			1,419,823
Changes in:
Loans held for sale	(12,208,390		)	6,878,565
Interest receivable	(129,050		)	97,764
Other assets	(3,310,447		)	(1,725,532		)
Other liabilities	554,788			2,138,332
Net cash (used in) provided by operating activities	(10,035,952		)	12,172,924
Investing activities:
Purchases of available-for-sale securities	(2,000,000		)	(5,347,950		)
Proceeds from sales and maturities of available-for-sale securities	5,561,191			31,059,584
Proceeds from sale of other real estate	105,121			—
Purchase of bank owned life insurance	(225,000		)	—
Purchases of premises and equipment	(536,468		)	(1,746,533		)
Redemption of restricted equity securities	389,600			527,750
Loan originations, net of principal repayments	(15,216,358		)	(2,199,662		)
Net cash (used in) provided by investing activities	(11,921,914		)	22,293,189
Financing activities:
Net increase in non-interest-bearing deposits	35,145,090			14,465,384
Net increase (decrease) in interest-bearing deposits	82,580,062			(13,414,115		)
Cash dividends paid on common stock	(858,261		)	(742,447		)
Net decrease in FHLB advances and federal funds purchased	(10,024,998		)	(24,997		)
Distributions to non-controlling interests	(28,877		)	(126,218		)
Proceeds from issuance of common stock, net of issuance costs	—			76,122
Proceeds from exercise of stock options	134,146			164,514
Cash in lieu of fractional shares	—			5
Net cash provided by financing activities	106,947,162			398,248
CHANGE IN CASH AND CASH EQUIVALENTS	84,989,296			34,864,361
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR	65,428,974			104,911,322
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	150,418,270		$	139,775,683
SUPPLEMENTAL SCHEDULES AND CASH FLOW INFORMATION
Cash paid for:
Interest on deposits and other borrowings	$	716,831		$	974,143
Income taxes	$	1,239,900		$	30,000
Loans transferred to foreclosed real estate during the year	$	100,000		$	—
Unrealized gain on securities available for sale	$	119,271		$	88,545
Unrealized gain on interest rate swap	$	—		$	72,120
Unrealized gain on supplemental executive's retirement plan	$	4,691		$	1,980
Unrealized gain on mutual fund	$	7,238		$	—

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

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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, 2015; the consolidated statements of income for the three months ended March 31, 2015 and 2014; the consolidated statements of comprehensive income for the three months ended March 31, 2015 and 2014; the consolidated statement of changes in stockholders’ equity for the three months ended March 31, 2015 and 2014; and the consolidated statements of cash flows for the three months ended March 31, 2015 and 2014. These financial statements have been prepared in accordance with the instructions to Form 10-Q and therefore, do not include all of the disclosures required by generally accepted accounting principles. The financial statements include the accounts of Monarch Financial Holdings, Inc. and its subsidiaries, and all significant inter-company accounts and transactions have been eliminated. Operating results for the three month period ended March 31, 2015 are not necessarily indicative of the results that may be expected for the year ended December 31, 2015.

Recent Accounting Pronouncements

In January 2014, the FASB issued ASU 2014-01, “Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments in this ASU should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In January 2014, the FASB issued ASU 2014-04, “Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers: Topic 606.” This ASU applies to any entity using U.S. GAAP that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The guidance supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition, most industry-specific guidance, and some cost guidance included in Subtopic 605-35, “Revenue Recognition-Construction-Type and Production-Type Contracts.” The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To be in alignment with the core principle, an entity must apply a five step process including: identification of the contract(s) with a customer, identification of performance obligations in the contract(s), determination of the transaction price, allocation of the transaction price to the performance obligations, and recognition of revenue when (or as) the entity satisfies a performance obligation. Additionally, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer have also been amended to be consistent with the guidance on recognition and measurement. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. In April 2015, the FASB voted in favor of a one year deferral of the effective date of this amendment. An exposure draft is expected with a 30 day comment period. The Company is currently assessing the impact that ASU 2014-09 will have on its consolidated financial statements.

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In June 2014, the FASB issued ASU 2014-10, “Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation.” The amendments in this ASU remove all incremental financial reporting requirements from U.S. GAAP for development stage entities, including the removal of Topic 915, “Development Stage Entities,” from the FASB Accounting Standards Codification. In addition, this ASU adds an example disclosure and removes an exception provided to development stage entities in Topic 810, “Consolidation,” for determining whether an entity is a variable interest entity. The presentation and disclosure requirements in Topic 915 will no longer be required for the first annual period beginning after December 15, 2014. The revised consolidation standards are effective for annual periods beginning after December 15, 2015. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-10 to have a material impact on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-11, “Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.” This ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement. The amendments in the ASU also require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. Additional disclosures will be required for the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. The amendments in this ASU are effective for the first interim or annual period beginning after December 15, 2014; however, the disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, “Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” The new guidance applies to reporting entities that grant employees share-based payments in which the terms of the award allow a performance target to be achieved after the requisite service period. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Existing guidance in “Compensation - Stock Compensation (Topic 718),” should be applied to account for these types of awards. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted and reporting entities may choose to apply the amendments in the ASU either on a prospective or retrospective basis. The Company is currently assessing the impact that ASU 2014-12 will have on its consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-14, “Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure.” The amendments in this ASU apply to creditors that hold government-guaranteed mortgage loans and are intended to eliminate the diversity in practice related to the classification of these guaranteed loans upon foreclosure. The new guidance stipulates that a mortgage loan be derecognized and a separate other receivable be recognized upon foreclosure if (1) the loan has a government guarantee that is not separable from the loan prior to foreclosure, (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim, and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the other receivable should be measured on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2014. Entities may adopt the amendments on a prospective basis or modified retrospective basis as of the beginning of the annual period of adoption; however, the entity must apply the same method of transition as elected under ASU 2014-04. Early adoption is permitted provided the entity has already adopted ASU 2014-04. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” This update is intended to provide guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Management is required under the new guidance to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued when preparing financial statements for each interim and annual reporting period. If conditions or events are identified, the ASU specifies the process that must be followed by management and also clarifies the timing and content of going concern footnote disclosures in order to reduce diversity in practice. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December

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15, 2016. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-15 to have a material impact on its consolidated financial statements.

In November 2014, the FASB issued ASU No. 2014-16, “Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity.” The amendments in ASU do not change the current criteria in U.S. GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required. The amendments clarify how current U.S. GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the amendments clarify that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of the host contract. Furthermore, the amendments clarify that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument. The amendments in this ASU also clarify that, in evaluating the nature of a host contract, an entity should assess the substance of the relevant terms and features (i.e., the relative strength of the debt-like or equity-like terms and features given the facts and circumstances) when considering how to weight those terms and features. The amendments in this ASU are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption, including adoption in an interim period, is permitted. The Company does not expect the adoption of ASU 2014-16 to have a material impact on its consolidated financial statements.

In January 2015, the FASB issued ASU No. 2015-01, “Income Statement-Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” The amendments in this ASU eliminate from U.S. GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement - Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity also is required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company does not expect the adoption of ASU 2015-01 to have a material impact on its consolidated financial statements.

In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis.” The amendments in this ASU are intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). In addition to reducing the number of consolidation models from four to two, the new standard simplifies the FASB Accounting Standards Codification™ and improves current GAAP by placing more emphasis on risk of loss when determining a controlling financial interest, reducing the frequency of the application of related-party guidance when determining a controlling financial interest in a variable interest entity (VIE), and changing consolidation conclusions for public and private companies in several industries that typically make use of limited partnerships or VIEs. The amendments in this ASU are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. ASU 2015-02 may be applied retrospectively in previously issued financial statements for one or more years with a cumulative-effect adjustment to retained earnings as of the beginning of the first year restated. The Company does not expect the adoption of ASU 2015-02 to have a material impact on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The amendments in this ASU are intended to simplify the presentation of debt issuance costs. These amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The amendments in this ASU are effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued. The Company does not expect the adoption of ASU 2015-03 to have a material impact on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” The amendments in this ASU provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the

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acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments do not change the accounting for a customer’s accounting for service contracts. As a result of the amendments, all software licenses within the scope of Subtopic 350-40 will be accounted for consistent with other licenses of intangible assets. The amendments in this ASU are effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. An entity can elect to adopt the amendments either: (1) prospectively to all arrangements entered into or materially modified after the effective date; or (2) retrospectively. The Company is currently assessing the impact that ASU 2015-05 will have on its consolidated financial statements.

NOTE 2. GENERAL

Monarch Financial Holdings, Inc. (the "Company" "Monarch") is a Virginia-chartered, single bank holding company engaged in business and consumer banking, investment and insurance sales, and mortgage origination and brokerage. The Company was created on June 1, 2006 through a reorganization plan, under the laws of the Commonwealth of Virginia, in which Monarch Bank (the "Bank") became a wholly-owned subsidiary. Monarch Bank was incorporated on May 1, 1998, and opened for business on April 14, 1999. The Company's corporate office and main office are both located in the Greenbrier area of Chesapeake. In addition there are nine other Virginia banking offices – in the Great Bridge area in Chesapeake, the Lynnhaven area, the Town Center area, the Oceanfront area, the Kempsville area, and the Hilltop area in Virginia Beach, the Ghent area and in the downtown area in Norfolk, and the New Town area in Williamsburg. In North Carolina our banking division operates as OBX Bank through two offices in Kitty Hawk and Nags Head. In July 2014 the Company closed its branch located in Suffolk, Virginia.

In August 2001, we formed Monarch Investment, LLC, to enable us to offer additional services to our clients. The Bank owns 100% of Monarch Investment, LLC. In August 2012, the Company formed an affiliation with Raymond James Financial Services, Inc., a broker-dealer headquartered in St. Petersburg, Florida, and launched Monarch Bank Private Wealth ("MBPW"). MBPW is a division of Monarch Bank that offers private banking to high net worth individuals. In addition, through its affiliation with Raymond James Financial Services, Inc., MBPW is able to offer these same individuals financial planning, trust and investment services. Monarch Investment, LLC, continues to provide non-deposit investment services under the name of Monarch Investments.

In January 2003, Monarch Investment, LLC, purchased a non-controlling 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 insurance 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. The Bank owns 100% of Monarch Capital, LLC.

In May 2007, Monarch 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 a division of Monarch, is led by a local management team and a local advisory board of directors.

In June 2007, we announced the expansion of mortgage operations through the acquisition of a team of experienced mortgage bankers, and the formation of a division 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 the Bank’s loan portfolio. Monarch Mortgage's primary office is in Virginia Beach with additional offices in Alexandria, Chesapeake, Fairfax, Fredericksburg, Midlothian, Norfolk, Newport News, Oakton, Richmond, Roanoke and Woodbridge, Virginia; Annapolis, Crofton, Dunkirk, Frederick, Greenbelt, Rockville, Towson and Waldorf, Maryland, Charlotte, Fayetteville, Kitty Hawk, Mooresville, Nags Head, South Park, and Wilmington, North Carolina; and Greenwood, and Greenville, South Carolina.

In July 2007, Monarch Investment, LLC, purchased a 50.01% ownership in Coastal Home Mortgage, LLC, from another bank. This joint venture provides residential loan services through Monarch Mortgage. The 49.99% ownership is shared by two companies 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 2010, Monarch Investment, LLC, formed Regional Home Mortgage, LLC, in Chesapeake, Virginia. Monarch Investment, LLC, owned 51% and TREG Funding, LLC owned 49% of the company, which was formed for the primary purpose

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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 Chesapeake and Virginia Beach, Virginia. This Company was liquidated as of September 31, 2014.

In March 2011, Monarch Investment, LLC, formed Crossways Holdings, LLC, in Chesapeake, Virginia. Crossways Holdings, LLC is a single member limited liability company, formed for the purpose of acquiring, maintaining, utilizing and disposing of assets for Monarch Bank.

In January 2015, Monarch Investment, LLC, purchased a non-controlling interest in Atlantic Real Estate Capital, a commercial real estate brokerage business located in Richmond, Virginia.

NOTE 3. EARNINGS PER SHARE (“EPS”)

Basic earnings per share (EPS) excludes dilution and is 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.



	For the Three Months Ended March 31,
	2015		2014
Net income available to common shareholders (numerator, basic)	$	3,461,207	$	2,537,265
Weighted average shares outstanding - basic (denominator)	10,728,526		10,572,435
Income per common share—basic	$	0.32	$	0.24
Net income (numerator, diluted)	$	3,461,207	2,537,265
Weighted average shares—diluted (denominator)	10,761,716		10,613,452
Income per common share—diluted	$	0.32	$	0.24
Dilutive effect-average number of common shares	33,190		41,017

There were no options to purchase common stock excluded from the computation of earnings per common share for the three months ended March 31, 2015 or March 31, 2014.

