LSBX Lsb Corp (MM)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20529

FORM 10-Q

þ		Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934

For the quarterly period ended September 30, 2007

o		Transition Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934

For the transition period from                      to                     

Commission File Number 000-32955

(978) 725-7500
(Registrant’s telephone number, including area code)

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

Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one).

Large Accelerated Filer o                      Accelerated Filer o                     Non-Accelerated Filer þ

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

Yes o                      No þ

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

Class		Outstanding as of November 8, 2007
Common Stock, par value $.10 per share		4,516,561 shares

 

 

LSB CORPORATION AND SUBSIDIARY

INDEX

PART I — FINANCIAL INFORMATION

					Page:
ITEM 1		FINANCIAL STATEMENTS
		Consolidated Balance Sheets			3
		Consolidated Statements of Operations			4
		Consolidated Statements of Changes in Stockholders’ Equity			5
		Consolidated Statements of Cash Flows			6
		Notes to Consolidated Financial Statements			7-9
ITEM 2		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			10-21
ITEM 3		QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK			21
ITEM 4		CONTROLS AND PROCEDURES			21
		PART II — OTHER INFORMATION
ITEM 1		LEGAL PROCEEDINGS			22
ITEM 1A		RISK FACTORS			22
ITEM 2		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			22
ITEM 3		DEFAULTS UPON SENIOR SECURITIES			22
ITEM 4		SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			22
ITEM 5		OTHER INFORMATION			23
ITEM 6		EXHIBITS			23
SIGNATURES					24
EXHIBIT INDEX					25
EX-31.1 Section 302 Certification of CEO
EX-31.2 Section 302 Certification of CFO
EX-32.1 Section 906 Certification of CEO
EX-32.2 Section 906 Certification of CFO

PART 1 — FINANCIAL INFORMATION

The accompanying notes are an integral part of these unaudited Consolidated Financial Statements.

The accompanying notes are an integral part of these unaudited Consolidated Financial Statements.

The accompanying notes are an integral part of these unaudited Consolidated Financial Statements.

LSB CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(UNAUDITED)

1. BASIS OF PRESENTATION

LSB Corporation (the “Corporation” or the “Company”) is a Massachusetts corporation and the holding company of its wholly-owned subsidiary River Bank (the “Bank”), a state-chartered Massachusetts savings bank organized in 1868. The Corporation was organized by the Bank on July 1, 2001 to be a bank holding company and to acquire all of the capital stock of the Bank.

The Corporation is supervised by the Board of Governors of the Federal Reserve System (“FRB”), and it is also subject to the jurisdiction of the Massachusetts Division of Banks, while the Bank is subject to the regulations of, and periodic examination by, the Federal Deposit Insurance Corporation (“FDIC”) and the Massachusetts Division of Banks. The Bank’s deposits are insured by the Deposit Insurance Fund of the FDIC up to $100,000 per account, as defined by the FDIC (except for certain retirement accounts which are insured up to $250,000), and the Depositors Insurance Fund (“DIF”) of Massachusetts, a private industry-sponsored insurer, for customer deposit amounts in excess of FDIC insurance limits. The Consolidated Financial Statements include the accounts of LSB Corporation and its wholly-owned consolidated subsidiary, River Bank, and the Bank’s wholly-owned subsidiaries, Shawsheen Security Corporation, Shawsheen Security Corporation II, and Spruce Wood Realty Trust. All inter-company balances and transactions have been eliminated in consolidation. The Company has one reportable operating segment. In the opinion of management, the accompanying Consolidated Financial Statements reflect all necessary adjustments consisting of normal recurring accruals for fair presentation. Certain amounts in prior periods may be re-classified to conform to the current presentation.

The Corporation’s Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America. Accordingly, management is required to make estimates and assumptions that affect amounts reported in the balance sheets and statements of income. Actual results could differ significantly from those estimates and judgments. Material estimates that are particularly susceptible to change relate to the allowance for loan losses, income taxes and impairment of investment securities.

