First Bancorp - 10-Q quarterly report FY

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 twelve 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.    xYES     o NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. o Large Accelerated Filer     x Accelerated Filer     o Non-Accelerated Filer

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

In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the consolidated financial position of the Company as of March 31, 2007 and 2006 and the consolidated results of operations and consolidated cash flows for the periods ended March 31, 2007 and 2006.  Reference is made to the 2006 Annual Report on Form 10-K filed with the SEC for a discussion of accounting policies and other relevant information with respect to the financial statements.  The results of operations for the periods ended March 31, 2007 and 2006 are not necessarily indicative of the results to be expected for the full year.

Note 1 to the 2006 Annual Report on Form 10-K filed with the SEC contains a description of the accounting policies followed by the Company and discussion of recent accounting pronouncements.  The following paragraphs update that information as necessary.

In July 2006, the Financial Accounting Standards Board (FASB) released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48).  FIN 48 clarifies the accounting and reporting for uncertainties in income tax law.  FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns.  The cumulative effect of applying the provisions of this interpretation is required to be reported separately as an adjustment to the opening balance of retained earnings in the year of adoption. The Company’s adoption of FIN 48 in the first quarter of 2007 did not impact the Company’s consolidated financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements” (Statement 157).  Statement 157 provides enhanced guidance for using fair value to measure assets and liabilities.  The standard also requires expanded disclosures about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings.  Statement 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  The Company does not expect the adoption of Statement 157 to materially impact the Company’s consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115” (Statement 159).  This statement permits, but does not require, entities to measure many financial instruments at fair value.  The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.  Entities electing this option will apply it when the entity first recognizes an eligible instrument and will report unrealized gains and losses on such instruments in current earnings.  This statement 1) applies to all entities, 2) specifies certain election dates, 3) can be applied on an instrument-by-instrument basis with some exceptions, 4) is irrevocable and 5) applies only to entire instruments.  One exception is demand deposit liabilities which are explicitly excluded as qualifying for fair value. With respect to SFAS 115, available for sale and held to maturity securities at the effective date are eligible for the fair value option at that date.  If the fair value option is elected for those securities at the effective date, cumulative unrealized gains and losses at that date shall be included in the cumulative-effect adjustment and thereafter, such securities will be accounted for as trading securities.  Statement

Certain amounts reported in the period ended March 31, 2006 have been reclassified to conform to the presentation for March 31, 2007.  These reclassifications had no effect on net income or shareholders’ equity for the periods presented, nor did they materially impact trends in financial information.

At March 31, 2007, the Company had the following equity-based compensation plans, all of which are stock option plans:  the First Bancorp 2004 Stock Option Plan, the First Bancorp 1994 Stock Option Plan, and four plans that were assumed from acquired entities, which are all described below.  The Company’s shareholders approved all equity-based compensation plans, except for those assumed from acquired companies.  As of March 31, 2007, the First Bancorp 2004 Stock Option Plan was the only plan that had shares available for future grants.

The First Bancorp 2004 Stock Option Plan and its predecessor plan, the First Bancorp 1994 Stock Option Plan, were intended to serve as a means of attracting, retaining and motivating key employees and directors and to associate the interests of the plans’ participants with those of the Company and its shareholders.  Stock option grants to non-employee directors have historically had no vesting requirements, whereas, except as discussed below, stock option grants to employees have generally had five-year vesting schedules (20% vesting each year).  In April 2004, the Company’s Compensation Committee granted 128,000 options to employees with no vesting requirements.  These options were granted without any vesting requirements for two reasons - 1) the options were granted primarily as a reward for past performance and therefore had already been “earned” in the view of the Committee, and 2) to potentially minimize the impact that any change in accounting standards for stock options could have on future years’ reported net income.  Employee stock option grants since the April 2004 grant have reverted to having five year vesting periods.  The Company’s options provide for immediate vesting if there is a change in control (as defined in the plans).  Under the terms of these two plans, options can have a term of no longer than ten years, and all options granted thus far under these plans have had a term of ten years.  Except for grants to directors (see below), the Company cannot estimate the amount of future stock option grants at this time.  In the past, stock option grants to employees have been irregular, generally falling into three categories - 1) to attract and retain new employees, 2) to recognize changes in responsibilities of existing employees, and 3) to periodically reward exemplary performance.  As it relates to directors, the Company has historically granted 2,250 stock options to each of the Company’s non-employee directors in June of each year, and expects to continue doing so for the foreseeable future.  At March 31, 2007, there were 596,021 options outstanding related to these two plans with exercise prices ranging from $9.75 to $22.12.  At March 31, 2007, there were 1,180,250 shares remaining available for grant under the First Bancorp 2004 Stock Option Plan.