NOTE 4. OTHER COMPREHENSIVE INCOME

The following table presents the changes in accumulated other comprehensive income (loss), by category, net of tax:



	Unrealized Loss on Supplemental Executive's Retirement Plan			Unrealized Gains (Loss) on Securities			Unrealized Loss on Interest Rate Swap			Unrealized Gain on Mutual Fund		Accumulated Other Comprehensive Income (Loss)
December 31, 2014	$	(134,167	)	$	31,721		$	—		$	209	$	(102,237	)
Net change for the quarter ended March 31, 2015	3,049			77,526			—			7,238		87,813
Balance at March 31, 2015	$	(131,118	)	$	109,247		$	—		$	7,447	$	(14,424	)

Balance at December 31, 2013	$	(139,315	)	$	(133,644	)	$	(146,537	)	$	—	$	(419,496	)
Net change for the quarter ended March 31, 2014	1,287			57,554			46,878			—		105,719
Balance at March 31, 2014	$	(138,028	)	$	(76,090	)	$	(99,659	)	$	—	$	(313,777	)

An unrealized gain of $7,238 on Mutual Funds associated with the Company's Executive Benefits Plan was recorded in other comprehensive income in the first quarter of 2015. The offset for this gain is carried in the investment in mutual funds on the balance sheet. Expenses of $3,049 and $1,287 related to the SERP were re-classed out of other comprehensive income into salaries and employee benefits expense in earnings during the first quarter of 2015 and 2014, respectively.

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NOTE 5. INVESTMENT SECURITIES

Securities available-for-sale consist of the following:



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
March 31, 2015
U.S. government agency obligations	$	16,001,511	$	84,762	$	(18,935	)	$	16,067,338
Mortgage-backed securities	1,208,056		14,526		—			1,222,582
Municipal securities	2,905,118		98,892		(11,172		)	2,992,838
	$	20,114,685	$	198,180	$	(30,107	)	$	20,282,758

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2014
U.S. government agency obligations	$	20,498,822	$	41,548	$	(86,495	)	$	20,453,875
Mortgage-backed securities	1,271,166		13,449		(982		)	1,283,633
Municipal securities	1,906,572		97,807		(16,525		)	1,987,854
	$	23,676,560	$	152,804	$	(104,002	)	$	23,725,362

Monarch did not own any held-to-maturity securities at March 31, 2015 or December 31, 2014.

The amortized cost and fair value of securities by contractual maturity date at March 31, 2015 were as follows:



Securities available-for-sale:	Amortized Cost		Fair Value
Due in one year or less	$	—	$	—
Due from one to five years	17,101,511		17,175,421
Due from five to ten years	1,313,845		1,349,955
Due after ten years	1,699,329		1,757,382
Total	$	20,114,685	$	20,282,758

There were ten investments in our securities portfolio with unrealized losses as of March 31, 2015.



As of March 31, 2015	Less than 12 months					12 months or more					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. government agency obligations	$	499,755	$	(245	)	$	3,981,310	$	(18,690	)	$	4,481,065	$	(18,935	)
Mortgage-backed securities	—		—			—		—			—		—
Municipal securities	—		—			506,675		(11,172		)	506,675		(11,172		)
Total	$	499,755	$	(245	)	$	4,487,985	$	(29,862	)	$	4,987,740	$	(30,107	)

Nine investments have been in a continuous unrealized loss position for more than 12 months. They are as follows:



	Count	Amortized Cost		Fair Value
U.S. government agency obligations	8	$	4,000,000	$	3,981,310
Municipal securities	1	517,847		506,675
Total	9	$	4,517,847	$	4,487,985

We have the ability to carry these investments to the final maturity of the instruments. Other-than-temporarily impaired (“OTTI”) guidance for investments states that an impairment is OTTI if any of the following conditions exist: 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

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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). An impaired security identified as OTTI should be separated and losses should be recognized in earnings.

We believe the unrealized losses in our portfolio are temporary impairments, caused by liquidity discounts and increases in the risk premiums required by market participants, rather than adverse changes in cash flows or fundamental weaknesses in the credit quality of the issuer or underlying assets as of March 31, 2015. There were no losses related to OTTI recognized in accumulated other comprehensive loss at either March 31, 2015 or December 31, 2014.

NOTE 6. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSS

The following table provides a breakdown, by class of our loans held for investment at March 31, 2015 and December 31, 2014.

Loans held for Investment



	March 31, 2015			December 31, 2014
Commercial	$	145,535,415		$	138,430,999
Real estate
Construction	172,917,857			172,502,330
Residential (1-4 family)	117,929,338			109,404,283
Home equity lines	64,142,603			67,487,000
Multifamily	21,292,712			21,809,189
Commercial	258,873,042			256,966,820
Real estate subtotal	635,155,552			628,169,622
Consumers
Consumer and installment loans	6,100,197			5,968,990
Overdraft protection loans	436,257			96,736
Loans to individuals subtotal	6,536,454			6,065,726
Total gross loans	787,227,421			772,666,347
Unamortized loan fees net of deferred costs	(224,468		)	(76,812		)
Loans held for investment, net of unearned income	787,002,953			772,589,535
Allowance for loan losses	(8,643,553		)	(8,948,837		)
Total net loans	$	778,359,400		$	763,640,698

We have certain lending policies and procedures in place 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.

Our loan portfolio is divided into three loan types; commercial, real estate and consumer. Some of these loan types are further broken down into segments. The commercial loan portfolio, which is not broken down further, includes commercial and industrial loans which are usually secured by the assets being financed or other business assets. The real estate portfolio is broken down into construction, residential 1-4 family, home equity lines, multifamily, and commercial real estate loan segments. The consumer loan portfolio is segmented into consumer and installment loans and overdraft protection loans.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand their business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined 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 repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

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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 could 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, 2015 approximately 43% and at December 31, 2014, approximately 44% 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, secured by non-owner occupied properties we may originate from time to time, we generally require the borrower to have an existing relationship with the Company and a 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 considerable 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.

We generally require multifamily real estate loan borrowers to have an existing relationship with the Company, a record of success and guarantor financial strength, commensurate with the project size. The underlying feasibility of a multifamily project is stress tested for sensitivity to both capitalization and interest rate changes. Each project is underwritten separately and additional underwriting standards are required for the guarantors, which include, but are not limited to, a maximum loan-to-value percentage, global cash flow analysis and contingent liability analysis. Sources of repayment for these types of loans may be rent rolls or sales of the developed property, either by unit or as a whole.

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 our larger 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. 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. This methodology begins with a look at the three loan types; commercial, real estate, and consumer. Loans within the commercial and real estate categories 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 type 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.

We designate loans within our loans held for investment portfolio as either “pass” or “watch list” based on nine numerical risk grades which are assigned to the loans. These numeric designations represent, from best to worst: minimal, modest, average, acceptable, acceptable with care, special mention, substandard, doubtful and loss. Special mention, substandard, doubtful and loss risk grades are watch list. 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. There were no loans classified as doubtful or loss at March 31, 2015 or December 31, 2014. Special mention loans 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 is assigned

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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.

We evaluate additional risk inherent in our satisfactory risk grade groups through a methodology that looks at these loans on a pool basis by loan segment which is further delineated by purpose. Each segment is assigned an expected loss factor based on a moving average “look-back” at our historical losses for that particular segment. In 2014, we reexamined our loss history and determined a five year "look back" or twenty quarter history would be a more prudent approach to modeling historical losses than our previous sixteen quarter "look-back". Therefore, at September 30, 2014 we began extending our "look-back" period by one quarter with a goal of twenty quarters or five years by June 2015. At March 31, 2015, the adjustment to our "look-back" period resulted in a $281,248 decrease in the unallocated component of the allowance for loan losses. We believe this methodology provides an accurate evaluation of the potential risk in our portfolio because delineation by purpose establishes a direct correlation to areas of weakness and strength within the portfolio.

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. For the periods presented, five internal and four external environmental factors were applied to the general risk grade groups. The five internal factors are specific to Monarch with regard to lending policies and practices, nature, volume and term of various portfolios, experience level and depth of management, changes in loan quality and concentrations of credits. The four external environmental factors focus on legal and regulatory impacts, changes in economic conditions, competitive pressures and uncertainties surrounding pending governmental actions and their impact on areas within our footprint. The assumptions used to determine the allowance are reviewed to ensure 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, 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 segregates our portfolio between pass and watch list loans, delineated by segments, within loan type for March 31, 2015 and December 31, 2014. The "Weighted Average Risk Grade" looks at the dollar value per risk grade within a segment compared to the total value of that segment. All segments fall within the average to acceptable range.

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	March 31, 2015
			Watch List						Weighted Average Risk Grade
	Pass		Special Mention		Substandard		Total		Weighted Average Risk Grade
Commercial	$	142,376,172	$	1,708,494	$	1,450,749	$	145,535,415	3.31
Real estate
Construction	171,644,558		793,975		479,324		172,917,857		3.26
Residential (1-4 family)	111,300,339		173,910		6,455,089		117,929,338		3.89
Home equity lines	62,870,082		—		1,272,521		64,142,603		4.13
Multifamily	21,034,995		257,717		—		21,292,712		3.27
Commercial	256,953,370		907,490		1,012,182		258,873,042		3.50
Real estate subtotal	623,803,344		2,133,092		9,219,116		635,155,552		3.56
Consumers
Consumer and installment loans	6,026,022		—		74,175		6,100,197		4.04
Overdraft protection loans	433,257		—		3,000		436,257		4.93
Loans to individuals subtotal	6,459,279		—		77,175		6,536,454		4.10
Total gross loans	$	772,638,795	$	3,841,586	$	10,747,040	$	787,227,421	3.52

	December 31, 2014
			Watch List						Weighted Average Risk Grade
	Pass		Special Mention		Substandard		Total		Weighted Average Risk Grade
Commercial	$	135,292,747	$	1,588,289	$	1,549,963	$	138,430,999	3.31
Real estate
Construction	171,136,553		93,397		1,272,380		172,502,330		3.26
Residential (1-4 family)	101,860,683		177,735		7,365,865		109,404,283		3.93
Home equity lines	66,282,828		102,575		1,101,597		67,487,000		4.12
Multifamily	19,616,130		2,193,059		—		21,809,189		3.53
Commercial	253,525,106		2,029,203		1,412,511		256,966,820		3.54
Real estate subtotal	612,421,300		4,595,969		11,152,353		628,169,622		3.59
Consumers
Consumer and installment loans	5,893,286		—		75,704		5,968,990		4.04
Overdraft protection loans	96,736		—		—		96,736		4.64
Loans to individuals subtotal	5,990,022		—		75,704		6,065,726		4.05
Total gross loans	$	753,704,069	$	6,184,258	$	12,778,020	$	772,666,347	3.55

An aging of our loan portfolio by class as of March 31, 2015 and December 31, 2014 is as follows:

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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, 2015
Commercial	$	7,321	$	—	$	548,059	$	555,380	$	144,980,035	$	—	$	548,059
Real estate
Construction	363,140		—		—		363,140		172,554,717		—		110,472
Residential (1-4 family)	2,103,144		216,836		3,238,393		5,558,373		112,370,965		174,976		3,187,438
Home equity lines	61,526		—		247,693		309,219		63,833,384		—		247,693
Multifamily	—		—		—		—		21,292,712		—		—
Commercial	—		—		230,994		230,994		258,642,048		—		230,994
Real estate subtotal	2,527,810		216,836		3,717,080		6,461,726		628,693,826		174,976		3,776,597
Consumers
Consumer and installment loans	79,135		1,869		—		81,004		6,019,193		—		86
Overdraft protection loans	—		3,000		—		3,000		433,257		—		—
Loans to individuals subtotal	79,135		4,869		—		84,004		6,452,450		—		86
Total gross loans	$	2,614,266	$	221,705	$	4,265,139	$	7,101,110	$	780,126,311	$	174,976	$	4,324,742

December 31, 2014
Commercial	$	—	$	—	$	582,059	$	582,059	$	137,848,940	$	—	$	582,059
Real estate
Construction	248,420		—		100,000		348,420		172,153,910		—		212,552
Residential (1-4 family)	761,696		2,412,128		1,252,644		4,426,468		104,977,815		174,976		1,427,931
Home equity lines	109,456		—		249,915		359,371		67,127,629		—		249,915
Multifamily	—		—		—		—		21,809,189		—		—
Commercial	—		166,618		230,994		397,612		256,569,208		—		230,994
Real estate subtotal	1,119,572		2,578,746		1,833,553		5,531,871		622,637,751		174,976		2,121,392
Consumers
Consumer and installment loans	139,446		—		—		139,446		5,829,544		—		1,121
Overdraft protection loans	—		—		—		—		96,736		—		—
Loans to individuals subtotal	139,446		—		—		139,446		5,926,280		—		1,121
Total gross loans	$	1,259,018	$	2,578,746	$	2,415,612	$	6,253,376	$	766,412,971	$	174,976	$	2,704,572

We currently have eight loans totaling $2,908,688 that are classified as restructured loans: two commercial real estate loans totaling $1,329,584, six residential 1-4 family loan totaling $1,506,884, and one consumer loan for $72,220. At March 31, 2015, two of the residential 1-4 family loans totaling $665,611 included in our restructured loans are classified as nonaccrual. The remaining six loans are performing. We did not restructure any loans in either the first quarter of 2015 or 2014. We have not had any defaults on restructured loans within twelve months of restructuring, during the quarter ended March 31, 2015 or 2014.

