Peapack-Gladstone Financial - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

ý           QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarter Ended September 30, 2008

OR

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 No. 001-16197

PEAPACK-GLADSTONE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

158 Route 206 North

Gladstone, New Jersey 07934

(Address of principal executive offices, including zip code)

(908) 234-0700

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý   Noo.

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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

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

Number of shares of Common Stock outstanding as of November 3, 2008:

8,288,634

PEAPACK-GLADSTONE FINANCIAL CORPORATION

PART 1  FINANCIAL INFORMATION

PART 2  OTHER INFORMATION

Item 1.  Financial Statements (Unaudited)

PEAPACK-GLADSTONE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CONDITION

(Dollars in thousands)

(Unaudited)

PEAPACK-GLADSTONE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except share data)

(Unaudited)

EAPACK-GLADSTONE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in thousands)

(Unaudited)

PEAPACK-GLADSTONE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

PEAPACK-GLADSTONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Certain information and footnote disclosures normally included in the unaudited consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission.  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the period ended December 31, 2007 for Peapack-Gladstone Financial Corporation (the “Corporation”).

Principles of Consolidation:  The Corporation considers that all adjustments necessary for a fair presentation of the statement of the financial position and results of operations in accordance with U.S. generally accepted accounting principles for these periods have been made.  Results for such interim periods are not necessarily indicative of results for a full year.

The consolidated financial statements of Peapack-Gladstone Financial Corporation are prepared on the accrual basis and include the accounts of the Corporation and its wholly owned subsidiary, Peapack-Gladstone Bank.  All significant intercompany balances and transactions have been eliminated from the accompanying consolidated financial statements.

Securities:  The Corporation accounts for its securities in accordance with Statement of Financial Accounting Standards Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (Statement No. 115).  Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity.  Debt securities are classified as available for sale when they might be sold before maturity due to changes in interest rates, prepayment, risk, liquidity or other factors.  Equity securities with readily determinable fair values are classified as available for sale.  Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

Interest income includes amortization of purchase premium or discount.  Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated.  Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses and results in a new cost basis being established.  In estimating other-than-temporary losses, management considers the length of time and extent that fair value has been less than cost; the financial condition and near-term prospects of the issuer; and the Corporation’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.

Securities are evaluated on at least a quarterly basis to determine whether a decline in their value is other-than-temporary.  To determine whether a loss in value is other-than-temporary, Management utilizes criteria such as the reasons underlying the decline, the magnitude and the duration of the decline and the intent and ability of the Corporation to retain its investment in the security for a period of time sufficient to allow for an anticipated recovery in the fair value.  “Other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment.  Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.  No impairment charge has been recognized for the three or nine months ended September 30, 2008 and 2007.

Allowance for Loan Losses:  The allowance for loan losses is maintained at a level considered adequate to provide for probable incurred loan losses in the Corporation’s loan portfolio.  The allowance is based on management’s evaluation of the loan portfolio considering, among other things, current economic conditions, the volume and nature of the loan portfolio, historical loan loss experience, and individual credit situations.  The allowance is increased by provisions charged to expense and reduced by charge-offs net of recoveries.

Stock Option Plans:  The Corporation has stock option plans that allow the granting of shares of the Corporation’s common stock as incentive stock options, nonqualified stock options, restricted stock awards and stock appreciation rights to directors, officers, employees and independent contractors of the Corporation and its subsidiaries.  The options granted under these plans are exercisable at a price equal to the fair market value of common stock on the date of grant and expire not more than ten years after the date of grant.  Stock options may vest during a period of up to five years after the date of grant.

For the three months ended September 30, 2008 and 2007, the Corporation recorded total compensation cost for share-based payment arrangements of $82 thousand and $52 thousand, respectively, with a recognized tax benefit of $6 thousand and $3 thousand for the third quarter of 2008 and 2007, respectively.

The Corporation recorded total compensation cost for share-based payment arrangements of $265 thousand and $151 thousand for the nine months ended September 30, 2008 and 2007, respectively, with a recognized tax benefit of $19 thousand and $9 thousand for the same periods.

As of September 30, 2008, there was approximately $1.1 million of unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Corporation’s stock incentive plans.  That cost is expected to be recognized over a weighted average period of 1.7 years.

For the Corporation’s stock option plans, changes in options outstanding during the nine months ended September 30, 2008 were as follows:

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Corporation’s closing stock price on the last trading day of the third quarter of 2008 and the exercise price, multiplied by the number of in-the-money options).