The interim results of consolidated income (loss) are not necessarily indicative of the results for any future interim period or for the entire year. These interim Consolidated Financial Statements do not include all disclosures associated with annual financial statements and, accordingly, should be read in conjunction with the annual Consolidated Financial Statements and accompanying notes included in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2006 filed with the Securities and Exchange Commission.

2. EQUITY AWARDS

At September 30, 2007, there were no shares available for grant under the Lawrence Savings Bank 1986 Stock Option Plan (the “1986 Plan”) and 16,925 shares available for grant under the Lawrence Savings Bank 1997 Stock Option Plan (the “1997 Plan”) due to stock option forfeitures by former participants. The available shares under the 1997 Plan expire in December 2007. Under all plans, the option exercise price equals the fair market value on the date of grant. All options granted under the 1986 and 1997 Plans vested over three years from the date of grant and have ten-year contractual terms. All currently outstanding options granted under these plans expire between 2007 and 2015. All options granted under the LSB Corporation 2006 Stock Option and Incentive Plan (the “2006 Plan”) vest over two years from the date of grant and have seven-year contractual terms. Options granted in 2006 under the 2006 Plan expire in 2013. Restricted stock awards were granted during 2006 representing 14,000 shares of stock granted with a transfer restriction of one year. These stock awards were fully vested upon grant and allow the receipt of dividends and voting rights on all shares. The Company issues shares for option exercises and restricted stock issuances from its pool of authorized but unissued shares.

Cash received from stock option exercises for the nine months ended September 30, 2007 and 2006 was $117,000 and $1.2 million, respectively. The actual tax benefit realized for the tax deductions from option exercises under all plans totaled $22,000 and $91,000, respectively, for the nine months ended September 30, 2007 and 2006. No cash was used by the Company to settle equity instruments granted under share-based compensation arrangements during the nine months ended September 30, 2007 and 2006.

A summary of the status of the Company’s 2006 Plan, 1997 Plan and 1986 Plan for the nine months ended September 30, 2007 is presented in the table below:

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the average of the high price and low price at which the Company’s common stock traded on September 30, 2007 of $360,000, which would have been received by the option holders had all option holders exercised their options as of that date.

A summary of the status of the Company’s nonvested stock awards and stock options as of September 30, 2007 and changes during the nine months then ended is presented in the table below:

3. DEFINED BENEFIT PLAN

The Company terminated the Savings Bank Employees’ Retirement Association defined benefit plan (the “Plan”) effective on December 31, 2006. All assets of the Plan will be applied to the payment of the accrued benefit obligations and plan expenses in connection with the plan’s termination. No pension benefits accrued under the Plan as of the termination date will be reduced or forfeited in connection with the plan termination. In connection with the termination of the Plan, the Company froze future pension benefits effective December 31, 2006. As a result of that cessation of future pension benefits in the fourth quarter of 2006, the Company recognized a curtailment gain of $602,000 pre-tax, due to the reversal of the accrued pension liability recorded on the financial statements.

Effective December 31, 2006, the Company adopted Statement of Financial Accounting Standards No. 158 which resulted in the recognition of the net gains or losses and prior service costs that had not yet been included in the net periodic benefits costs as components of the ending balance of accumulated other comprehensive income, net of tax. The Plan’s assets are distributed to Plan participants in the form of benefits. The Plan paid benefits of $2.0 million and $142,000 for the Plan years ended October 31, 2006 and 2005, respectively. The Company anticipates that the Plan will distribute all of its assets, or approximately $5.6 million in total, during the third and fourth quarter of 2007. The Company recorded settlement gains of $357,000 during the third quarter of 2007 based on the distribution of $2.6 million, or 47%, of the Plan assets. Concurrent with the final distributions in the fourth quarter of 2007, the Company anticipates recording settlement gains of approximately $400,000.

4. COMMON STOCK REPURCHASE PROGRAM

On April 26, 2007, the Company’s Board of Directors approved a common stock repurchase program. Under the program, which was effective immediately, the Company is authorized to repurchase up to 230,000 shares, or approximately 5% of the shares of Company common stock outstanding on that date. The Company expects to make open market or privately negotiated purchases from time to time and may use a plan that is intended to meet the requirements of SEC Rule 10b5-1 to enable stock repurchases to occur during periods when the trading window would otherwise be closed. The timing and amount of stock repurchases will depend upon market conditions, securities law limitations and other corporate considerations; the Company has placed no deadline on the duration of the repurchase program. The repurchase program may be modified, suspended, or terminated by the Board of Directors at any time.