The Company also has four stock option plans as a result of assuming plans of acquired companies.  At March 31, 2007, there were 35,421 stock options outstanding in connection with these plans, with option prices ranging from $10.22 to $11.49.

The Company issues new shares when options are exercised.

Prior to January 1, 2006, the Company accounted for all of these plans using the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations.  Because all of the Company’s stock options had an exercise price equal to the market value of the underlying common stock on the date of grant, no compensation cost had ever been recognized.  On January 1, 2006, the Company adopted Statement No. 123(R), Share-Based Payment.  Statement 123(R) supersedes Opinion 25 (and related interpretations) and requires that the compensation cost relating to share-based payment transactions be recognized in the financial statements.  Statement 123(R) permitted public companies to adopt its requirements using one of two methods.  The “modified prospective” method recognizes compensation for all

The Company measures the fair value of each option award on the date of grant using the Black-Scholes option-pricing model.  The Company determines the assumptions used in the Black-Scholes option pricing model as follows:  the risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant; the dividend yield is based on the Company’s dividend yield at the time of the grant (subject to adjustment if the dividend yield on the grant date is not expected to approximate the dividend yield over the expected life of the option); the volatility factor is based on the historical volatility of the Company’s stock (subject to adjustment if future volatility is reasonably expected to differ from the past); the weighted-average expected life is based on the historical behavior of employees related to exercises, forfeitures and cancellations.

In the first quarter of 2007 and 2006, the adoption of Statement 123(R) resulted in stock-based compensation expense of $12,000 and $47,000, respectively, with no associated tax benefits, which was classified as “salaries expense” on the Consolidated Statements of Income and reduced both income before income taxes and net income by that same amount.  This compensation expense was reflected as an adjustment to cash flows from operating activities on the Company’s Consolidated Statement of Cash Flows.  At March 31, 2007, the Company had $45,000 of unrecognized compensation costs related to unvested stock options.  The cost is expected to be amortized over a weighted-average life of 1.55 years, with $36,000 being expensed during the remainder of 2007 equally distributed among the three remaining quarters, and $3,000 being expensed in each of 2008, 2009 and 2010, equally distributed among each of the four quarters of each year.  In addition, as discussed above, the Company expects to grant 2,250 options, without vesting requirements, to each of its non-employee directors on June 1, 2007 and on June 1 of each year thereafter.

As noted above, certain of the Company’s stock option grants contain terms that provide for a graded vesting schedule whereby portions of the award vest in increments over the requisite service period.  As provided for under Statement 123(R), the Company has elected to recognize compensation expense for awards with graded vesting schedules on a straight-line basis over the requisite service period for the entire award.  Statement 123(R) requires companies to recognize compensation expense based on the estimated number of stock options and awards for which service is to be rendered.  Over the past five years, there have been only nine forfeitures or expirations, totaling 13,500 options, and therefore the Company assumes that all options granted will become vested.

There were no option grants during the first quarters of 2006 or 2007.

The following table presents information regarding the activity during the first three months of 2007 related to all of the Company’s stock options outstanding:

The Company received $76,000 and $429,000 as a result of stock option exercises during the three months ended March 31, 2007 and 2006, respectively.  The intrinsic value of the stock options exercised during the three months ended March 31, 2007 and 2006 was $290,000 and $527,000, respectively.  No nonqualified stock options were exercised during the first quarters of 2007 or 2006, and thus the Company did not record any associated tax benefits.

