Form 10-Q

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

10-Q 1 d509669d10q.htm FORM 10-Q Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2013

¨	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: 0-20957

SUN BANCORP, INC.

(Exact name of registrant as specified in its charter)

New Jersey

52-1382541

(State or other jurisdiction of

incorporation or organization

(I.R.S. Employer

Identification No.)

226 Landis Avenue, Vineland, New Jersey 08360

(Address of principal executive offices)

(Zip Code)

(856) 691-7700

(Registrant’s telephone number, including area code)

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b2 of the Exchange Act). Yes ¨ No x

Common Stock, $1.00 Par Value – 86,304,195 Shares Outstanding at May 3, 2013

TABLE OF CONTENTS


	Page Number

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

Unaudited Condensed Consolidated Statements of Financial Condition at March 31, 2013 and December 31, 2012		3

Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2013 and 2012		4

Unaudited Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2013 and 2012		5

Unaudited Condensed Consolidated Statements of Shareholders’ Equity for the Three Months Ended March 31, 2013 and 2012		6

Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2013 and 2012		7

Notes to Unaudited Condensed Consolidated Financial Statements		8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		37

Item 3. Quantitative and Qualitative Disclosures about Market Risk		47

Item 4. Controls and Procedures		48

PART II—OTHER INFORMATION

Item 1. Legal Proceedings		49

Item 1A. Risk Factors		49

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		49

Item 3. Defaults Upon Senior Securities		49

Item 4. Mine Safety Disclosures		49

Item 5. Other Information		49

Item 6. Exhibits		50

Signatures		50

Exhibits

Exhibit 3.1 Amended and Restated Certificate of Incorporation of Sun Bancorp, Inc.
Exhibit 3.2 Certificate of Amendment to Restated Certificate of Incorporation
Exhibit 3.3 Amended and Restated Bylaws of Sun Bancorp, Inc.
Exhibit 4.1 Common Security Specimen
Exhibit 31(a) Section 302 Certification of CEO
Exhibit 31(b) Section 302 Certification of Chief Financial Officer
Exhibit 32 Section 906 Certifications
Exhibit 101.INS XBRL Instance Document
Exhibit 101.SCH XBRL Taxonomy Extension Schema Document
Exhibit 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
Exhibit 101.LAB XBRL Taxonomy Extension Label Linkbase Document
Exhibit 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
Exhibit 101.DEF XBRL Taxonomy Definition Linkbase Document

SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands, except par value amounts)


	March 31, 2013			December 31, 2012
ASSETS
Cash and due from banks	$	63,608		$	77,564
Interest-earning bank balances		248,052			92,052

Cash and cash equivalents		311,660			169,616
Investment securities available for sale (amortized cost of $315,810 and $439,488 at March 31, 2013 and December 31, 2012, respectively)		317,838			443,182
Investment securities held to maturity (estimated fair value of $920 and $960 at March 31, 2013 and December 31, 2012, respectively)		881			912
Loans receivable (net of allowance for loan losses of $47,124 and $45,873 at March 31, 2013 and December 31, 2012, respectively)		2,204,436			2,230,287
Loans held-for-sale, at lower of cost or market		—			21,922
Loans held-for-sale, at fair value		41,469			99,013
Restricted equity investments, at cost		17,125			17,886
Bank properties and equipment, net		49,477			50,805
Real estate owned		8,472			7,473
Accrued interest receivable		7,704			8,054
Goodwill		38,188			38,188
Intangible assets, net		2,341			3,262
Bank owned life insurance (BOLI)		75,802			76,858
Receivable from sales and maturities of investments		101,947			—
Other assets		49,806			56,573

Total assets	$	3,227,146		$	3,224,031

LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits	$	2,723,337		$	2,713,224
Securities sold under agreements to repurchase – customers		2,726			1,968
Advances from the Federal Home Loan Bank of New York (FHLBNY)		61,077			61,415
Obligations under capital lease		7,541			7,609
Junior subordinated debentures		92,786			92,786
Deferred taxes, net		828			1,509
Other liabilities		74,510			82,925

Total liabilities		2,962,805			2,961,436

Commitments and contingencies (see Note 10)
Shareholders’ equity:
Preferred stock, $1 par value, 1,000,000 shares authorized; none issued		—			—
Common stock, $1 par value, 200,000,000 shares authorized; 88,403,100 shares issued and 86,296,377 shares outstanding at March 31, 2013; 88,300,637 shares issued and 86,193,914 shares outstanding at December 31, 2012		88,403			88,301
Additional paid-in capital		506,773			506,537
Retained deficit		(305,558	)		(308,011	)
Accumulated other comprehensive income		1,200			2,186
Deferred compensation plan trust		(315	)		(256	)
Treasury stock at cost, 2,106,723 shares at March 31, 2013 and December 31, 2012		(26,162	)		(26,162	)

Total shareholders’ equity		264,341			262,595

Total liabilities and shareholders’ equity	$	3,227,146		$	3,224,031

See Notes to Unaudited Condensed Consolidated Financial Statements.

SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except share and per share amounts)


	For the Three Months Ended March 31,
	2013			2012
INTEREST INCOME
Interest and fees on loans	$	24,899		$	26,204
Interest on taxable investment securities		1,544			2,542
Interest on non-taxable investment securities		394			434
Dividends on restricted equity investments		246			227

Total interest income		27,083			29,407

INTEREST EXPENSE
Interest on deposits		3,015			3,684
Interest on funds borrowed		443			351
Interest on junior subordinated debentures		547			722

Total interest expense		4,005			4,757

Net interest income		23,078			24,650
PROVISION FOR LOAN LOSSES		171			30,683

Net interest income (loss) after provision for loan losses		22,907			(6,033	)

NON-INTEREST INCOME
Service charges		2,229			2,741
Mortgage banking revenue, net		3,404			716
Gain on sale of available for sale securities		3,487			—
Investment products income		679			432
BOLI income		448			517
Derivative credit valuation adjustment		(504	)		(314	)
Other		1,139			1,427

Total non-interest income		10,882			5,519

NON-INTEREST EXPENSE
Salaries and employee benefits		14,292			13,747
Commission expense		2,041			1,024
Occupancy expense		3,576			3,049
Equipment expense		1,859			1,765
Data processing expense		999			1,056
Amortization of intangible assets		921			921
Insurance expense		1,430			1,479
Professional fees		2,647			479
Advertising expense		553			297
Problem loan expense		799			1,477
Real estate owned expense, net		234			81
Office supplies expense		229			319
Other		1,756			1,870

Total non-interest expense		31,336			27,564

INCOME (LOSS) BEFORE INCOME TAXES		2,453			(28,078	)
INCOME TAX EXPENSE		—			—

NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS	$	2,453		$	(28,078	)

Basic earnings (loss) per share	$	0.03		$	(0.33	)

Diluted earnings (loss) per share	$	0.03		$	(0.33	)

Weighted average shares – basic		86,245,121			85,776,858

Weighted average shares – diluted		86,370,435			85,776,858

SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)


	For the Three Months Ended March 31,
	2013					2012
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS	$			2,453		$			(28,078	)
Other Comprehensive Income, net of tax
Unrealized gains on securities:
Unrealized holding gains arising during period	$	1,078				$	1,513
Less: reclassification adjustment for gains included in net income		(2,064	)				(3	)
Reclassification adjustment for net impairment loss recognized in earnings		—					—

Other comprehensive (loss) income				(986	)				1,510

COMPREHENSIVE INCOME (LOSS)	$			1,467		$			(26,568	)

SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Dollars in thousands)


	Preferred Stock		Common Stock		Additional Paid-In Capital		Retained Deficit			Accumulated Other Comprehensive Income			Deferred Compensation			Treasury Stock			Total
BALANCE, JANUARY 1, 2012	$	—	$	87,825	$	504,508	$	(257,520	)	$	625		$	(193	)	$	(26,162	)	$	309,083
Net loss		—		—		—		(28,078	)		—			—			—			(28,078	)
Other comprehensive income		—		—		—		—			1,510			—			—			1,510
Issuance of common stock		—		71		136		—			—			—			—			207
Stock-based compensation		—		28		413		—			—			—			—			441

BALANCE, March 31, 2012	$	—	$	87,924	$	505,057	$	(285,598	)	$	2,135		$	(193	)	$	(26,162	)	$	283,163

BALANCE, JANUARY 1, 2013	$	—	$	88,301	$	506,537	$	(308,011	)	$	2,186		$	(256	)	$	(26,162	)	$	262,595
Net income		—		—		—		2,453			—			—			—			2,453
Other comprehensive income		—		—		—		—			(986	)		—			—			(986	)
Issuance of common stock		—		58		142		—			—			(59	)		—			141
Stock-based compensation		—		44		94		—			—			—			—			138

BALANCE, March 31, 2013	$	—	$	88,403	$	506,773	$	(305,558	)	$	1,200		$	(315	)	$	(26,162	)	$	264,341

See Notes to Unaudited Condensed Consolidated Financial Statements.

SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)


	For the Three Months Ended March 31,
	2013			2012
OPERATING ACTIVITIES
Net income (loss)	$	2,453		$	(28,078	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses		171			30,683
Reserve for unfunded commitments		108			322
Depreciation, amortization and accretion		3,257			3,002
Write down of book value of bank properties and equipment and real estate owned		47			143
Net loss (gain) on sale of real estate owned		94			(138	)
Increase in fair value of interest rate lock commitments		214			—
Net gain on sales and calls of investment securities available-for-sale		(3,489	)		—
Gain on sale of mortgage loans		(4,006	)		(716	)
Gain on bulk sale of jumbo residential mortgage loans		(856	)		—
Derivative credit valuation adjustments		530			158
Increase in cash surrender value of BOLI		(448	)		(517	)
Stock-based compensation		138			442
Shares contributed to employee benefit plans		200			207
Change in fair value of residential mortgage loans held-for-sale		1,243			—
Mortgage loans originated for sale		(139,347	)		(32,808	)
Proceeds from the sale of mortgage loans		199,753			31,682
Change in assets and liabilities which provided (used) cash:
Accrued interest receivable		350			351
Other assets		1,479			1,597
Other liabilities		(13,700	)		(5,771	)

Net cash provided by operating activities		48,191			559

INVESTING ACTIVITIES
Purchases of available-for-sale securities		(31,776	)		(76,768	)
Net redemption (purchases) of restricted equity securities		761			(20	)
Proceeds from maturities, prepayments or calls of investment securities available for sale		35,409			34,355
Proceeds from maturities, prepayments or calls of investment securities held to maturity		30			332
Proceeds from sale of securities available for sale		31,359
Net (increase) decrease in loans		(27,493	)		44,388
Proceeds from the sale of commercial real estate loans		20,771			—
Proceeds from bulk sale of jumbo residential mortgage loans		52,328			—
Return of surrender value of BOLI		1,504			—
Purchases of bank properties and equipment		(424	)		(365	)
Proceeds from sale of real estate owned		919			1,383

Net cash provided by investing activities		83,388			3,305

FINANCING ACTIVITIES
Net increase (decrease) in deposits		10,113			(35,947	)
Net issuances of securities sold under agreements to repurchase – customer		758			202
Repayment of advances from FHLBNY		(338	)		(325	)
Repayment of obligations under capital leases		(68	)		(63	)

Net cash provided by (used in) financing activities		10,465			(36,133	)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		142,044			(32,269	)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		169,616			119,822

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	311,660		$	87,553

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid	$	7,561		$	5,027
Income taxes paid		—			—
SUPPLEMENTAL DISCLOSURE OF NON-CASH ITEMS
Trade date receivable from sale of investment securities	$	94,509		$	—
Obligations to purchase investment securities		10,500			—
Transfer of loans to real estate owned		2,070			492

See Notes to Unaudited Condensed Consolidated Financial Statements.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(All dollar amounts presented in the tables, except share and per share amounts, are in thousands)

(1) Summary of Significant Accounting Policies

Basis of Presentation. The accompanying unaudited condensed consolidated financial statements were prepared in accordance with instructions to Form 10-Q, and therefore, do not include information or footnotes necessary for a complete presentation of financial condition, results of operations, comprehensive income, changes in equity and cash flows in conformity with Generally Accepted Accounting Principles in the United States of America (“GAAP”).

All normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the unaudited condensed consolidated financial statements have been included. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the accompanying notes thereto included in the Annual Report on Form 10-K of Sun Bancorp, Inc. (the “Company”) for the year ended December 31, 2012. The results for the three months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013 or any other period. The preparation of the unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the reporting period. The significant estimates include the allowance for loan losses, other-than-temporary impairment on investment securities, income taxes and the fair value of financial instruments. Actual results may differ from these estimates under different assumptions or conditions.

Reclassifications. Certain reclassifications have been made to prior periods in the unaudited condensed statements of operations to conform to current reporting. Such changes are not deemed material.

Basis of Consolidation. The unaudited condensed consolidated financial statements include, after all intercompany balances and transactions have been eliminated, the accounts of the Company, its principal wholly owned subsidiary, Sun National Bank (the “Bank”), and the Bank’s wholly owned subsidiaries, Sun Financial Services, L.L.C., 2020 Properties, L.L.C., and 4040 Properties, L.L.C. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“FASB ASC”) 810-10, Consolidation, Sun Capital Trust V, Sun Capital Trust VI, Sun Capital Trust VII, Sun Statutory Trust VII, Sun Capital Trust VIII, Sun Capital Trust IX and Sun Capital Trust X, collectively, the “Issuing Trusts”, are presented on a deconsolidated basis.

Segment Information. As defined in accordance with FASB ASC 280, Segment Reporting, the Company has one reportable operating segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent upon the ability of the Company to fund itself with deposits and other borrowings and manage interest rate and credit risk. Accordingly, all significant operating decisions are based upon analysis of the Company as one segment or unit.

Loans held-for-sale. Loans held-for-sale totaled $41.5 million and $120.9 million at March 31, 2013 and December 31, 2012, respectively. The balance at March 31, 2013 represented residential mortgages originated with the intent to sell and recorded at fair value. The balance at December 31, 2012 includes $99.0 million of residential mortgages originated with the intent to sell which were recorded at fair value and $21.9 million of commercial real estate loans, recorded at the lower of cost or market. Effective July 1, 2012, the Company elected the fair value option under FASB ASC 825, The Fair Value Option for Financial Instruments (“FASB ASC 825”), on its loans held-for-sale portfolio.

Mortgage banking revenue, net. Mortgage banking revenue, net includes revenues associated with residential mortgage loans originated with the intent to sell, net of estimated recourse liability reserves. The components of this line item are as follows:


	For the Three Months Ended March 31,
	2013			2012
Gains on the sale of residential mortgage loans	$	4,106		$	716
Gain on bulk sale of jumbo residential mortgage loans		856			—
Market value adjustment on loans held-for-sale		(1,244	)		—
Fair value of interest rate lock commitments		(214	)		—
Recourse liability reserves		(100	)		—

Mortgage banking revenue, net	$	3,404		$	716

Accumulated Other Comprehensive Income. The Company classifies items of accumulated comprehensive income by their nature and displays the details of other comprehensive loss in the unaudited condensed consolidated statements of comprehensive income. Amounts categorized as comprehensive loss represent net unrealized gains or losses on investment securities available for sale, net of tax and the non-credit portion of any other-than-temporary impairment (“OTTI”) loss not recorded in earnings. Reclassifications are made to avoid double counting items which are displayed as part of net income (loss) for the period. These reclassifications for the three months ended March 31, 2013 and 2012 were as follows:


	For the Three Months Ended March 31,
	2013									2012
	Pre-tax			Tax			After-tax			Pre-tax			Tax			After-tax
Unrealized holding gain on securities available for sale during the period	$	1,823		$	(745	)	$	1,078		$	2,559		$	(1,046	)	$	1,513
Reclassification adjustment for net gain included in net income⁽¹⁾		(3,487	)		1,423			(2,064	)		(5	)		2			(3	)

Net unrealized gain on securities available for sale	$	(1,664	)	$	678		$	(986	)	$	2,554		$	(1,044	)	$	1,510

(1)	All amounts are included in gain on sale of available for sale securities in the unaudited condensed consolidated statements of operations.

Recent Accounting Principles.

In February 2013, the FASB issued Accounting Standards Update (“ASU”) 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The amendments in this update aim to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments seek to attain that objective by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account instead of directly to income or expense in the same reporting period. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. The Company’s financial statements include the disclosures required upon the adoption of this accounting standards update.

In July 2012, the FASB issued ASU 2012-02, Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This amendment provides an entity with the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. This amendment is effective for public entities for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The guidance had no impact on the Company as it does not have any indefinite-lived intangible assets.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”). This amendment results in common offsetting requirements and disclosure requirements in GAAP and International Financial Reporting Standards (“IFRS”). This guidance is not intended to change, but enhance, the application requirements in FASB ASC 210, Balance Sheet (“FASB ASC 210”). This guidance is effective for public entities during interim and annual periods beginning after January 1, 2013. This guidance amends only the disclosure requirements and not the application of the accounting standard. In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. The amendments in this update clarify that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with FASB ASC 815, Derivatives and Hedging (“FASB ASC 815”), including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with FASB ASC 210 or FASB ASC 815 or subject to an enforceable master netting arrangement or similar agreement. This guidance is effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods presented. The adoption of these accounting standards updates had no impact on the Company’s financial statements.

(2) Stock-Based Compensation

The Company accounts for stock-based compensation issued to employees, and when appropriate, non-employees, in accordance with the fair value recognition provisions of FASB ASC 718, Compensation – Stock Compensation, (“FASB ASC 718”). Under the fair value provisions of FASB ASC 718, stock-based compensation cost is measured at the grant date based on the fair value of the award and it is recognized as expense over the appropriate vesting period using the straight-line method. However, consistent with FASB ASC 718, the amount of stock-based compensation cost recognized at any date must at least equal the portion of the grant date value of the award that is vested at that date and, as a result, it may be necessary to recognize the expense using a ratable method. Although the provisions of FASB ASC 718 should generally be applied to non-employees, FASB ASC 505-50, Equity-Based Payments to Non-Employees, is used in determining the measurement date of the compensation expense for non-employees.