During the quarter ended September 30, 2007, the Company repurchased 46,656 shares of common stock at a weighted average share price of $16.35.

5. CONTINGENCIES

The Bank is involved in various legal proceedings incidental to its business. During the quarter ended September 30, 2007, no new legal proceeding was filed and no material development in any pending legal proceeding occurred that the Company expects will have a material adverse effect on its financial condition or operating results.

6. RECENT ACCOUNTING PRONOUNCEMENTS

In March 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 156, “Accounting for Servicing of Financial Assets — An Amendment of FASB Statement No. 140” (“SFAS 156”). SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The statement permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. SFAS 156 is effective for fiscal years that begin after September 15, 2006. The adoption of SFAS 156 did not have a material impact on the Company’s financial statements.

In June 2006, the FASB issued Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes- An Interpretation of FASB Statement No. 109” (“FIN 48”) which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and provides guidance on evaluating and measuring a company’s tax position and recognition of income tax assets and liabilities. Application for the provisions of this Interpretation will be effective for reporting periods beginning after December 15, 2006. The adoption of FIN 48 as of January 1, 2007 did not have a material impact on the Company’s financial statements.

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”) to provide consistency and comparability in determining fair value measurements and to provide for expanded disclosures about fair value measurements. The definition of fair value maintains the exchange price notion in earlier definitions of fair value but focuses on the exit price of the asset or liability. The exit price is the price that would be received to sell the asset or paid to transfer the liability adjusted for certain inherent risks and restrictions. Expanded disclosures are also required about the use of fair value to measure assets and liabilities. The effective date is for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not believe that adoption of SFAS 157 will have a material impact on the Company’s financial statements.

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to measure certain financial assets and financial liabilities at fair value and amended FASB Statement No. 115, “Accounting for Investments in Debt and Equity Securities”. Unrealized gains and losses on items for which the fair value option is elected will be reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Management is currently evaluating the impact of adopting this statement on the Company’s financial statements. Early adoption was allowed but the Company decided against early adoption.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

In this report, the Company has made forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 as amended) that are subject to risks and uncertainties. Such forward-looking statements are expressions of management’s expectations as of the date of this report regarding future events or trends and which do not relate to historical matters. Such expectations may or may not be realized, depending on a number of variable factors, including but not limited to, changes in interest rates, general economic conditions, regulatory considerations and competition. For more information about these factors, please see our 2006 Annual Report on Form 10-K on file with the SEC, including the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. As a result of such risk factors and uncertainties, among others, the Company’s actual results may differ materially from such forward-looking statements. The Company does not undertake and specifically disclaims any obligation to publicly release updates or revisions to any such forward-looking statements as a result of new information, future events or otherwise.

Critical Accounting Policies & Estimates

The Company has not changed its significant accounting and reporting policies from those disclosed in its 2006 Annual Report on Form 10-K. In applying these accounting policies, management is required to exercise judgment in determining many of the methodologies, assumptions and estimates to be utilized. As discussed in the Company’s 2006 Annual Report on Form 10-K, the three most significant areas in which management applies critical assumptions and estimates that are particularly susceptible to change relate to the determination of the allowance for loan losses, deferred tax asset valuation and impairment of the investment portfolio. Management’s estimates and assumptions affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ from those estimates.