The aggregate intrinsic value of options exercised during the nine months ended September 30, 2008 and 2007 was $392 thousand and $242 thousand, respectively.

The per share weighted-average fair value of stock options granted during the first nine months of 2008 and 2007 for all plans was $13.42 and $10.38, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions:

Earnings per Common Share – Basic and Diluted:  The following is a reconciliation of the calculation of basic and diluted earnings per share.  Basic net income per common share is calculated by dividing net income to common shareholders by the weighted average common shares outstanding during the reporting period.  Diluted net income per common share is computed similarly to that of basic net income per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, principally stock options, were issued during the reporting period utilizing the Treasury stock method.

Stock options with an exercise price below the Corporation’s market price equal to 315,384 and 379,708 shares were not included in the computation of diluted earnings per share in the third quarters of 2008 and 2007, respectively because they were antidilutive.  Stock options with an exercise price below the Corporation’s market price equal to 382,443 and 375,268 shares were not included in the computation of diluted earnings per share in the nine months ended September 30, 2008 and 2007, respectively because they would be antidilutive.

Income Taxes:   The Corporation files a consolidated Federal income tax return and separate state income tax returns for each subsidiary based on current laws and regulations.

The Corporation is no longer subject to examination by the U.S. Federal tax authorities for years prior to 2004 or by New Jersey tax authorities for years prior to 2003.  The Corporation does not expect the total amount of unrecognized tax benefits to significantly increase in the next 12 months.  The Corporation is currently under an audit by the U.S. Federal tax authorities for 2006 and does not expect it to materially effect the financial statements.

The Corporation recognizes interest related to income tax matters as interest expense and penalties related to income tax matters as other expense.  The Corporation did not have any amounts accrued for interest and penalties at January 1, 2008.

Comprehensive Income:  Comprehensive income consists of net income and the change during the period in the Corporation’s pension benefit obligation and the net unrealized gains and losses on securities available for sale during the applicable period of time less adjustments for realized gains and losses and net amortization of the unrealized loss on securities transferred to held to maturity from available for sale.  Total comprehensive income for the third quarter of 2008 was $4.9 million and $2.5 million for the third quarter in 2007.  Total comprehensive income for the nine months ended September 30, 2008 and 2007 was $3.0 million and $6.9 million, respectively.

Reclassification:  Certain reclassifications have been made in the prior periods’ financial statements in order to conform to the 2008 presentation.

2.  LOANS

Loans outstanding as of September 30, 2008, and December 31, 2007, consisted of the following:

Non-performing assets, which are loans past due in excess of 90 days and still accruing, non-accrual loans and other real estate owned totaled $5.0 million at September 30, 2008 and $2.1 million at December 31, 2007.  Management believes that the value of the real estate exceeds the balance due on the loans and expects no loss.

3.  INVESTMENT SECURITIES HELD TO MATURITY

A summary of amortized cost and approximate fair value of investment securities held to maturity included in the consolidated statements of condition as of September 30, 2008 and December 31, 2007 follows:

The following tables present the Corporation’s investment securities held to maturity with continuous unrealized losses and the approximate fair value of these investments as of September 30, 2008 and December 31, 2007.

 

Management has determined that the unrealized losses on debt securities of state and political subdivisions are temporary and due to interest rate fluctuations rather than the credit ratings of the issuers.  The Corporation has a policy to purchase only from issuers with an investment grade credit rating and monitors credit ratings periodically.

The unrealized losses on investments in mortgage-backed securities were caused by interest rate increases and recent volatile market conditions in the mortgage-backed securities market.  These securities are all rated AAA.  The Corporation has the ability and intent to hold these securities for a period of time sufficient to recover all gross unrealized losses.

Other securities represents the Corporation’s investment in trust preferred pooled securities, which consist of 46 separate issues.  The trust preferred pooled instruments consist of securities issued primarily by banks and insurance companies. Three of the issues held by the Corporation are senior tranches and the remainder are mezzanine tranches.  The senior and mezzanine tranches generally are protected from defaults by over-collateralization and cash flow default protection provided by subordinated tranches, with senior tranches having the greatest protection and mezzanine tranches subordinated to the senior tranches.  No single issuer comprised more than five percent of the total principal of any one pool.

Due to the challenging environment for most banks in the United States, there has been an increase in payment deferrals and defaults by issuers within these securities.  In addition, the Corporation feels the market for these securities has been negatively and severely affected by the ongoing credit crisis, a lack of institutional buying activity leading to market illiquidity and forced sales by institutions in distressed situations.  As a result of the increase in payment deferrals and defaults by the underlying issuers, and what the Corporation feels are non-functioning markets, the fair value of the securities, or the value the Corporation could realize if it were forced to sell the securities into the market now, has declined materially.  The original cost of these securities was $67.1 million, and as of September 30, 2008, the estimated fair value of these securities was $19.0 million.