Determining the fair value of stock-based awards at measurement date requires judgment, including estimating the expected term of the stock options and the expected volatility of the Company’s stock. In addition, judgment is required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates or different key assumptions were used, it could have a material effect on the Company’s unaudited condensed consolidated financial statements.

The Company’s stock-based incentive plans authorize the issuance of shares of common stock pursuant to awards that may be granted in the form of stock options to purchase common stock (“Options”) and awards of shares of common stock (“Stock Awards”). The purpose of the Company’s stock-based incentive plans is to attract and retain personnel for positions of substantial responsibility and to provide additional incentive to certain officers, directors, advisory directors, employees and other persons to promote the success of the Company. Under the Company’s stock-based incentive plans, Options generally expire ten years after the date of grant, unless terminated earlier under the option terms. A committee of non-employee directors has the authority to determine the conditions upon which the Options granted will vest. Options are granted at the then fair market value of the Company’s stock. All or a portion of any Stock Awards earned as compensation by a director may be deferred under the Company’s Directors’ Deferred Fee Plan.

Activity in the stock option plans for the three months ended March 31, 2013 was as follows:

Summary of Stock Option Activity


	Number of Options			Weighted Average Exercise Price		Number of Options Exercisable
January 1, 2013		1,785,157		$	7.35		1,178,775
Granted		83,610			3.57
Exercised		—			—
Forfeited		(136	)		—
Expired		—			—

March 31, 2013		1,868,631		$	7.18		1,334,882
Stock Options vested or expected to vest⁽¹⁾		1,826,424		$	7.26

(1)	Includes vested shares and nonvested shares after the application of a forfeiture rate, which is based upon historical data.

The weighted average remaining contractual term was approximately 6.7 years for Options outstanding and 6.0 years for Options exercisable as of March 31, 2013.

At March 31, 2013, the aggregate intrinsic value was $103 thousand for Options outstanding and $17 thousand for Options exercisable.

During the three months ended March 31, 2013 and 2012, the Company granted 83,610 Options and 183,647 Options, respectively. In accordance with FASB ASC 718, the fair value of the Options granted are estimated on the date of grant using the Black-Scholes option pricing model which uses the assumptions in the table below. The expected term of a stock option is estimated using historical exercise behavior of employees at a particular level of management who were granted Options with a comparable term. The Options have historically been granted with a 10 year term. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected volatility is based on the historical volatility of the Company’s stock price.

Significant weighted average assumptions used to calculate the fair value of the Options for the three months ended March 31, 2013 and 2012 are as follows:


	For the Three Months Ended March 31,
	2013			2012
Weighted average fair value of Options granted	$	1.84		$	1.37
Weighted average risk-free rate of return		0.76	%		1.04	%
Weighted average expected option life in months		59			61
Weighted average expected volatility		62	%		61	%
Expected dividends⁽¹⁾	$	—		$	—

(1)	To date, the Company has not paid cash dividends on its common stock.

A summary of the Company’s nonvested Stock Award activity during the three months ended March 31, 2013 is presented in the following table:

Summary of Nonvested Stock Award Activity


	Number of Shares			Weighted Average Grant Date Fair Value
Nonvested Stock Awards outstanding, January 1, 2013		639,037		$	3.30
Issued		—			—
Vested		(73,336	)		4.60
Forfeited		—			—

Nonvested Stock Awards outstanding, March 31, 2013		565,701		$	3.13

There were no nonvested Stock Awards issued during the three months ended March 31, 2013. During the three months ended March 31, 2012, there were 49,623 shares of nonvested Stock Awards issued. The value of these shares is based upon the closing price of the common stock on the date of grant. Compensation expense is recognized on a straight-line basis over the service period for all of the nonvested Stock Awards issued.

Total compensation expense recognized related to Options and nonvested Stock Awards, including that for non-employee directors, during the three months ended March 31, 2013 and 2012 was $238 thousand and $493 thousand, respectively. As of March 31, 2013 there was approximately $929 thousand and $1.7 million of total unrecognized compensation cost related to Options and nonvested Stock Awards, respectively, granted by the Company. The cost of the Options and Stock Awards is expected to be recognized over a weighted average period of 3.0 years and 4.4 years, respectively.

(3) Investment Securities

The amortized cost of investment securities and the approximate fair value at March 31, 2013 and December 31, 2012 were as follows:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
March 31, 2013
Available for sale:
U.S. Treasury securities	$	30,986	$	—	$	(1	)	$	30,985
U.S. Government agency securities		4,967		—		(32	)		4,935
U.S. Government agency mortgage-backed securities		223,111		6,246		(433	)		228,924
Other mortgage-backed securities		285		2		—			287
State and municipal securities		31,086		2,566		—			33,652
Trust preferred securities		12,623		—		(6,320	)		6,303
Collateralized loan obligations		10,500		—		—			10,500
Other securities		2,252		—		—			2,252

Total available for sale		315,810		8,814		(6,786	)		317,838

Held to maturity:
U.S. Government agency mortgage-backed securities		631		39		—			670
Other securities		250		—		—			250

Total held to maturity		881		39		—			920

Total investment securities	$	316,691	$	8,853	$	(6,786	)	$	318,758

December 31, 2012
Available for sale:
U.S. Treasury securities	$	9,998	$	13	$	—		$	10,011
U.S. Government agency securities		4,966		—		(17	)		4,949
U.S. Government agency mortgage-backed securities		348,854		7,104		(980	)		354,978
Other mortgage-backed securities		287		—		(1	)		286
State and municipal obligations		36,848		3,322		—			40,170
Trust preferred securities		12,622		—		(6,740	)		5,882
Corporate bonds		24,449		993		—			25,442
Other securities		1,464		—		—			1,464

Total available for sale		439,488		11,432		(7,738	)		443,182

Held to maturity:
U.S. Government agency mortgage-backed securities		662		48		—			710
Other securities		250		—		—			250

Total held to maturity		912		48		—			960

Total investment securities	$	440,400	$	11,480	$	(7,738	)	$	444,142

During the three months ended March 31, 2013, the Company had one state and municipal security called prior to maturity at a par value of $680 thousand, resulting in gross realized gains of $2 thousand, 40 available for sale securities were sold prior to maturity for gross proceeds of $128.3 million, of which $96.9 million has not been received as of March 31, 2013, resulting in gross realized gains of $3.5 million, and two securities matured which had an aggregate value of $10.0 million, of which $5.0 million has not been received as of March 31, 2013. The following table provides the gross unrealized losses and fair value, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position at March 31, 2013 and December 31, 2012:

Gross Unrealized Losses by Investment Category


	Less than 12 Months					12 Months or Longer					Total
	Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses
March 31, 2013
U.S. Treasury securities	$	30,985	$	(1	)	$	—	$	—		$	30,985	$	(1	)
U.S. Government agency securities		4,935		(32	)		—		—			4,935		(32	)
U.S. Government agency mortgage-backed securities		26,174		(433	)		—		—			26,174		(433	)
Trust preferred securities		—		—			6,303		(6,320	)		6,303		(6,320	)

Total	$	62,094	$	(466	)	$	6,303	$	(6,320	)	$	68,397	$	(6,786	)

December 31, 2012
U.S. Government agency securities	$	4,949	$	(17	)	$	—	$	—		$	4,949	$	(17	)
U.S. Government agency mortgage-backed securities		69,145		(980	)		—		—			69,145		(980	)
Other mortgage-backed securities		286		(1	)		—		—			286		(1	)
Trust preferred securities		—		—			5,882		(6,740	)		5,882		(6,740	)

Total	$	74,380	$	(998	)	$	5,882	$	(6,740	)	$	80,262	$	(7,738	)

The Company determines whether unrealized losses are temporary in accordance with FASB ASC 325-40, Investments – Other, when applicable, and FASB ASC 320-10, Investments – Overall (“FASB ASC 320-10”). The evaluation is based upon factors such as the creditworthiness of the underlying borrowers, performance of the underlying collateral, if applicable, and the level of credit support in the security structure. Management also evaluates other factors and circumstances that may be indicative of an OTTI condition. These include, but are not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost and near-term prospects of the issuer.

FASB ASC 320-10 requires the Company to assess if an OTTI exists by considering whether the Company has the intent to sell the security or it is more likely than not that it will be required to sell the security before recovery. If either of these situations applies, the guidance requires the Company to record an OTTI charge to earnings for the difference between the amortized cost basis of the security and the fair value of the security. If neither of these situations applies, the Company is required to assess whether it is expected to recover the entire amortized cost basis of the security. If the Company is not expected to recover the entire amortized cost basis of the security, the guidance requires the Company to bifurcate the identified OTTI into a credit loss component and a component representing loss related to other factors. A discount rate is applied which equals the effective yield of the security. The difference between the present value of the expected cash flows and the amortized book value is considered a credit loss. When a market price is not readily available, the market value of the security is determined using the same expected cash flows; the discount rate is a rate the Company determines from open market and other sources as appropriate for the security. The difference between the market value and the present value of cash flows expected to be collected is recognized in accumulated other comprehensive loss on the consolidated statements of financial condition. Application of this guidance resulted in no OTTI charges during the three months ended March 31, 2013 and 2012.

The following is a roll-forward for the three months ended March 31, 2013 and 2012 of OTTI charges recognized in earnings as a result of credit losses on investments:


	For the Three Months Ended March 31,
	2013		2012
Cumulative OTTI, beginning of period	$	10,203	$	10,203
Additional increase as a result of net impairment losses recognized on investments		—		—
Decrease as a result of the sale of an investment with net impairment losses		—		—

Cumulative OTTI, end of period	$	10,203	$	10,203

U.S. Treasury Securities. At March 31, 2013, the gross unrealized loss in the category of less than 12 months of $1 thousand consisted of one agency security with an estimated fair value of $31.0 million issued and guaranteed by the U.S. Treasury. The Company monitors key credit metrics such as delinquencies, defaults, cumulative losses and credit support levels to determine if an OTTI exists. As of March 31, 2013, management concluded that an OTTI did not exist on the aforementioned security based upon its assessment. Management also concluded that it does not intend to sell the security, and that it is not more likely than not it will be required to sell the security, before its recovery, which may be maturity, and management expects to recover the entire amortized cost basis of this security.

U.S. Government Agencies. At March 31, 2013, the gross unrealized loss in the category of less than 12 months of $32 thousand consisted of one agency security with an estimated fair value of $4.9 million issued and guaranteed by a U.S. Government sponsored agency. The Company monitors key credit metrics such as delinquencies, defaults, cumulative losses and credit support levels to determine if an OTTI exists. As of March 31, 2013, management concluded that an OTTI did not exist on the aforementioned security based upon its assessment. Management also concluded that it does not intend to sell the security, and that it is not more likely than not it will be required to sell the security, before its recovery, which may be maturity, and management expects to recover the entire amortized cost basis of this security.

U.S. Government Agency Mortgage-Backed Securities. At March 31, 2013, the gross unrealized loss in the category of less than 12 months of $433 thousand consisted of three mortgage-backed securities with an estimated fair value of $26.2 million issued and guaranteed by a U.S. Government sponsored agency. The Company believes the unrealized losses are due to increases in market interest rates since the time the underlying securities were purchased. The Company monitors key credit metrics such as delinquencies, defaults, cumulative losses and credit support levels to determine if an OTTI exists. As of March 31, 2013, management concluded that an OTTI did not exist on any of the aforementioned securities based upon its assessment. Management also concluded that it does not intend nor will it be required to sell the securities, before their recovery, which may be maturity, and management expects to recover the entire amortized cost basis of these securities.

Trust Preferred Securities. At March 31, 2013, the gross unrealized loss in the category of 12 months or longer of $6.3 million consisted of two trust preferred securities. The trust preferred securities are comprised of one non-rated single issuer security with an amortized cost of $3.8 million and an estimated fair value of $2.0 million, and one non-investment grade rated pooled security with an amortized cost of $8.8 million with an estimated fair value of $4.3 million.

For the pooled security, the Company monitors each issuer in the collateral pool with respect to financial performance using data from the issuer’s most recent regulatory reports as well as information on issuer deferrals and defaults. Also, the security structure is monitored with respect to collateral coverage and current levels of subordination. Expected future cash flows are projected assuming additional defaults and deferrals based on the performance of the collateral pool. The non-investment grade pooled security is in a senior position in the capital structure. The security had a 1.94 times principal coverage. As of the most recent reporting date, interest has been paid in accordance with the terms of the security. The Company reviews projected cash flow analysis for adverse changes in the present value of projected future cash flows that may result in an other-than-temporary credit impairment to be recognized through earnings. The most recent valuations assumed no recovery on any defaulted collateral, no recovery on any deferring collateral and an additional 3.6% of defaults or deferrals’ every three years with no recovery rate. As of March 31, 2013, management concluded that an OTTI did not exist on the aforementioned security based upon its assessment. Management also concluded that it does not intend to sell the security, and that it is not more likely than not it will be required to sell the security, before their recovery, which may be maturity, and management expects to recover the entire amortized cost basis of this security.

The financial performance of the non-rated single issuer trust preferred security is monitored on a quarterly basis using data from the issuer’s most recent regulatory reports to assess the probability of cash flow impairment. Expected future cash flows are projected by incorporating the contractual cash flow of the security adjusted, if necessary, for potential changes in the amount or timing of cash flows due to the underlying creditworthiness of the issuer and covenants in the security.

In August 2009, the issuer of the non-rated single issuer trust preferred security elected to defer its normal quarterly dividend payment. As contractually permitted, the issuer may defer dividend payments up to five years with accumulated dividends, and interest on those deferred dividends, payable upon the resumption of its scheduled dividend payments. The issuer is currently operating under an agreement with its regulators. The agreement stipulates that the issuer must receive permission from its regulators prior to resuming its scheduled dividend payments.

During the three months ended March 31, 2013, the Company did not record an OTTI credit-related charge related to this deferring single issuer trust preferred security. Based on the Company’s most recent evaluation, the Company does not expect the issuer to default on the security based primarily on the issuer’s subsidiary bank reporting that it meets the minimum regulatory requirements to be considered a “well capitalized” institution. The Company recognizes that the length of time the issuer has been in deferral, the difficult economic environment and some weakened performance measures, while recently improving, increased the probability that a full recovery of principal and anticipated dividends may not be realized. However, the Company concluded that an impairment charge was not warranted at March 31, 2013.

The amortized cost and estimated fair value of the investment securities, by contractual maturity, at March 31, 2013 and December 31, 2012 are shown below. Actual maturities will differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


March 31, 2013	Available for Sale				Held to Maturity
	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Due in one year or less	$	33,215	$	33,214	$	—	$	—
Due after one year through five years		547		579		250		250
Due after five years through ten years		16,459		17,392		—		—
Due after ten years		42,193		37,442		—		—

Total investment securities, excluding mortgage-backed securities		92,414		88,627		250		250
U.S. Government agency mortgage-backed securities		223,111		228,924		631		670
Other mortgage-backed securities		285		287		—		—

Total investment securities	$	315,810	$	317,838	$	881	$	920

December 31, 2012
Due in one year or less	$	11,437	$	11,452	$	—	$	—
Due after one year through five years		24,697		25,691		250		250
Due after five years through ten years		12,971		13,735		—		—
Due after ten years		41,242		37,040		—		—

Total investment securities, excluding mortgage-backed securities		90,347		87,918		250		250
U.S. Government agency mortgage-backed securities		348,854		354,978		662		710
Other mortgage-backed securities		287		286		—		—

Total investment securities	$	439,488	$	443,182	$	912	$	960

At March 31, 2013, the Company had $101.1 million, amortized cost, and $104.6 million, estimated fair value, of investment securities pledged to secure public deposits. As of March 31, 2013, the Company had $135.9 million, amortized cost, and $140.3 million, estimated fair value, of investment securities pledged as collateral on secured borrowings.

(4) Loans

The components of loans as of March 31, 2013 and December 31, 2012 were as follows:

Loan Components


	March 31, 2013			December 31, 2012
Commercial:
Commercial and industrial	$	556,342		$	556,966
CRE owner occupied		528,033			527,825
CRE non-owner occupied		609,415			584,857
Land and development		43,289			55,919
Consumer:
Home equity lines of credit		200,084			207,720
Home equity term loans		29,235			30,842
Residential real estate		248,875			273,413
Other		36,287			38,618

Total gross loans held-for-investment		2,251,560			2,276,160
Allowance for loan losses		(47,124	)		(45,873	)

Net loans held-for-investment	$	2,204,436		$	2,230,287

Loans past due 90 days and accruing	$	—		$	—

Loans on Non-Accrual Status


	March 31, 2013		December 31, 2012
Commercial:
Commercial & industrial	$	14,963	$	12,156
Commercial & Industrial, held-for-sale		—		1,114
CRE owner occupied		15,024		14,957
CRE owner occupied, held-for-sale		—		3,223
CRE non-owner occupied		4,459		5,305
CRE non-owner occupied, held-for-sale		—		5,298
Land and development		10,568		20,897
Land and development, held-for-sale		—		589
Consumer:
Home equity lines of credit		4,723		3,714
Home equity term loans		1,256		1,226
Residential real estate		5,537		5,747
Other		621		658

Total non-accrual loans	$	57,151	$	74,884

Troubled debt restructuring, non-accrual		16,632		18,244
Troubled debt restructuring, non-accrual, held-for-sale		—		2,499

Many of the Company’s commercial and industrial loans have a real estate component as part of the collateral securing the loan. Additionally, the Company makes commercial real estate loans for the acquisition, refinance, improvement and construction of real property. Loans secured by owner-occupied properties are dependent upon the successful operation of the borrower’s business. If the operating company experiences difficulties in terms of sales volume and/or profitability, the borrower’s ability to repay the loan may be impaired. Loans secured by properties where repayment is dependent upon payment of rent by third-party tenants or the sale of the property may be impacted by loss of tenants, lower lease rates needed to attract new tenants or the inability to sell a completed project in a timely fashion and at a profit.