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Additional information on restructured loans in our portfolio as of March 31, 2015 is as follows:

Troubled Debt Restructurings



	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Quarter Ended March 31, 2015	None	—	—
Quarter Ended March 31, 2014	None	—	—

Troubled Debt Restructurings That Subsequently Defaulted



	Number of Contracts	Recorded Investment
Quarter Ended March 31, 2015	None	—
Quarter Ended March 31, 2014	None	—

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, 2015	Commercial			Construction			Residential			Home Equity			Multifamily			Commercial
Allowance for loan losses:
Beginning balance	$	1,157,867		$	1,678,022		$	2,456,418		$	1,911,634		$	85,056		$	1,458,664
Charge-offs	(34,000		)	(17,500		)	(546,954		)	—			—			—
Recoveries	2,300			13,661			3,779			23,430			—			—
Provision	241,463			15,100			62,005			(202,494		)	(2,014		)	93,866
Ending balance	$	1,367,630		$	1,689,283		$	1,975,248		$	1,732,570		$	83,042		$	1,552,530

Individually evaluated for impairment	$	623,191		$	78,827		$	702,139		$	476,808		$	—		$	332,611
Collectively evaluated for impairment	744,439			1,610,456			1,273,109			1,255,762			83,042			1,219,919
Loans:
Ending balance	$	145,535,415		$	172,917,857		$	117,929,338		$	64,142,603		$	21,292,712		$	258,873,042
Ending balance: individually evaluated for impairment	1,936,381			1,179,922			6,827,143			1,272,522			—			2,722,900
Ending balance: collectively evaluated for impairment	$	143,599,034		$	171,737,935		$	111,102,195		$	62,870,081		$	21,292,712		$	256,150,142



	Consumers
	Consumer and Installment loans			Overdraft Protection		Unallocated		Total
Allowance for loan losses:
Beginning balance	$	104,661		$	260	$	96,255	$	8,948,837
Charge-offs	—			—		—		(598,454		)
Recoveries	—			—		—		43,170
Provision	(1,462		)	1,244		42,292		250,000
Ending balance	$	103,199		$	1,504	$	138,547	$	8,643,553

Individually evaluated for impairment	$	74,089		$	—	$	—	$	2,287,665
Collectively evaluated for impairment	29,110			1,504		138,547		6,355,888
Loans:
Ending balance	$	6,100,197		$	436,257	$	—	$	787,227,421
Ending balance: individually evaluated for impairment	74,175			3,000		—		14,016,043
Ending balance: collectively evaluated for impairment	$	6,026,022		$	433,257	$	—	$	773,211,378

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				Real Estate
December 31, 2014	Commercial			Construction			Residential			Home Equity			Multifamily		Commercial
Allowance for loan losses:
Beginning balance	$	1,219,255		$	1,978,320		$	1,685,502		$	2,132,916		$	59,586	$	1,305,131
Charge-offs	(21,789		)	(190,812		)	(163,048		)	(174,319		)	—		—
Recoveries	205,200			79,922			31,505			122,809			—		—
Provision	(244,799		)	(189,408		)	902,459			(169,772		)	25,470		153,533
Ending balance	$	1,157,867		$	1,678,022		$	2,456,418		$	1,911,634		$	85,056	$	1,458,664

Individually evaluated for impairment	$	441,265		$	100,159		$	1,261,490		$	547,172		$	—	$	335,033
Collectively evaluated for impairment	716,602			1,577,863			1,194,928			1,364,462			85,056		1,123,631
Loans:
Ending balance	$	138,430,999		$	172,502,330		$	109,404,283		$	67,487,000		$	21,809,189	$	256,966,820
Ending balance: individually evaluated for impairment	1,549,963			1,272,380			7,198,325			1,101,597			—		3,130,893
Ending balance: collectively evaluated for impairment	$	136,881,036		171,229,950			$	102,205,958		$	66,385,403		$	21,809,189	$	253,835,927



	Consumers
	Consumer and Installment loans		Overdraft Protection			Unallocated			Total
Allowance for loan losses:
Beginning balance	$	99,271	$	688		$	580,700		$	9,061,369
Charge-offs	—		(2,000		)	—			(551,968		)
Recoveries	—		—			—			439,436
Provision	5,390		1,572			(484,445		)	—
Ending balance	$	104,661	$	260		$	96,255		$	8,948,837

Individually evaluated for impairment	$	74,582	$	—		—			$	2,759,701
Collectively evaluated for impairment	30,079		260			96,255			6,189,136
Loans:
Ending balance	$	5,968,990	$	96,736		$	—		$	772,666,347
Ending balance: individually evaluated for impairment	75,704		—			—			14,328,862
Ending balance: collectively evaluated for impairment	$	5,893,286	$	96,736		$	—		$	758,337,485

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.

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The following table sets forth our impaired loans at March 31, 2015 and December 31, 2014.



Impaired Loans
	With No Related Allowance
	Recorded Investment		Unpaid Principal Balance		Average Recorded Investment		Interest Income Recognized
March 31, 2015
Commercial	$	902,690	$	902,690	$	1,039,586	$	14,959
Real estate
Construction	946,422		946,422		974,407		15,414
Residential (1-4 family)	2,686,001		2,862,544		2,694,317		22,029
Home equity lines	359,436		359,436		359,885		2,869
Multifamily	—		—		—		—
Commercial	1,026,580		1,026,580		1,109,630		16,086
Consumers
Consumer and installment loans	86		1,730		743		—
Overdraft protection loans	3,000		3,000		2,992		104
Total	$	5,924,215	$	6,102,402	$	6,181,560	$	71,461
December 31, 2014
Commercial	$	—	$	—	$	—	$	—
Real estate
Construction	935,467		935,467		954,181		56,004
Residential (1-4 family)	2,704,883		2,880,739		3,067,193		119,011
Home equity lines	115,925		115,925		115,324		3,962
Multifamily	—		—		—		—
Commercial	1,430,533		1,430,533		1,317,972		79,891
Consumers
Consumer and installment loans	1,122		2,729		3,088		—
Overdraft protection loans	—		—		—		—
Total	$	5,187,930	$	5,365,393	$	5,457,758	$	258,868

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	With Related Allowance
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
March 31, 2015
Commercial	$	1,033,691	$	1,067,691	$	623,191	$	1,068,858	$	7,593
Real estate
Construction	233,500		256,126		78,827		234,046		2,650
Residential (1-4 family)	4,141,142		4,635,762		702,139		4,534,553		18,804
Home equity lines	913,086		915,308		476,808		913,329		7,966
Multifamily	—		—		—		—		—
Commercial	1,696,320		1,696,320		332,611		1,697,158		15,869
Consumers
Consumer and installment loans	74,089		74,089		74,089		75,629		637
Overdraft protection loans	—		—		—		—		—
Total	$	8,091,828	$	8,645,296	$	2,287,665	$	8,523,573	$	53,519
December 31, 2014
Commercial	$	1,549,963	$	1,549,963	$	441,265	$	1,618,461	$	93,073
Real estate
Construction	336,913		441,459		100,159		408,460		12,358
Residential (1-4 family)	4,493,442		4,535,549		1,261,490		4,564,008		232,522
Home equity lines	985,672		985,672		547,172		988,494		46,161
Multifamily	—		—		—		—		—
Commercial	1,700,360		1,700,360		335,033		1,721,563		79,323
Consumers
Consumer and installment loans	74,582		74,582		74,582		79,632		2,792
Overdraft protection loans	—		—		—		—		—
Total	$	9,140,932	$	9,287,585	$	2,759,701	$	9,380,618	$	466,229

NOTE 7. 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.

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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, 2015 and December 31, 2014:



	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, 2015
Investment securities—available for sale
U.S. government agency obligations	$	16,067,338	$	—	$	16,067,338	$	—
Mortgage-backed securities	1,222,582		—		1,222,582		—
Municipal securities	2,992,838		—		2,992,838		—
Mortgage loans held for sale	159,898,666		—		159,898,666		—
Derivative financial asset	3,234,292		—		3,234,292		—
Derivative financial liability	$	1,587,991	$	—	$	1,587,991	$	—
Assets at December 31, 2014
Investment securities—available for sale
U.S. government agency obligations	$	20,453,875	$	—	$	20,453,875	$	—
Mortgage-backed securities	1,283,633		—		1,283,633		—
Municipal securities	1,987,854		—		1,987,854		—
Mortgage loans held for sale	147,690,276		—		147,690,276		—
Derivative financial asset	1,514,083		—		1,514,083		—
Derivative financial liability	$	1,195,405	$	—	$	1,195,405	$	—

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, 2015 and December 31, 2014.



	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, 2015
Real estate owned
Real estate construction	$	100,000	$	—	$	—	$	100,000
Restructured and impaired loans, net	5,804,163		—		—		5,804,163
At December 31, 2014
Real estate owned
Real estate construction	$	144,000	$	—	$	—	$	144,000
Restructured and impaired loans, net	6,381,231		—		—		6,381,231

There were no residential real estate properties classified as other real estate at March 31, 2015 or December 31, 2014. There were three residential real estate properties totaling $694,916 in the process of foreclosure at March 31, 2015 and one residential real estate property totaling $182,256 in process of foreclosure at December 31, 2014.

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The following table displays quantitative information about Level 3 Fair Value Measurements for March 31, 2015 and December 31, 2014.



	Fair Value Measurement at March 31, 2015
	Fair Value		Valuation Technique	Unobservable Inputs	Weighted Average
Commercial	$	410,500	Market comparables	Discount applied to market comparables (1)	50	%
Real Estate
Construction	154,673		Market comparables	Discount applied to market comparables (1)	35	%
Residential (1-4 family)	3,439,003		Market comparables	Discount applied to market comparables (1)	21	%
Home equity lines	436,278		Market comparables	Discount applied to market comparables (1)	22	%
Multifamily	—		Market comparables	Discount applied to market comparables (1)	—	%
Commercial	1,363,709		Market comparables	Discount applied to market comparables (1)	13	%
Consumer
Consumer and installment loans	—		Market comparables	Discount applied to market comparables (1)	—	%
Total restructures and impaired loans	$	5,804,163
Real estate owned	$	100,000	Market comparables	Discount applied to market comparables (1)	43	%



	Fair Value Measurement at December 31, 2014
	Fair Value		Valuation Technique	Unobservable Inputs	Weighted Average
Commercial	$	1,108,698	Market comparables	Discount applied to market comparables (1)	34	%
Real Estate
Construction	236,754		Market comparables	Discount applied to market comparables (1)	36	%
Residential (1-4 family)	3,231,952		Market comparables	Discount applied to market comparables (1)	22	%
Home equity lines	438,500		Market comparables	Discount applied to market comparables (1)	22	%
Multifamily	—		Market comparables	Discount applied to market comparables (1)	—	%
Commercial	1,365,327		Market comparables	Discount applied to market comparables (1)	13	%
Consumer
Consumer and installment loans	—		Market comparables	Discount applied to market comparables (1)	—	%
Total restructures and impaired loans	$	6,381,231
Real estate owned	$	144,000	Market comparables	Discount applied to market comparables (1)	11	%

(1) A discount percentage is applied based on age of independent appraisals, current market conditions, and experience within the local markets.

For the three months ended March 31, 2015, we recorded no gains and a loss of $38,879 and for the three months ended March 31, 2014. There were no gains or losses to report on the sale of other real estate owned. Gains or losses on sale of other real estate owned are included in foreclosed property expense.

At the time a loan secured by real estate becomes real estate owned, we record the property at fair value net of estimated selling costs. 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. No valuation adjustments related to other real estate owned were recorded in the three months ended March 31, 2015 or 2014. Adjustments, when necessary, are included in foreclosed property expense.

Valuation Methods

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 and included in the Company’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, loans held for sale and overnight borrowings.

Investment 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

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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.

Mortgage loans held for sale are recorded at their fair value when originated and reevaluated quarterly, based on our expected return from the secondary market.

Loans held for investment 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.

The carrying amounts of accrued interest approximate fair value.

Interest rate lock commitments ("IRLC") are recorded at fair value, which is based on estimated future receipts net of estimated future expenses when the underlying loan is sold on the secondary market, using observable Level 2 market inputs, reflecting current market inputs as of the measurement date.

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

Bank owned life insurance represents insurance policies on officers of the Bank. The cash values of the policies are estimated using information provided by insurance carriers. These policies are carried at their cash surrender value, which approximates the 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 all borrowings is based on discounting expected cash flows at the interest rate of debt with the same or similar remaining maturities and collateral requirements.

Derivative financial instruments are recorded at fair value using observable Level 2 market inputs related to:

•Loans held for sale forward sales commitments are recorded at their fair value based on the estimated number of days remaining in the IRLC at the measurement date and expected return from the secondary market. Forward mortgage loan sales commitments are recorded at their fair value based on the gain or loss that would occur if the loan were paired off with an investor at measurement date. A derivative asset of $3,234,292 and a derivative liability of $1,587,991 related to loans held for sale were recorded at March 31, 2015. At December 31, 2014, a derivative asset of $1,514,083 and a derivative liability of $1,195,405 were recorded.