At September 30, 2008, 38 of these securities maintained an investment grade rating of A3 or better, 6 of Baa or better, and two issues with an original cost of $2.5 million were rated Ba1.  In addition, the rating agencies have placed a number of these securities on credit watch while they evaluate the current rating for possible downgrade.

The Corporation has the intent and ability to hold these securities to maturity.  Consequently, as of July 1, 2008, Management changed the accounting treatment for the portfolio from “available for sale” to “held to maturity.”  As of that date, the fair value as of June 30, 2008, of $48.4 million, became the new book value with the decline, net of tax, of $11.2 million recorded as a component of accumulated other comprehensive income to be amortized into income over the remaining lives of the securities.

These securities are accounted for under the scope of EITF-99-20.  Based on management’s review including cash flow analyses of each security, Management currently expects all to return 100% of their principal and interest.  Accordingly, the corporation has not recorded a charge for other-than-temporary-impairment at this time.  The Corporation will continue to evaluate these securities for possible impairment in future periods.

4.  SECURITIES AVAILABLE FOR SALE

A summary of amortized cost and approximate fair value of securities available for sale included in the consolidated statements of condition as of September 30, 2008 and December 31, 2007 follows:

The following tables present the Corporation’s available for sale securities with continuous unrealized losses and the approximate fair value of these investments as of September 30, 2008 and December 31, 2007.

 

Management has determined that the unrealized losses on debt securities are temporary and due to interest rate fluctuations and volatility rather than the credit ratings of the issuers.  The Corporation has a policy to purchase debt securities only from issuers with an investment grade credit rating and monitors credit ratings periodically.

The unrealized losses on investments in mortgage-backed securities were caused by interest rate increases and recent volatile market conditions in the mortgage-backed securities market.  These securities are all rated AAA.  The Corporation has the ability and intent to hold these securities for a period of time sufficient to recover all gross unrealized losses.

As noted above, Management reclassified the trust preferred pooled securities portfolio from “available for sale” to “held to maturity” as of July 1, 2008 since the Corporation has the ability and intent to hold these securities to maturity.

5.  FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS

Advances from the Federal Home Loan Bank of New York (FHLB) totaled $40.1 million and $29.2 million at September 30, 2008 and December 31, 2007, respectively, with a weighted average interest rate of 3.59 percent and 3.69 percent, respectively.  Advances totaling $13.0 million at September 30, 2008, have fixed maturity dates, while advances totaling $4.1 million were amortizing advances with monthly payments of principal and interest.  These advances are secured by blanket pledges of certain 1-4 family residential mortgages totaling $208.0 million at September 30, 2008.

At September 30, 2008, the Corporation had $23.0 million in fixed rates advances that are noncallable for one, two or three years and then callable quarterly within final maturities of three, five or ten years.  These advances are secured by pledges of investment securities totaling $24.6 million at September 30, 2008.

Overnight borrowings at September 30, 2008 totaled $55.0 million, while overnight borrowings at December 31, 2007 totaled $15.7 million.  For the three months ended September 30, 2008, overnight borrowings from the FHLB averaged $13.9 million with a weighted average interest rate of 2.21 percent, while overnight borrowings for the same quarter last year averaged $7.3 million with a weighted average interest rate of 5.20 percent  For the nine months ended September 30, 2008 and 2007, overnight borrowings from the FHLB averaged $7.1 million with a weighted average interest rate of 2.36 percent and $3.9 million with a weighted average interest rate of 5.25 percent, respectively.

The final maturity dates of the advances and other borrowings are scheduled as follows:

6.  BENEFIT PLANS

The Corporation has a defined benefit pension plan covering substantially all of its salaried employees which was discontinued on May 12, 2008.  The Plan was settled and substantially all benefits were paid to employees during September.  Contributions totaling $2.1 million have been made during 2008 and no further contributions are expected.  The Corporation amended its existing 401-K profit-sharing and investment plan to enhance the contributions to its salaried employees starting in May 2008.