As of March 31, 2013, the Company had $27.0 million outstanding on 14 residential construction, commercial construction and land development relationships which agreements included interest reserves. As of December 31, 2012, the Company had $24.3 million outstanding on 19 residential construction, commercial construction and land development relationships which agreements included interest reserves. The total amount available in those reserves to fund interest payments was $3.4 million and $3.6 million at March 31, 2013 and December 31, 2012, respectively. There were no relationships with interest reserves which were on non-accrual status as of March 31, 2013 and December 31, 2012. Construction projects are monitored throughout their lives by professional inspectors engaged by the Company. The budgets for loan advances and borrower equity injections are developed at the time of underwriting in conjunction with the review of the plans and specifications for the project being financed. Advances of the Company’s funds are based on the prepared budgets and will not be made unless the project has been inspected by the Company’s professional inspector who must certify that the work related to the advance is in place and properly complete. As it relates to construction project financing, the Company does not extend, renew or restructure terms unless its borrower posts cash collateral in an interest reserve.

Included in the Company’s loan portfolio are modified commercial loans. Per FASB ASC 310-40, Troubled Debt Restructuring, a modification is one in which the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider, such as providing a below market interest rate and/or forgiving principal or previously accrued interest; this modification may stem from an agreement or be imposed by law or a court, and may involve a multiple note structure. Generally, prior to the modification, the loans which are modified as a troubled debt restructuring (“TDR”) are already classified as non-performing. These loans may only be returned to performing (i.e. accrual status) after considering the borrower’s sustained repayment performance for a reasonable amount of time, generally six months; this sustained repayment performance may include the period of time just prior to the restructuring. During the first quarter of 2013, the Company entered into one TDR agreement. At March 31, 2013, the carrying value of this TDR was $197 thousand. The Company granted a concession to a distressed borrower affected by Hurricane Sandy by providing interest only payments for a period of six months. The TDR is currently on non-accrual status.

(5) Allowance for Loan Losses

Changes in the allowance for loan losses were as follows:

Allowance for Loan Losses and Recorded Investment in Financing Receivables


	For the Three Months Ended March 31, 2013
	Commercial and Industrial			Home Equity⁽¹⁾			Residential Real Estate			Other			Total
Allowance for loan losses:
Beginning balance	$	33,197		$	2,734		$	3,333		$	6,609		$	45,873
Charge-offs		(2,986	)		(665	)		—			(151	)		(3,802	)
Recoveries		4,758			53			3			68			4,882

Net recoveries (charge-offs)		1,772			(612	)		3			(83	)		1,080
Provision for loan losses		735			2,625			(333	)		(2,856	)		171
Ending balance	$	35,704		$	4,747		$	3,003		$	3,670		$	47,124

Ending balance: individually evaluated for impairment	$	2,021		$	—		$	119		$	—		$	2,140

Ending balance: collectively evaluated for impairment	$	35,430		$	4,763		$	2,894		$	1,897		$	44,984

Financing Receivables:
Ending balance	$	1,737,079		$	229,319		$	248,875		$	36,287		$	2,251,560

Ending balance: individually evaluated for impairment	$	61,339		$	5,923		$	5,734		$	618		$	73,614

Ending balance: collectively evaluated for impairment	$	1,675,740		$	223,396		$	243,141		$	35,669		$	2,177,946

(1)	Amount includes both home equity lines of credit and term loans


	For the Three Months Ended March 31, 2012
	Commercial and Industrial			Home Equity⁽¹⁾			Residential Real Estate			Other⁽²⁾			Total
Allowance for loan losses:
Beginning balance	$	34,227		$	2,566		$	903		$	3,971		$	41,667
Charge-offs		(20,053	)		(462	)		(32	)		(253	)		(20,800	)
Recoveries		500			27			5			45			577

Net charge-offs		(19,553	)		(435	)		(27	)		(208	)		(20,223	)
Provision for loan losses		29,380			709			374			220			30,683
Ending balance	$	44,054		$	2,840		$	1,250		$	3,983		$	52,127

Ending balance: individually evaluated for impairment	$	1,909		$	—		$	—		$	—		$	1,909

Ending balance: collectively evaluated for impairment	$	42,145		$	2,840		$	1,250		$	3,983		$	50,218

Financing Receivables:
Ending balance	$	1,820,054		$	258,741		$	109,807		$	36,952		$	2,225,554

Ending balance: individually evaluated for impairment	$	103,685		$	3,833		$	2,545		$	210		$	110,273

Ending balance: collectively evaluated for impairment	$	1,716,369		$	254,908		$	107,262		$	36,742		$	2,115,281

(1)	Amount includes both home equity lines of credit and term loans

(2)	Includes the unallocated portion of the allowance for loan losses.

The allowance for loan losses was $47.1 million and $45.9 million at March 31, 2013 and December 31, 2012, respectively. The ratio of allowance for loan losses to gross loans receivable was 2.09% at March 31, 2013 and 2.02% at December 31, 2012.

The provision for loan losses charged to expense is based upon historical loan loss experience, a series of qualitative factors and an evaluation of estimated losses in the current loan portfolio, including the evaluation of impaired loans under FASB ASC 310, Receivables (“FASB ASC 310”). Values assigned to the qualitative factors and those developed from historic loss experience provide a dynamic basis for the calculation of reserve factors for both pass-rated loans (general pooled allowance) and those criticized and classified loans that continue to perform.

A loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan. An insignificant delay or insignificant shortfall in amount of payments does not necessarily result in a loan being identified as impaired. For this purpose, delays less than 90 days are considered to be insignificant. Impairment losses are included in the provision for loan losses in the consolidated statements of operations. Loans not individually reviewed are evaluated as a group using reserve factor percentages based on historical loss experience and qualitative factors. Such loans generally include consumer loans, residential real estate loans and small business loans. In determining the appropriate level of the general pooled allowance, management makes estimates based on internal risk ratings, which take into account such factors as debt service coverage, loan-to-value ratios, management’s abilities and external factors.

The following table presents the Company’s components of impaired loans receivable, segregated by class of loans. Commercial and consumer loans that were collectively evaluated for impairment are not included in the data that follows:


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Accrued Interest Income Recognized		Cash Interest Income Recognized
For the Three Months Ended March 31, 2013
With no related allowance:
Commercial:
Commercial & industrial	$	7,262	$	7,667	$	—	$	7,455	$	—	$	—
CRE owner occupied		20,165		33,893		—		21,552
CRE non-owner occupied		3,986		4,369		—		4,737		—		—
Land and development		11,111		12,661		—		14,924		—		—
Consumer:
Home equity lines of credit		4,723		6,068		—		3,944		—		—
Home equity term loans		1,200		1,336		—		1,242		2		2
Residential real estate		5,293		5,774		—		5,348		7		7
Other		618		1,475		—		561		2		2

With an allowance recorded:
Commercial:
Commercial & industrial	$	13,054	$	13,474	$	1,178	$	9,872	$	—	$	—
CRE owner occupied		5,289		9,453		707		5,296		—		—
CRE non-owner occupied		473		473		135		53		—		—
Consumer:
Residential Real Estate		443		453		119		371		—		—

Total commercial	$	61,339	$	81,990	$	2,021	$	63,889	$	—	$	—
Total consumer	$	12,276	$	15,105	$	119	$	11,466	$	11	$	11

For the Year Ended December 31, 2012
With no related allowance:
Commercial:
Commercial & industrial	$	17,257	$	19,260	$	—	$	14,977	$	53	$	53
Commercial & Industrial, held-for-sale		1,125		2,252		—		1,987		—		—
CRE owner occupied		22,586		44,110		—		25,521		86		86
CRE owner occupied held-for-sale		5,596		17,091		—		11,384		—		—
CRE non-owner occupied		5,305		9,761		—		14,452		24		2 4
CRE non-owner occupied held-for-sale		5,428		9,583		—		5,269		—		—
Land and development		20,649		33,607		—		27,353		22		22
Land and development held-for-sale		589		2,124		—		1,255		—		—
Consumer:
Residential real estate		5,428		5,852		—		4,334		—		—
Home Equity Lines of Credit		3,582		4,610		—		2,942		9		9
Home Equity Term Loans		1,174		1,285		—		1,023		3		3
Other		631		1,489		—		231		—		—

With an allowance recorded:
Commercial:
Commercial & industrial	$	—	$	939	$	—	$	1,222	$	—	$	—
CRE owner occupied		4,649		8,779		649		6,029		—		—
Land and development		997		1,013		302		553		—		—
Consumer:
Residential Real Estate		184		194		98		71		—		—
Other		—		—		—		4		—		—

Total commercial	$	84,182	$	148,519	$	951	$	110,002	$	185	$	185
Total consumer	$	10,999	$	13,430	$	98	$	8,605	$	12	$	12

The unaudited condensed consolidated statements of operations for the three months ended March 31, 2013 included $11 thousand of recognized interest income (on the accrual and cash basis) on average impaired loans of $75.4 million.

In accordance with FASB ASC 310, those impaired loans which are fully collateralized do not result in a specific allowance for loan losses. Included in impaired loans at March 31, 2013 were five TDRs, all of which were fully collateralized. In addition, one of the TDRs at March 31, 2013 included a commitment to lend additional funds of $143 thousand as of March 31, 2013.

The following table presents an analysis of the Company’s TDR agreements entered into during the three months ended March 31, 2013 and the three months ended March 31, 2012.

Troubled Debt Restructurings

As of March 31, 2013

Number of
Contracts

Pre-Modification
Outstanding
Recorded
Investment

Post-Modification
Outstanding
Recorded
Investment

Residential real estate

199

197


	Troubled Debt Restructurings
	As of March 31, 2012
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
CRE owner occupied		11	$	31,950	$	21,436
Commercial and industrial		3		8,760		4,973
CRE non-owner occupied		1		265		265

During the three months ended March 31, 2013 and the three months ended March 31, 2012, the Company did not have any TDR agreements that had subsequently defaulted.

The following table presents the Company’s distribution of risk ratings within the held-for-investment loan portfolio, segregated by class, as of March 31, 2013 and December 31, 2012:

Credit Quality Indicators by Internally Assigned Grade


	Commercial & industrial	CRE owner occupied	CRE non-owner occupied	Land and development	Home Equity Lines of Credit	Home Equity Term Loans		Residential Real Estate		Other
As of March 31, 2013
Grade:
Pass	$ 462,867	$ 441,690	$ 567,426	$ 30,722	$ 192,146	$	27,947	$	240,736	$	35,282
Special Mention	50,518	33,578	24,768	—	—		—		—		—
Substandard	42,958	52,765	17,220	12,567	7,938		1,288		8,139		1,005

Total	$ 556,343	$ 528,032	$ 609,415	$ 43,289	$ 200,084	$	29,235	$	248,875	$	36,287

As of December 31, 2012

Grade:
Pass	$ 479,983	$ 456,576	$ 544,645	$ 32,791	$ 200,429	$	29,561	$	265,139	$	37,561
Special Mention	36,233	19,955	24,885	—	—		—		—		—
Substandard	40,750	51,294	15,327	23.128	7,291		1,281		8,274		1,057

Total	$ 556,966	$ 527,825	$ 584,857	$ 55,919	$ 207,720	$	30,842	$	273,413	$	38,618

The Company’s primary tool for assessing risk when evaluating a loan in terms of its underwriting, structure, documentation and eventual collectability is a risk rating system where the loan is assigned a numeric value. Behind each numeric category is a defined set of characteristics reflective of the particular level of risk.

The risk rating system is based on a nine point grade using a two-digit scale. The lower five grades are for “pass” categories, while the higher four grades represent “criticized” categories which are equivalent to the guidelines utilized by the Office of the Comptroller of the Currency (“OCC”).

The loan officer is responsible for assigning, maintaining, and documenting accurate risk ratings for all commercial loans and commercial real estate loans. The loan officer assigns a risk rating at the inception of the loan, reaffirms it at each renewal, extension, or modification, and adjusts the rating based on the performance of the loan. As part of the loan review process, a regional credit officer will review risk ratings for accuracy. The loan officer’s risk rating will also be reviewed periodically by the loan review department and the Bank’s regulators.

To calculate risk ratings in a consistent fashion, the Company uses a Risk Rating Form that provides for a numerical grade to be assigned up to six characteristics of a loan including elements of its financial condition, abilities of management, position in the market, collateral support and the impact of changing conditions. When combined, an overall risk rating is provided. A separate set of risk rating elements are provided for loans associated with the financing of real estate projects.

Aging of Receivables


	30-59 Days Past Due		60-89 Days Past Due		90 Days Past Due		Total Past Due		Current		Total Financing Receivables		Loans 90 Days Past Due and Accruing
As of March 31, 2013
Commercial:
Commercial & industrial	$	5,525	$	3,105	$	1,805	$	10,435	$	545,907	$	556,342	$	—
CRE owner occupied		3,963		1,947		10,584		16,494		511,539		528,033		—
CRE non-owner occupied		623		—		2,642		3,265		606,150		609,415		—
Land and development		—		—		11,012		11,012		32,277		43,289		—
Consumer:														—
Home equity lines of credit		2,095		583		3,377		6,055		194,029		200,084		—
Home equity term loans		280		214		1,014		1,508		27,727		29,235		—
Residential real estate		612		134		5,127		5,873		243,002		248,875		—
Other		406		271		431		1,108		35,179		36,287		—

Total	$	13,504	$	6,254	$	35,992	$	55,750	$	2,195,810	$	2,251,560	$	—

As of December 31, 2012
Commercial:
Commercial & industrial	$	3,192	$	797	$	2,350	$	6,339	$	550,627	$	556,966	$	—
CRE owner occupied		5,828		223		10,811		16,862		510,963		527,825		—
CRE non-owner occupied		4,037		1		2,974		7,012		577,845		584,857		—
Land and development		3.823		—		12,139		15,962		39,957		55,919		—
Consumer:
Home equity lines of credit		2,296		880		2,518		5,694		202,026		207,720		—
Home equity term loans		960		340		972		2,272		28,570		30,842		—
Residential real estate		8,387		328		5,288		14,003		259,410		273,413		—
Other		599		273		499		1,371		37,247		38,618		—

Total	$	29,122	$	2,842	$	37,551	$	69,515	$	2,206,645	$	2,276,160	$	—

(6) Real Estate Owned

Real estate owned at March 31, 2013 and December 31, 2012 was as follows:


	March 31, 2013		December 31, 2012
Commercial properties	$	6,619	$	5,382
Residential properties		458		696
Bank properties		1,395		1,395

Total	$	8,472	$	7,473

Summary of Real Estate Owned Activity

Commercial
Properties

Residential
Properties

Bank
Properties

Total

Beginning balance, January 1, 2013

5,382

696

1,395

7,473

Transfers from loans

1,960

110

—

2,070

Sale of real estate owned

(665

)

(348

)

—

(1,013

)

Write down of real estate owned

(58

)

—

(58

)

Ending balance, March 31, 2013

6,619

458

1,395

8,472

(7) Derivative Financial Instruments and Hedging Activities

Derivative financial instruments involve, to varying degrees, interest rate, market and credit risk. The Company manages these risks as part of its asset and liability management process and through credit policies and procedures. The Company seeks to minimize counterparty credit risk by establishing credit limits and collateral agreements. The Company utilizes certain derivative financial instruments to enhance its ability to manage interest rate risk that exists as part of its ongoing business operations. In general, the derivative transactions entered into by the Company fall into one of two types: a fair value hedge of a specific fixed-rate loan agreement and an economic hedge of a derivative offering to a Bank customer. The Company does not use derivative financial instruments for trading purposes.

Fair Value Hedges – Interest Rate Swaps. The Company has entered into interest rate swap arrangements to exchange the periodic payments on fixed-rate commercial loan agreements for variable-rate payments based on the one-month London Interbank Offered Rate (“LIBOR”) without the exchange of the underlying principal. The interest rate swaps are designated as fair value hedges under FASB ASC 815, Derivatives and Hedging (“FASB ASC 815”), and are executed for periods and terms that match the related underlying fixed-rate loan agreements. The Company applies the “shortcut” method of accounting under FASB ASC 815, which assumes there is no ineffectiveness of a hedging arrangement’s ability to hedge risk as changes in the interest rate component of the swaps’ fair value are expected to exactly offset the corresponding changes in the fair value of the underlying commercial loan agreements. Because the hedging arrangement is considered highly effective, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in a net impact to earnings; however, there may be fair value adjustments related to credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820, Fair Value Measurements and Disclosures (“FASB ASC 820”). The fair value adjustments related to credit quality were not material as of March 31, 2013 and December 31, 2012.