Real Estate Owned is carried at the fair value less estimated selling costs. 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 less selling costs. Any valuation adjustments at the time a loan becomes real estate owned is charged to the allowance for loan losses. Fair value is determined through an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2). When evaluating fair value, management may discount the appraisal further if, based on their understanding of the market conditions, it is determined the collateral is further impaired below the appraisal value (Level 3). Any subsequent valuation adjustments are applied to earnings in our consolidated statements of income. We did not record any losses due to valuation adjustments for the three months ended March 31, 2015. We recorded no losses due to valuation adjustments on real estate owned within foreclosed property expense in the year ended December 31, 2014.

Restructured and Impaired Loans measurement 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. 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). When evaluating fair value, management may discount the appraisal further if, based on their understanding of the market conditions, it is determined the collateral is further impaired below the appraised value (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

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receivables collateral are based on financial statement balances or aging reports (Level 3). Restructured and impaired loans are periodically reevaluated to determine if additional adjustments to the carrying value are necessary.

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.

Fair Value of Financial Instruments

The following table presents the carrying amounts and fair value of our financial instruments at March 31, 2015 and December 31, 2014. 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.



			Fair Value Measurements at March 31, 2015 using
	Carrying Value		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying Value		Level 1		Level 2		Level 3		Balance
Assets
Cash and cash equivalents	$	150,418,270	$	150,418,270	$	—	$	—	$	150,418,270
Investment securities available for sale	20,282,758		—		20,282,758		—		20,282,758
Loans held for sale	159,898,666		—		159,898,666		—		159,898,666
Loans held for investment (net)	778,359,400		—		—		791,617,106		791,617,106
Accrued interest receivable	2,092,248		—		2,092,248		—		2,092,248
Restricted equity securities	3,242,900		—		3,242,900		—		3,242,900
Bank owned life insurance	9,949,757		—		9,949,757		—		9,949,757
Derivative financial assets	3,234,292		—		3,234,292		—		3,234,292
Liabilities
Deposits	$	1,037,139,065	$	—	$	1,034,054,013	$	—	$	1,034,054,013
Borrowings	11,050,499		—		1,071,389		5,689,759		6,761,148
Accrued interest payable	63,530		—		63,530		—		63,530
Derivative financial liabilities	1,587,991		—		1,587,991		—		1,587,991

			Fair Value Measurements at December 31, 2014 using
	Carrying Value		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying Value		Level 1		Level 2		Level 3		Balance
Assets
Cash and cash equivalents	$	65,428,974	$	65,428,974	$	—	$	—	$	65,428,974
Investment securities available for sale	23,725,362		—		23,725,362		—		23,725,362
Loans held for sale	147,690,276		—		147,690,276		—		147,690,276
Loans held for investment (net)	763,640,698		—		—		776,974,812		776,974,812
Accrued interest receivable	2,087,880		—		2,087,880		—		2,087,880
Restricted equity securities	3,632,500		—		3,632,500		—		3,632,500
Bank owned life insurance	9,656,803		—		9,656,803		—		9,656,803
Derivative financial assets	1,514,083				1,514,083				1,514,083
Liabilities
Deposits	$	919,413,913	$	—	$	917,008,847	$	—	$	917,008,847
Borrowings	21,075,497		—		11,109,566		5,641,087		16,750,653
Accrued interest payable	43,280		—		43,280		—		43,280
Derivative financial liability	1,195,405		—		1,195,405		—		1,195,405

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NOTE 8. STOCK-BASED COMPENSATION

In May 2014, Monarch stockholders ratified the adoption of the Monarch Bank 2014 Equity Incentive Plan ("2014EIP"), a stock-based compensation plan which succeeds the Monarch Bank 2006 Equity Incentive Plan (“2006EIP”). The 2006EIP had succeeded the Monarch Bank 1999 Incentive Stock Option Plan ("1999ISO") and was the only plan under which equity-based compensation could be awarded. Like the 2006EIP, the 2014EIP 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 advisers to the Company and its subsidiaries.

The 2014EIP authorized the Company to issue up to 1,000,000 shares of Monarch Common Stock plus the number of shares of our Common Stock outstanding under the predecessor plans. The Plan also provides that no award may be granted more than 10 years after the May 2014 ratification date.

As of March 31, 2015, 1,140,859 shares were available for grants under all plans. A total of 482,392 shares are subject to outstanding awards under the 2006EIP and 1999ISO, including 86,842 stock options and 392,550 shares of non-vested restricted stock. The stock options outstanding as of March 31, 2015 have a weighted average exercise price of $7.85 and a weighted average remaining term of 9 months and are fully vested. Restricted stock typically vests over a 60 month period. Total compensation costs are recognized over the service period to vesting.

No additional options were granted in the periods covered. There were 17,272 options exercised in the first quarter of 2015. No options on shares were forfeited in the first quarter of 2015.

Compensation expense related to our restricted stock totaled $171,643 in the first quarter of 2015. Remaining vesting periods are between 9 and 57 months with unrecognized remaining compensation expense of $2,168,867. We issued 72,800 shares of restricted stock in the first quarter of 2015. During the first quarter of 2015, 1,200 Shares vested and 4,400 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.

Funding for retail mortgage banking services' loans held for sale (LHFS) portfolio is provided by community banking services. The outstanding LHFS balance and related interest earned for the bank's interim holding period of these loans is recorded in the community banking segment. This interim interest income was $1,307,037 in the first quarter of 2015 and $772,732 in the first quarter of 2014, respectively. In the event of early payment default, Monarch has recorded a reserve for loan repurchases which totaled $3,199,101 at March 31, 2015 and $3,013,396 at December 31, 2014. Our reserve for loan repurchases is not a part of our loan loss reserve and is carried in other liabilities. This reserve, which is an estimate of the potential for losses based on investor contracts, is not an indication that losses will occur and is periodically analyzed and adjusted through income.

The retail mortgage banking 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 inter-segment 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, 2015 and 2014 is shown in the following tables.

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Selected Financial Information



	Commercial and Other Banking			Mortgage Banking Operations			Inter-segment Eliminations			Total
Quarter Ended March 31, 2015
Income:
Interest income	$	11,083,292		$	302,278		$	—		$	11,385,570
Non-interest income	1,585,123			21,063,679			(382,639		)	22,266,163
Total operating income	12,668,415			21,365,957			(382,639		)	33,651,733
Expenses:
Interest expense	(737,081		)	(382,639		)	382,639			(737,081		)
Provision for loan losses	(250,000		)	—			—			(250,000		)
Personnel expense	(4,673,467		)	(14,365,947		)	—			(19,039,414		)
Other non-interest expenses	(3,986,372		)	(4,152,046		)	—			(8,138,418		)
Total operating expenses	(9,646,920		)	(18,900,632		)	382,639			(28,164,913		)
Income before income taxes	3,021,495			2,465,325			—			5,486,820
Provision for income taxes	(1,097,697		)	(895,643		)	—			(1,993,340		)
Less: Net income attributable to non-controlling interests	(15,905		)	(16,368		)	—			(32,273		)
Net income attributable to Monarch Financial Holdings, Inc.	$	1,907,893		$	1,553,314		$	—		$	3,461,207

Quarter Ended March 31, 2014
Income:
Interest income	$	9,661,351		$	772,732		$	—		$	10,434,083
Non-interest income	1,221,721			12,202,162			(115,232		)	13,308,651
Total operating income	10,883,072			12,974,894			(115,232		)	23,742,734
Expenses:
Interest expense	(971,112		)	—			—			(971,112		)
Personnel expense	(3,672,019		)	(8,610,070		)	(436		)	(12,282,525		)
Other non-interest expenses	(3,344,614		)	(3,235,162		)	115,668			(6,464,108		)
Total operating expenses	(7,987,745		)	(11,845,232		)	115,232			(19,717,745		)
Income before income taxes	2,895,327			1,129,662			—			4,024,989
Provision for income taxes	(1,058,319		)	(412,921		)	—			(1,471,240		)
Less: Net income attributable to non-controlling interests	316			(16,800		)	—			(16,484		)
Net income attributable to Monarch Financial Holdings, Inc.	$	1,837,324		$	699,941		$	—		$	2,537,265



Segment Assets
March 31, 2015	$	1,173,153,968	$	19,925,468	$	(14,699,175	)	$	1,178,380,261
December 31, 2014	$	1,062,825,141	$	15,071,113	$	(11,159,280	)	$	1,066,736,974



Capital Expenditures
March 31, 2015	$	409,286	$	127,182	$	—	$	536,468
December 31, 2014	$	3,932,268	$	352,505	$	—	$	4,284,773

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 were no intangible assets at March 31, 2015.

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



	March 31, 2015		December 31, 2014
Goodwill	$	775,000	$	775,000

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Goodwill is related the acquisition of a Maryland mortgage office plus certain other mortgage related assets in August 2007. Intangible assets related to this acquisition were fully amortized in 2014. Amortization expense for intangible assets totaled $0 for the three months ending March 31, 2015 and $44,643 for the three months ending March 31, 2014.

NOTE 11. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

On July 29, 2009 we entered into an interest rate swap agreement with PNC Bank (PNC) of Pittsburgh, PA, 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 allowed 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 was $10 million, and had an expiration date of September 30, 2014. Under the terms of the agreement, at the end of each quarter we swapped our floating rate for a fixed rate of 3.26%. Including the additional 160 basis points, the effective fixed rate of interest cost was 4.86% on our $10 million Trust Preferred borrowings.

The fixed-rate payment feature of this swap was structured to mirror the provisions of the hedged borrowing agreement. This swap qualified as a cash flow hedge and the underlying liability was 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. This swap expired on September 30, 2014 and was not renewed.

In August 2014 we began participating in a mandatory delivery program for mortgage loans. Under the mandatory delivery program we committed 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. 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. 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 only allows us to commit $50 million to the program at any given time. We utilize the services of Optimal Blue to help monitor and manage our rate lock activities in this program. We reported a gain related to our mandatory delivery program in the first quarter of 2015 of $394 thousand was recorded in mortgage banking income. We did not participate in mandatory delivery in 2013.

NOTE 12. LOW INCOME HOUSING TAX CREDITS

The Company has invested in one housing equity fund at March 31, 2015. The general purpose of this fund is to encourage and assist participants in investing in low-income residential rental properties located in the Commonwealth of Virginia, develop and implement strategies to maintain projects as low-income housing, deliver Federal Low Income Housing Credits to investors, allocate tax losses and other possible tax benefits to investors, and to preserve and protect project assets. The investment in this fund was recorded as other assets on the consolidated balance sheets and was $500,000 at both March 31, 2015 and December 31, 2014. The expected term of this investment and the related tax benefits run through 2032. Tax credits and other tax benefits related to this investment recognized during the quarters ended March 31, 2015 and March 31, 2014 were $0. Total projected tax credits to be received for 2015 are $23,977, which is based on the most recent quarterly estimates received from the funds. Additional capital calls expected for the funds total $494,500 at March 31, 2015 and December 31, 2014.

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ITEM 2.

MONARCH FINANCIAL HOLDINGS, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Company. 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 average 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 our assets further influences the amount of interest income lost due to 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, fee income from title 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, 2014.

CRITICAL ACCOUNTING POLICIES

Critical accounting policies are those applications of accounting principles or practices that require considerable judgment, estimation, or sensitivity analysis by management. In the financial service industry, examples, though not an all inclusive list, of disclosures that may fall within this definition are the determination of the adequacy of the allowance for loan losses, valuation of derivatives or securities without a readily determinable market value, and the valuation of the fair value of intangibles and goodwill. Except for the determination of the adequacy of the allowance for loan losses, derivative financial instrument estimations and fair value estimations related to foreclosed real estate, we do not believe there are other practices or policies that require significant sensitivity analysis, judgments, or estimations.

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Our financial statements are prepared in accordance with GAAP. The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Our critical accounting policies are listed below. A summary of our significant accounting policies is set forth in Item 8, Note 1 of our Annual Report on Form 10-K for the year ended December 31, 2014.

Allowance for Loan Losses

Our allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on GAAP guidance which requires that losses be accrued when they have a probability of occurring and are estimable and that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

Our allowance for loan losses has three basic components: the formula allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses along with various economic factors and, as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur may be mitigated. The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified loans. Historical loss information, expected cash flows and fair value of collateral are used to estimate these losses. The unallocated allowance captures losses whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance. The use of these values is inherently subjective, and our actual losses could be greater or less than the estimates.

Derivative Financial Instruments

We use derivatives to manage risks related to interest rate movements. Interest rate swap contracts designated and qualifying as cash flow hedges are reported at fair value. The gain or loss on the effective portion of the hedge initially is included as a component of other comprehensive income and is subsequently reclassified into earnings when interest on the related debt is paid. We document our risk management strategy and hedge effectiveness at the inception of and during the term of each hedge. Our interest rate risk management strategy is to stabilize cash flow requirements by maintaining interest rate swap contracts to convert variable-rate debt to a fixed rate. We did not hold any interest rate swap contracts at March 31, 2015 or December 31, 2014. We do not hold or issue derivative financial instruments for trading purposes.