Basic earnings per share were computed by dividing net income by the weighted average common shares outstanding.  Diluted earnings per share includes the potentially dilutive effects of the Company’s stock option plan. The following is a reconciliation of the numerators and denominators used in computing basic and diluted earnings per share:

For the three months ended March 31, 2007, there were no options in which the exercise price exceeded the average market price for the period (“antidilutive”).  For the three months ended March 31, 2006, there were 191,730 antidilutive options, and these options were excluded from the calculation of the effect of dilutive securities.

Nonperforming assets are defined as nonaccrual loans, loans past due 90 or more days and still accruing interest, restructured loans and other real estate.  Nonperforming assets are summarized as follows:

Loans are shown on the Consolidated Balance Sheets net of net deferred loan costs of approximately $9,000, $27,000, and $76,000 at March 31, 2007, December 31, 2006, and March 31, 2006, respectively.

The following is a summary of the gross carrying amount and accumulated amortization of amortizable intangible assets as of March 31, 2007, December 31, 2006, and March 31, 2006 and the carrying amount of unamortized intangible assets as of those same dates.

Amortization expense totaled $94,000 and $61,000 for the three months ended March 31, 2007 and 2006, respectively.

The following table presents the estimated amortization expense for each of the five calendar years ending December 31, 2011 and the estimated amount amortizable thereafter.  These estimates are subject to change in future periods to the extent management determines it is necessary to make adjustments to the carrying value or estimated useful lives of amortized intangible assets.

The Company sponsors two defined benefit pension plans – a qualified retirement plan (the “Pension Plan”), which is generally available to all employees, and a Supplemental Executive Retirement Plan (the “SERP Plan”), which is for the benefit of certain senior management executives of the Company.

The Company recorded pension expense totaling $516,000 and $581,000 for the three months ended March 31, 2007 and 2006, respectively, related to the Pension Plan and the SERP Plan.  The following table contains the components of the pension expense.

The Company’s contributions to the Pension Plan are based on computations by independent actuarial consultants and are intended to ensure that the Pension Plan exceeds minimum funding standards at all times according to standards established by the Internal Revenue Service.  The contributions are invested to provide for benefits under the Pension Plan.  The Company estimates that its contribution to the Pension Plan will be $1,000,000 during 2007.

The Company’s funding policy with respect to the SERP Plan is to fund the related benefits primarily from the operating cash flow of the Company.  The Company estimates that its payments to participants in the SERP Plan will be $184,000 in 2007.

The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices followed by the banking industry.  Certain of these principles involve a significant amount of judgment and/or use of estimates based on the Company’s best assumptions at the time of the estimation.  The Company has identified three policies as being more sensitive in terms of judgments and estimates, taking into account their overall potential impact to the Company’s consolidated financial statements – 1) the allowance for loan losses, 2) tax uncertainties, and 3) intangible assets.

Due to the estimation process and the potential materiality of the amounts involved, the Company has identified the accounting for the allowance for loan losses and the related provision for loan losses as an accounting policy critical to the Company’s consolidated financial statements.  The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb losses inherent in the portfolio.

Management’s determination of the adequacy of the allowance is based primarily on a mathematical model that estimates the appropriate allowance for loan losses.  This model has two components.  The first component involves the estimation of losses on loans defined as “impaired loans.”  A loan is considered to be impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  The estimated valuation allowance is the difference, if any, between the loan balance outstanding and the value of the impaired loan as determined by either 1) an estimate of the cash flows that the Company expects to receive from the borrower discounted at the loan’s effective rate, or 2) in the case of a collateral-dependent loan, the fair value of the collateral.