The following tables provide information pertaining to interest rate swaps designated as fair value hedges under FASB ASC 815 at March 31, 2013 and December 31, 2012:

Summary of Interest Rate Swaps Designated As Fair Value Hedges


	March 31, 2013					December 31, 2012
Balance Sheet Location	Notional		Fair Value			Notional		Fair Value
Other liabilities	$	26,561	$	(2,842	)	$	30,545	$	(3,503	)

Summary of Interest Rate Swap Components


	March 31, 2013			December 31, 2012
Weighted average pay rate		6.91	%		6.85	%
Weighted average receive rate		2.24	%		2.22	%
Weighted average maturity in years		2.5			2.6

Customer Derivatives – Interest Rate Swaps/Floors. The Company enters into interest rate swaps that allow our commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to an interest rate swap agreement, which serves to effectively swap the customer’s variable-rate loan into a fixed-rate loan. The Company then enters into a corresponding swap agreement with a third party in order to economically hedge its exposure on the variable and fixed components of the customer agreement. The interest rate swaps with both the customers and third parties are not designated as hedges under FASB ASC 815 and are marked to market through earnings. As the interest rate swaps are structured to offset each other, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in an impact to earnings; however, there may be fair value adjustments related to credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820. The Company recognized negative derivative valuation adjustments of $504 thousand and $314 thousand in fair value adjustment charges during the three months ended March 31, 2013 and 2012, respectively. These balances included swap termination fees of $26 thousand and $156 thousand during the three months ended March 31, 2013 and 2012, respectively. These amounts are included in the derivative credit valuation adjustment in the unaudited condensed consolidated statements of operations as a reduction to other income.


	March 31, 2013					December 31, 2012
Balance Sheet Location	Notional		Fair Value			Notional		Fair Value
Other assets	$	334,916	$	35,617		$	358,753	$	40,594
Other liabilities		334,916		(36,203	)		358,753		(40,646	)

In addition, the Company has entered into an interest rate floor sale transaction with one commercial customer. The Company entered into corresponding interest rate floor purchase transactions with a third party in order to offset its exposure on the variable and fixed components of the customer agreements. As the interest rate floors with both the customer and the third party are not designated as hedges under FASB ASC 815, the instruments are marked to market through earnings. As the interest rate floors are structured to offset each other, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in a net impact to earnings; however, there may be fair value adjustments related to credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820. The combined notional amount of the two interest rate floors was $15.7 million and $15.9 million at March 31, 2013 and December 31, 2012, respectively.

Interest rate lock commitments on residential mortgages. As a part of its normal residential mortgage operations, the Bank will enter into an interest rate lock commitment with a potential borrower. The Bank enters into a corresponding commitment to an investor to sell that loan at a specific price shortly after origination. In accordance with FASB ASC 820, adjustments are recorded through earnings to account for the net change in fair value of these transactions. The interest rate lock commitment had notional amounts of $91.5 million for the held-for-sale pipeline, as of March 31, 2013.

(8) Deposits

Deposits consist of the following major classifications:


	March 31, 2013		December 31, 2012
Interest-bearing demand deposits	$	1,251,135	$	1,215,548
Non-interest-bearing demand deposits		520,186		535,635
Savings deposits		269,194		264,155
Time certificates under $100,000		321,779		323,768
Time certificates $100,000 or more		247,834		256,725
Brokered time deposits		113,209		117,393

Total	$	2,723,337	$	2,713,224

(9) Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of shares of common stock outstanding, net of any treasury shares, during the period. Diluted earnings per share is calculated by dividing net income (loss) available to common shareholders by the weighted average number of shares of common stock outstanding, net of any treasury shares, after consideration of the potential dilutive effect of common stock equivalents, based upon the treasury stock method using an average market price for the period.

Earnings (Loss) Per Share Computation


	For the Three Months Ended March 31,
	2013		2012
Net income (loss)	$	2,453	$	(28,078	)
Average common shares outstanding		86,245,121		85,776,858
Net effect of dilutive common stock equivalents		125,314		—

Adjusted average shares outstanding - dilutive		86,370,435		85,776,858

Basic earnings (loss) per share	$	0.03	$	(0.33	)
Diluted earnings (loss) per share	$	0.03	$	(0.33	)

(10) Commitments and Contingent Liabilities

Letters of Credit

In the normal course of business, the Company has various commitments and contingent liabilities, such as customers’ letters of credit (including standby letters of credit of $40.3 million and $40.5 million at March 31, 2013 and December 31, 2012, respectively) which are not reflected in the accompanying unaudited condensed consolidated financial statements. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In the judgment of management, the financial condition of the Company will not be affected materially by the final outcome of any letters of credit.

Reserve for Unfunded Commitments

The Company maintains a reserve for unfunded loan commitments and letters of credit which is reported in other liabilities in the unaudited condensed consolidated statements of financial condition consistent with FASB ASC 825, Financial Instruments. As of March 31, 2013, the Company recorded estimated losses inherent with unfunded loan commitments in accordance with FASB ASC 450, Contingencies, and estimated future obligations under letters of credit in accordance with FASB ASC 460, Guarantees. The methodology used to determine the adequacy of this reserve is integrated in the Company’s process for establishing the allowance for loan losses and considers the probability of future losses and obligations that may be incurred under these off-balance sheet agreements. The reserve for unfunded loan commitments and letters of credit at March 31, 2013 and December 31, 2012 was $721 thousand and $613 thousand, respectively. Management believes this reserve level is sufficient to absorb estimated probable losses related to these commitments.

Reserve for Residential Mortgage Loans Sold with Recourse

The Company maintains a reserve for residential mortgage loans sold with recourse to third-party purchasers which is reported in other liabilities in the consolidated statements of financial condition. As of March 31, 2013, the Company records estimated losses inherent with residential mortgage loans sold with recourse in accordance with FASB ASC 450, Contingencies. This reserve is determined based upon the probability of future losses which is calculated using historical Company and industry loss data. The reserve for residential mortgage loan recourse as of March 31, 2013 and December 31, 2012 was $425 thousand and $325 thousand, respectively. Management believes this reserve level is sufficient to address potential recourse exposure.

(11) Fair Value of Financial Instruments

The Company accounts for fair value measurement in accordance with FASB ASC 820. FASB ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. FASB ASC 820 does not require any new fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value. FASB ASC 820 clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability. The definition focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). FASB ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement and also clarifies the application of fair value measurement in a market that is not active.

FASB ASC 820 describes three levels of inputs that may be used to measure fair value:

•

Level 1 - Quoted prices in active markets for identical assets or liabilities.

•

Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

•

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

FASB ASC 820 requires the Company to disclose the fair value for financial assets on both a recurring and non-recurring basis. The assets and liabilities measured at fair value on a recurring basis are as follows:


			Category Used for Fair Value Measurement
March 31, 2013	Total		Level 1		Level 2		Level 3
Assets:
Investment securities available for sale:
U.S. Treasury securities	$	30,985	$	30,985	$	—	$	—
U.S. Government agencies		4,935		—		4,935		—
U.S. Government agency mortgage-backed securities		228,924		—		228,924		—
Other mortgage-backed securities		287		—		287		—
State and municipal securities		33,652		—		33,652		—
Trust preferred securities		6,303		—		—		6,303
Collateralized loan obligations		10,500		—		—		10,500
Other securities		2,252		2,252		—		—
Residential mortgage loans held-for-sale		41,469		—		41,469		—
Interest rate lock commitments on residential mortgages		633		—		—		633
Interest rate swaps		35,617		—		35,617		—
Interest rate floor		237		—		237		—
Liabilities:
Fair value interest rate swaps		2,842		—		2,842		—
Interest rate swaps		36,203		—		36,203		—
Interest rate floor		237		—		237		—

December 31, 2012
Assets:
Investment securities available for sale:
U.S. Treasury securities	$	10,011	$	10,011	$	—	$	—
U.S. Government agencies		4,949				4,949
U.S. Government agency mortgage-backed securities		354,978		—		354,978		—
Other mortgage-backed securities		286		—		286		—
State and municipal obligations		40,170		—		40,170		—
Trust preferred securities		5,882		—		—		5,882
Corporate bonds		25,442		—		25,442		—
Other securities		1,464		1.464		—		—
Residential loans held-for-sale		99,013		—		99,013		—
Interest rate lock commitments on residential mortgages		847		—		—		847
Interest rate swaps		40,594		—		40,594		—
Interest rate floor		275		—		275		—
Liabilities:
Fair value interest rate swaps		3,503		—		3,503		—
Interest rate swaps		40,646		—		40,646		—
Interest rate floor		275		—		275		—

Level 1 Valuation Techniques and Inputs

U.S. Treasury securities. The Company reports U.S. Treasury securities at fair value utilizing Level 1 inputs. These securities are priced using observable quotations for the indicated security.

Other securities. The other securities category is comprised of money market mutual funds. Given the short maturity structure and the expectation that the investment can be redeemed at par value, the fair value of these investments is assumed to be the book value.

Level 2 Valuation Techniques and Inputs

The majority of the Company’s investment securities are reported at fair value utilizing Level 2 inputs. Prices of these securities are obtained through independent, third-party pricing services. Prices obtained through these sources include market derived quotations and matrix pricing and may include both observable and unobservable inputs. Fair market values take into consideration data such as dealer quotes, new issue pricing, trade prices for similar issues, prepayment estimates, cash flows, market credit spreads and other factors. The Company reviews the output from the third-party providers for reasonableness by the pricing consistency among securities with similar characteristics, where available, and by comparing values with other pricing sources available to the Company.

In general, the Level 2 valuation process uses the following significant inputs in determining the fair value of the Company’s different classes of investments:

U.S. Government agency securities. The Company’s U.S. agency securities consist of a fixed rate agency callable security. These securities are evaluated based on either a nominal spread basis for non–callable securities or an option adjusted spread (“OAS”) basis for callable securities. The nominal spread and OAS levels are derived from observations of identical or comparable securities actively trading in the markets.

U.S. Government agency mortgage-backed securities. The Company’s agency mortgage-backed securities generally fall into one of two categories, fixed-rate agency mortgage-backed pools or adjustable-rate agency mortgage-backed pools.

Fixed-rate agency mortgage-backed pools are evaluated based on spreads to actively traded To-Be-Announced (“TBA”) and seasoned securities, the pricing of which is provided by inter-dealer brokers, broker dealers and other contributing firms active in trading the security class. Further delineation is made by weighted average coupon (“WAC”) and weighted average maturity (“WAM”) with spreads on individual securities relative to actively traded securities as determined and quality controlled using OAS valuations.

Adjustable-rate agency mortgage-backed pools are evaluated on a bond equivalent effective margin (“BEEM”) basis obtained from broker-dealers and other contributing firms active in the market. BEEM levels are established for key sectors using characteristics such as month-to-roll, index, periodic and life caps and index margins and convertibility. Individual securities are then evaluated based on how their characteristics map to the sectors established.

Other mortgage-backed securities. The Company’s other mortgage-backed securities consist of whole loan, non-agency collateralized mortgage obligations (“CMOs,” individually, each a “CMO”). These securities are evaluated based on generic tranches and generic prepayment speed estimates of various types of collateral from contributing firms and broker/dealers in the whole loan CMO market.

State and municipal obligations. These securities are evaluated using information on identical or similar securities provided by market makers, broker/dealers and buy-side firms, new issue sales and bid-wanted lists. The individual securities are then priced based on mapping the characteristics of the security such as obligation type (general obligation, revenue, etc.), maturity, state discount and premiums, call features, taxability and other considerations.

Corporate bonds. The fair value measurements for corporate bonds consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit quality information and the bond’s terms and conditions, among other things. If relevant and observable prices are available, those valuations would be classified as Level 2.

Residential mortgage loans held-for-sale. Effective July 1, 2012, the Company’s residential mortgage loans held-for-sale were recorded at fair value utilizing Level 2 measurements. This fair value measurement is determined based upon third party quotes obtained on similar loans. The Company adopted the fair value option on these loans as it believes the fair value measurement of such loans reduces certain timing differences between related revenue and expense recognition in the Company’s financial statements and better aligns with the management of the portfolio from a business perspective. The fair value option allows the Company to record the mortgage loans held-for-sale portfolio at fair market value as opposed to the lower of cost or market. The Company economically hedges its residential loans held for sale portfolio with forward sale agreements which are reported at fair value. A lower of cost or market accounting treatment would not allow the Company to record the excess of the fair market value over book value but would require the Company to record the corresponding reduction in value on the hedges. Both the loans and related hedges are carried at fair value which reduces earnings volatility. For loans held-for-sale for which the fair value option has been elected, the aggregate fair value exceeded the aggregate principal balance by $821 thousand as of March 31, 2013. There were no residential mortgage loans held-for-sale that were nonaccrual or 90 or more days past due as of March 31, 2013 or December 31, 2012. Interest income on these loans is recognized in interest and fees on loans in the consolidated statements of operations.

Interest rate swaps. The Company’s interest rate swaps, including fair value interest rate swaps and small exposures in interest rate caps and floors, are reported at fair value utilizing models provided by an independent, third-party and observable market data. When entering into an interest rate swap agreement, the Company is exposed to fair value changes due to interest rate movements, and also the potential nonperformance of our contract counterparty. Interest rate swaps are evaluated based on a zero coupon LIBOR curve created from readily observable data on LIBOR, interest rate futures and the interest rate swap markets. The zero coupon curve is used to discount the projected cash flows on each individual interest rate swap. In addition, the Company has developed a methodology to value the nonperformance risk based on internal credit risk metrics and the unique characteristic of derivative instruments, which include notional exposure rather than principal at risk and interest payment netting. The results of this methodology are used to adjust the base fair value of the instrument for the potential counterparty credit risk. Interest rate caps and floors are evaluated using industry standard options pricing models and observed market data on LIBOR and Eurodollar option and cap/floor volatilities.

Level 3 Valuation Techniques and Inputs

Trust preferred securities. The trust preferred securities are evaluated on a quarterly basis based on whether the security is an obligation of a single issuer or part of a securitization pool. For single issuer obligations, the Company uses discounted cash flow models which incorporate the contractual cash flow for each issue adjusted as necessary for any potential changes in amount or timing of cash flows. The cash flow model of a pooled issue incorporates anticipated loss rates and severities of the underlying collateral as well as credit support provided within the securitization. At least quarterly, the Company’s Treasury personnel review the modeling assumptions and the discount and forward rates. Changes in those assumptions could potentially have a significant impact on the fair value of the trust preferred securities.

The cash flow model for the pooled issue owned by the Company at March 31, 2013 and December 31, 2012 assumes no recovery on defaulted collateral, no recovery on securities in deferral and an additional 3.6% future default rate assumption on the remaining performing collateral every three years with no recovery rate.

For trust preferred securities, projected cash flows are discounted at a rate based on a trading group of similar securities quoted on the New York Stock Exchange (“NYSE”) or over-the-counter markets which is reviewed for market data points such as credit rating, maturity, price and liquidity. The Company indexes the securities to a comparable maturity interest rate swap to determine the market spread, which is then used as the discount rate in the cash flow models. As of the reporting date, those market spreads were 5.5% for the pooled security and 9.5% for the single issuer that is currently deferring interest payments. An increase or decrease of 3% in the discount rate on the pooled issue would result in a decrease of $1.4 million or an increase of $2.4 million in the security fair value, respectively. An increase or decrease of 3% in the discount rate on the single issuer would result in a decrease of $440 thousand or an increase of $705 thousand in the security fair value, respectively.

Collateralized loan obligations. The fair value measurements for collateralized loan obligations are obtained through a third party pricing service. Inputs into the model-based valuations can include changes in market indexes, selling prices of similar securities, management’s assumptions related to the credit rating of the security, prepayment assumptions and other factors such as credit loss assumptions and management’s assessment of the current market conditions. Those valuations would be classified as Level 3. Due to the proximity of the purchases of these securities to the balance sheet date, the fair value of the collateralized loan obligations equaled their purchase price at March 31, 2013.

Interest rate lock commitments on residential mortgages. The determination of the fair value of interest rate lock commitments is based on agreed upon pricing with the respective investor on each loan and includes a pull through percentage. The pull through percentage represents an estimate of loans in the pipeline to be delivered to an investor versus the total loans committed for delivery. Significant changes in this input could result in a significantly higher or lower fair value measurement. As the pull through percentage is a significant unobservable input, this is deemed a Level 3 valuation input. The pull through percentage, which is based upon historical experience, was 70% as of March 31, 2013 and December 31, 2012. An increase or decrease of 20% in the pull through assumption would result in a positive or negative change of $181 thousand in the fair value of interest rate lock commitments. The fair value of interest rate lock commitments was $633 thousand at March 31, 2013 and $847 thousand at December 31, 2012.

Fair Value Measurements Using Significant Unobservable Inputs-Level 3

Investment Securities


	For the Three Months Ended March 31,
	2013		2012
Balance, beginning of period	$	5,882	$	4,908
Total gains, realized/unrealized:
Included in earnings		—		—
Included in accumulated other comprehensive income		421		1,070
Purchases		10,500		—
Maturities		—		—
Prepayments		—		—
Calls		—		—
Transfers into Level 3		—		—

Balance, end of period	$	16,803	$	5,978

Fair Value Measurements Using Significant Unobservable Inputs-Level 3

Interest Rate Lock Commitments on Residential Mortgages


	For the Three Months Ended March 31,
	2013			2012
Balance, beginning of period	$	847		$	—
Total gains, realized/unrealized:
Included in earnings⁽¹⁾		(214	)		—
Included in accumulated other comprehensive income					—
Transfers into Level 3		—			—

Balance, end of period	$	633		$	—

(1)	Amount included in mortgage banking revenue, net of the unaudited condensed consolidated statements of operations.

Certain assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The Company measures impaired loans, Small Business Administration (“SBA”) servicing assets, restricted equity investments, goodwill and loans or bank properties transferred into other real estate owned at fair value on a non-recurring basis. At March 31, 2013 and 2012, these assets were valued in accordance with GAAP and, except for impaired loans and real estate owned included in the following table, did not require fair value disclosure under the provisions of FASB ASC 820.