Commitments to fund mortgage loans are Interest Rate Lock Commitment ("IRLC") to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are free standing derivatives. The fair value of the interest rate lock is recorded at the end of the financial reporting period and adjusted for the expected exercise of the commitment before the loan is funded. In order to hedge the change in interest rates resulting from its commitments to fund the loans, the Company enters into forward commitments for the future delivery of mortgage loans. Fair value of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. Changes in the fair value of these derivatives are included in net gains on sale of loans.

Periodically, we participate in a “mandatory” delivery program for mortgage loans. Under the mandatory delivery system, loans with interest rate locks are paired with the sale of a notional security bearing similar attributes. Interim income or loss on the pairing of the loans and securities is recorded in mortgage banking income on our income statement. In addition, at the time the loan is delivered to an investor, matched securities are repurchased and a gain or loss on the pairing is recorded in mortgage banking income on our income statement. Management has elected to limit our exposure to this form of delivery to $50 million in outstanding loans. We had $47.0 million in the mandatory delivery program at March 31, 2015 and $48.6 million at December 31, 2014.

Fair Value Measurements

Under GAAP we are permitted to choose or required to measure many financial instruments and certain other items at fair value. The estimation of fair value is significant to certain assets, including loans held-for-sale, available-for-sale securities, and foreclosed real estate owned. These assets are recorded at fair value or lower of cost or fair value, as applicable. The fair values of loans held-for-sale are based on commitments from investors. The fair values of available-for-sale securities are based on published market or dealer quotes for similar securities. The fair values of rate lock commitments are based on net fees currently

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charged to enter into similar agreements. The fair value of foreclosed real estate owned is estimated based on current appraisals, but may be further adjusted based upon our evaluation of the fair value of similar properties.

Fair values can be volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, and market conditions, among others. Since these factors can change significantly and rapidly, fair values are difficult to predict and subject to material changes that could impact our financial condition and results of operation.

RESULTS OF OPERATIONS

Net Income

Our consolidated financial statements include the accounts of the Company, the Bank and its subsidiaries, after all significant inter-company transactions have been eliminated. Net income attributable to our non-controlling interests of $32 thousand and $16 thousand were deducted for the quarters ended March 31, 2015 and 2014, to arrive at net income attributable to Monarch Financial Holdings, Inc. The ensuing references and ratios are related to net income attributable to Monarch Financial Holdings, Inc., (hereon referred to as "net income") after net income attributable to non-controlling interests has been deducted.

Net Income Attributable to Monarch Financial Holdings, Inc.



	For the Three Months Ended March 31,
	2015			2014
Net income	$	3,493,480		$	2,553,749
Less: Net income attributable to non-controlling interests	(32,273		)	(16,484		)
Net income attributable to Monarch Financial Holdings, Inc.	$	3,461,207		$	2,537,265

Net income for the quarter ended March 31, 2015 was $3.5 million, an increase of $924 thousand or 36.4% over the same quarter in 2014. Basic and diluted earnings per share for the first quarter of 2015 and 2014 were $0.32 and $0.24, 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”) for the three months ended March 31, 2015 was 1.31% compared to 1.06% for the same respective period in 2014. Our annualized return on equity (“ROE”) for the first quarter of 2015 was 12.98% compared to 10.46% in 2014.

Net interest income increased $1.1 million or 12.5% in the first quarter of 2015 compared to 2014. Non-interest income increased $9.0 million or 67.3% for the same respective periods. Non-interest expense increased $8.4 million or 45.0% in the first quarter of 2015 compared to 2014. A combination of higher interest income and lower interest expense was the source of net interest income growth. Strong first quarter mortgage production was the primary source of growth in non-interest income and non-interest expense.

We recorded our first loan loss provision in two years in the first quarter of 2015. That provision was $250 thousand compared to $0 in 2014. We reported net charge offs of $555 thousand in the first quarter of 2015 and recoveries in excess of charge offs of $152 thousand in the first quarter of 2014.

Net Interest Income

Net interest income, which is the excess of interest income over interest expense, is a major source of banking 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 average volume of interest-earning assets and interest bearing liabilities, and the mix of interest-earning assets and interest bearing liabilities.

Interest rates have been at a record low since December 2008, when the federal funds rate set by the Federal Reserve Bank’s Federal Open Market Committee was reduced to 0.25%. Wall Street Journal Prime Rate (“WSJ”), which generally moves with the federal funds rate, has been 3.25% since December 2008, as well. With rates low but stable, we believe we have been able to position our balance sheet to respond quickly in the future when rates begin to rise, and thereby buffer the potential impact of those rising rates.

Net interest income was $10.6 million in the first quarter of 2015 compared to $9.5 million in 2014, an increase of $1.1 million, or 12.5%. Interest income was $11.4 million in 2015, an increase of $951 thousand or 9.1% over interest income of $10.4 million for the first quarter of 2014. Interest expense declined $234 thousand or 24.1% to $737 thousand in the first quarter of 2015 compared to $971 thousand in the first quarter of 2014.

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Our greatest earning assets are loans which are comprised of two major portfolio classifications: mortgage loans held for sale and loans held for investment. Both portfolios provided interest income growth in the first quarter of 2015 compared to 2014.

Mortgage loans held for sale, which are residential mortgages originated by our mortgage division and sold to investors, earn interest while on our books but at rates typically lower than our loans held for investment portfolio. This portfolio is also subject to greater fluctuations in outstanding balances due to a combination of market demand, economic conditions and the prevailing mortgage rates. Market demand was higher in the first quarter of 2015 compared to prior first quarter results. Interest income on our mortgage loans held for sale was $1.3 million in the first quarter of 2015 compared to $773 thousand, one year prior. Average volume increased $65 million to $136 million through March 31, 2015 compared to $71 million in average volume in the first quarter of 2014. Average yield declined 52 basis points to 3.90% in 2015 compared to 4.42% in 2014.

Loans held for investment are commercial, real estate, and consumer loans originated and maintained on the Bank's books. Average loan volume in the first quarter of 2015 increased $67 million to $766 million, when compared to $699 million one year prior. Year to date 2015, interest income increased $361 thousand over 2014. Average yield declined 29 basis points to 5.21% from 5.50% one year prior. However, a non-recurring interest adjustment of $417 thousand in 2014 was the primary source of this decline. Excluding the non-recurring interest adjustment in 2014 from the yield calculation, average yield on our loans held for investment has only declined 5 basis points from 5.26% to 5.21%.

Interest expense declined $234 thousand or 24.1% in the first quarter of 2015 compared to 2014. The source of this decline was lower interest expense on interest bearing liabilities and trust preferred subordinated debt. Interest expense on interest bearing liabilities declined $166 thousand or 19.9% to $668 thousand from $834 thousand. Interest expense on trust preferred subordinated debt declined $76 thousand in 2015 compared to 2014 to $46 thousand from $122 thousand.

Average volume on our interest bearing deposits increased $36 million driven by time deposit growth. At the same time, average interest cost on interest bearing deposits declined 13 basis point, to 0.40% from 0.53%, driven by lower interest rates across all products. We lowered interest rates on all products throughout 2014. Despite nearly $10 million additional average volume in borrowings, interest expense on these products declined $68 thousand, driven by a 364 basis point decline in rate from 4.97% to 1.33%. The maturity of an interest rate swap on our $10 million trust preferred subordinated debt, which swapped a variable rate instrument for a fixed rate instrument, was the source of this decline. The expired fixed rate was 4.96% and the variable rate was the three month London Interbank Offering Rate ("LIBOR") plus 160 basis points or 1.86% in the first quarter of 2015.

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 35% was used in both 2015 and 2014 when adjusting interest on BOLI and tax-exempt securities 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 10 basis points in the first quarter of 2015 to 4.19% from 4.09% in 2014. Our net interest margin for the first quarter of 2015 was 4.32%, an increase over 2014 of 7 basis points from 4.25%.

Bank Owned Life Insurance (BOLI) has been included in interest earning assets. We purchased $6.0 million in BOLI during the fourth quarter of 2005. We purchased an additional $2.0 million in BOLI during the third quarter of 2014 and an additional $225 thousand in BOLI in the first quarter of 2015. Income on BOLI is not subject to federal income tax, giving it a tax-effective yield of 4.37% for the first quarter of 2015 compared to 4.86% in 2014.

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.

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

NET INTEREST INCOME ANALYSIS

(in thousands)



For the Three Months Ended March 31,
	2015							2014							2013
	Average Balance			Income/ Expense		Yield Rate (1)		Average Balance			Income/ Expense		Yield Rate (1)		Average Balance			Income/ Expense		Yield Rate (1)
ASSETS
Securities, at amortized cost (2)	$	21,107		$	94	1.81	%	$	27,800		$	81	1.18	%	$	15,923		$	63	1.60	%
Loans, held for investment, net	765,635			9,840		5.21	%	698,645			9,479		5.50	%	662,207			8,975		5.50	%
Mortgage loans, held for sale	136,084			1,307		3.90	%	70,856			773		4.42	%	316,189			2,734		3.51	%
Federal funds sold	16,481			8		0.20	%	72,318			40		0.22	%	8,740			5		0.23	%
Dividend-earning restricted equity securities	3,633			39		4.35	%	3,622			30		3.36	%	8,534			74		3.52	%
Deposits in other banks	56,713			102		0.73	%	30,257			36		0.48	%	15,042			8		0.22	%
Bank owned life insurance (2)	9,736			105		4.37	%	7,432			89		4.86	%	7,203			89		5.01	%
Total earning assets	1,009,389			11,495		4.62	%	910,930			10,528		4.69	%	1,033,838			11,948		4.69	%
Less: Allowance for loan losses	(8,891		)					(9,085		)					(11,024		)
Nonperforming loans	6,016							6,073							3,334
Total non-earning assets	64,067							62,897							79,785
Total assets	$	1,070,581						$	970,815						$	1,105,933
LIABILITIES and STOCKHOLDERS’ EQUITY
Interest-bearing deposits:
Demand	$	54,776		$	17	0.13	%	$	49,265		$	19	0.16	%	$	50,724		$	26	0.21	%
Savings	19,931			13		0.26	%	22,743			22		0.39	%	22,654			24		0.43	%
Money market savings	364,473			274		0.30	%	371,388			349		0.38	%	337,067			382		0.46	%
Time deposits	240,764			364		0.61	%	200,342			444		0.90	%	265,423			597		0.91	%
Total interest-bearing deposits	679,944			668		0.40	%	643,738			834		0.53	%	675,868			1,029		0.62	%
Borrowings	21,049			69		1.33	%	11,174			137		4.97	%	123,291			408		1.34	%
Total interest-bearing liabilities	700,993			$	737	0.43	%	654,912			$	971	0.60	%	799,159			$	1,437	0.73	%
Non-interest-bearing liabilities
Demand deposits	246,041							205,231							189,180
Other non-interest-bearing liabilities	15,373							12,298							29,064
Total liabilities	962,407							872,441							1,017,403
Stockholders’ equity	108,174							98,374							88,430
Total liabilities and stockholders’ equity	$	1,070,581						$	970,815						$	1,105,833
Net interest income (2)				$	10,758						$	9,557						$	10,511
Interest rate spread (2)(3)						4.19	%						4.09	%						3.96	%
Net interest margin (2)(4)						4.32	%						4.25	%						4.12	%


(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 35%, with a $41,828 adjustment for 2015 and a $36,355 adjustment for 2014 and a $36,530 adjustment for 2013.


(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.

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Rate/Volume Analysis

The goal of a rate/volume analysis is to compare two or more periods to determine whether the difference between those periods is the result of changes in rate, or volume, or some combination of the two. This is achieved through a “what if” analysis. We calculate what the potential income would have been in the new period if the prior period rate 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 are 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	For the Three Months Ended March 31,
	2015		2014		2013
Interest income:
Total interest income	$	11,385,570	$	10,434,083	$	11,853,870
Bank owned life insurance	67,954		57,773		58,082
Tax equivalent adjustment (35% tax rate)
Bank owned life insurance	36,591		31,109		31,275
Municipal securities	5,237		5,246		5,255
Adjusted income on earning assets	11,495,352		10,528,211		11,948,482
Interest expense:
Total interest expense	737,081		971,112		1,437,682
Net interest income—adjusted	$	10,758,271	$	9,557,099	$	10,510,800

Adjusted net interest income increased approximately $1.2 million in the first quarter of 2015 compared to 2014. Interest income increased $967 thousand quarter over quarter while interest expense declined $234 thousand.

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 increase in interest income for both our mortgage loans held for sale and loans held for investment has been driven by volume. An additional $1.5 million in interest income from volume was reduced $619 thousand due to a reduction in interest rate. Lower volume in securities was offset by higher yields for a net increase of $13 thousand in interest income. Lower volume and rates on federal funds sold resulted in a $32 thousand decline in interest income from that product. Increases in volume and rate on our deposits in other banks provided and additional $66 thousand in interest income. Growth in BOLI provided an additional $26 thousand in interest income that was reduced $10 thousand due to lower rates.

Interest expense declined $234 thousand in the first quarter of 2015 due to lower rates net of increased volume. Lower rates in all deposit categories reduced interest expense $239 thousand. Growth in interest bearing demand and time deposits partially offset this decline for a net reduction in interest expense on deposits of $166 thousand. Lower rates on borrowings resulted in a $141 thousand decline in interest expense that was partially offset by volume growth for a net decline in interest expense of $68 thousand.

