Sun Bancorp (SNBC) 10-Q 2009 Q2 Quarterly report

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 June 30, 2009

or

[  ] 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 [  ] 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. Large accelerated filer [  ] Accelerated filer [x]  Non-accelerated filer [  ] Smaller reporting company [  ]

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 – 23,158,110 Shares Outstanding at August 6, 2009

SUN BANCORP, INC.

TABLE OF CONTENTS 

		Page Number
PART I - FINANCIAL INFORMATION
	Item 1. Financial Statements
Unaudited Condensed Consolidated Statements of Financial Condition at June 30, 2009 and December 31, 2008		3
Unaudited Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2009 and 2008		4
Unaudited Condensed Consolidated Statements of Shareholders’ Equity for the Six Months Ended June 30, 2009 and 2008		5
Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008		6
Notes to Unaudited Condensed Consolidated Financial Statements		7
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	35
	Item 3. Quantitative and Qualitative Disclosures about Market Risk	57
	Item 4. Controls and Procedures	59
PART II - OTHER INFORMATION
	Item 1. Legal Proceedings	60
	Item 1A. Risk Factors	60
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	60
	Item 3. Defaults upon Senior Securities	60
	Item 4. Submission of Matters to a Vote of Security Holders	60
	Item 5. Other Information	61
	Item 6. Exhibits	61
	Signatures	62
	Certifications
	Exhibit 31(a) Section 302 Certification of CEO	63
	Exhibit 31(b) Section 302 Certification of CFO	64
	Exhibit 32 Section 906 Certifications	65

2

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

SUN BANCORP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except par value amounts)
	June 30, 2009			December 31, 2008
ASSETS
Cash and due from banks	$	53,020		$	31,237
Interest-earning bank balances		2,846			26,784
Federal funds sold		-			412
Cash and cash equivalents		55,866			58,433
Investment securities available for sale (amortized cost of $418,700 and $444,628 at June 30, 2009 and December 31, 2008, respectively)		406,082			423,513
Investment securities held to maturity (estimated fair value of $9,646 and $13,601 at June 30, 2009 and December 31, 2008, respectively)		9,639			13,765
Loans receivable (net of allowance for loan losses of $44,316 and $37,309 at June 30, 2009 and December 31, 2008, respectively)		2,689,656			2,702,516
Restricted equity investments		15,510			16,306
Bank properties and equipment, net		52,502			48,642
Real estate owned		10,620			1,962
Accrued interest receivable		11,269			12,254
Goodwill		127,894			127,894
Intangible assets, net		16,414			18,769
Deferred taxes, net		16,476			16,707
Bank owned life insurance (BOLI)		76,578			75,504
Other assets		72,604			105,861
Total assets	$	3,561,110		$	3,622,126
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits	$	2,875,502		$	2,896,364
Federal funds purchased		87,500			71,500
Securities sold under agreements to repurchase – customers		17,398			20,327
Advances from the Federal Home Loan Bank of New York (FHLBNY)		15,805			42,081
Securities sold under agreements to repurchase – FHLBNY		15,000			15,000
Obligation under capital lease		8,383			5,189
Junior subordinated debentures		92,786			92,786
Other liabilities		88,076			120,371
Total liabilities		3,200,450			3,263,618
Commitments and contingencies (see Note 13)
Shareholders’ equity:
Preferred stock, $1 par value, 1,000,000 shares authorized; none issued		-			-
Common stock, $1 par value, 50,000,000 shares authorized; 25,250,583 shares issued and 23,140,520 shares outstanding at June 30, 2009; 24,037,431 shares issued and 21,930,708 shares outstanding at December 31, 2008		25,251			24,037
Additional paid-in capital		361,095			351,430
Retained earnings		8,285			22,580
Accumulated other comprehensive loss		(7,788	)		(13,377	)
Deferred compensation plan trust		(21	)		-
Treasury stock at cost, 2,106,723 shares at  June 30, 2009 and December 31, 2008		(26,162	)		(26,162	)
Total shareholders’ equity		360,660			358,508
Total liabilities and shareholders’ equity	$	3,561,110		$	3,622,126
See Notes to Unaudited Condensed Consolidated Financial Statements.