The second component of the allowance model is to estimate losses for all loans not considered to be impaired loans.  First, loans that have been risk graded by the Company as having more than “standard” risk but are not considered to be impaired are assigned estimated loss percentages generally accepted in the banking industry.  Loans that are classified by the Company as having normal credit risk are segregated by loan type, and estimated loss percentages are assigned to each loan type, based on the historical losses, current economic conditions, and operational conditions specific to each loan type.

The reserve estimated for impaired loans is then added to the reserve estimated for all other loans.  This becomes the Company’s “allocated allowance.”  In addition to the allocated allowance derived from the model, management also evaluates other data such as the ratio of the allowance for loan losses to total loans, net loan growth information, nonperforming asset levels and trends in such data.  Based on this additional analysis, the Company may determine that an additional amount of allowance for loan losses is necessary to reserve for probable losses.  This additional amount, if any, is the Company’s “unallocated allowance.”  The sum of the allocated allowance and the unallocated allowance is compared to the actual allowance for loan losses recorded on the books of the Company and any adjustment necessary for the recorded allowance to equal the computed allowance is recorded as a provision for loan losses.  The provision for loan losses is a direct charge to earnings in the period recorded.

Although management uses the best information available to make evaluations, future adjustments may be necessary if economic, operational, or other conditions change.  In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses.  Such agencies may require the Company to recognize additions to the allowance based on the examiners’ judgment about information available to them at the time of their examinations.

For further discussion, see “Nonperforming Assets” and “Summary of Loan Loss Experience” below.

The Company reserves for tax uncertainties in instances when it has taken a position on a tax return that may differ from the opinion of the applicable taxing authority.  In accounting for tax contingencies, the Company assesses the relative merits and risks of certain tax transactions, taking into account statutory, judicial and regulatory guidance in the context of the Company's tax position.  For those matters where it is probable that the Company will have to pay additional taxes, interest or penalties and a loss or range of losses can be reasonably estimated, the Company records reserves in the consolidated financial statements.  For those matters where it is reasonably possible but not probable that the Company will have to pay additional taxes, interest or penalties and the loss or range of losses can be reasonably estimated, the Company only makes disclosures in the notes and does not record reserves in the consolidated financial statements.  The process of concluding that a loss is reasonably possible or probable and estimating the amount of loss or range of losses and related tax reserves is inherently subjective and future changes to the reserve may be necessary based on changes in management's intent, tax law or related interpretations, or other functions.

Due to the estimation process and the potential materiality of the amounts involved, the Company has also identified the accounting for intangible assets as an accounting policy critical to the Company’s consolidated financial statements.

When the Company completes an acquisition transaction, the excess of the purchase price over the amount by which the fair market value of assets acquired exceeds the fair market value of liabilities assumed represents an intangible asset.  The Company must then determine the identifiable portions of the intangible asset, with any remaining amount classified as goodwill.  Identifiable intangible assets associated with these acquisitions are generally amortized over the estimated life of the related asset, whereas goodwill is tested annually for impairment, but not systematically amortized.  Assuming no goodwill impairment, it is beneficial to the Company’s future earnings to have a lower amount assigned to identifiable intangible assets and higher amount of goodwill as opposed to having a higher amount considered to be identifiable intangible assets and a lower amount classified as goodwill.

For the Company, the primary identifiable intangible asset typically recorded in connection with a whole bank or bank branch acquisition is the value of the core deposit intangible, whereas when the Company acquires an insurance agency, the primary identifiable intangible asset is the value of the acquired customer list.  Determining the amount of identifiable intangible assets and their average lives involves multiple assumptions and estimates and is typically determined by performing a discounted cash flow analysis, which involves a combination of any or all of the following assumptions:  customer attrition/runoff, alternative funding costs, deposit servicing costs, and discount rates.  The Company typically engages a third party consultant to assist in each analysis.  For the whole bank and bank branch transactions recorded to date, the core deposit intangibles have generally been estimated to have a life ranging from seven to ten years, with an accelerated rate of amortization.  For insurance agency acquisitions, the identifiable intangible assets related to the customer lists were determined to have a life of ten to fifteen years, with amortization occurring on a straight-line basis.