			Category Used for Fair Value Measurement						Total Losses Or Changes in Net Assets
	Total		Level 1		Level 2		Level 3		Total Losses Or Changes in Net Assets
March 31, 2013
Assets:
Impaired loans	$	55,560	$	—	$	—	$	55,560	$	(3,896	)
Real estate owned		154		—		—		154		(58	)
March 31, 2012
Assets:
Impaired loans	$	63,143	$	—	$	—	$	63,143	$	(17,092	)
Real estate owned		84		—		—		84		(103	)

Under FASB ASC 310, the fair value of collateral dependent impaired loans is based on the fair value of the underlying collateral, typically real estate, which is based on valuations. It is the policy of the Company to obtain a current appraisal or evaluation when a loan has been identified as non-performing. The type of appraisal obtained will be commensurate with the size and complexity of the loan. The resulting value will be adjusted for the potential cost of liquidation and decline of values in the market. New appraisals will be obtained on an annual basis until the loan is repaid in full, liquidated, or returns to performing status.

While the loan policy dictates that a loan be assigned to the special assets department when it is placed on non-accrual status, there is a need for loan officers to consistently and accurately determine collateral values when a loan is initially designated as criticized or classified. The most effective means of determining the fair value of real estate collateral at a point in time is by obtaining a current appraisal or evaluation of the property. In anticipation of the receipt of a current appraisal or evaluation, the Company has provided for an alternative and interim means of determining the fair value of the real estate collateral.

The most recent appraisal or reported value of the collateral securing a loan, net of a discount for the estimated cost of liquidation, is the Company’s basis for determining fair value.

The following steps are taken to determine the fair value of real estate securing a loan that will be potentially subject to impairment:


Loan Category Used for Impairment Review		Method of Determining the Value
Loans less than $1 million		Evaluation or restricted use appraisal
Loans $1 million or greater
Existing appraisal 18 months or less		Restricted use appraisal
Existing appraisal greater than 18 months		Summary form appraisal
Commercial Loans secured primarily by residential real estate
Loans less than $1 million		Automated valuation model
Loans $1 million or greater		Summary form appraisal
Non-commercial loans secured primarily by residential real estate
Loans less than $250,000		Automated valuation model or summary form appraisal
Loans $250,000 or greater		Summary form appraisal

An evaluation report, as defined by the OCC, is a written report prepared by an appraiser that describes the real estate collateral, its condition, current and projected uses and sources of information used in the analysis, and provided an estimate of value in situations when an appraisal is not required.

A restricted appraisal is defined as a written report prepared under the Uniform Standards of Professional Appraisal Practice (“USPAP”). A restricted use appraisal is for the Company’s use only and should contain a brief statement of information significant to the determination of the collateral value. This report can be used for ongoing collateral monitoring.

A summary form appraisal is defined as a written report prepared under the USPAP which contains a detailed summary of all information significant to the solution of the appraisal problem. This report is more detailed than a restricted use report and provides sufficient information to enable the user to understand the rationale for the opinions and conclusions in the report.

An automated valuation model is an internal computer program that estimates a property’s market value based on market, economic, and demographic factors.

On a quarterly basis, or more frequently as necessary, the Company will review the circumstances of each collateral dependent loan and real estate owned property. A collateral dependent loan is defined as one that relies solely on the operation or the sale of the collateral for repayment. Adjustments to any specific reserve relating to a collateral shortfall, as compared to the outstanding loan balance, will be made if justified by appraisals, market conditions or current events concerning the loan.

All appraisals received which are utilized to determine valuations for criticized and classified loans or properties placed in real estate owned are provided under an “as is” value. Partially charged off loans are measured for impairment upon receipt of an updated appraisal based on the relationship between the remaining balance of the charged down loan and the discounted appraised value. Such loans will remain on non-accrual status unless performance by the borrower warrants a return to accrual status. Recognition of non-accrual status occurs at the time a loan can no longer support principal and interest payments in accordance with the original terms and conditions of the loan documents. When impairment is determined, a specific reserve reflecting any calculated shortfall between the value of the collateral and the outstanding balance of the loan is recorded. Subsequent adjustments, prior to receipt of a new appraisal, to any related specific reserve will be made if justified by market conditions or current events concerning the loan. If an internal discount-based evaluation is being used, the discount percentage may be adjusted to reflect market changes, changes to the collateral value of similar loans or circumstances of the individual loan itself. The amount of the charge off is determined by calculating the difference between the current loan balance and the current collateral valuation, plus estimated cost to liquidate.

Impaired loan fair value measurements are based upon unobservable inputs, and therefore, are categorized as a Level 3 measurement. Specific reserves were calculated for impaired loans with an aggregate carrying amount of $14.6 million and $5.4 million at March 31, 2013 and 2012, respectively. The collateral underlying these loans had a fair value of $13.1 million and $3.6 million, including a specific reserve in the allowance for loan losses of $1.5 million and $1.9 million at March 31, 2013 and 2012, respectively. There were $0 and $55 thousand in charge-offs of impaired loans with specific reserves during the three months ended March 31, 2013 and 2012, respectively. No specific reserve was calculated for impaired loans with an aggregate carrying amount of $42.4 million and $59.6 million at March 31, 2013 and 2012, respectively, as the underlying collateral was not below the carrying amount; however, these loans did include charge-offs of $2.4 million and $15.1 million during the three months ended March 31, 2013 and 2012, respectively.

Once a loan is determined to be uncollectible, the underlying collateral is repossessed and reclassified as other real estate owned. The balance of other real estate owned also includes bank properties transferred from operations. These assets are carried at lower of cost or fair value of the collateral, less cost to sell. In some cases, adjustments are made to the appraised values for various factors including age of the appraisal, age of comparable properties included in the appraisal, and known changes in the market and the collateral. During the three months ended March 31, 2013, the Company recorded decreases in fair value of $58 thousand on two commercial properties. During the three months ended March 31, 2012, the Company recorded a decrease in fair value of $103 thousand on two commercial properties. The adjustments to the bank properties and commercial properties were based upon unobservable inputs, and therefore categorized as Level 3 measurements.

There were no transfers between the three categories of the fair value hierarchy during the three months ended March 31, 2013 or 2012. The Company evaluates its hierarchy on a quarterly basis to ensure proper classification.

Carrying Amounts and Estimated Fair Values of Financial Assets and Liabilities

March 31, 2013

December 31, 2012

Carrying
Amount

Estimated
Fair Value

Carrying
Amount

Estimated
Fair Value

Assets:

Cash and due from banks

63,608

77,564

Interest-earning bank balances

248,052

92,052

Investment securities available for sale

317,838

443,182

Investment securities held to maturity

881

920

912

960

Loans receivable, net

2,177,876

2,049,638

2,203,307

2,055,025

Loans held-for-sale

41,469

123,005

Hedged commercial loans⁽¹⁾

26,540

29,380

26,980

30,477

Restricted equity investments

17,125

17,886

Interest rate lock commitments on residential mortgages

633

847

Interest rate swaps

35,617

40,594

Interest rate floor

237

275

Liabilities:

Demand deposits

1,771,321

1,749,575

1,751,183

1,729,671

Savings deposits

269,194

267,686

264,155

262,636

Time deposits

682,822

680,071

697,886

695,093

Securities sold under agreements to repurchase – customers

2,726

1,968

Advances from FHLBNY

61,077

62,539

61,415

62,784

Junior subordinated debentures

92,786

60,102

92,786

57,072

Fair value interest rate swaps

2,842

3,503

Interest rate swaps

36,203

40,646

Interest rate floor

237

275

(1)	Includes positive market value adjustment of $2.8 million and $3.5 million at March 31, 2013 and December 31, 2012, respectively, which is equal to the change in value of related interest rate swaps designated as fair value hedges of these hedged loans in accordance with FASB ASC 815.

Cash and cash equivalents. For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value. This is a Level 1 fair value input.

Investment securities. For investment securities, fair values are based on a combination of quoted prices for identical assets in active markets, quoted prices for similar assets in markets that are either actively or not actively traded and price models, discounted cash flow methodologies, or similar techniques that may contain unobservable inputs that are supported by little or no market activity and require significant judgment. The fair value of available-for-sale securities is measured using all Level inputs, but primarily Level 2. The fair value of held-to-maturity securities is measured utilizing Level 2 inputs.

Loans receivable. The fair value of loans receivable is estimated using discounted cash flow analysis. Projected future cash flows are calculated using loan characteristics, and assumptions of voluntary and involuntary prepayment speeds. For performing loans, Level 2 inputs are utilized as the cash flow analysis is performed using available market data on the performance of similar loans. Projected cash flows are prepared using discount rates believed to represent current market rates. For non-performing loans, the cash flow assumptions are considered Level 3 inputs as market data is not readily available.

Loans held-for-sale. Loans held-for-sale includes residential mortgage loans that are originated with the intent to sell. These loans were recorded at fair value as the Company elected the fair value option under FASB ASC 825, effective July 1, 2012. The fair value of loans held-for-sale is valued using the quoted market price of such loans, which is a Level 2 input. At December 31, 2012, loans held-for-sale also included $21.9 million of commercial real estate loans recorded at lower of cost or estimated fair value for which the fair value was determined based upon the agreed upon sales price with the third-party purchaser.

Hedged commercial loans. The hedged commercial loans are one component of a declared hedging relationship as defined under FASB ASC 815. The interest rate swap component of the declared hedging relationship is carried at its fair value and the carrying value of the commercial loans includes a similar change in fair values. The fair value of these loans is measured utilizing Level 2 inputs.

Restricted equity securities. Ownership in equity securities of Federal Reserve Bank, FHLBNY and Atlantic Central Bankers Bank is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value. As these securities are not readily marketable, the fair value is based on Level 2 inputs.

Interest rate lock commitments on residential mortgages. The fair value of interest rate lock commitments is estimated using pricing from existing purchase commitments on each loan in the pipeline. This value is adjusted for a pull through estimate which is determined based on historical experience with loan deliveries from the residential mortgage pipeline. As this estimate is unobservable and can result in significant fluctuation in the fair value determination, this is considered a Level 3 input under the fair value hierarchy.

Interest rate swaps/floors and fair value interest rate swaps. The Company’s derivative financial instruments are not exchange-traded and therefore are valued utilizing models with the primary input being readily observable market parameters, specifically the LIBOR swap curve. In addition, the Company incorporates a qualitative fair value adjustment related to credit quality variations between counterparties as required by FASB ASC 820. This is a Level 2 input.

Demand deposits, savings deposits and time deposits. The fair value of demand deposits and savings deposits is determined by projecting future cash flows using an estimated economic life based on account characteristics, a Level 2 input. The resulting cash flow is discounted using rates available on alternative funding sources. The fair value of time deposits is estimated using the rate and maturity characteristics of the deposits to estimate their cash flow. This cash flow is discounted at rates for similar term wholesale funding.

Securities sold under agreements to repurchase – FHLBNY and FHLBNY advances. The fair value is estimated through Level 2 inputs by determining the cost or benefit for early termination of the individual borrowing.

Junior subordinated debentures. The fair value was estimated by discounting approximate cash flows of the borrowings by yields estimating the fair value of similar issues. The valuation model considers current market spreads, known and anticipated credit issues of the underlying collateral, term and reinvestment period and market transactions of similar issues, if available. This is a Level 3 input under the fair value hierarchy.

The fair value estimates presented herein are based on pertinent information available to management as of March 31, 2013 and December 31, 2012. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these condensed consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amount presented herein.

(12) Regulatory Matters

The Company is subject to risk-based capital guidelines adopted by the Board of Governors of the Federal Reserve System (the “FRB”) for bank holding companies. The Bank is also subject to similar capital requirements adopted by the OCC. Under the requirements the federal bank regulatory agencies have established quantitative measures to ensure that minimum thresholds for Total Capital, Tier 1 Capital and Leverage (Tier 1 Capital divided by average assets) ratios (set forth in the table below) are maintained. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets and certain off-balance sheet items as calculated under regulatory practices.

The Company’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the federal bank regulators about components, risk weightings and other factors. The Company’s and the Bank’s risk-based capital ratios have been computed in accordance with regulatory practices. The Company and the Bank were in compliance with these regulatory capital requirements of the FRB and the OCC as of March 31, 2013. As discussed below and elsewhere herein, additional capital requirements have been imposed on the Bank by the OCC, which the Bank was also in full compliance with as of March 31, 2013 and December 31, 2012.

On April 15, 2010, the Bank entered into a written agreement with the OCC (the “OCC Agreement”) which contained requirements to develop and implement a profitability and capital plan which provides for the maintenance of adequate capital to support the Bank’s risk profile in the current economic environment. The capital plan was also required to contain a dividend policy allowing dividends only if the Bank is in compliance with the capital plan, and obtains prior approval from the OCC. During the second quarter of 2010, the Company delivered its profit and capital plans to the OCC.

The Bank also agreed to: (a) implement a program to protect the Bank’s interest in criticized or classified assets, (b) review and revise the Bank’s loan review program; (c) implement a program for the maintenance of an adequate allowance for loan losses; and (d) revise the Bank’s credit administration policies. During the second quarter of 2010, the Company revised and implemented changes to policies and procedures pursuant to the OCC Agreement. The Bank also agreed that its brokered deposits will not exceed 3.5% of its total liabilities unless approved by the OCC. Effective October 18, 2012, the OCC approved an increase of this limit to 6.0%. Management does not expect this restriction will limit its access to liquidity as the Bank does not rely on brokered deposits as a major source of funding. As of March 31, 2013, the Bank’s brokered deposits represented 3.8% of its total liabilities.

In addition, the Federal Reserve Bank of Philadelphia (the “Federal Reserve”) has also recently notified us that we are now required to seek the prior approval of the Federal Reserve before paying interest, principal or other sums on trust preferred securities or any related subordinated debentures.

In October 2011, the Board of Directors of the Company resolved, among other things, not to declare or pay cash dividends, take dividends from the Bank or repurchase its stock, without the prior written approval of the Federal Reserve.

The Bank is also subject to individual minimum capital ratios established by the OCC requiring the Bank to continue to maintain a Leverage ratio at least equal to 8.50% of adjusted total assets, to continue to maintain Tier 1 Capital ratio at least equal to 9.50% of risk-weighted assets and to maintain a Total Capital ratio at least equal to 11.50% of risk-weighted assets. At March 31, 2013, the Bank met all of the three capital ratios established by the OCC as its Leverage ratio was 9.33%, its Tier 1 Capital ratio was 12.25%, and its Total Capital ratio was 13.50%.

The following table provides both the Company’s and the Bank’s risk-based capital ratios as of March 31, 2013 and December 31, 2012.

Regulatory Capital Levels


	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provision⁽¹⁾
	Amount		Ratio			Amount		Ratio			Amount			Ratio
March 31, 2013
Total capital (to risk-weighted assets):
Sun Bancorp, Inc.	$	342,986		14.21	%	$	193,163		8.00	%			N/A
Sun National Bank		325,398		13.50			192,760		8.00		$	240,950			10.00	%
Tier I capital (to risk-weighted assets):
Sun Bancorp, Inc.		297,571		12.32			96,581		4.00				N/A
Sun National Bank		295,060		12.25			96,380		4.00			144,570			6.00
Leverage ratio:
Sun Bancorp, Inc.		297,571		9.40			126,631		4.00				N/A
Sun National Bank		295,060		9.33			126,444		4.00			158,055			5.00
December 31, 2012
Total capital (to risk-weighted assets):
Sun Bancorp, Inc.	$	340,111		13.72	%	$	198,340		8.00	%			N/A
Sun National Bank		322,041		13.02			197,964		8.00		$	247.455			10.00	%
Tier I capital (to risk-weighted assets):
Sun Bancorp, Inc.		293.008		11.82			99.170		4.00				N/A
Sun National Bank		290.922		11.76			98.982		4.00			148.473			6.00
Leverage ratio:
Sun Bancorp, Inc.		293.008		9.30			126.080		4.00				N/A
Sun National Bank		290.922		9.24			125.902		4.00			157.377			5.00

(1)	Not applicable for bank holding companies.

At March 31, 2013 and December 31, 2012, although the Company and the Bank exceeded the regulatory minimum ratios for classification as “well capitalized,” due to the fact that it was subject to the OCC Agreement, it cannot be deemed “well capitalized.”

The ability of the Bank to pay dividends to the Company is controlled by certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock. In addition, a national bank may not pay any dividends in an amount greater than its undivided profits and a national bank may not declare any dividends if such declaration would leave the bank inadequately capitalized. Therefore, the ability of the Bank to declare dividends will depend on its future net income and capital requirements. Also, banking regulators have indicated that national banks should generally pay dividends only out of current operating earnings. Following this guidance, the amount available for payment of dividends to the Company by the Bank totaled $0 at March 31, 2013. Per the OCC Agreement and the Board resolutions referenced above, a dividend may only be declared if it is in accordance with the approved capital plan, the Bank remains in compliance with the capital plan following the payment of the dividend and the dividend is approved by the OCC and the Federal Reserve.

The Bank’s deposits are insured to applicable limits by the Federal Deposit Insurance Corporation (“FDIC”). Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), the Federal Deposit Insurance Act was amended to increase the maximum deposit insurance amount from $100,000 to $250,000 and extended the unlimited deposit insurance coverage for noninterest-bearing transaction accounts until December 31, 2012, at which time the extension expired. Upon expiration, these types of deposits were only insured up to the same $250,000 limit as other types of deposit accounts.

In November 2009, instead of imposing additional special assessments, the FDIC amended the assessment regulations to require all insured depository institutions to prepay their estimated risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012 on December 30, 2009. For purposes of estimating the future assessments, each institution’s base assessment rate in effect on September 30, 2009 was used, assuming a 5 percent annual growth rate in the assessment base and a 3 basis point increase in the assessment rate in 2011 and 2010. The prepaid assessment will be applied against actual quarterly assessments until exhausted. Any funds remaining after June 30, 2013 will be returned to the institution. If the prepayment would impair an institution’s liquidity or otherwise create significant hardship, it was able to apply for an exemption. Requiring this prepaid assessment did not preclude the FDIC from changing assessment rates or from further revising the risk-based assessment system. On December 31, 2009, the Company paid the FDIC prepaid assessment of $18.3 million. At March 31, 2013, the Company’s prepaid assessment balance was $1.6 million, with $1.0 million being recognized in expense during the three months ended March 31, 2013.