In the first quarter of 2014 compared to 2013 net interest income declined $954 thousand. Volume declines in our mortgage loans held for sale portfolio adversely impacted interest income. Interest income on this portfolio declined $1.9 million, quarter over quarter. Our loans held for investment portfolio provided $504 thousand in additional income due primarily to higher volume. Reduced interest expense was the result of both lower rates and volume on our deposits which declined $195 thousand. Additionally, lower volume in borrowings which were partially offset by higher rates for a net reduction in interest expense of $271 thousand.

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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,
	2015 vs. 2014									2014 vs. 2013
	Interest Increase (Decrease)			Change Attributable to						Interest Increase (Decrease)			Change Attributable to
	Interest Increase (Decrease)			Rate			Volume			Interest Increase (Decrease)			Rate			Volume
Interest income
Securities	$	13		$	36		$	(23	)	$	18		$	(20	)	$	38
Loans held for investment	361			(517		)	878			504			10			494
Mortgage loans held for sale	534			(102		)	636			(1,961		)	575			(2,536		)
Federal funds sold	(32		)	(4		)	(28		)	35			—			35
Dividend-earning restricted equity securities	9			9			—			(44		)	(3		)	(41		)
Deposits in other banks	66			24			42			28			15			13
Bank owned life insurance	16			(10		)	26			—			(3		)	3
Total interest income	$	967		$	(564	)	$	1,531		$	(1,420	)	$	574		$	(1,994	)

Interest expense
Deposits:
Demand	$	(2	)	(4		)	2			$	(7	)	(6		)	(1		)
Savings	(9		)	(7		)	(2		)	(2		)	(2		)	—
Money market	(75		)	(69		)	(6		)	(33		)	(69		)	36
Time	(80		)	(159		)	79			(153		)	(9		)	(144		)
Total deposits	(166		)	(239		)	73			(195		)	(86		)	(109		)
Borrowings	(68		)	(141		)	73			(271		)	353			(624		)
Total interest expense	(234		)	(380		)	146			(466		)	267			(733		)
Net interest income	$	1,201		$	(184	)	$	1,385		$	(954	)	$	307		$	(1,261	)

Non-Interest Income

Non-interest income was $22.3 million in the first quarter of 2015, an $8.9 million or 67.3% increase from the first quarter of 2014. Mortgage banking income, which is our largest source of non-interest income, was the source of the changes. Non-interest income is broken out into more detail in the following table.

NON-INTEREST INCOME



	For the Three Months Ended March 31,
	2015		2014
Mortgage banking income	$	21,063,679	$	12,202,162
Service charges and fees	516,554		470,212
Title company income	232,771		105,034
Bank owned life insurance income	67,954		57,773
Investment and insurance commissions	344,126		445,472
Gain on sale of assets	35,011		—
Other	6,068		27,998
	$	22,266,163	$	13,308,651

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.

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Mortgage banking income grew in the first quarter of 2015 compared to 2014 due to higher loan volume. The following table summarizes mortgage loan production for the first three months of 2015 compared to 2014.



Mortgage Banking Income
	2015					2014
	Number	Dollar Volume (000s)		Purchase		Number	Dollar Volume (000s)		Purchase
First Quarter	1,840	$	487,423	53.0	%	1,106	$	271,233	80.8	%

Investment and insurance income declined $101 thousand in the first quarter due to lower production. Income from Monarch Bank Private Wealth ("MBPW") is derived from a combination of new business and fees on existing business. Differing quarterly production levels can impact the income produced in a quarter. MBPW offers products and services and asset management through affiliation with Raymond James Financial Services, Inc.

Service charges and fees on deposit accounts increased $46 thousand in the first quarter of 2015 compared to 2014. The primary components of service charges and fees are non-sufficient fund and overdraft fees and ATM transaction fees and merchant service fees. Income growth is attributable to increases in our demand deposit products, year over year and increased merchant service income. We offer a credit card product through a third party vendor which has added to fee income. Monarch has 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 12 ATMs located at our banking center sites. Combined with our third-party vendor relationship, our network includes 50 active branded ATMs.

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 income increased $128 thousand in the first quarter of 2015 compared to 2014 driven by higher home buying activities in 2015.

Non-interest Expense

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

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NON-INTEREST EXPENSE



	For the Three Months Ended March 31,
	2015			2014
Salaries and employee benefits	$	9,594,276		$	8,271,561
Commissions and incentives	9,445,138			4,010,964
Loan expense	2,458,663			1,363,141
Occupancy expenses, net of rental income	1,446,833			1,503,847
Furniture and equipment expense	841,675			772,856
Marketing expense	746,227			521,841
Data processing services	629,750			479,278
Professional fees	258,601			249,839
Telephone	325,746			311,137
FDIC Insurance	134,741			132,266
Stationery and supplies	114,986			106,118
Virginia Franchise Tax	207,869			201,951
Postage and shipping	100,733			135,130
Travel expense	128,944			86,451
ATM expense	90,400			77,746
Amortization of intangibles	—			44,643
Insurance expense	110,739			56,094
Title expense	38,495			14,459
Other real estate expense	16,402			7,139
Rental income, other real estate	(1,955		)	—
(Gain) loss on sale of other real estate, net	38,879			—
Other	450,690			400,172
	$	27,177,832		$	18,746,633

Total non-interest expenses increased $8.4 million to $27.2 million from $18.8 million. Net overhead expense, which is the difference between non-interest income and non-interest expense, improved $526 thousand in the first quarter of 2015 compared to 2014.

Employee compensation; in the form of salaries, benefits, commissions and incentives, represent approximately 70% of non-interest expense in 2015 compared to 66% in 2014. The number of full time equivalent employees at March 31, 2015 totaled 642 compared to 644 one year prior. Salaries and benefits increased $1.3 million or 16% compared to prior year, driven by annual salary increases, higher employment taxes and health insurance costs. Commissions and incentives have increased $5.4 million in the quarter or 135.5% driven by higher mortgage loans held for sale production. A significant number of our mortgage division employees are commission based.

We are committed to providing our clients with optimal service through our employees, facilities and technology. To that end we evaluate our branch locations, aesthetics, potential areas for expansion and operations continuously. Costs associated with occupancy expense, furniture and equipment have increased due to this commitment. In the first quarter of 2015 we relocated our Towne Center office to better serve our client base. Technology is an ever changing landscape that requires a significant investment to protect our clients' information and provide them with cutting edge banking options. We continuously evaluate and upgrade technology security. Branding and giving back to the community through participation in community projects is important to us as is reflected by our marketing expense. Loan expense is driven by the mortgage volume noted previously.

We had one property in other real estate at March 31, 2015. One property was moved into other real estate in the first quarter. One property sold in the first quarter at a loss of $38,879. We had one property in other real estate at March 31, 2014 that had been moved into other real estate in the prior year. No properties were sold in the first quarter of 2014. There were no valuation adjustments recorded in either year to date. Rental income on other real estate was $2 thousand in the first quarter of 2015 and $0 for the same period in 2014. Expenses related to the maintenance and sale of other real estate were $16 thousand in the first quarter of 2015 and $7 thousand in the first quarter of 2014.

The following summary identifies non-interest expenses with the most significant quarter-over-quarter change.

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	Change - Increase (Decrease) For the Three Months Ended March 31, 2015
	Dollars		Percentage
Commissions and incentives	$	5,434,174	135.5	%
Salaries and employee benefits	1,322,715		16.0	%
Loan expense	1,095,522		80.4	%
Marketing expense	224,386		43.0	%
Data processing	150,472		31.4	%

Income Taxes

Our federal income tax provision was $1.9 million in the first quarter of 2015 compared to $1.4 million in the first quarter of 2014. State income tax provision for the states of Maryland, North Carolina and South Carolina totaled $106 thousand and $118 thousand same respective periods.

BOLI income and certain municipal securities are not subject to federal income tax. We had tax exempt income of $78 thousand in the first quarter of 2015 and $68 thousand in the first quarter of 2014.

Certain expenses related to marketing are non-deductible for tax purposes. These non-deductible expenses totaled $115 thousand and $114 thousand in the first quarter of 2015 and 2014.

The table below presents a summary of income taxes and the effective tax rate for quarters ended March 31, 2015 and 2014.



Income Tax Summary
	For the Three Months Ended March 31,
	2015			2014
Income tax provision	$	1,993,340		$	1,471,240
Less: state tax provision	105,840			117,840
Federal tax provision	$	1,887,500		$	1,353,400

Net income before tax	$	5,486,820		$	4,024,989

Effective federal tax rate	34.4		%	33.6		%

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

GENERAL

Total assets were $1.178 billion at March 31, 2015, a $111.6 million or 10.5% increase compared to assets of $1.067 billion at December 31, 2014. Total cash and cash equivalents increased $85.0 million or 129.9%. Loans held for investment increased $14.4 million or 1.9% and mortgage loans held for sale increased $12.2 million or 8.3%. Restricted equity securities declined $390 thousand or 10.7% and investment securities declined $3.4 million or 14.5%.

Cash and cash equivalents, which fluctuate daily based on our liquidity levels and mortgage settlement activity, increased $85.0 million. This increase is due to a $62.2 million increase in federal funds sold and a $23.4 million increase in interest bearing bank balances. The increase in federal funds was driven by a large short term deposit from a business client. The bank began investing in Bank Certificates of Deposits in 2014 and the increase in interest bearing balances is related to those investments.

Our loans held for investment portfolio which is comprised primarily of commercial loans and real estate loans increased $14.4 million in the first quarter of 2014. The majority of this growth was in commercial loans and residential (1-4 family) real estate. Our mortgage loans held for sale portfolio represents mortgage loans that have been closed and are awaiting investor funding. A majority of our mortgage loans are pre-sold. These loans typically remain on our books for thirty to forty-five days. Outstanding balances, which are dependent on the current mortgage market, the timing of closings, and investor turn around, may fluctuate significantly between periods. With higher levels of quarterly production the outstanding balances during the quarter increased $12.2 million.

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In the first quarter of 2015, we purchased an additional $225 thousand in bank owned life insurance (BOLI). Income from BOLI is not subject to federal income tax. Property and equipment declined $197 thousand due to asset depreciation and limited new purchases in the first quarter of 2015. Restricted equity securities include stock in the Federal Reserve, Federal Home Loan Bank and other bankers' banks. The level of stock we retain is subject to evaluation by the various entities and may result in a periodic increase or decrease in share level. Our stock in the Federal Home Loan Bank is impacted by lower borrowing levels. Investment securities declined $3.4 million due to maturities and calls, net of purchases.

Total liabilities were $1.07 billion at March 31, 2015, an increase of $108.6 million or 11.3% from December 31, 2014 liabilities of $959.2 million. Total deposits, which are our primary liability source, increased $117.7 million to $1.04 billion at March 31, 2015 compared to $919.4 million at year-end 2014. Total borrowings decreased $10.0 million at March 31, 2015 compared to December 31, 2014.

Non-interest bearing demand deposits increased $35.1 million or 14.9% in the first quarter of 2015. Money market accounts increased $48.1 million and time deposits increased $42.9 million. Interest bearing demand deposits declined $8.0 million and savings deposits declined $484 thousand.

Our non-interest bearing deposits represent 26.1% and 25.6% of our total deposits at March 31, 2015 and December 31, 2014, respectively. Commercial and small business checking accounts comprise the largest percentage of non-interest bearing demand deposits. At March 31, 2015, commercial checking accounts increased $24.8 million over December 31, 2014 and at $167.7 million were 62% of non-interest bearing demand. Small business checking accounts increased $700 thousand to $60.5 million, 22% of non-interest bearing demand. We are primarily a business bank and, as such, have focused our efforts on obtaining company operating accounts, which are demand deposit accounts. Attorney escrow accounts at $21.7 million represented 8% of non-interest bearing deposits at March 31, 2015 and increased $7.1 million compared to December 31, 2014. Escrow accounts ordinarily house real estate funds, which makes them sensitive to the growth within the real estate market. Our focus on the business sector, coupled with the growth in business operating accounts, has resulted in continued growth in demand deposits.

Interest bearing demand deposits declined $8.0 million from December 31, 2014, primarily in commercial checking. Interest bearing demand deposits represent 7.6% of interest bearing deposits. Money market and time deposits ("CDs") represent roughly 89.8% and savings deposits represent roughly 2.5%, of interest bearing deposits. Money market deposits, which were $417.3 million at March 31, 2015, increased $48.1 million since December 31, 2014. Brokered money market deposit accounts are included in our money market totals at both March 31, 2015 and December 31, 2014 and declined $1.2 million since year end. Excluding these accounts, non-brokered money market balances increased $49.2 million since year end 2014. This increase is related to a short term deposit made by a single client near quarter end. These funds will be disbursed over the next two quarters, having a negative impact on deposit growth. Excluding this deposit, money market account balances actually declined $29.4 million in the quarter. We have been managing money market account growth through pricing of our multi-tiered money market product, while keeping rates attractive and highly competitive in the market. Given the runoff, we recently increased the rates on our money market accounts in an attempt to remain competitive with other banks in the area and retain deposits. Money market accounts are the most suitable product for these individuals because rates are higher than demand and savings accounts but they have withdrawal features more flexible than CDs. Therefore, our money market balances may be adversely impacted in the future when the economy is more stable and investors return to higher, but riskier, rate alternatives.