Subsequent to the initial recording of the identifiable intangible assets and goodwill, the Company amortizes the identifiable intangible assets over their estimated average lives, as discussed above.  In addition, on at least an annual basis, goodwill is evaluated for impairment by comparing the fair value of the Company’s reporting units to their related carrying value, including goodwill (the Company’s community banking operation is its only material reporting unit).  At its last evaluation, the fair value of the Company’s community banking operation exceeded its carrying value, including goodwill.  If the carrying value of a reporting unit were ever to exceed its fair value, the Company would determine whether the implied fair value of the goodwill, using a discounted cash flow analysis, exceeded the carrying value of the goodwill.  If the carrying value of the goodwill exceeded the implied

The Company reviews identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.  The Company’s policy is that an impairment loss is recognized, equal to the difference between the asset’s carrying amount and its fair value, if the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset.  Estimating future cash flows involves the use of multiple estimates and assumptions, such as those listed above.

See Note 2 to the Consolidated Financial Statements above as it relates to accounting standards that have been recently adopted by the Company.

Net income for the three months ended March 31, 2007 was $4,886,000, or $0.34 per diluted share, which represents a 2.1% decrease in net income and a 2.9% decrease in diluted earnings per share from the net income of $4,991,000, or $0.35 per diluted share, reported for the first quarter of 2006.  The slightly lower earnings were a result of a lower net interest margin and higher operating expenses, which offset the positive impact of the Company’s balance sheet growth.

During the first quarter of 2007, the Company continued to experience strong growth in loans and deposits.  Loans outstanding grew by $36 million, or 8.3% on an annualized basis, while deposits grew by $50 million, or 11.9% on an annualized basis.

Total assets at March 31, 2007 amounted to $2.18 billion, 14.1% higher than a year earlier.  Total loans at March 31, 2007 amounted to $1.78 billion, a 14.3% increase from a year earlier, and total deposits amounted to $1.75 billion at March 31, 2007, an 11.5% increase from a year earlier.

The growth in loans and deposits was the primary reason for an increase in the Company’s net interest income when comparing the first quarter of 2007 to the first quarter of 2006.  Net interest income for the first quarter of 2007 amounted to $18.9 million, a 5.7% increase over the $17.9 million recorded in the first quarter of 2006.

The impact of the growth in loans and deposits on the Company’s net interest income was partially offset by a decline in the Company’s net interest margin (tax-equivalent net interest income divided by average earning assets).  The Company’s 3.97% net interest margin in the first quarter of 2007 was 36 basis points lower than the 4.33% margin realized in the first quarter of 2006, and the first quarter of 2007 was the fifth consecutive quarter that the net interest margin has declined.  The compressing margin has been primarily due to deposit rates paid by the Company rising by more than loan and investment yields, which is associated with the flat interest rate yield curve that has prevailed in the marketplace for most of the past year.  The Company has also been negatively impacted by customers shifting their funds from low cost deposits to higher cost deposits as rates have risen.  Neither of these factors significantly worsened in the first quarter of 2007 compared to the fourth quarter of 2006.  Instead, the eight basis point decrease in the Company’s net interest margin from the fourth quarter of 2006 to the first quarter of 2007 was primarily a result of the repricing of time deposits that matured during the quarter that had been originated in periods when interest rates were lower.

The Company’s provision for loan losses did not vary significantly between the periods presented, amounting to $1,121,000 in the first quarter of 2007 compared to $1,015,000 in the first quarter of 2006.  Factors that played an offsetting role in this comparison were i) lower 2007 loan growth, which generally results in a lower provision

Noninterest income amounted to $4.2 million for the first quarter of 2007, a 7.1% increase from the first quarter of 2006.  There were no unusual items of noninterest income that were significant in either period.