The net periodic expense for the periods indicated included the following components:

7.      BUSINESS SEGMENTS

Late in 2007, the Corporation changed internal accounting and reporting processes in order to segregate and assess its results among two operating segments, Banking and PGB Trust and Investments and adopted the new processes as of January 1, 2008.  Management uses certain methodologies to allocate income and expense to the business segments.  A funds transfer pricing methodology is used to assign interest income and interest expense to each interest-earning asset and interest-bearing liability on a matched maturity funding basis.  Certain indirect expenses are allocated to segments.  These include support unit expenses such as technology and operations and other support functions.  Taxes are allocated to each segment based on the effective rate for the period shown.

The Banking segment includes commercial, commercial real estate, residential and consumer lending activities; deposit generation; operation of ATMs; telephone and internet banking services; merchant credit card services and customer support and sales.

PGB Trust & Investments includes asset management services provided for individuals and institutions; personal trust services, including services as executor, trustee, administrator, custodian and guardian; corporate trust services including services as trustee for pension and profit sharing plans; and other financial planning and advisory services.

The following table presents the statements of income and total assets for the Corporation’s reportable segments for the three and nine months ended September 30, 2008.

Statement 157 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value:

Level 1:    Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2:    Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3:    Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

GENERAL:  The following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements are not historical facts and include expressions about management’s view of future interest income and net loans, management’s confidence and strategies and management’s expectations about new and existing programs and products, relationships, opportunities and market conditions.  These statements may be identified by such forward-looking terminology as “expect”, “look”, “believe”, “anticipate”, “may”, “will”, or similar statements or variations of such terms.  Actual results may differ materially from such forward-looking statements.  Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities:

The Corporation assumes no responsibility to update such forward-looking statements in the future.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES:  “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon the Corporation’s consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.  The preparation of these financial statements requires the Corporation to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.  Note 1 to the Corporation’s Audited Consolidated Financial Statements included in the December 31, 2007 Annual Report on Form 10-K, contains a summary of the Corporation’s significant accounting policies.  Management believes the Corporation’s policy with respect to the methodology for the determination of the allowance for loan losses involves a higher degree of complexity and requires management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters.  Changes in these judgments, assumptions or estimates could materially impact results of operations.  This critical policy and its application are periodically reviewed with the Audit Committee and the Board of Directors.

The provision for loan losses is based upon management’s evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectibility may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions.  Although management uses the best information available, the level of the allowance for loan losses remains an estimate, which is subject to significant judgment

and short-term change.  Various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s provision for loan losses.  Such agencies may require the Corporation to make additional provisions for loan losses based upon information available to them at the time of their examination.  Furthermore, the majority of the Corporation’s loans are secured by real estate in the State of New Jersey.  Accordingly, the collectibility of a substantial portion of the carrying value of the Corporation’s loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or should New Jersey experience adverse economic conditions.  Future adjustments to the provision for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Corporation’s control.

Securities are evaluated on at least a quarterly basis to determine whether a decline in their value is other-than-temporary.  To determine whether a loss in value is other-than-temporary, Management utilizes criteria such as the reasons underlying the decline, the magnitude and the duration of the decline and the intent and ability of the Corporation to retain its investment in the security for a period of time sufficient to allow for an anticipated recovery in the fair value.  “Other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment.  Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.  No impairment charge has been recognized for the three or nine months ended September 30, 2008 and 2007.

EXECUTIVE SUMMARY:  The Corporation recorded net income of $3.5 million for the third quarter of 2008 as compared to $2.6 million for the third quarter of 2007, an increase of $868 thousand, or 32.8 percent.  Earnings per share were $0.42 per diluted share in the third quarter of 2008 as compared to $0.32 per diluted share for the same quarter of 2007.  The primary factor contributing to the increase in net income is the improvement in net interest income and the net interest margin, which is explained below.  Annualized return on average assets for the quarter was 1.04 percent and annualized return on average equity was 13.46 percent for the third quarter of 2008.

Net interest income, on a fully tax-equivalent basis, was $12.4 million in the third quarter of 2008, an increase of $3.3 million or 36.4 percent from the third quarter last year and an increase of $706 thousand or 6.0 percent over the second quarter of 2008.  On a fully tax-equivalent basis, the net interest margin was 3.92 percent for the third quarter of 2008 as compared to 2.92 percent for the same period last year and 3.63 percent for the second quarter of 2008.

For the third quarter of 2008, average loans increased $102.2 million or 11.1 percent to $1.02 billion.  The Corporation’s long-term plan calls for a substantial shift in the asset mix, with less emphasis on residential mortgages and more emphasis on higher yielding commercial loans and commercial mortgages.  As a result of this strategy, the average commercial loan portfolios grew $90.6 million or 24.7 percent, while the average mortgage loan portfolio increased $9.8 million to $504.7 million.  Loan rates declined 33 basis points from the third quarter of 2007 to 5.85 percent for the same quarter of 2008.