Forward-Looking Statements

This Quarterly Report on Form 10-Q of the “Company” and the documents incorporated by reference herein may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are intended to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. We are including this statement for the purpose of invoking those safe harbor provisions. Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” These forward-looking statements may include, among other things:

•

statements and assumptions relating to financial performance;

•

statements relating to the anticipated effects on results of operations or financial condition from recent or future developments or events;

•

statements relating to our business and growth strategies and our regulatory capital levels;

•

statements relating to potential sales of our criticized and classified assets; and

•

any other statements, projections or assumptions that are not historical facts.

Actual future results may differ materially from our forward-looking statements, and we qualify all forward-looking statements by various risks and uncertainties we face, some of which are beyond our control, as well as the assumptions underlying the statements, including, among others, the following factors:

•

the strength of the United States economy in general and the strength of the local economies in which we conduct operations;

•

market volatility;

•

the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs;

•

the overall quality of the composition of our loan and securities portfolios;

•

the market for criticized and classified assets that we may sell;

•

legislative and regulatory changes, including the Dodd-Frank Act and impending regulations, changes in banking, securities and tax laws and regulations and their application by our regulators and changes in the scope and cost of FDIC insurance and other coverages;

•

the effects of, and changes in, monetary and fiscal policies and laws, including interest rate policies of the FRB;

•

inflation, interest rate, market and monetary fluctuations;

•

fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas;

•

the effect of and our compliance with the terms of the OCC Agreement as well as compliance with the individual minimum capital ratios established for the Bank by the OCC;

•

the results of examinations of us by the Federal Reserve and of the Bank by the OCC, including the possibility that the OCC may, among other things, require the Bank to increase its allowance for loan losses or to write-down assets;

•

our ability to control operating costs and expenses;

•

our ability to manage delinquency rates;

•

our ability to retain key members of our senior management team;

•

the costs of litigation, including settlements and judgments;

•

the increased competitive pressures among financial services companies;

•

the timely development of and acceptance of new products and services and the perceived overall value of these products and services by businesses and consumers, including the features, pricing and quality compared to our competitors’ products and services;

•

technological changes;

•

acquisitions;

•

changes in consumer and business spending, borrowing and saving habits and demand for financial services in our market area;

•

adverse changes in securities markets;

•

the inability of key third-party providers to perform their obligations to us;

•

changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the FASB;

•

war or terrorist activities;

•

other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere herein or in the documents incorporated by reference herein and our other filings with the Securities and Exchange Commission (“SEC”); and

•

our success at managing the risks involved in the foregoing.

Some of these and other factors are discussed in the Company’s December 31, 2012 Annual Report on Form 10-K under “Item 1A. Risk Factors” as such may be amended or supplemented herein or in other filings pursuant to the Securities Exchange Act of 1934, as amended. The development of any or all of these factors could have an adverse impact on our financial position and results of operations.

Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference herein or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise, unless otherwise required to do so by law or regulation. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed herein or in the documents incorporated by reference herein might not occur, and you should not put undue reliance on any forward-looking statements.

NON-GAAP FINANCIAL MEASURES

This Quarterly Report on Form 10-Q of the Company contains financial information calculated by methods other than in accordance with GAAP. Management uses these “non-GAAP” measures in their analysis of the Company’s performance. Management believes that these non-GAAP financial measures provide a greater understanding of ongoing operations and enhance comparability of results with prior periods and demonstrate the effects of significant gains and charges in the current period. The Company believes that a meaningful analysis of its financial performance requires an understanding of the factors underlying that performance. These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Management uses these measures to evaluate the underlying performance and efficiency of operations. Management believes these measures reflect core trends of the business.

Tax Equivalent Net Interest Income:

This Quarterly Report on Form 10-Q references tax-equivalent interest income. Tax-equivalent interest income is a non-GAAP financial measure. Tax-equivalent interest income assumes a 35% marginal federal tax rate for all periods. The fully taxable equivalent adjustments for the three months ended March 31, 2013 and March 31, 2012 were $212 thousand and $233 thousand, respectively. Tax-equivalent net interest income is net interest income plus the taxes that would have been paid had tax-exempt securities been taxable. This number attempts to enhance the comparability of the performance of assets that have different tax liabilities. The following table provides a reconciliation of tax equivalent net interest income to GAAP net interest income using a 35% tax rate:


March 31,	2013		2012
Net interest income, as presented	$	23,078	$	24,650
Effect of tax-exempt income		212		233

Net interest income, tax equivalent	$	23,290	$	24,883

Core Deposits:

Core deposits is calculated by excluding time deposits and brokered deposits from total deposits. The following table provides a reconciliation of core deposits to GAAP total deposits at March 31, 2013 and December 31, 2012:


	March 31, 2013		December 31, 2012
Total deposits	$	2,723,337	$	2,713,224
Less: Time deposits		569,613		580,493
Less: Brokered deposits		113,209		117,393

Core deposits	$	2,040,515	$	2,015,338

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

(All dollar amounts presented in the tables are in thousands)

Overview

The Company is a bank holding company headquartered in Vineland, New Jersey, and has an executive office in Mt. Laurel, New Jersey, with its principal subsidiary being the Bank. At March 31, 2013, the Company had total assets of $3.2 billion, total liabilities of $3.0 billion and total shareholders’ equity of $264.3 million. Through the Bank, the Company provides commercial and consumer banking services. The Company offers a comprehensive array of lending, depository and financial services to its commercial and consumer customers throughout the marketplace. The Company funds its lending activities primarily through retail and brokered deposits, the scheduled maturities of its investment portfolio and other wholesale funding sources.

As a financial institution with a primary focus on traditional banking activities, the Company generates the majority of its revenue through net interest income, which is defined as the difference between interest income earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon the Company’s ability to prudently manage the balance sheet for growth, combined with how successfully it maintains or increases net interest margin. The Company also generates revenue through fees earned on the various services and products offered to its customers and through sales of loans, primarily SBA loans and residential mortgages. Offsetting these revenue sources are provisions for credit losses on loans, operating expenses and income taxes.

The economic recovery has been slower than anticipated, but signs of growth that began to appear in the fourth quarter of 2012 have continued into the first quarter of 2013. Interest rates have remained near historical lows. The unemployment rate in the U.S. remained stable at 7.8% in March 2013 from December 2012 and has since declined to 7.5%. According to recently released estimates, the U.S. gross domestic product for the fourth quarter of 2012 increased at an annual rate of 2.5% as compared to 0.4% growth in the fourth quarter of 2012. The increase is primarily due to improved private inventory investment, acceleration in personal consumption expenditures, an increase in exports and a smaller decrease in federal government spending that were partly offset by increased imports and slower nonresidential fixed investment. The increase in job growth which occurred during 2012 coupled with increased spending and some improvements in the housing sector have created some optimism in the markets that an economic recovery may be underway. New Jersey has also been hit particularly hard by the economic slump for the past few years and remains hampered by high unemployment. Signs of improvement in New Jersey were recently seen as the unemployment rate in the state declined to 9.0% in March 2013 from 9.6% as of December 2012.

At its latest meeting in March 2013, the FRB decided to keep the Federal Funds target rate unchanged in a continued effort to help stimulate economic growth. Since December 2008, the FRB has kept the Federal Funds rate, a key indicator of short-term rates such as credit card rates and HELOC rates, at a range of 0.00%-0.25% with the intent of encouraging consumers and businesses to borrow and spend to help jump start the economy. The FRB decided to maintain this target range and anticipates that it will be appropriate at least as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a 0.5% above the 2% percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

The continued uncertainty with the economy, together with the challenging regulatory environment, will continue to affect the Company and the markets in which it does business and may adversely impact the Company’s results in the future. The following discussion provides further detail on the financial condition and results of operations of the Company at and for the quarter ended March 31, 2013.

Critical Accounting Policies, Judgments and Estimates

The discussion and analysis of the financial condition and results of operations are based on the unaudited condensed consolidated financial statements, which are prepared in conformity with GAAP. The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. Management evaluates these estimates and assumptions on an ongoing basis, including those related to the allowance for loan losses, goodwill, intangible assets, income taxes, stock-based compensation and the fair value of financial instruments. Management bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances. These form the basis for making judgments on the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Allowance for Loan Losses. Through the Bank, the Company originates loans that it intends to hold for the foreseeable future or until maturity or repayment. The Company may not be able to collect all principal and interest due on these loans. The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio as of the balance sheet date. The determination of the allowance for loan losses requires management to make significant estimates with respect to the amounts and timing of losses and market and economic conditions. The allowance for loan losses is maintained at a level that management considers adequate to provide for estimated losses and impairment based upon an evaluation of known and inherent risk in the loan portfolio. Loan impairment is evaluated based on the fair value of collateral or estimated net realizable value. A provision for loan losses is charged to operations based on management’s evaluation of the estimated losses that have been incurred in the Company’s loan portfolio. It is the policy of management to provide for losses on unidentified loans in its portfolio in addition to classified loans.

Management monitors its allowance for loan losses on a monthly basis and makes adjustments to the allowance through the provision for loan losses as economic conditions and other pertinent factors warrant. The quarterly review and adjustment of the qualitative factors employed in the allowance methodology and the updating of historic loss experience allow for timely reaction to emerging conditions and trends. In this context, a series of qualitative factors are used in a methodology as a measurement of how current circumstances are affecting the loan portfolio. Included in these qualitative factors are:

•

Levels of past due, classified and non-accrual loans, troubled debt restructurings and modifications

•

Nature, volume, and concentrations of loans;

•

Historical loss trends;

•

Changes in lending policies and procedures, underwriting standards, collections, charge-offs and recoveries, and for commercial loans, the level of loans being approved with exceptions to policy;

•

Experience, ability and depth of management and staff;

•

National and local economic and business conditions, including various market segments;

•

Quality of the Company’s loan review system and degree of Board oversight; and

•

Effect of external factors, including the deterioration of collateral values, on the level of estimated credit losses in the current portfolio.

Additionally, historic loss experience over a three-year horizon, based on a rolling 12-quarter migration analysis, is taken into account for commercial loans. For non-commercial loans, future losses are estimated based on historical loss rates. In determining the allowance for loan losses, management has established both specific and general pooled allowances. Values assigned to the qualitative factors and those developed from historic loss experience provide a dynamic basis for the calculation of reserve factors for both pass-rated loans (general pooled allowance) and those criticized and classified loans without reserves (specific allowance). A specific allowance is calculated on individually identified impaired loans. Loans not individually reviewed are evaluated as a group using reserve factor percentages based on historic loss experience and the qualitative factors described above. In determining the appropriate level of the general pooled allowance, management makes estimates based on internal risk ratings, which take into account such factors as debt service coverage, loan-to-value ratios and external factors. Estimates are periodically measured against actual loss experience.

As changes in the Company’s operating environment occur and as recent loss experience fluctuates, the factors for each category of loan based on type and risk rating will change to reflect current circumstances and the quality of the loan portfolio. Given that the components of the allowance are based partially on historical losses and on risk rating changes in response to recent events, required reserves may trail the emergence of any unforeseen deterioration in credit quality.

Although the Company maintains its allowance for loan losses at levels considered adequate to provide for the inherent risk of loss in its loan portfolio, if economic conditions differ substantially from the assumptions used in making the evaluations, there can be no assurance that future losses will not exceed estimated amounts or that additional provisions for loan losses will not be required in future periods. Accordingly, the current state of the national economy and local economies of the areas in which the loans are concentrated and their slow recovery from a severe recession could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss allowances in future periods. In addition, the Company’s determination as to the amount of its allowance for loan losses is subject to review by the Bank’s primary regulator, the OCC, as part of its examination process, which may result in the establishment of an additional allowance based upon the judgment of the OCC after a review of the information available at the time of the OCC examination.

Accounting for Income Taxes. The Company accounts for income taxes in accordance with FASB ASC 740, Income Taxes (“FASB ASC 740”). FASB ASC 740 requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the unaudited condensed consolidated statements of operations. Assessment of uncertain tax positions under FASB ASC 740 requires careful consideration of the technical merits of a position based on management’s analysis of tax regulations and interpretations. Significant judgment may be involved in applying the requirements of FASB ASC 740.

Management expects that the Company’s adherence to FASB ASC 740 may result in increased volatility in quarterly and annual effective income tax rates, as FASB ASC 740 requires that any change in judgment or change in measurement of a tax position taken in a prior period be recognized as a discrete event in the period in which it occurs. Factors that could impact management’s judgment include changes in income, tax laws and regulations, and tax planning strategies.

Fair Value Measurement. The Company accounts for fair value measurement in accordance with FASB ASC 820, Fair Value Measurements and Disclosures (“FASB ASC 820”). FASB ASC 820 establishes a framework for measuring fair value. FASB ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, emphasizing that fair value is a market-based measurement and not an entity-specific measurement. FASB ASC 820 clarifies the application of fair value measurement in a market that is not active. FASB ASC 820 also includes additional factors for determining whether there has been a significant decrease in market activity, affirms the objective of fair value when a market is not active, eliminates the presumption that all transactions are not orderly unless proven otherwise, and requires an entity to disclose inputs and valuation techniques, and changes therein, used to measure fair value. FASB ASC 820 addresses the valuation techniques used to measure fair value. These valuation techniques include the market approach, income approach and cost approach. The market approach uses price or relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach involves converting future amounts into a single present value. The measurement is valued based on current market expectations about those future amounts. The cost approach is based on the amount that currently would be required to replace the service capacity of the asset.

FASB ASC 820 establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement. The three levels within the fair value hierarchy are described as follows:

•

Level 1 - Quoted prices in active markets for identical assets or liabilities.

•

Level 3 - Unobservable inputs that are support by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The Company’s policy is to recognize transfers that occur between the fair value hierarchy, Levels 1, 2 and 3, at the beginning of the quarter of when the transfer occurred.

Investment securities available for sale. Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated using quoted prices of securities with similar characteristics or discounted cash flows based on observable market inputs and are classified within Level 2 of the fair value hierarchy. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Level 3 market value measurements include an internally developed discounted cash flow model combined with using market data points of similar securities with comparable credit ratings in addition to market yield curves with similar maturities in determining the discount rate. In addition, significant estimates and unobservable inputs are required in the determination of Level 3 market value measurements. If actual results differ significantly from the estimates and inputs applied, it could have a material effect on the Company’s unaudited condensed consolidated financial statements.

Derivative financial instruments. The Company’s derivative financial instruments are not exchange-traded and therefore are valued utilizing models that use as their basis readily observable market parameters, specifically the LIBOR swap curve, and are classified within Level 2 of the valuation hierarchy.

Residential mortgage loans held-for-sale. Effective July 1, 2012, the Company’s residential mortgage loans held-for-sale were recorded at fair value utilizing Level 2 measurements. This fair value measurement is determined based upon third party quotes obtained on similar loans.

The Company adopted the fair value option on these loans which allows the Company to record the mortgage loans held-for-sale portfolio at fair market value as opposed to the lower of cost or market. The Company economically hedges its residential loans held-for-sale portfolio with forward sale agreements which are reported at fair value. A lower of cost or market accounting treatment would not allow the Company to record the excess of the fair market value over book value but would require the Company to record the corresponding reduction in value on the hedges. Both the loans and related hedges are carried at fair value which reduces earnings volatility as the amounts more closely offset, particularly in environments in which interest rates are declining. For loans held-for-sale for which the fair value option has been elected, the aggregate fair value exceeded the aggregate principal balance by $821 thousand as of March 31, 2013 and $847 thousand at December 31, 2012.

Interest rate lock commitments on residential mortgages. The Company enters into interest rate lock commitments on its residential mortgage loans originated for sale. The determination of the fair value of interest rate lock commitments is based on agreed upon pricing with the respective investor on each loan and includes a pull through percentage. The pull through percentage represents an estimate of loans in the pipeline to be delivered to an investor versus the total loans committed for delivery. Significant changes in this input could result in a significantly higher or lower fair value measurement. As the pull through percentage is a significant unobservable input, this is deemed a Level 3 valuation input. The pull through percentage, which is based upon historical experience, was 70% at March 31, 2013.

In addition, certain assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The Company measures impaired loans, commercial loans held-for-sale, SBA servicing assets, restricted equity investments and loans or bank properties transferred in other real estate owned at fair value on a non-recurring basis.

Valuation techniques and models utilized for measuring financial assets and liabilities are reviewed and validated by the Company at least quarterly.

Goodwill. Goodwill is the excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a business combination. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. FASB ASC 350-20-35, Intangibles – Goodwill and Other – Goodwill, outlines a two-step goodwill impairment test. Significant judgment is applied when goodwill is assessed for impairment. Step one, which is used to identify potential impairment, compares the fair value of the reporting unit with its carrying amount, including goodwill. As defined in FASB ASC 280, Segment Reporting, a reporting unit is an operating segment or one level below an operating segment. The Company has one reportable operating segment, “Community Banking”, as defined in Note 1 of the notes to the unaudited condensed consolidated financial statements. If the fair value of a reporting unit exceeds it carrying value, goodwill of the reporting unit is considered not impaired and step two is therefore unnecessary. If the carrying amount of the reporting unit exceeds it implied fair value, the second step is performed to measure the amount of the impairment loss, if any. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Company typically evaluates its goodwill for impairment annually at December 31, unless circumstances indicate that a test is required at an earlier date.

Recent Accounting Principles.