Noninterest expenses amounted to $14.1 million in the first quarter of 2007, an 11.0% increase over 2006.  This increase is primarily a result of the Company’s overall growth.  Additionally, during the first quarter of 2007, the Company incurred $286,000 in expense related to a performance improvement consulting project that was substantially begun and completed during the quarter, which negatively impacted earnings per share by approximately one cent per share.  The near absence of this expense in future quarters and efficiencies that are expected to be derived from the project are expected to benefit earnings in the future.

The Company’s effective tax rate did not vary significantly, amounting to 37.8% in the first quarter of 2007 compared to 38.1% in the first quarter of 2006.

The Company’s annualized return on average assets for the first quarter of 2007 was 0.95% compared to 1.12% for the first quarter of 2006.  The Company’s annualized return on average equity for the first quarter of 2007 was 11.89% compared to 12.78% for the first quarter of 2006.

Net interest income is the largest component of earnings, representing the difference between interest and fees generated from earning assets and the interest costs of deposits and other funds needed to support those assets.  Net interest income for the three month period ended March 31, 2007 amounted to $18,866,000, an increase of $1,013,000, or 5.7% from the $17,853,000 recorded in the first quarter of 2006.  Net interest income on a taxable equivalent basis for the three month period ended March 31, 2007 amounted to $18,990,000, an increase of $1,011,000, or 5.6% from the $17,979,000 recorded in the first quarter of 2006.  Management believes that analysis of net interest income on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest income amounts in different periods without taking into account the different mix of taxable versus non-taxable investments that may have existed during those periods.

There are two primary factors that cause changes in the amount of net interest income recorded by the Company - 1) growth in loans and deposits, and 2) the Company’s net interest margin.  For the three months ended March 31, 2007, the increase in net interest income was caused by growth in loans and deposits, as the Company’s net interest margin of 3.97% in the first quarter of 2007 was lower than the 4.33% recorded in the first quarter of 2006.  The Company’s believes the primary reasons behind its decreasing net interest margin are 1) deposit rates paid by the Company rising by more than loan and investment yields, which is largely associated with the flat interest rate yield curve currently prevailing in the marketplace, and 2) the negative impact of the Company having more of its overall funding occurring in its highest cost funding sources, which is a result of needing to fund high loan growth, as well as customers shifting their funds from low cost deposits to higher cost deposits as interest rates have risen.

Average loans outstanding for the first quarter of 2007 were $1.757 billion, which was 15.9% higher than the average loans outstanding for the first quarter of 2006 ($1.516 billion).  The mix of the Company’s loan portfolio remained substantially the same at March 31, 2007 compared to December 31, 2006, with approximately 86% of the Company’s loans being real estate loans, 9% being commercial, financial, and agricultural loans, and the remaining 5% being consumer installment loans.  The majority of the Company’s real estate loans are personal and commercial loans where real estate provides additional security for the loan.

Average deposits outstanding for the first quarter of 2007 were $1.713 billion, which was 12.3% higher than the average amount of deposits outstanding in the first quarter of 2006 ($1.525 billion).  Generally, the Company can reinvest funds from deposits at higher yields than the interest rate being paid on those deposits, and therefore increases in deposits typically result in higher amounts of net interest income for the Company.

See additional discussion regarding the nature of the growth in loans and deposits in the section entitled “Financial Condition” below.  The effect of the higher amounts of average loans and deposits was to increase net interest income in 2007.

As derived from the table above, in comparing first quarter 2007 to first quarter 2006, the yield earned on loans, the Company’s primary earning asset, increased by only 51 basis points (from 7.16% to 7.67%) while the average rate paid on other time deposits, the Company’s largest deposit category, increased by 100 basis points (from 3.63% to 4.63%).  The difference in these increases negatively impacted the Company’s net interest margin and was largely a result of short-term interest rates prevailing in the market place increasing faster than long-term interest rates - with short-term interest rates being approximately the same as long-term interest rates at March 31, 2007 (commonly referred to as a “flat yield curve”).  A flat yield curve is unfavorable for the Company because the Company’s funding costs are generally tied to short-term interest rates, while its investment rates, in the form of securities and loans, are more closely correlated to long-term interest rates prevailing in the marketplace.