EXECUTIVE LEVEL OVERVIEW

The Company’s financial results are dependent on the following areas of the income statement: net interest income, provision for loan losses, non-interest income, non-interest expense and provision for income taxes. Net interest income is the primary earnings of the Company and the main focus of management. Net interest income is the difference between interest earned on loans and investment securities and interest paid on deposits and borrowings. Management’s efforts in this area are to increase the corporate loan portfolio, which include construction, commercial real estate and commercial loans. Management’s efforts for funding are to increase core deposit accounts, which are lower interest-bearing accounts. Deposits and borrowings typically have short durations and the costs of these funds do not necessarily rise and fall concurrent with earnings from loans and investment securities. There are many risks involved in managing net interest income including, but not limited to, credit risk, interest rate risk and duration risk. These risks have a direct impact on the level of net interest income. The Company manages these risks through its internal credit and underwriting function and review at meetings of the Asset and Liability Management Committee (“ALCO”) on a regular basis. The credit review process reviews loans for underwriting and grading of loan quality while ALCO reviews the liquidity, interest rate risk, duration risk and allocation of capital resources. Loan quality has a direct impact on the amount of provisions for loan losses the Company reports.

The provision for loan losses was $465,000 for the nine months ended September 30, 2007 based on management’s assessment of the adequacy of the allowance based on an evaluation of the Bank’s loan portfolio and the level of non-performing loans. During the comparable period of 2006, our provision for loan losses was $60,000. The increase in the provision during 2007 reflects management’s analysis of the growth in the loan portfolio.

Non-interest income includes gains and losses on sales of investment securities, various fees and increases on cash surrender value from the Company’s investment in BOLI. Customers’ loan and deposit accounts generate various amounts of fee income depending on the product selected. The Company receives fee income from servicing loans that were sold in previous periods. Non-interest income is primarily impacted by the volume of customer transactions, which could change in response to changes in interest rates, pricing and competition.

Non-interest expenses include salaries and employee benefits, occupancy and equipment, professional, data processing and other expenses of the Company, which generally are directly related to business volume and are controlled by a budget process.

Provisions for income taxes are directly related to earnings of the Company. Changes in the statutory tax rates and the earnings of the Company, the Bank and its subsidiaries, as well as the mix of earnings among the different entities would affect the amount of income tax expense reported and the overall effective income tax rate recorded.

The Company believes that the most significant challenge in the current interest rate environment is to increase net interest income while also maintaining competitive deposit rates. The Company’s net interest income for the nine months ended September 30, 2007 was $11.5 million, a 12.01% increase from $10.2 million for the comparable period in 2006 primarily due to the balance sheet restructuring undertaken in the second quarter of 2006 that resulted in a non-recurring charge of $2.4 million in that period. The Company’s continued emphasis on increasing loan originations instead of purchasing lower-yielding investment securities also favorably affected net interest income.

FINANCIAL CONDITION

SUMMARY

The Company maintains its commitment to servicing the banking needs of the local community in the Merrimack Valley area of northeastern Massachusetts and southern New Hampshire. The Company had total assets of $609.1 million at September 30, 2007, compared to $543.0 million at December 31, 2006. The increase in asset size at September 30, 2007 from December 31, 2006 reflected strong loan growth of $61.1 million since year end 2006 partially offset by a decline of $2.9 million in the investment portfolio from December 31, 2006.

Investments:

The investment securities portfolio totaled $215.7 million, or 35.4% of total assets at September 30, 2007, compared to $218.7 million, or 40.3% of total assets at December 31, 2006, a decrease of $2.9 million from year-end.

During the first nine months of 2007, $20.3 million of investments available for sale paid down while $11.5 million matured and the funds were reinvested in new loan originations. The Company intends to use the principal paydowns and maturities from the investment portfolio to fund future loan growth as a strategy to improve the Company’s net interest margin.

The net unrealized loss on securities available for sale as of September 30, 2007 totaled $2.0 million, or $1.2 million net of taxes. The unrealized losses are attributable to changes in interest rates and a corresponding decline in fair value and are not related to credit quality, nor are they deemed to be other than temporarily impaired. However, there are two corporate obligations that are on the Bank’s securities watch list due to their current credit ratings by external, independent rating agencies. The amortized cost of these two corporate bonds totaled $3.9 million as of September 30, 2007 with an unrealized loss of $130,000, or 3.4% of amortized cost. Management is monitoring these securities on a monthly basis and it is the intent of management to hold these debt securities to maturity.