3

SUN BANCORP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except share and per share amounts)
	For the Three Months Ended June 30,								For the Six Months Ended June 30,
	2009				2008				2009				2008
INTEREST INCOME
Interest and fees on loans	$		32,996		$		37,890		$		65,188		$		78,285
Interest on taxable investment securities			3,706				3,807				7,936				7,990
Interest on non-taxable investment securities			882				843				1,726				1,604
Dividends on restricted equity investments			217				277				390				546
Interest on federal funds sold			-				66				-				97
Total interest income			37,801				42,883				75,240				88,522
INTEREST EXPENSE
Interest on deposits			12,405				15,957				26,335				34,270
Interest on funds borrowed			479				1,008				963				2,127
Interest on junior subordinated debentures			1,133				1,354				2,319				2,898
Total interest expense			14,017				18,319				29,617				39,295
Net interest income			23,784				24,564				45,623				49,227
PROVISION FOR LOAN LOSSES			6,950				6,527				10,950				8,660
Net Interest income after provision for loan losses			16,834				18,037				34,673				40,567
NON-INTEREST INCOME
Service charges on deposit accounts			3,096				3,561				6,140				6,954
Other service charges			79				75				161				153
Gain on sale of loans			693				411				1,038				835
Gain on derivative instruments			85				1,037				212				1,676
Investment products income			756				848				1,278				1,625
BOLI income			561				772				1,074				1,578
Net impairment losses on available for sale securities:
Total impairment losses		(6,432)				-				(6,710)				-
Portion of loss recognized in other comprehensive income (before taxes)		1,874				-				1,874				-
Net impairment losses recognized in earnings			(4,558	)			-				(4,836	)			-
Other			1,020				1,098				1,986				2,356
Total non-interest income			1,732				7,802				7,053				15,177
NON-INTEREST EXPENSE
Salaries and employee benefits			13,216				12,283				25,179				24,703
Occupancy expense			2,782				2,810				5,917				5,852
Equipment expense			1,685				1,666				3,223				3,290
Data processing expense			1,052				1,065				2,062				2,185
Amortization of intangible assets			1,178				1,178				2,355				2,355
Insurance expense			3,330				728				4,773				1,397
Professional fees			507				483				885				1,048
Advertising expense			871				484				1,416				1,183
Real estate owned expense, net			93				(534	)			273				(525	)
Other			2,936				2,750				5,384				5,390
Total non-interest expense			27,650				22,913				51,467				46,878
(LOSS) INCOME BEFORE INCOME TAXES			(9,084	)			2,926				(9,741	)			8,866
INCOME TAX (BENEFIT) EXPENSE			(4,450	)			597				(5,492	)			2,354
NET (LOSS) INCOME			(4,634	)			2,329				(4,249	)			6,512
Preferred stock dividend and discount accretion			4,146				-				5,351				-
NET (LOSS) INCOME AVAILABLE TO COMMON SHAREHOLDERS	$		(8,780	)	$		2,329		$		(9,600	)	$		6,512
Basic (loss) earnings per share (1)	$		(0.38	)	$		0.10		$		(0.42	)	$		0.27
Diluted (loss) earnings per share (1)	$		(0.38	)	$		0.10		$		(0.42	)	$		0.27
Weighted average shares – basic (1)			23,103,975				23,830,980		23,073,683				23,878,272
Weighted average shares – diluted (1)			23,103,975				24,371,330		23,073,683				24,481,106
(1) Data is adjusted for a 5% stock dividend issued in May 2009.
See Notes to Unaudited Condensed Consolidated Financial Statements.

4

SUN BANCORP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Dollars in thousands)
		Preferred Stock			Common Stock		Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Deferred Compensation Plan Trust			Treasury Stock			Total
BALANCE, JANUARY 1, 2008	$	-		$	22,723	$	336,668		$	20,338		$	(1,027	)	$	-		$	(16,525	)	$	362,177
Comprehensive income:
Net income		-			-		-			6,512			-			-			-			6,512
Unrealized losses on available for sale securities net of reclassification adjustment, net of tax (See Note 1)		-			-		-			-			(5,827	)		-			-			(5,827	)
Comprehensive income																						685
Exercise of stock options		-			5		40			-			-			-			-			45
Excess tax benefit related to stock options		-			-		15			-			-			-			-			15
Issuance of common stock		-			51		529			-			-			-			-			580
Stock-based compensation		-			9		749			-			-			-			-			758
Stock dividend		-			1,083		11,557			(12,640	)		-			-			-			-
Cash paid for fractional shares resulting from stock dividend		-			-		-			(12	)		-			-			-			(12	)
Treasury shares purchased		-			-		-			-			-			-			(3,980	)		(3,980	)
BALANCE, JUNE 30, 2008	$	-		$	23,871	$	349,558		$	14,198		$	(6,854	)	$	-		$	(20,205	)	$	360,268
BALANCE, JANUARY 1, 2009	$	-		$	24,037	$	351,430		$	22,580		$	(13,377	)	$	-		$	(26,162	)	$	358,508
Adjustment to adopt FSP SFAS No. 115-2 and SFAS No. 124-2 (net of tax of $2.1 million)		-			-		-			3,110			(3,110	)		-			-			-
Comprehensive income:
Net loss		-			-		-			(4,249	)		-			-			-			(4,249	)
Unrealized gains on available for sale securities net of reclassification adjustment, net of tax (See Note 1)		-			-		-			-			6,698			-			-			6,698
Portion of impairment loss transferred to earnings, net of tax (See Note 1)		-			-		-			-			2,001			-			-			2,001
Comprehensive income																						4,450
Issuance of preferred stock (net of original issuance discount of $4.1 million)		85,175			-		-			-			-						-			85,175
Redemption of preferred stock		(89,310	)																			(89,310	)
Discount accretion		4,135			-		-			(4,135	)		-			-			-			-
Preferred stock issuance cost		-			-		-			(112	)		-			-			-			(112	)
Issuance of common stock		-			101		490			-			-			-			-			591
Issuance of warrant		-			-		4,135			-			-			-			-			4,135
Redemption of warrant		-			-		(2,100	)		-			-			-			-			(2,100	)
Stock-based compensation		-			14		437			-			-			(21	)		-			430
Stock dividend		-			1,099		6,703			(7,802	)		-			-			-			-
Cash paid for fractional shares resulting from stock dividend		-								(3	)					-			-			(3	)
Preferred stock dividends		-			-		-			(1,104	)		-			-			-			(1,104	)
BALANCE, JUNE 30, 2009	$	-		$	25,251	$	361,095		$	8,285		$	(7,788	)	$	(21	)	$	(26,162	)	$	360,660
See Notes to Unaudited Condensed Consolidated Financial Statements.