See additional information regarding net interest income in the section entitled “Interest Rate Risk.”

The Company’s provision for loan losses did not increase significantly in 2007 compared to 2006, amounting to $1,121,000 in the first quarter of 2007 versus $1,015,000 in the first quarter of 2006.  Factors that played an offsetting role in this comparison were i) lower 2007 loan growth, which generally results in a lower provision for loan losses, and ii) higher 2007 net charge-offs, which generally increases the necessary provision for loan losses.  In the first quarter of 2007, net loan growth amounted to $36 million compared to $71 million in the first quarter of 2006.  In the first quarter of 2007, the Company recorded $590,000 in net charge-offs compared to $121,000 in the first quarter of 2006.  The Company’s ratio of annualized net charge-offs to average loans was 0.14% for the first quarter of 2007 compared to 0.03% for the first quarter of 2006.  The Company’s ratio of nonperforming assets to total assets was 0.38% at March 31, 2007 compared to 0.25% at March 31, 2006.

Noninterest income amounted to $4,236,000 for the first quarter of 2007, a 7.1% increase from the $3,954,000 recorded in the first quarter of 2006.  The increase in noninterest income was primarily associated with the Company’s growth.  There were no unusual items of noninterest income that were significant in either period.

Noninterest expenses amounted to $14.1 million in the first quarter of 2007, an 11.0% increase over 2006.  This increase is primarily a result of the Company’s overall growth.  Additionally, during the first quarter of 2007, the Company incurred $286,000 in expense related to a performance improvement consulting project that was substantially begun and completed during the quarter, which negatively impacted earnings per share by approximately one cent per share.  The near absence of this expense in future quarters and efficiencies that are expected to be derived from the project are expected to benefit earnings in the future.

The provision for income taxes was $2,965,000 in the first quarter of 2007, an effective tax rate of 37.8%, compared to $3,072,000 in the first quarter of 2006, an effective tax rate of 38.1%.  The Company expects its effective tax rate to remain at approximately 38% for the foreseeable future.

The Consolidated Statements of Comprehensive Income reflect “Other Comprehensive Income” of $218,000 and “Other Comprehensive Loss” of $49,000 during the first quarters of 2007 and 2006, respectively.  The primary component of other comprehensive income/loss for the periods presented relates to changes in unrealized holding gains/losses of the Company’s available for sale securities.  The Company’s available for sale securities portfolio is predominantly comprised of fixed rate bonds that increase in value when market yields for fixed rate bonds decrease and decline in value when market yields for fixed rate bonds increase.

Total assets at March 31, 2007 amounted to $2.18 billion, 14.1% higher than a year earlier.  Total loans at March 31, 2007 amounted to $1.78 billion, a 14.3% increase from a year earlier, and total deposits amounted to $1.75 billion at March 31, 2007, an 11.5% increase from a year earlier.

The following tables present information regarding the nature of the Company’s growth since March 31, 2006.

The Company experienced strong loan and deposit growth during the first quarter of 2007, with loans increasing by $36 million, or 8.3% on an annualized basis, and deposits increasing by $50 million, or 11.9% on an annualized basis.

The mix of the Company’s loan portfolio remains substantially the same at March 31, 2007 compared to December 31, 2006, with approximately 86% of the Company’s loans being real estate loans, 9% being commercial, financial, and agricultural loans, and the remaining 5% being consumer installment loans.  The majority of the Company’s real estate loans are personal and commercial loans where real estate provides additional security for the loan.

Nonperforming assets are defined as nonaccrual loans, loans past due 90 or more days and still accruing interest, restructured loans and other real estate.  Nonperforming assets are summarized as follows:

Management has reviewed the collateral for the nonperforming assets, including nonaccrual loans, and has included this review among the factors considered in the evaluation of the allowance for loan losses discussed below.