In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The amendments in this update aim to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments seek to attain that objective by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account instead of directly to income or expense in the same reporting period. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. The Company’s financial statements include the disclosures required upon the adoption of this accounting standards update.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. This amendment results in common offsetting requirements and disclosure requirements in GAAP and International Financial Reporting Standards (“IFRS”). This guidance is not intended to change, but enhance, the application requirements in FASB ASC 210, Balance Sheet (“FASB ASC 210”). This guidance is effective for public entities during interim and annual periods beginning after January 1, 2013. This guidance amends only the disclosure requirements and not the application of the accounting standard. In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. The amendments in this update clarify that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with FASB ASC 815, Derivatives and Hedging (“FASB ASC 815”), including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with FASB ASC 210 or FASB ASC 815 or subject to an enforceable master netting arrangement or similar agreement. This guidance is effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods presented. The adoption of these accounting standards updates had no impact on the Company’s financial statements.

Financial Condition

Total assets were $3.23 billion at March 31, 2013 as compared to $3.22 billion at December 31, 2012. Loans receivable, net of allowance for loan losses, decreased $25.9 million to $2.20 billion at March 31, 2013 as compared to $2.23 billion at December 31, 2012. This decrease was primarily due to the sale of a pool of $51.5 million of jumbo residential mortgage loans from the held-for-investment portfolio during the quarter ended March 31, 2013. Loans held-for-sale decreased $79.5 million, or 66.7%. This was due to the closing of the commercial loan sale in the first quarter as well as a net decrease of $57.5 million in the residential mortgage loan held-for-sale portfolio, as volume typically declines during the winter months. Investments available-for-sale decreased $125.3 million from $443.2 million at December 31, 2012 to $317.8 million at March 31, 2013 due primarily to the sale of $124.8 million of securities, of which $94.6 million are pending settlement at March 31, 2013.

Total liabilities equaled $2.96 billion at March 31, 2013 and December 31, 2012. Deposits increased $10.1 million, or 0.4%, partially offset by a decrease in other liabilities of $8.4 million, or 10.2%. Shareholders’ equity was $264.3 million at March 31, 2013 as compared to $262.6 million at December 31, 2012, with the increase primarily as a result of the net income of $2.5 million for the first quarter of 2013.

Total non-performing loans decreased $21.8 million to $73.8 million at March 31, 2013 from December 31, 2012. The decrease in non-performing loans was due primarily to pay downs and the settlement of nonperforming loans moved to held for sale in the fourth quarter of 2012, both for $12.7 million. Total non-accruing troubled debt restructurings (‘TDRs’) at March 31, 2013 were $16.6 million.

As of March 31, 2013, the Company had $27.0 million outstanding on 14 residential construction, commercial construction and land development relationships which agreements included interest reserves. As of December 31, 2012, the Company had $24.3 million outstanding on 19 residential construction, commercial construction and land development relationships which agreements included interest reserves. The total amount available in those reserves to fund interest payments was $3.4 million and $3.6 million at March 31, 2013 and December 31, 2012, respectively. There were no relationships with interest reserves which were on non-accrual status as of March 31, 2013 and December 31, 2012. Construction projects are monitored throughout their lives by professional inspectors engaged by the Company. The budgets for loan advances and borrower equity injections are developed at underwriting time in conjunction with the review of the plans and specifications for the project being financed. Advances of the Company’s funds are based on the prepared budgets and will not be made unless the project has been inspected by the Company’s professional inspector who must certify that the work related to the advance is in place and properly complete. As it relates to construction project financing, the Company does not extend, renew or restructure terms unless its borrower posts cash collateral in an interest reserve.

Table 1 provides detail regarding the Company’s non-performing assets and TDRs at March 31, 2013 and December 31, 2012.

Table 1: Summary of Non-performing Assets and TDRs


	March 31, 2013		December 31, 2012
Non-performing assets:
Non-accrual loans	$	57,151	$	74,884
Troubled debt restructuring, non-accruing		16,632		18,244
Troubled debt restructuring, non-accruing, held-for-sale		—		2,499
Loans past due 90 days and accruing		—		—
Real estate owned, net		8,472		7,473

Total non-performing assets	$	82,255	$	103,100

The Company’s allowance for losses on loans increased to $47.1 million, or 2.09% of gross loans receivable, at March 31, 2013 from $45.9 million, or 2.02% of gross loans receivable, at December 31, 2012. The provision for loan losses was $171 thousand for the three months ended March 31, 2013 compared to $30.7 million for the same period in 2012. Recoveries were $4.9 million for the first quarter of 2013 primarily driven by the payoff of two commercial loans which resulted in $3.0 million of recoveries. Charge-offs recorded in the current quarter were $3.8 million, as compared to $26.7 million of charge-offs for the linked quarter and $20.2 million of charge-offs for the comparable prior year quarter.

Real estate owned increased $1.0 million to $8.5 million at March 31, 2013 as compared to $7.5 million at December 31, 2012. During the three months ended March 31, 2013, the Company transferred five commercial properties in the aggregate amount of $1.96 million and one residential property totaling $110 thousand from loans into real estate owned. During the three months ended March 31, 2013, the Company recorded $58 thousand of write-downs of real estate owned relating to two commercial properties. There were two residential properties with a total carrying amount of $348 thousand sold and three commercial properties with a carrying amount of $665 thousand sold for a loss of $93 thousand during the three months ended March 31, 2013. At March 31, 2013, the Company had 30 properties in the real estate owned portfolio, six of which are former bank branches.

The net deferred tax liability decreased $681 thousand from $1.5 million at December 31, 2012 to $828 thousand at March 31, 2013 due to an increase in the unrealized gains on investment securities. The Company maintains a valuation allowance of $112.7 million against the remaining portion of the gross deferred tax asset as the Company is a three-year cumulative loss company and it is more likely than not that the full deferred tax asset will not be realized.

Investment securities available for sale decreased $125.3 million, or 28.3%, from $443.2 million at December 31, 2012 to $317.8 million at March 31, 2013 due primarily to the sale of $124.8 million of securities, of which $94.6 million are pending settlement at March 31, 2013. These securities were sold due to the anticipation of a rising interest rate environment. Investment securities held to maturity decreased $31 thousand, or 3.4%, from $912 thousand at December 31, 2012 to $881 thousand at March 31, 2013.

Other assets decreased $6.8 million, or 12.0%, to $49.8 million at March 31, 2013 from $56.6 million at December 31, 2012. This decrease was primarily the result of $5.0 million in market value adjustments on swap transactions recorded during the three months ended March 31, 2013 and a $1.0 million reduction in prepaid FDIC insurance assessments. For more information on the Company’s financial derivative instruments, see Note 7 of the notes to unaudited condensed consolidated financial statements.

Total borrowings, excluding debentures held by trusts, totaled $71.3 million and $71.0 million at March 31, 2013 and December 31, 2012, respectively.

Other liabilities decreased $8.4 million, or 10.2%, to $74.5 million at March 31, 2013 from $82.9 million at December 31, 2012. This decrease was primarily due to a decrease of $11.7 million relating to normal cash settlements with the Federal Reserve as well as $5.1 million in market value adjustments on swap transactions partially offset by an increase of $10.5 million in trade date liabilities for unsettled investment purchases.

Shareholders’ equity increased $1.7 million, or 0.6%, to $264.3 million at March 31, 2013 from $262.6 million at December 31, 2012. This increase was primarily a result of $2.5 million of income the Company experienced during the three months ended March 31, 2013.

Comparison of Operating Results for the Three Months Ended March 31, 2013 and 2012

Overview. The Company recognized net income available to shareholders for the three months ended March 31, 2013 of $2.5 million, or $0.03 per common share, compared to a net loss of $28.1 million, or a loss of $0.33 per common share, for the same period in 2012. During the three months ended March 31, 2013 and 2012, the Company recorded $171 thousand and $30.7 million of loan loss provisions, respectively.

Net Interest Income. Net interest income is the most significant component of the Company’s income from operations. Net interest income is the difference between interest earned on total interest-earning assets (primarily loans and investment securities), on a fully taxable equivalent basis, where appropriate, and interest paid on total interest-bearing liabilities (primarily deposits and borrowed funds). Fully taxable equivalent basis represents income on total interest-earning assets that is either tax-exempt or taxed at a reduced rate, adjusted to give effect to the prevailing incremental federal tax rate, and adjusted for nondeductible carrying costs and state income taxes, where applicable. Yield calculations, where appropriate, include these adjustments. Net interest income depends on the volume and interest rate earned on interest-earning assets and the volume and interest rate paid on interest-bearing liabilities.

Net interest income, on a tax-equivalent basis, decreased $1.6 million to $23.3 million for the three months ended March 31, 2013, from $24.9 million for the same period in 2012.

Tax equivalent interest income decreased $2.3 million, or 7.9%, from $29.6 million for the three months ended March 31, 2012, to $27.3 million for the three months ended March 31, 2013. This decrease was primarily yield driven as the average interest-earning assets yield decreased 45 basis points as compared to the quarter ended March 31, 2012. This was primarily due to the increase of $149.4 million in average interest-earning bank balances as a result of the sales of investment securities and a bulk jumbo mortgage pool in the first quarter.

Interest expense decreased $752 thousand, or 15.8%, for the three months ended March 31, 2013, as compared to the same period in 2012. This decrease was yield driven as the cost of interest-bearing liabilities decreased 16 basis points from March 31, 2012.

The interest rate spread and net interest margin for the three months ended March 31, 2013 were 3.02% and 3.16%, respectively, compared to 3.31% and 3.48%, respectively, for the same period in 2012.

Table 2 provides detail regarding the Company’s average daily balances with corresponding interest income (on a tax-equivalent basis) and interest expense as well as yield and cost information for the three months ended March 31, 2013 and 2012.

Table 2: Average Balance Sheets

SUN BANCORP, INC. AND SUBSIDIARIES

AVERAGE BALANCE SHEETS (Unaudited)

(Dollars in thousands)


	For the Three Months Ended March 31,
	2013							2012
	Average Balance		Income/ Expense		Yield/ Cost			Average Balance		Income/ Expense		Yield/ Cost
Interest-earning assets:
Loans receivable ^(1),(2)^:
Commercial and industrial	$	1,744,553	$	18,959		4.35	%	$	1,849,216	$	21,275		4.60	%
Home equity		204,311		1,906		3.73			220,411		2,244		4.07
Second mortgage		30,347		428		5.64			41,346		590		5.71
Residential real estate		330,916		3,071		3.71			123,567		1,376		4.45
Other		30,410		535		7.04			41,733		719		6.89

Total loans receivable		2,340,537		24,899		4.26			2,276,273		26,204		4.60
Investment securities⁽³⁾		428,024		2,285		2.14			550,498		3,420		2.49
Interest-earning bank balances		179,260		111		0.25			29,851		17		0.23

Total interest-earning assets		2,947,821		27,295		3.70			2,856,622		29,641		4.15

Non-interest earning assets:
Cash and due from banks		72,775							71,751
Bank properties and equipment, net		50,363							54,338
Goodwill and intangible assets, net		40,983							44,666
Other assets		94,594							127,385

Total non-interest-earning assets		258,715							298,140

Total assets	$	3,206,536						$	3,154,762

Interest-bearing liabilities:
Interest-bearing deposit accounts:
Interest-bearing demand deposits	$	1,241,861		1,111		0.36	%	$	1,251,690		1,259		0.40	%
Savings deposits		265,391		215		0.32			262,203		229		0.35
Time deposits		689,187		1,689		0.98			620,755		2,196		1.42

Total interest-bearing deposit accounts		2,196,439		3,015		0.55			2,134,648		3,684		0.69

Short-term borrowings:
Federal funds purchased		—		—		—			6,374		6		0.38
Securities sold under agreements to repurchase - customers		2,926		1		0.14			6,669		2		0.12
Long-term borrowings:
FHLBNY advances ⁽⁴⁾		61,160		316		2.07			17,519		214		4.89
Obligations under capital lease		7,572		126		6.66			7,834		130		6.64
Junior subordinated debentures		92,786		547		2.36			92,786		722		3.11

Total borrowings		164,444		990		2.41			131,182		1,074		3.27

Total interest-bearing liabilities		2,360,883		4,005		0.68			2,265,830		4,758		0.84

Non-interest bearing liabilities:
Non-interest-bearing demand deposits		506,600							487,088
Other liabilities		75,983							89,562

Total non-interest bearing liabilities		582,583							576,650

Total liabilities		2,943,466							2,842,480
Shareholders’ equity		263,070							312,281

Total liabilities and shareholders’ equity	$	3,206,536						$	3,154,762

Net interest income			$	23,290						$	24,883

Interest rate spread ⁽⁵⁾						3.02	%						3.31	%

Net interest margin ⁽⁶⁾						3.16	%						3.48	%

Ratio of average interest-earning assets to average interest-bearing liabilities						124.86	%						126.07	%

(1)	Average balances include non-accrual loans and loans held-for-sale.

(2)	Loan fees are included in interest income and the amount is not material for this analysis.

(3)	Interest earned on non-taxable investment securities is shown on a tax-equivalent basis assuming a 35% marginal federal tax rate for all periods. The fully taxable equivalent adjustments for the three months ended March 31, 2013 and 2012 were $212 thousand and $233 thousand, respectively.

(4)	Amounts include Advances from FHLBNY and Securities sold under agreements to repurchase - FHLBNY.

(5)	Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(6)	Net interest margin represents net interest income as a percentage of average interest-earning assets.

Table 3: Rate/Volume⁽¹⁾


	For the Three Months Ended March 31, 2013 vs. 2012
	Increase (Decrease) Due To
	Volume			Rate			Net
Interest income:
Loans receivable:
Commercial and industrial	$	(1,181	)	$	(1,135	)	$	(2,316	)
Home equity lines of credit		(158	)		(180	)		(338	)
Home equity term loan		(155	)		(7	)		(162	)
Residential real estate		1,683			12			1,695
Other		(180	)		(4	)		(184	)

Total loans receivable		9			(1,314	)		(1,305	)
Investment securities		(696	)		(439	)		(1,135	)
Interest-earning deposits with banks		92			2			94

Total interest-earning assets		(595	)		(1,751	)		(2,346	)

Interest expense:
Interest-bearing deposit accounts:
Interest-bearing demand deposits		(11	)		(137	)		(148	)
Savings deposits		—			(14	)		(14	)
Time deposits		(12	)		(495	)		(507	)

Total interest-bearing deposit accounts		(23	)		(646	)		(669	)

Short-term borrowings:
Federal funds purchased		(3	)		(3	)		(6	)
Securities sold under agreements to repurchase - customers		(1	)		—			(1	)
Long-term borrowings:
FHLBNY advances⁽²⁾		151			(49	)		102
Obligations under capital lease		(4	)		—			(4	)
Junior subordinated debentures		—			(175	)		(175	)

Total borrowings		143			(227	)		(84	)

Total interest-bearing liabilities		120			(873	)		(753	)

Net change in net interest income	$	(715	)	$	(878	)	$	(1,593	)

(1)

For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by prior period rate) and (ii) changes in rate (changes in rate multiplied by prior period average volume). The combined effect of changes in both volume and rate has been allocated to volume or rate changes in proportion to the absolute dollar amounts of the change in each.

(2)	Amounts include Advances from FHLBNY and Securities sold under agreements to repurchase - FHLBNY.

Provision for Loan Losses. The Company recorded a provision for loan losses of $171 thousand during the three months ended March 31, 2013, as compared to $30.7 million for the same period in 2012. The Company’s total loans receivable before allowance for loan losses, or gross loans receivable, decreased $24.6 million, or 1.1%, to $2.25 billion at March 31, 2013 as compared to $2.28 billion at December 31, 2012. In addition, total non-performing loans decreased $21.8 million from $95.6 million at December 31, 2012 to $73.8 million at March 31, 2013. The ratio of allowance for loan losses to gross loans receivable was 2.09% at March 31, 2013 as compared to 2.02% at December 31, 2012. Net recoveries for the three months ended March 31, 2013 were $1.1 million as compared to net charge-offs of $20.2 million during the same period in 2012.

The provision recorded is the amount necessary to bring the allowance for loan losses to a level deemed appropriate by management based on the current risk profile of the portfolio. At least monthly, management performs an analysis to identify the inherent risk of loss in the Company’s loan portfolio. This analysis includes a qualitative evaluation of the amount and composition of the loan portfolio (including loans being specifically monitored by management), the nature, volume, and concentrations of loans, past loss experience, lending policy, management experience, current economic conditions, and other factors. Additionally, management updates the migration analysis and historic loss experience on a quarterly basis.

Non-Interest Income. Non-interest income increased $5.4 million to $10.9 million for the three months ended March 31, 2013, as compared to $5.5 million for the same period in 2012. This increase was primarily attributable to an increase of $3.5 million in gains on the sale of investment securities available for sale and an increase of $2.9 million in mortgage banking revenue, net. For the three months ended March 31, 2013, mortgage banking revenue, net included a gain of $856 thousand on the sale of a pool of $51.5 in jumbo residential mortgage loans. Excluding that sale, mortgage banking revenues increased significantly from the prior year due to substantial increases in production volume. These increases were partially offset by a decrease of $513 thousand in service charges on deposit accounts.

Non-Interest Expense. Non-interest expense increased $3.8 million to $31.3 million for the three months ended March 31, 2013 as compared to $27.6 million for the same period in 2012. This increase was primarily attributable to increases in professional fees, commission expense and salaries and benefits of $2.1 million, $1.0 million and $545 thousand, respectively, from the same period in the prior year. Professional fees have increased due to additional compliance related consulting expenses incurred during the first quarter of 2013. Commission expense as well as salaries and benefits increased from the prior year due to the significant growth of the Company’s mortgage operations which began at the end of the first quarter of 2012.

Liquidity and Capital Resources

The liquidity of the Company is the ability to maintain cash flows that are adequate to fund operations and meet its other obligations on a timely and cost-effective basis in various market conditions. The ability of the Company to meet its current financial obligations is a function of balance sheet structure, the ability to liquidate assets and the availability of alternative sources of funds. To meet the needs of the clients and manage the risk of the Company, the Company engages in liquidity planning and management.