Average deposits grew $17.2 million, or 1.5 percent, to $1.18 billion in the third quarter of 2008 over the levels of the same quarter in 2007.  Deposit gathering remains highly competitive as short-term market rates have continued to decline in this year.  Rates paid for interest-bearing deposits were 2.15 percent in the third quarter of 2008, as compared to 3.69 percent for the third quarter of 2007, a decline of 154 basis points.

For the first nine months of 2008, net income was $10.6 million, an increase of $2.4 million or 29.5 percent over the $8.2 million recorded for the same period of 2007.  For the nine months ended September 30, 2008 and 2007, earnings per diluted share were $1.26 and $0.97, respectively.  Annualized return on average assets for the year to date was 1.04 percent and annualized return on average equity was 13.26 percent for the first nine months of 2008.

On a fully tax-equivalent basis, net interest income was $34.9 million for the nine months ended September 30, 2008, an increase of $8.4 million or 31.5 percent from the same period a year ago.  The net interest margin on a fully tax-equivalent basis was 3.63 percent and 2.86 percent for the nine months ended September 30, 2008 and 2007, respectively.

Average loans for the nine months ended September 30, 2008 totaled $998.2 million, growing $104.9 million, or 11.7 percent, as compared to $893.3 million over the same period last year.  While the average mortgage loan portfolio remained flat compared to the first nine months of 2007, the commercial loan portfolios averaged $443.9, rising $100.4 million or 29.2 percent.  Loan rates declined 24 basis points to 5.87 percent for the first nine months of 2008 as compared to 2007.

In the nine months ended September 30, 2008 and 2007, deposits averaged $1.19 billion and $1.16 billion, respectively, an increase of $31.0 million or 2.7 percent.  Rates paid for interest-bearing deposits declined 118 basis points to 2.48 percent in the first nine months of 2008.  Borrowings for the nine months ended September 30, 2008 averaged $48.4 million, an increase of $19.5 million.  During the first quarter of 2008, the Corporation borrowed $12.0 million in fixed rate advances that are noncallable for one, two or three years.

Average investments declined $55.1 million for the first nine months of 2008 when compared to the same year-to-date period of 2007 and yields on investments remained relatively constant.  For the past year, the Corporation followed a strategy of investing the proceeds of maturing and sold securities into higher yielding loans.

EARNINGS ANALYSIS

NET INTEREST INCOME:  For the third quarter of 2008, net interest income, on a tax-equivalent basis on interest-earning assets and before the provision for loan losses, was $12.4 million as compared to $9.1 million for the same quarter of 2007, an increase of $3.3 million or 36.4 percent.  On a fully tax-equivalent basis, the net interest margin was 3.92 percent and 2.92 percent in the third quarters of 2008 and 2007, respectively, an increase of 100 basis points.  When compared to the second quarter of 2008, net interest income for the third quarter of 2008, rose $706 thousand, or 6.0 percent, from $11.7 million on a tax-equivalent basis.  On a fully tax equivalent basis, the net interest margin, increased from 3.63 percent in the second quarter of 2008, to 3.92 percent in the third quarter of 2008.

Loans averaged $1.02 billion for the third quarter of 2008, an increase of $102.2 million or 11.1 percent from $917.6 million for the same quarter of 2007.  While the average mortgage loan portfolio increased slightly to $504.7 million during this period, the average commercial loan portfolios grew $90.6 million or 24.7 percent.

Average deposits were $1.18 billion and $1.16 billion for the quarters ended September 30, 2008 and 2007, respectively, growing $17.2 million, or 1.5 percent.  Average non-interest bearing demand deposits increased $9.6 million, or 5.2 percent, to $193.1 million for the third quarter of 2008, from the same quarter in 2007.  Average money markets rose $13.8 million or 3.6 percent from the third quarter in 2007, totaling $397.8 million in the third quarter of 2008.  Average certificates of deposit declined $24.1 million or 6.1 percent due to competitive pressure on rates and the maturity of certificates offered at a special rate for the grand opening of the Summit Branch beginning in March 2007.  Average borrowings increased by $22.5 million to $58.1 million in the third quarter of 2008, from $35.6 million in the same quarter of 2007.