 The variances in nonperforming loans among the periods presented has been primarily due to changes in nonaccrual loans, as restructured loans have not changed significantly.  At March 31, 2006, nonperforming loans were at an unusually low level due the collection and/or charge-offs of several large nonaccrual relationships in the fourth quarter of 2005.  Since then, the Company has experienced more typical activity within its nonaccrual loan category, and the level of nonaccrual loans has increased to more normal levels as a percentage of the total loan portfolio.  In the first quarter of 2007, the Company foreclosed on several loans secured by real estate, which is largely responsible for the $981,000 decrease in nonaccrual loans and the $812,000 increase in other real estate since December 31, 2006.  At March 31, 2007, the Company’s largest nonaccrual loan relationship amounted to $590,000 and the largest carrying amount of any single piece of other real estate amounted to $390,000.

At March 31, 2007, December 31, 2006, and March 31, 2006, the recorded investments in loans considered to be impaired were $2,682,000, $2,864,000, and $1,205,000, respectively, all of which were on nonaccrual status.  At March 31, 2007, December 31, 2006, and March 31, 2006, the related allowances for loan losses for all impaired loans were $698,000, $511,000, and $298,000, respectively.  At March 31, 2007, December 31, 2006, and March 31, 2006, there was $691,000, $842,000, and $124,000 in impaired loans for which there was no related allowance.  The average recorded investments in impaired loans during the three month period ended March 31, 2007, the year ended December 31, 2006, and the three months ended March 31, 2006 were approximately $2,773,000, $1,445,000, and $772,000, respectively.  For the same periods, the Company recognized no interest income on those impaired loans during the period that they were considered to be impaired.

The Company has no foreign loans, few agricultural loans and does not engage in significant lease financing or highly leveraged transactions.  Commercial loans are diversified among a variety of industries.  The majority of the Company’s real estate loans are primarily various personal and commercial loans where real estate provides additional security for the loan.  Collateral for virtually all of these loans is located within the Company’s principal market area.

The Company’s provision for loan losses remained relatively stable in 2007 compared to 2006, amounting to $1,121,000 in the first quarter of 2007 versus $1,015,000 in the first quarter of 2006.  Factors that played an offsetting role in this comparison were i) lower 2007 loan growth, which generally results in a lower provision for loan losses, and ii) higher 2007 net charge-offs, which generally increases the necessary provision for loan losses.  In the first quarter of 2007, net loan growth amounted to $36 million compared to $71 million in the first quarter of 2006.  In the first quarter of 2007, the Company recorded $590,000 in net charge-offs compared to $121,000 in the first quarter of 2006.  The Company’s ratio of annualized net charge-offs to average loans amounted to 14 basis points for the first quarter of 2007 compared to 3 basis points for the first quarter of 2006.  The Company’s ratio of nonperforming assets to total assets was 0.38% at March 31, 2007 compared to 0.25% at March 31, 2006.

At March 31, 2007, the allowance for loan losses amounted to $19,478,000, compared to $18,947,000 at December 31, 2006 and $16,610,000 at March 31, 2006.  The allowance for loan losses as a percentage of total loans was 1.10% at March 31, 2007, 1.09% at December 31, 2006, and 1.07% at March 31, 2006.

Management believes the Company’s reserve levels are adequate to cover probable loan losses on the loans outstanding as of each reporting date.  It must be emphasized, however, that the determination of the reserve using the Company's procedures and methods rests upon various judgments and assumptions about economic conditions and other factors affecting loans.  No assurance can be given that the Company will not in any particular period sustain loan losses that are sizable in relation to the amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings.  See “Critical Accounting Policies – Allowance for Loan Losses” above.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and value of other real estate.  Such agencies may require the Company to recognize adjustments to the allowance or the carrying value of other real estate based on their judgments about information available at the time of their examinations.

For the periods indicated, the following table summarizes the Company's balances of loans outstanding, average loans outstanding, changes in the allowance for loan losses arising from charge-offs and recoveries, additions to the allowance for loan losses that have been charged to expense, and additions that were recorded related to acquisitions.