The following table reflects the components and carrying values of the investment securities portfolio at September 30, 2007 and December 31, 2006:

Loans:

Total loans increased $61.1 million to $349.3 million and represented 57.3% of total assets at September 30, 2007 versus $288.2 million and 53.1%, respectively, of total assets at December 31, 2006. Retail loans, comprised primarily of residential mortgage loans, increased $7.8 million during the first nine months of 2007 while corporate loans, comprised mainly of construction and commercial real estate loans, increased $53.3 million during the same period. The increase is due to loan growth experienced in all corporate and retail loan categories and reflects the continued strategic preference toward loan originations rather than investment security purchases.

The following table reflects the loan portfolio at September 30, 2007 and December 31, 2006:

The allowance for loan losses increased to $4.8 million at September 30, 2007 as compared to $4.3 million at December 31, 2006. However, the allowance for loan losses as a percent of total loans has decreased to 1.36% at September 30, 2007 down from 1.50% at December 31, 2006, due to an increase in total loans outstanding at September 30, 2007 compared to December 31, 2006. The Company considers the current level of the allowance for loan losses to be appropriate and adequate.

The amount of the allowance for loan losses reflects management’s assessment of estimated credit quality and is based on a review of the risk characteristics of the loan portfolio. The Company considers many factors in determining the adequacy of the allowance for loan losses. Collateral values on a loan by loan basis, trends of loan delinquencies on a portfolio segment level, risk classification identified in the Company’s regular review of individual loans, and economic conditions are primary factors in establishing allowance levels. Management believes the allowance level is adequate to absorb the estimated credit losses inherent in the loan portfolio. The allowance for loan losses reflects information available to management at the end of each period.

Risk Assets:

Risk assets consist of non-performing loans and other real estate owned (OREO). Non-performing loans consist of both loans 90 days or more past due and loans placed on non-accrual because full collection of the principal balance is in doubt. Other real estate owned is comprised of foreclosed properties where the Company has formally received title or has possession of the collateral.

Total risk assets were $343,000 and $1.0 million, respectively, at September 30, 2007 and December 31, 2006. Impaired loans totaled $934,000 and $1.0 million, respectively, at September 30, 2007 and December 31, 2006. All of the $934,000 and $1.0 million in impaired loans at September 30, 2007 and December 31, 2006, respectively, had been measured using the fair value of the collateral method and did not require a related allowance. The decrease in non-performing loans since December 31, 2006 was primarily due to the resolution and payment in full of multiple loans to one borrower that were collateral dependent during the first quarter of 2007. The Company had impaired loans of $1.0 million at September 30, 2006, none of which required a related allowance.

The following table summarizes the Company’s risk assets at September 30, 2007, December 31, 2006 and September 30, 2006:

Deposits:

Total interest-bearing deposits amounted to $296.3 million at September 30, 2007, compared to $264.2 million at December 31, 2006, an increase of $32.1 million due to an increase of $33.9 million in certificates of deposit. Money market accounts and NOW accounts increased $2.3 million and $168,000 to $75.5 million and $17.9 million, respectively, from December 31, 2006. The increase in term certificates of deposit reflects the customers’ preference in achieving the highest yields possible as the rates paid on these accounts have increased in conjunction with the increases in interest rates coupled with an aggressive promotional campaign targeting new customers. Partially offsetting these increases were decreases of $4.3 million in savings accounts and $1.1 million in non-interest bearing or demand deposit accounts from December 31, 2006.

The following table reflects the components of the deposit portfolio at September 30, 2007 and December 31, 2006:

Borrowings:

Borrowings consist of long-term and short-term Federal Home Loan Bank (FHLB) advances and securities sold under agreements to repurchase. Total borrowings amounted to $219.6 million at September 30, 2007, compared to $184.8 million at December 31, 2006, an increase of $34.9 million. While the total borrowings increased since year-end, the mix of borrowings has shifted from a heavier reliance on short-term borrowings to longer-term advances. Short-term borrowings decreased $36.0 million from December 31, 2006, while long-term FHLB advances increased $44.9 million due to the availability of more favorable, longer term rates. The Company believes its borrowing position leaves the Company less vulnerable to rate fluctuations in the coming year.