Outstanding CDs increased $42.9 million to $271.1 million at March 31, 2015 compared to December 31, 2014. Included in CDs are brokered CDs which are used along with our brokered money market accounts and Federal Home Loan Bank ("FHLB") borrowings to fund our loans held for sale portfolio. The majority of these brokered CDs are Certificate of Deposit Account Registry Service^® (“CDARS”), which are typically short term, with maturities of between 4 and 13 weeks. However, we also house certain municipal deposits in CDARS because of the additional deposit insurance protection offered by the product. Brokered deposits increased $58.9 million at March 31, 2015 compared to December 31, 2014. We had placed deposits with CDARS prior to notification of the receipt of the large business deposit. Our remaining CD portfolio has continued to decline, by design. CD shoppers typically expect higher interest rates. We have focused on relationship pricing for CDs, with non- clients receiving lower rates for CDs than existing clients, thereby encouraging relationships which are beneficial to both the Bank and our clients.

Excluding brokered deposits, our loans held for investment to deposit ratio was 90.0% and 95.0% for March 31, 2015 and December 31, 2014, respectively.

Stockholders’ equity was $110.5 million at March 31, 2015, compared to $107.5 million at December 31, 2014. Components of the increase in stockholders’ equity include net income of $3.5 million, decrease in unrealized losses in other comprehensive income of $87 thousand, exercised stock options of $134 thousand, stock based compensation expense totaling $172 thousand, common stock dividend payments of $858 thousand, and distributions to non-controlling interests of $29 thousand.

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Loans Held for Investment

Our lending activities are our principal source of income. Loans held for investment, net of unearned income, increased $14.4 million or 1.9% in the first three months of 2015. Our allowance for loan losses declined $305 thousand in the quarter after a provision of $250 thousand and net charge offs of $555 thousand.

The following table provides a breakdown, by segment of our loans held for investment at March 31, 2015 and December 31, 2014.

LOANS HELD FOR INVESTMENT



	March 31, 2015			December 31, 2014
Commercial	$	145,535,415		$	138,430,999
Real estate
Construction	172,917,857			172,502,330
Residential (1-4 family)	117,929,338			109,404,283
Home equity lines	64,142,603			67,487,000
Multifamily	21,292,712			21,809,189
Commercial	258,873,042			256,966,820
Real estate subtotal	635,155,552			628,169,622
Consumers
Consumer and installment loans	6,100,197			5,968,990
Overdraft protection loans	436,257			96,736
Loans to individuals subtotal	6,536,454			6,065,726
Total gross loans	787,227,421			772,666,347
Unamortized loan fees, net of deferred costs	(224,468		)	(76,812		)
Loans held for investment, net of unearned income	787,002,953			772,589,535
Allowance for loan losses	(8,643,553		)	(8,948,837		)
Total net loans	$	778,359,400		$	763,640,698

Allowance and Provision for Loan Losses

We have certain lending policies and procedures in place, 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.

Inherent losses in our loan portfolio are supported by our allowance for loan losses. 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 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 by analyzing loans on both, a pooled basis and individually. Our allowance for loan losses consists of amounts applicable to the following three loan types: commercial, real estate, and consumer. In addition, loans within these types 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 loan segment with loan type and losses modeled utilizing historical experience by segment, other known and inherent risks, and quantitative techniques which management has determined fit the characteristics of the loan type or segment within that type. We utilize a moving average historical loss "look back" period of seventeen quarters.

The commercial loan type 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 their business.

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The real estate loan type includes all loans secured by real estate. This type is further broken down into segments. These segments are: 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 two classes: 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 type 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:



“Pass”	“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 pass and watch list loans at March 31, 2015 and December 31, 2014. There were no loans risk graded Doubtful (8) or Loss (9) included in our portfolio at March 31, 2015 or December 31, 2014.

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PASS AND WATCH LIST LOANS



	March 31, 2015
			Watch List					Weighted Average Risk Grade
	Pass		Special Mention		Substandard		Total	Weighted Average Risk Grade
Commercial	$	142,376,172	$	1,708,494	$	1,450,749	145,535,415	3.31
Real estate
Construction	171,644,558		793,975		479,324		172,917,857	3.26
Residential (1-4 family)	111,300,339		173,910		6,455,089		117,929,338	3.89
Home equity lines	62,870,082		—		1,272,521		64,142,603	4.13
Multifamily	21,034,995		257,717		—		21,292,712	3.27
Commercial	256,953,370		907,490		1,012,182		258,873,042	3.50
Real estate subtotal	623,803,344		2,133,092		9,219,116		635,155,552	3.56
Consumers
Consumer and installment loans	6,026,022		—		74,175		6,100,197	4.04
Overdraft protection loans	433,257		—		3,000		436,257	4.93
Loans to individuals subtotal	6,459,279		—		77,175		6,536,454	4.10
Total gross loans	$	772,638,795	$	3,841,586	$	10,747,040	787,227,421	3.52



	December 31, 2014
			Watch List						Weighted Average Risk Grade
	Pass		Special Mention		Substandard		Total		Weighted Average Risk Grade
Commercial	$	135,292,747	$	1,588,289	$	1,549,963	$	138,430,999	3.31
Real estate
Construction	171,136,553		93,397		1,272,380		172,502,330		3.26
Residential (1-4 family)	101,860,683		177,735		7,365,865		109,404,283		3.93
Home equity lines	66,282,828		102,575		1,101,597		67,487,000		4.12
Multifamily	19,616,130		2,193,059		—		21,809,189		3.53
Commercial	253,525,106		2,029,203		1,412,511		256,966,820		3.54
Real estate subtotal	612,421,300		4,595,969		11,152,353		628,169,622		3.59
Consumers
Consumer and installment loans	5,893,286		—		75,704		5,968,990		4.04
Overdraft protection loans	96,736		—		—		96,736		4.64
Loans to individuals subtotal	5,990,022		—		75,704		6,065,726		4.05
Total gross loans	$	753,704,069	$	6,184,258	$	12,778,020	$	772,666,347	3.55

Additional regulatory guidance with regard to the specifications of the special mention (6) risk grade, stipulates that loans with this risk grade be treated as transitory and should not remain special mention for more than one year. We continue to monitor and evaluate loans in our special mention risk grade on a monthly basis.

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 2014 Annual Report on Form10-K.)

We evaluate additional risk inherent in our satisfactory risk grade groups through a methodology that looks at these loans on a pool basis by loan segment which is further delineated by purpose. Each segment is assigned an expected loss factor based on a moving average “look-back” at our historical losses for that particular segment. In 2014, we reexamined our loss history and determined a five year "look back" or twenty quarter history would be a more prudent approach to modeling historical losses than our previous four year "look back". Therefore, at September 30, 2014 we began extending our "look-back" period by one quarter with a goal of twenty quarters or five years by June 2015. This methodology provides a supportable means of evaluating the potential risk in our portfolio because the delineation by purpose establishes a stronger focus on areas of weakness and strength within the portfolio.

This evaluation includes, but is not limited to, the application of a loss factor which is arrived at by using a multi-year moving average “look back” at our historical losses. This loss factor is multiplied by the outstanding principal of loans not individually evaluated for impairment 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

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concentrations, specific industry conditions in the regional economy, regulatory examination results, external audit and loan review findings, and recent loss experiences in particular portfolio classes. 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.

We recorded a $250 thousand provision for loan losses in the first quarter of 2015 and no provision for loan losses in the first quarter of 2014. Based on the current economic environment and the composition of our loan portfolio, the level of our charged-off loans combined with our loss experience, we consider our loan loss allowance sufficient to meet the losses inherent in our portfolio.

Loans charged off during first quarter of 2015 totaled $598,454 compared to $12,554 for the same period in 2014. Recoveries totaled $43,170 in the first quarter of 2015 compared to $164,285 for the same period in 2014. The ratio of net charge-offs to average outstanding loans for the first quarter of 2015 was 0.07% compared to (0.09%) in 2014. A total of $582,500 in specific reserves for loans charged off in the first three months of 2015 were included in our December 31, 2014 loan loss allowance. Specific reserves totaling $12,554 were included in our December 31, 2013 loan loss allowance for loans charged off in the first three months of 2014.

In the first quarter of 2015, approximately $565 thousand in loans charged off were related to business failure and $34 thousand were related to residential properties. In the first quarter of 2014, approximately $13 thousand in loans charged off were related to business failure.

The allowance for loan losses totaled $8,643,553 at March 31, 2015, a decrease of $305,284 from December 31, 2014. The ratio of the allowance to loans held for investment, less unearned income, was 1.10% at March 31, 2015, and 1.16% at December 31, 2014. We believe the allowance for loan losses is adequate to absorb any inherent losses on existing loans in our loan portfolio at March 31, 2015. 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.

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LOAN LOSS ALLOWANCE AND LOSS EXPERIENCE



	For the Three Months Ended March 31,
	2015			2014
Balance, beginning of period	$	8,948,837		$	9,061,369
Loans charged-off
Commercial	(34,000		)	—
Real estate
Construction	(17,500		)	—
Residential (1-4 family)	(546,954		)	(12,554		)
Home equity lines	—			—
Multifamily	—			—
Commercial	—			—
Consumers
Consumer and installment loans	—			—
Overdraft protection loans	—			—
Loans charged-off total	(598,454		)	(12,554		)
Recoveries
Commercial	2,300			88,300
Real estate
Construction	13,661			8,590
Residential (1-4 family)	3,779			8,385
Home equity lines	23,430			59,010
Multifamily	—			—
Commercial	—			—
Consumers
Consumer and installment loans	—			—
Overdraft protection loans	—			—
Loan recoveries total	43,170			164,285
Net Charge Offs	(555,284		)	151,731
Provisions charged to operations	250,000			—
Balance, end of period	$	8,643,553		$	9,213,100

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A summary of our allowance as of March 31, 2015 and December 31, 2014 by segment is as follows:

ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES



	March 31, 2015
	Amount			Percentage of loans in each category to total loans
Commercial	$	1,367,630		18.5	%
Real estate
Construction	1,689,283			22.0	%
Residential (1-4 family)	1,975,248			15.0	%
Home equity lines	1,732,570			8.1	%
Multifamily	83,042			2.7	%
Commercial	1,552,530			32.9	%
Consumers
Consumer and installment loans	103,199			0.8	%
Overdraft protection loans	1,504			—	%
Unallocated	138,547
	$	8,643,553		100.0	%
Total loans held for investment outstanding *	$	787,002,953
Ratio of allowance for loan losses to total loans held for investment	1.10		%



	December 31, 2014
	Amount			Percentage of loans in each category to total loans
Commercial	$	1,157,867		17.9	%
Real estate
Construction	1,678,022			22.3	%
Residential (1-4 family)	2,456,418			14.2	%
Home equity lines	1,911,634			8.7	%
Multifamily	85,056			2.8	%
Commercial	1,458,664			33.3	%
Consumers
Consumer and installment loans	104,661			0.8	%
Overdraft protection loans	260			—	%
Unallocated	96,255
	$	8,948,837		100.0	%
Total loans held for investment outstanding *	$	772,589,535
Ratio of allowance for loan losses to total loans held for investment	1.16		%



*	Total loans held for investment outstanding includes unamortized loan costs, net of deferred fees of $224,468 at March 31, 2015 and $76,812 at December 31, 2014.

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. Based on this definition total non-performing loans as a percentage of total loans were 0.86% and 0.73% at March 31, 2015 and December 31, 2014. However, all but two of our troubled debt restructure loans were performing at March 31, 2015 and all but one of our troubled

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debt restructure loans was performing at December 31, 2014. Excluding performing troubled debt restructure this percentage declines to 0.57% and 0.37% at March 31, 2015 and December 31, 2014, respectively. Non-performing assets at March 31, 2015 and December 31, 2014 are presented below.