On a tax-equivalent basis, average interest rates on interest-earning assets declined 19 basis points to 5.73 percent for the third quarter of 2008 from 5.92 percent for the third quarter of 2007.  Average interest rates earned on loans and investment securities declined 33 basis points to 5.85 percent and 11 basis points to 5.32 percent, respectively, for the third quarter of 2008 as compared to the same period in 2007.  The decline in interest income due to lower rates has been mitigated by the increase in the volume of loans due to our long-term plan, which calls for a substantial shift in our asset mix, with less emphasis on residential mortgages and more emphasis on higher yielding commercial loans and commercial mortgages.  Adjustable rates on the commercial portfolios have declined due to competitive pressures and the lowering of the federal funds rate.

For the third quarter of 2008, average rates paid on interest-bearing deposits declined 154 basis points to 2.15 percent as compared to 3.69 percent for the same quarter of 2007.  For the third quarter of 2008, yields on money market products averaged 1.91 percent, declining 203 basis points, while certificates of deposit yields averaged 3.21 percent, declining 169 basis points, from the same quarter of 2007.  Overnight rates on borrowings have also declined 299 basis points since the third quarter of 2007 to 2.21 percent for the third quarter in 2008.

The cost of funds decreased to 1.87 percent for the third quarter of 2008 as compared to 3.14 percent for the same quarter in 2007, a decline of 127 basis points.  The net interest income and net interest margin have benefited from the Federal Reserve Board’s decisions to reduce the fed funds target rate 275 basis points since the beginning of the year.

Net interest income, on a fully tax-equivalent basis and before the provision for loan losses, for the nine months ended September 30, 2008 and 2007, was $34.9 million and $26.6 million, respectively, increasing $8.4 million or 31.5 percent.  The net interest margin, on a fully tax-equivalent basis, was 3.63 percent for the first nine months of 2008 as compared to 2.86 percent for the same nine month period in 2007, an increase of 77 basis points.  Net interest income has mostly benefited from the reduction in short-term market rates as liability costs have declined $7.8 million for the nine months ended September 30, 2008 when compared to the same period in 2007.

For the nine months ended September 30, 2008 and 2007, loans averaged $998.2 million and $893.3 million, respectively, an increase of $104.9 million or 11.7 percent.  The average commercial loan portfolios grew to $443.9 million for the first nine months of 2008 from $343.5 million for the same period in 2007, an increase of $100.4 million or 29.2 percent.  The average mortgage loan portfolio remained flat during this same period.  Average investments declined $55.1 million or 16.8 percent to $273.3 million.  As previously discussed, most maturities in this portfolio were reinvested in the loan portfolio.

Average deposits were $1.19 billion, an increase of $31.0 million or 2.7 percent.  Non-interest bearing demand deposits averaged $192.6 million and $184.7 million for the first nine months of 2008 and 2007, respectively, rising $7.9 million or 4.3 percent.  Average money markets rose $21.4 million or 5.7 percent from the nine months ended September 30, 2007, totaling $399.4 million in the first nine months of 2008.  Average certificates of deposit totaled $391.0 million for the first nine months of 2008, remaining flat when compared to the same period a year ago.  For the same nine months of 2008, average borrowings increased by $19.5 million to $48.4 million from $28.9 million in the same period in 2007, as the Corporation increased its level of fixed rate advances.  These advances are noncallable for one, two or three years and then callable quarterly within final maturities of three, five or ten years.

Average interest rates on assets, on a tax-equivalent basis, for the first nine months of 2008 and 2007 were 5.68 percent and 5.84 percent, respectively, declining 16 basis points between 2008 and 2007.  Accounting for much of this decrease, average interest rates earned on loans declined 24 basis points to 5.87 percent for the period in 2008 from 6.11 percent for the same period in 2007.

For the nine months ended September 30, 2008, average rates paid on interest-bearing deposits declined 118 basis points to 2.48 percent as compared to 3.66 percent for the same period in 2007.

Yields on money market products averaged 2.13 percent, while certificates of deposit yields averaged 3.80 percent for the first nine months of 2008.  Average rates paid on borrowings declined 46 basis points, yielding 3.37 percent and 3.83 percent for the first nine months of 2008 and 2007, respectively.

The cost of funds for the first nine months of 2008 also declined to 2.13 percent from 3.10 percent for the same year ago period.  The net interest income and net interest margin has benefited from the Federal Reserve Board’s decisions to reduce the fed funds target rate 250 basis points since the beginning of the year.

The following tables reflect the components of net interest income for the periods indicated:

Average Balance Sheet

Unaudited

Quarters Ended

(Tax-Equivalent Basis, Dollars in Thousands)