The following table reflects the components of borrowings at September 30, 2007 and December 31, 2006:

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

SUMMARY

The Company reported net income of $1.0 million, or $0.22 per diluted share, as compared to a net income of $808,000, or $0.18 per diluted share, for the three months ended September 30, 2007 and 2006, respectively. The third quarter of 2007 experienced an increase in net income primarily due to a settlement gain of $357,000 recorded in connection with the pension plan termination announced in October, 2006. Partially offsetting this gain, the

Company recorded a provision for loan losses of $250,000 in the third quarter of 2007 resulting from continued, sustained corporate loan growth since December 31, 2006.

Net Interest Income From Operations:

Net interest income for the three months ended September 30, 2007 increased by $209,000, or 5.8%, to $3.8 million from $3.6 million for the same period of 2006. The net interest rate spread decreased to 2.16% for the three months ended September 30, 2007 versus 2.33% for the same period of 2006. Interest income for the three months ended September 30, 2007 increased $1.5 million primarily due to higher average loan balances and higher loan and investment security rates compared to the same period of 2006. Partially offsetting the increase in total interest income was an increase of $1.3 million in total interest expense primarily due to higher rates paid on deposits and an increase in average deposit and borrowing balances. Net interest margin decreased to 2.66% versus 2.86% for the quarters ended September 30, 2007 and 2006, respectively.

Interest Income:

Interest income increased $1.5 million, or 20.5%, during the third quarter of 2007 versus the same quarter in 2006, primarily attributable to a rise in average loan balances.

Average loan interest rates increased 23 basis points from 7.02% to 7.25% during the third quarters of 2006 and 2007, respectively, contributing $63,000 to interest income. Average loan balances rose $81.6 million from $258.0 million in 2006 to $339.6 million in 2007 contributing $1.6 million to interest income.

Average investment security interest rates increased 8 basis points during the third quarter of 2007 from 4.83% in 2006 to 4.91% in 2007 adding $4,000 to interest income. Average investment security balances declined $11.1 million from $244.9 million in 2006 to $233.8 million in 2007 reducing interest income by $98,000.

Interest Expense:

Interest expense increased $1.3 million, or 34.1%, during the third quarter of 2007 from $3.9 million in the third quarter of 2006 to $5.3 million in the third quarter of 2007, primarily due to the rise in overall market interest rates experienced by the deposit portfolio coupled with increases in average deposit and average borrowed funds volumes.

Average deposit interest rates increased 82 basis points from 2.87% to 3.69% in the third quarter of 2006 and 2007, respectively, contributing $415,000 to interest expense. Average interest-bearing deposit balances increased by $15.6 million from $274.7 million in 2006 to $290.4 million in 2007, accompanied by a change in the mix resulting in a preference for higher costing certificates of deposit which increased interest expense by $292,000.

Average borrowed funds interest rates decreased 22 basis points from 4.97% in the third quarter of 2006 to 4.75% in the same quarter of 2007 resulting in a decrease of $93,000 to interest expense. Average borrowed fund balances rose $60.1 million, or 39.0%, from $154.3 million in 2006 to $214.5 million in 2007. This increase resulted in additional interest expense of $724,000 due to an increase in longer term borrowed funds.

Provision for Loan Losses:

The provision for loan losses totaled $250,000 and $30,000 for the three months ended September 30, 2007 and 2006, respectively. The provisions in 2007 and 2006 reflect management’s analysis of loan growth during the third quarter of 2007 and 2006. The balance of the allowance for loan losses has grown to $4.8 million at September 30, 2007, from $4.2 million at September 30, 2006, respectively. The coverage of the allowance for loan losses decreased to 1.36% at September 30, 2007 from 1.59% at September 30, 2006 due to the loan growth experienced during 2007 and 2006 which, combined with the low levels of non-performing and delinquent loans, led to management’s assessment of the allowance for loan losses being adequate as of September 30, 2007.

The following table presents the Company’s average balance sheet, net interest income and average interest rates for the three months ended September 30, 2007 and 2006. Average loans include non-performing loans.