NON-PERFORMING ASSETS



	Non-Performing Loans
	Over 90 Days and Accruing		Nonaccrual Loans		Non-accruing Restructured Loans		Accruing Restructured Loans		Total Non-Performing Loans		Other Real Estate Owned		Total Non-Performing Assets
	Over 90 Days and Accruing		Nonaccrual Loans		Non-accruing Restructured Loans		Accruing Restructured Loans		Total Non-Performing Loans		Other Real Estate Owned		Total Non-Performing Assets
March 31, 2015
Commercial	$	—	$	548,059	$	—	$	—	$	548,059	$	—	$	548,059
Real estate
Construction	—		110,472		—		—		110,472		100,000		210,472
Residential (1-4 family)	174,976		2,521,827		665,611		841,273		4,203,687		—		4,203,687
Home equity lines	—		247,693		—		—		247,693		—		247,693
Multifamily	—		—		—		—		—		—		—
Commercial	—		230,994		—		1,329,584		1,560,578		—		1,560,578
Consumers
Consumer and installment loans	—		86		—		72,220		72,306		—		72,306
Overdraft protection loans	—		—		—		—		—		—		—
Total	$	174,976	$	3,659,131	$	665,611	$	2,243,077	$	6,742,795	$	100,000	$	6,842,795

December 31, 2014
Commercial	$	—	$	582,059	$	—	$	—	$	582,059	$	—	$	582,059
Real estate
Construction	—		212,552		—		—		212,552		144,000		356,552
Residential (1-4 family)	174,976		1,244,531		183,400		1,336,990		2,939,897		—		2,939,897
Home equity lines	—		249,915		—		—		249,915		—		249,915
Multifamily	—		—		—		—		—		—		—
Commercial	—		230,994		—		1,332,589		1,563,583		—		1,563,583
Consumers
Consumer and installment loans	—		1,121		—		74,582		75,703		—		75,703
Overdraft protection loans	—		—		—		—		—		—		—
Total	$	174,976	$	2,521,172	$	183,400	$	2,744,161	$	5,623,709	$	144,000	$	5,767,709



	March 31, 2015		December 31, 2014
Asset Quality Ratios:
Non-accruing nonperforming loans to period end loans	0.57	%	0.37	%
Non-accruing nonperforming assets to total assets	0.39	%	0.28	%
Nonperforming assets to period end assets	0.58	%	0.54	%
Allowance for loan losses to non-accruing nonperforming loans	192.09	%	310.77	%
Nonperforming loans to period end loans	0.86	%	0.73	%

Restructured loans are loans for which it has been determined the borrower is in financial distress and a concession has been made to those terms that would not otherwise have been considered. Restructured loans are evaluated in accordance with applicable accounting guidance as impaired loans. 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, 2015 or December 31, 2014.

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TROUBLED DEBT RESTRUCTURING



	Residential 1-4 Family			Real Estate Construction			Consumer			Total

March 31, 2015
Balance beginning of the period	$	1,520,390		$	1,332,589		$	74,582		$	2,927,561
Investment in restructured loans
Additions (payments received) during the period	(13,506		)	(3,005		)	(2,362		)	(18,873		)
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	$	1,506,884		$	1,329,584		$	72,220		$	2,908,688

December 31, 2014
Balance beginning of the period	$	263,624		$	4,568,883		$	83,792		$	4,916,299
Investment in restructured loans
Additions (payments received) during the period	1,256,766			(3,236,294		)	(9,210		)	(1,988,738		)
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	$	1,520,390		$	1,332,589		$	74,582		$	2,927,561

Recoveries of charged-off balance
March 31, 2015	$	—		$	—		$	—		$	—
December 31, 2014	$	—		$	—		$	—		$	—

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 non-interest expense, when identified. Expenses associated with the maintenance of other real estate are charged to operations, foreclosed property expense, as incurred. When a property is sold, any gain or loss on the sale is recorded as gain or loss on foreclosed property in non-interest expense.

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OTHER REAL ESTATE



	March 31, 2015
	Balance			Number
January 1,	$	144,000		1
Balance moved into other real estate	100,000			1
	244,000			2
Write down of property charged to operations	—
Payments received after foreclosure	—
Properties sold	(144,000		)	(1	)
Balance at March 31, 2015	$	100,000		1
Gross gains of sale of other real estate	$	—
Gross losses on sale of other real estate	(38,879		)
Write down of property charged to operations	—
Rental income, other real estate	1,955
Other real estate expense	(16,402		)
Foreclosed property (expense) income	$	(53,326	)

	December 31, 2014
	Balance			Number
January 1,	$	301,963		1
Balance moved into other real estate	942,285			3
	1,244,248			4
Write down of property charged to operations	—
Payments received after foreclosure	—
Properties sold	(1,100,248		)	(3	)
Balance at December 31, 2014	$	144,000		1
Gross gains of sale of other real estate	$	—
Gross losses on sale of other real estate	(6,976		)
Write down of property charged to operations	—
Rental income, other real estate	9,620
Other real estate expense	(80,580		)
Foreclosed property (expense) income	$	(77,936	)

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 six 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”).

Cash, cash equivalents and federal funds sold totaled $150.4 million as of March 31, 2015 compared to $65.4 million as of December 31, 2014. At March 31, 2015, cash, interest bearing bank balances, securities classified as available for sale and federal funds sold were $170.7 million or 14.5% of total assets, compared to $89.1 million or 8.4% of total assets at December 31, 2014.

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 $68.0 million. These lines mature and re-price daily. At March 31, 2015 and December 31, 2014, we had $0 in federal funds purchased outstanding.

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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 30% of assets or $353.5 million from this program at March 31, 2015. We had $123.2 million on our balance sheet from this program at March 31, 2015 and $64.5 million at December 31, 2014.

We have lines of credit with the Federal Home Loan Bank of Atlanta (“FHLB”) that can equal up to 30% of our assets. Our line of credit totaled approximately $123.1 million with $114.0 million available at March 31, 2015. This line is currently reduced by $8.0 million, which has been pledged as collateral for public deposits.

Borrowings outstanding under the combined FHLB lines of credit were $1.1 million at March 31, 2015 and $11.1 million at December 31, 2014. We had the following borrowing advances under our Primary line outstanding as of March 31, 2015 with the following final maturities:



Advance Amount		Expiration Date
$	1,050,499	9/28/2015
$	1,050,499

This advance 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 utilized this advance to match-fund several long term fixed rate loans. The interest rate for this advance is fixed at 4.96%.

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, 2015 and December 31, 2014 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 $8 million at March 31, 2015 and December 31, 2014.



	Commitments
	March 31, 2015		December 31, 2014
Commitments to grant loans	$	200,839,550	$	205,003,879
Interest rate lock commitments	$	102,237,931	$	79,415,083
Unfunded commitments under lines of credit and similar arrangements	$	142,504,700	$	148,660,017
Standby letters of credit and guarantees written	$	30,686,375	$	29,328,041

The table above summarizes our off-balance sheet commitments at March 31, 2015 and December 31, 2014. Commitments to extend credit and unfunded commitments under existing lines of credit 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. 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 did not have any outstanding commitments to purchase securities at March 31, 2015 or December 31, 2014.

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We have thirty-eight non-cancellable leases for premises. The original lease terms are from one to thirty 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 are 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, 2015, the amount available was approximately $19.1 million. We paid our first common stock cash dividend in 2010. We began paying common stock cash dividends on a quarterly basis in the first quarter of 2012. We paid semi-annual cash dividends on our common stock in 2011. Below is a table of our cash dividend history.

In June 2012, we received approval from the Securities and Exchange Commission to begin a Dividend Reinvestment Program ("DRP"). The DRP, which is available to existing shareholders, allows for dividends to be reinvested in Monarch stock. In addition, shareholders may purchase additional shares on a quarterly basis.

COMMON STOCK DIVIDENDS



Payment Date	Per Share Dividend		Total Dividend
2015
February 28, 2015	$	0.08	$	858,261
2014
November 28, 2014	$	0.08	$	851,749
August 29, 2014	$	0.08	$	850,803
June 13, 2014	$	0.08	$	849,563
February 28, 2014	$	0.07	$	742,447
2013
November 30, 2013	$	0.07	$	733,448
August 30, 2013	$	0.06	$	628,325
May 31, 2013	$	0.06	$	624,443
February 28, 2013	$	0.05	$	453,880
2012
November 30, 2012	$	0.05	$	332,754
August 31, 2012	$	0.05	$	302,161
May 31, 2012	$	0.05	$	299,174
February 28, 2012	$	0.04	$	240,000
2011
November 30, 2011	$	0.08	$	475,531
June 22, 2011	$	0.08	$	477,227

Basel III

The Dodd-Frank Act contains a number of provisions dealing with capital adequacy of insured depository institutions and their holding companies, which has resulted in more stringent capital requirements. Under the Collins Amendment to the Dodd-

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Frank Act, federal regulators established minimum leverage and risk-based capital requirements for banks and bank holding companies on a consolidated basis. In July 2013, the Federal Reserve published the Basel III Capital Rules establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the Basel Committee’s December 2010 framework known as “Basel III” for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act.

The Basel III Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions, including the Company and the Bank, compared to the current U.S. risk-based capital rules. The Basel III Capital Rules define the components of capital and address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The Basel III Capital Rules also address risk weights and other issues affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing risk-weighting approach, which was derived from the Basel I capital accords of the Basel Committee, with a more risk-sensitive approach based, in part, on the standardized approach in the Basel Committee’s 2004 “Basel II” capital accords. The Basel III Capital Rules also implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules. The Basel III Capital Rules were effective for the Company and the Bank, subject to a phase-in period, on January 1, 2015.

The Basel III Capital Rules (i) introduce a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expand the scope of the deductions/adjustments as compared to existing regulations.

When fully phased in on January 1, 2019, the Basel III Capital Rules will require the Company and the Bank to maintain

(i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets (as compared to a current minimum leverage ratio of 3% for banking organizations that either have the highest supervisory rating or have implemented the appropriate federal regulatory authority’s risk-adjusted measure for market risk).

Under the Basel III Capital Rules, the initial minimum capital ratios as of January 1, 2015, will be as follows:

• 4.5% CET1 to risk-weighted assets.

• 6.0% Tier 1 capital to risk-weighted assets.

• 8.0% Total capital to risk-weighted assets.

The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).

As of March 31, 2015, 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, Common Equity 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, 2015 and December 31, 2014.

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RISK BASED CAPITAL



	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, 2015
Total Risk-Based Capital Ratio
Consolidated company	$	129,195	13.57	%	$	76,154	8.00	%	N/A		N/A
Bank	$	127,287	13.38	%	$	76,129	8.00	%	$	95,162	10.00	%
(Total Risk-Based Capital to Risk-Weighted Assets)
Tier 1 Risk-Based Capital Ratio
Consolidated company	$	120,551	12.61	%	$	57,116	6.00	%	N/A		N/A
Bank	$	118,643	12.47	%	$	57,097	6.00	%	$	76,129	8.00	%
(Tier 1 Capital to Risk-Weighted Assets)
Common Equity Risk-Based Capital
Consolidated company	$	120,551	12.61	%	$	42,837	4.50	%	N/A		N/A
Bank	$	118,643	12.47	%	$	42,823	4.50	%	$	61,855	6.50	%
(Total Common Equity to Risk-Weighted Assets)
Tier 1 Leverage Ratio
Consolidated company	$	120,551	11.28	%	$	42,780	4.00	%	N/A		N/A
Bank	$	118,643	11.10	%	$	42,780	4.00	%	$	53,475	5.00	%
(Tier 1 Capital to Average Assets)
As of December 31, 2014
Total Risk-Based Capital Ratio
Consolidated company	$	125,728	13.79	%	$	72,925	8.00	%	N/A		N/A
Bank	$	125,807	13.81	%	$	72,900	8.00	%	$	91,125	10.00	%
(Total Risk-Based Capital to Risk-Weighted Assets)
Tier 1 Risk-Based Capital Ratio
Consolidated company	$	116,779	12.81	%	$	36,462	4.00	%	N/A		N/A
Bank	$	116,858	12.82	%	$	36,450	4.00	%	$	54,675	6.00	%
(Tier 1 Capital to Risk-Weighted Assets)
Tier 1 Leverage Ratio
Consolidated company	$	116,779	11.44	%	$	40,821	4.00	%	N/A		N/A
Bank	$	116,858	11.45	%	$	40,821	4.00	%	$	51,026	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, the 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. ALCO 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.

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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. There have been no material changes in interest rates in the first quarter of March 31, 2015 compared to December 31, 2014.

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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.

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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 2014 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. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

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Item 6. Exhibits



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.
101.0 –	Financial statements and schedules in interactive data format.

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 8, 2015
Brad E. Schwartz Chief Executive Officer
/s/ Lynette P. Harris.	Date: May 8, 2015
Lynette P. Harris Executive Vice President & Chief Financial Officer

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Exhibit 31.1

SECTION 302 CERTIFICATION

I, Brad E. Schwartz, certify that:


1.	I have reviewed this quarterly report on Form 10-Q of Monarch Financial Holdings, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: May 8, 2015 /s/ Brad E. Schwartz _______________

Brad E. Schwartz

Chief Executive Officer

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Exhibit 31.2

SECTION 302 CERTIFICATION

I, Lynette P. Harris, certify that:


1.	I have reviewed this quarterly report on Form 10-Q of Monarch Financial Holdings, Inc.;

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: May 8, 2015 /s/ Lynette P. Harris. ___________________

Lynette P. Harris

Executive Vice President & Chief Financial Officer

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Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report on Form 10-Q of Monarch Financial Holdings, Inc. (the "Company") for the period ending March 31, 2015 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned Chief Executive Officer and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that based on their knowledge and belief:

(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Brad E. Schwartz ______________

Brad E. Schwartz,

Chief Executive Officer

/s/ Lynette P. Harris. ___________________

Lynette P. Harris

Executive Vice President & Chief Financial Officer

Date: May 8, 2015

Monarch Financial Holdings, Inc. - FORM 10-Q - May 8, 2015

Attached files

Monarch Financial Holdings, Inc. Reports