The major source of the Company’s funding on a consolidated basis is deposits, which management believes will be sufficient to meet the Company’s daily and long-term operating liquidity needs. The ability of the Company to retain and attract new deposits is dependent upon the variety and effectiveness of its customer account products, customer service and convenience, and rates paid to customers. The Company also obtains funds from the repayment and maturities of loans, loan sales or participations and maturities or calls of investment securities. Additional liquidity can be obtained in a variety of wholesale funding sources as well, including, but not limited to, federal funds purchased, FHLBNY advances, securities sold under agreements to repurchase, and other securities and unsecured borrowings. Through the Bank, the Company also purchases brokered deposits for funding purposes; however, this funding source is currently limited to 6.0% of the Bank’s total liabilities in accordance with a written agreement between the Bank and the OCC (the “OCC Agreement”) and the OCC’s subsequent approved increase in the limit, as discussed later in this section. In a continued effort to balance deposit growth and net interest margin, especially in the current interest rate environment and with competitive local deposit pricing, the Company continually evaluates these other funding sources for funding cost efficiencies. Deposit rates continued to decrease in 2013, but at a rate slower than in previous quarters. Core deposits, which exclude all certificates of deposit, increased by $25.2 million to $2.04 billion, or 74.9% of total deposits at March 31, 2013, as compared to $2.02 billion, or 74.3% of total deposits at December 31, 2012. The Company has additional secured borrowing capacity with the Federal Reserve Bank of approximately $173.5 million, of which none was utilized, and the FHLBNY of approximately $150.7 million, of which $61.1 million was utilized. In addition to secured borrowings, the Company also has unsecured borrowing capacity through lines of credit with other financial institutions of $35.0 million, of which none were utilized as of March 31, 2013. Management continues to monitor the Company’s liquidity and has taken measures to increase its borrowing capacity by providing additional collateral through the pledging of loans. As of March 31, 2013, the Company had a par value of $305.1 million and $134.5 million in loans and securities, respectively, pledged as collateral on secured borrowings.

The Company’s primary uses of funds are the origination of loans, the funding of the Company’s maturing certificates of deposit, deposit withdrawals, the repayment of borrowings and general operating expenses. Certificates of deposit scheduled to mature during the 12 months ending March 31, 2014 total $417.0 million, or approximately 61.1% of total certificates of deposit. The Company continues to operate with a core deposit relationship strategy that values a long-term stable customer relationship. This strategy employs a pricing strategy that rewards customers that establish core accounts and maintain a certain minimum threshold account balance. Based on market conditions and other liquidity considerations, the Company may also avail itself to the secondary borrowings discussed above.

The Company anticipates that deposits, cash and cash equivalents on hand, the cash flow from assets, as well as other sources of funds will provide adequate liquidity for the Company’s future operating, investing and financing needs.

The Bank’s deposits are insured to applicable limits by the FDIC. Pursuant to the Dodd-Frank Act, the Federal Deposit Insurance Act was amended to increase the maximum deposit insurance amount from $100,000 to $250,000 and extended the unlimited deposit insurance coverage for noninterest-bearing transaction accounts until December 31, 2012, at which time the extension expired. Upon expiration, these types of deposits were only insured up to the same $250,000 limit as other types of deposit accounts.

On April 15, 2010, the Bank entered into the OCC Agreement which contained requirements to develop and implement a profitability and capital plan which will provide for the maintenance of adequate capital to support the Bank’s risk profile in the current economic environment. The capital plan was required to contain a dividend policy allowing dividends only if the Bank is in compliance with the capital plan, and obtains prior approval from the OCC. The Federal Reserve also has recently notified us that we are now required to seek the prior approval of the Federal Reserve before paying interest, principal or other sums on trust preferred securities or any related subordinated debentures until further notice.

The Bank also agreed to: (a) implement a program to protect the Bank’s interest in criticized or classified assets, (b) review and revise the Bank’s loan review program; (c) implement a program for the maintenance of an adequate allowance for loan losses; and (d) revise the Bank’s credit administration policies. The Bank also agreed that its brokered deposits will not exceed 3.5% of its total liabilities unless approved by the OCC. Effective October 18, 2012, the OCC approved an increase of this limit to 6.0%. Management does not expect this restriction will limit its access to liquidity as the Bank does not rely on brokered deposits as a major source of funding. At March 31, 2013, the Bank’s brokered deposits represented 3.8% of its total liabilities.

Management is taking all necessary actions to ensure the Bank becomes fully compliant with all requirements of the OCC Agreement. In October 2011, the Board of Directors of the Company resolved, among other things, not to declare or pay cash dividends, take dividends from the Bank or repurchase its stock, without the prior written approval of the Federal Reserve.

The Bank is also subject to individual minimum capital ratios established by the OCC for the Bank requiring the Bank to continue to maintain a Leverage ratio at least equal to 8.50% of adjusted total assets, to continue to maintain a Tier 1 Capital ratio at least equal to 9.50% of risk-weighted assets and maintain a Total Capital ratio at least equal to 11.50% of risk-weighted assets. At March 31 2013, the Bank met all of the three capital ratios established by the OCC as its Leverage ratio was 9.33%, Tier 1 Capital ratio was 12.25%, and Total Capital ratio was 13.50%.

The following table provides both the Company’s and the Bank’s regulatory capital ratios as of March 31, 2013:

Table 4: Regulatory Capital Levels

Actual

For Capital
Adequacy Purposes

To Be Well Capitalized Under
Prompt Corrective Action Provision⁽¹⁾

Amount

Ratio

Amount

Ratio

Amount

Ratio

March 31, 2013

Total capital (to risk-weighted assets):

Sun Bancorp, Inc.

342,986

14.21

193,163

8.00

N/A

Sun National Bank

325,398

13.50

192,760

8.00

240,950

10.00

Tier I capital (to risk-weighted assets):

Sun Bancorp, Inc.

297,571

12.32

96,581

4.00

N/A

Sun National Bank

295,060

12.25

96,380

4.00

144,570

6.00

Leverage ratio:

Sun Bancorp, Inc.

297,571

9.40

126,631

4.00

N/A

Sun National Bank

295,060

9.33

126,444

4.00

158,055

5.00

(1)	Not applicable for bank holding companies.

The Company’s capital securities qualify as Tier 1 capital under federal regulatory guidelines. These instruments are subject to a 25% capital limitation under risk-based capital guidelines developed by the FRB. In March 2005, the FRB amended its risk-based capital standards to expressly allow the continued limited inclusion of outstanding and prospective issuances of capital securities in a bank holding company’s Tier 1 capital, subject to tightened quantitative limits. The FRB’s amended rule was to become effective March 31, 2010, and would have limited capital securities and other restricted core capital elements to 25 percent of all core capital elements, net of goodwill less any associated deferred tax liability. On March 16, 2010, the FRB extended for two years the ability for bank holding companies to include restricted core capital elements as Tier 1 capital up to 25 percent of all core capital elements, including goodwill. The portion that exceeds the 25 percent capital limitation qualifies as Tier 2, or supplementary capital of the Company. At March 31, 2013, $75.0 million of a total of $90.0 million in capital securities qualified as Tier 1 with $15.0 million qualifying as Tier 2.

The ability of the Bank to pay dividends to the Company is governed by certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock. In addition, a national bank may not pay any dividends in an amount greater than its undivided profits and a national bank may not declare any dividends if such declaration would leave the bank inadequately capitalized. Therefore, the ability of the Bank to declare dividends will depend on its future net income and capital requirements. Also, banking regulators have indicated that national banks should generally pay dividends only out of current operating earnings. Following this guidance, the amount available for payment of dividends to the Company by the Bank totaled $0 at March 31, 2013. Per the OCC Agreement and the Board resolutions, a dividend may only be declared if it is in accordance with the approved capital plan, the Bank remains in compliance with the capital plan following the payment of the dividend and the dividend is approved by the OCC and the Federal Reserve.

See Note 12 of the notes to unaudited condensed consolidated financial statements for additional information regarding regulatory matters.

Disclosures about Commitments

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The guarantees are primarily issued to support private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In the event of a draw by the beneficiary that complies with the terms of the letter of credit, the Company would be required to honor the commitment. The Company takes various forms of collateral, such as real estate assets and customer business assets, to secure the commitment. Additionally, all letters of credit are supported by indemnification agreements executed by the customer. The maximum undiscounted exposure related to these commitments at March 31, 2013 was $40.3 million and the portion of the exposure not covered by collateral was approximately $550 thousand. We believe that the utilization rate of these letters of credit will continue to be substantially less than the amount of these commitments, as has been our experience to date.

The Company maintains a reserve for unfunded loan commitments and letters of credit, which is reported in other liabilities in the unaudited condensed consolidated statements of financial condition, consistent with FASB ASC 825. As of the balance sheet date, the Company records estimated losses inherent with unfunded loan commitments in accordance with FASB ASC 450, Contingencies, and estimated future obligations under letters of credit in accordance with FASB ASC 460, Guarantees. The methodology used to determine the adequacy of this reserve is integrated in the Company’s process for establishing the allowance for loan losses and considers the probability of future losses and obligations that may be incurred under these off-balance sheet agreements. The reserve for unfunded loan commitments and letters of credit at March 31, 2013 and December 31, 2012 was $720 thousand and $613 thousand, respectively. Management believes this reserve level is sufficient to absorb estimated probable losses related to these commitments.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Asset and Liability Management

Interest rate, credit and operational risks are among the most significant market risks impacting the performance of the Company. The Company has an Asset Liability Committee (“ALCO”), composed of senior management representatives from a variety of areas within the Company. ALCO devises strategies and tactics to maintain the net interest income of the Company within acceptable ranges over a variety of interest rate scenarios. Should the Company’s risk modeling indicate an undesired exposure to changes in interest rates, there are a number of remedial options available including changing the investment portfolio characteristics, and changing loan and deposit pricing strategies. Two of the tools used in monitoring the Company’s sensitivity to interest rate changes are gap analysis and net interest income simulation.

Gap Analysis. Banks are concerned with the extent to which they are able to match maturities or re-pricing characteristics of interest-earning assets and interest-bearing liabilities. Such matching is facilitated by examining the extent to which such assets and liabilities are interest-rate sensitive and by monitoring the bank’s interest rate sensitivity gap. Gap analysis measures the volume of interest-earning assets that will mature or re-price within a specific time period, compared to the interest-bearing liabilities maturing or re-pricing within that same time period. On a monthly basis the Company and the Bank monitor their gap, primarily cumulative through both nine months and one year maturities.

At March 31, 2013, the Company’s gap analysis showed an asset sensitive position with total interest-earning assets maturing or re-pricing within one year exceeding interest-bearing liabilities maturing or re-pricing during the same time period by $526.6 million representing a positive one-year gap ratio of 16.32%. All amounts are categorized by their actual maturity or anticipated call or re-pricing date with the exception of interest-bearing demand deposits and savings deposits. Though the rates on interest-bearing demand and savings deposits generally trend with open market rates, they often do not fully adjust to open market rates and frequently adjust with a time lag. As a result of prior experience during periods of rate volatility and management’s estimate of future rate sensitivities, the Company allocates the interest-bearing demand deposits and savings deposits based on an estimated decay rate for those deposits.

Net Interest Income Simulation. Due to the inherent limitations of gap analysis, the Company also uses simulation models to measure the impact of changing interest rates on its operations. The simulation model attempts to capture the cash flow and re-pricing characteristics of the current assets and liabilities on the Company’s balance sheet. Assumptions regarding such things as prepayments and rate change behaviors are incorporated into the simulation model. Net interest income is simulated over a twelve month horizon under a variety of linear yield curve shifts, subject to certain limits agreed to by ALCO.

Net interest income simulation analysis at March 31, 2013 shows a position that is asset sensitive as interest rates increase with a slightly negative bias as rates decrease. The net income simulation results are impacted by an expected continuation of deposit pricing competition which may limit deposit pricing flexibility in both increasing and decreasing rate environments, floating-rate loan floors initially limiting loan rate increases and a relatively short liability maturity structure including retail certificates of deposit.

Actual results may differ from the simulated results due to such factors as the timing, magnitude and frequency of interest rate changes, changes in market conditions, management strategies and differences in actual versus forecasted balance sheet composition and activity. Table 5 provides the Company’s estimated earnings sensitivity profile versus the most likely rate forecast as of March 31, 2013. The Company anticipates that strong deposit pricing competition will continue to limit deposit pricing flexibility in an increasing and a decreasing rate environment.

Table 5: Sensitivity Profile


Change in Interest Rates (Basis Points)	Percentage Change in Net Interest Income Year 1
Change in Interest Rates (Basis Points)	Percentage Change in Net Interest Income Year 1
+200		4.63	%
+100		2.22	%
-100		(1.25	)%
-200		(2.40	)%

Derivative Financial Instruments. The Company utilizes certain derivative financial instruments to enhance its ability to manage interest rate risk that exists as part of its ongoing business operations. In general, the derivative transactions entered into by the Company fall into one of two types: a fair value hedge of a specific fixed-rate loan agreement and an economic hedge of a derivative offering to a Bank customer. Derivative financial instruments involve, to varying degrees, interest rate, market and credit risk. The Company manages these risks as part of its asset and liability management process and through credit policies and procedures. The Company seeks to minimize counterparty credit risk by establishing credit limits and collateral agreements. The Company does not use derivative financial instruments for trading purposes. For more information on the Company’s financial derivative instruments, please see Note 7 of the notes to unaudited condensed consolidated financial statements.

Item 4.

Controls and Procedures

(a) Evaluation of disclosure controls and procedures. Based on their evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)), the Company’s principal executive officer and principal accounting officer have concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q, such disclosure controls and procedures were designed and functioning effectively to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and (ii) accumulated and communicated to the Company’s management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures.

(b) Changes in internal control over financial reporting. During the quarter under report, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

The Company and the Bank are periodically involved in various claims and lawsuits, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, and claims involving the making and servicing of real property loans. While the ultimate outcome of these proceedings cannot be predicted with certainty, the Company’s management, after consultation with counsel representing the Company in these proceedings, does not expect that the resolution of these proceedings will have a material effect on the Company’s financial condition, results of operations or cash flows.

Item 1A.

Risk Factors

In addition to the risk factors previously disclosed under item 1A of the Company’s Form 10-K filing for the year ended December 31, 2012, previously filed with the Securities and Exchange Commission, management identified the additional material risk related to our business and an investment in the Company’s securities as noted below.

We are prohibited from paying interest, principal or other sums on trust preferred securities or any related subordinated debentures without prior Federal Reserve approval, which could result in a default of the terms of the agreements governing these securities.

The Federal Reserve has recently notified us that we are now required to seek the prior approval of the Federal Reserve before paying interest, principal or other sums on trust preferred securities or any related subordinated debentures. We expect to seek the prior approval of the Federal Reserve before paying any interest on our junior subordinated debentures (which will be used to make distributions on the trust preferred securities). Under the applicable indentures, we have the right, from time to time, and without causing an event of default, to defer payments of interest on the subordinated debentures by extending the interest payment period at any time and from time to time during the term of the subordinated debentures for up to twenty consecutive quarterly periods. If we are unable to make payments on our junior subordinated debentures for more than twenty consecutive quarters, we would be in default under the governing agreements for such securities and the amounts due under such agreements would be immediately due and payable. Our inability to receive approval from the Federal Reserve to make distributions of interest, principal or other sums on our trust preferred securities and subordinated debentures could result in a default under those obligations if we need to defer such payments for longer than twenty consecutive quarterly periods.

Other than the risk factor noted above, management of the Company does not believe there have been any material changes to the Risk Factors previously disclosed under Item 1A of the Company’s Form 10-K for the year ended December 31, 2012, previously filed with the Securities and Exchange Commission.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

Item 3.

Defaults Upon Senior Securities

Not applicable

Item 4.

Mine Safety Disclosures.

Not applicable

Item 5.

Other Information

Not Applicable

Item 6.

Exhibits

Exhibit 3.1 Amended and Restated Certificate of Incorporation of Sun Bancorp, Inc. (1)

Exhibit 3.2 Certificate of Amendment to Restated Certificate of Incorporation (2)

Exhibit 3.3 Amended and Restated Bylaws of Sun Bancorp, Inc. (3)

Exhibit 4.1 Common Security Specimen (4)

Exhibit 31(a) Section 302 Certification of CEO

Exhibit 31(b) Section 302 Certification of Chief Financial Officer

Exhibit 32 Section 906 Certifications

Exhibit 101.INS XBRL Instance Document

Exhibit 101.SCH XBRL Taxonomy Extension Schema Document

Exhibit 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document

Exhibit 101.LAB XBRL Taxonomy Extension Label Linkbase Document

Exhibit 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

Exhibit 101.DEF XBRL Taxonomy Definition Linkbase Document

(1)	Incorporated by reference to Exhibit 3.1 of the Company’s Registration Statement on Form S-3 filed on February 6, 2009 (Registration Number 333-157131).

(2)	Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on July 27, 2011 (File No. 0-20957).

(3)	Incorporated by reference to the exhibits to the Company’s Current Report on Form 8-K filed on October 24, 2007 (File No. 0-20957).

(4)	Incorporated by reference to the registrant’s Registration Statement on Form S-1 filed with the Commission on February 14, 1997 (File No. 333-21903).

SIGNATURES

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


		Sun Bancorp, Inc.
		Registrant

Date: May 10, 2013		/s/ Thomas X. Geisel
		Thomas X. Geisel
		President and Chief Executive Officer
		(Duly Authorized Representative)

Date: May 10, 2013		/s/ Thomas R. Brugger
		Thomas R. Brugger
		Executive Vice President and
		Chief Financial Officer
		(Duly Authorized Representative)