5

SUN BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
	For the Six  Months Ended June 30,
	2009			2008
OPERATING ACTIVITIES
Net (loss) income	$	(4,249	)	$	6,512
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		10,950			8,660
Depreciation, amortization and accretion		5,386			4,570
Write down of book value of bank equipment and real estate owned		212			18
Credit impairment loss on available for sale securities		4,836			-
Net gain on call of investment securities available for sale		(18	)		-
Loss (gain) on sale real estate owned		59			(577	)
Gain on sale of loans		(1,038	)		(835	)
Increase in cash value of BOLI		(1,074	)		(1,578	)
Deferred income taxes		(4,826	)		(1,942	)
Stock-based compensation		430			673
Excess tax benefits related to stock options		-			(15	)
Shares contributed to employee benefit plans		315			291
Loans originated for sale		(79,883	)		(41,339	)
Proceeds from the sale of loans		69,770			42,765
Change in assets and liabilities which provided (used) cash:
Accrued interest receivable		985			2,639
Other assets		(1,572	)		352
Other liabilities		1,291			(333	)
Net cash provided by operating activities		1,574			19,861
INVESTING ACTIVITIES
Purchases of investment securities available for sale		(28,359	)		(172,252	)
Redemption (purchase) of restricted equity securities		796			(1,065	)
Redemption of investment in capital securities		-			155
Proceeds from maturities, prepayments or calls of investment securities available for sale		55,594			204,864
Proceeds from maturities, prepayments or calls of investment securities held to maturity		4,123			2,745
Net decrease (increase) in loans		4,005			(133,974	)
Purchase of bank properties and equipment		(3,116	)		(3,257	)
Proceeds from sale of real estate owned		189			652
Net cash provided by (used in) investing activities		33,232			(102,132	)
FINANCING ACTIVITIES
Net (decrease) increase  in deposits		(20,862	)		83,089
Net borrowings (repayments) of federal funds purchased		16,000			(500	)
Net repayments of securities sold under agreements to repurchase - customer		(2,929	)		(4,323	)
Repayment of advances from FHLBNY		(26,276	)		15,394
Repayment of obligation under capital lease		(36	)		(34	)
Proceeds from exercise of stock options		-			45
Excess tax benefits related to stock-based compensation		-			15
Redemption of junior subordinated debentures		-			(5,155	)
Proceeds from the issuance of preferred stock and warrant		89,310			-
Redemption of preferred stock		(89,310	)		-
Redemption of warrant		(2,100	)		-
Payment of preferred stock dividend		(1,104	)		-
Preferred stock issuance costs		(112	)		-
Proceeds from issuance of common stock		49			61
Cash paid for fractional interests resulting from stock dividend		(3	)		(12	)
Treasury stock purchased		-			(3,980	)
Net cash (used in) provided by financing activities		(37,373	)		84,600
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(2,567	)		2,329
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		58,433			86,513
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	55,866		$	88,842
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid	$	28,451		$	40,600
Income taxes paid		3,065			2,886
SUPPLEMENTAL DISCLOSURE OF NON-CASH ITEMS
Transfer of loans or bank properties to real estate owned	$	9,056		$	2,467
Commitments to purchase investment securities		1,500			658
See Notes to Unaudited Condensed Consolidated Financial Statements.

6

SUN BANCORP, INC.

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, changes in equity and cash flows in conformity with Generally Accepted Accounting Principles in the United States of America (“GAAP”). However, all normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the consolidated financial statements have been included. These financial statements should be read in conjunction with the Audited Consolidated Financial Statements and the accompanying notes thereto included in Sun Bancorp, Inc’s. (the “Company’s”) Annual Report on Form 10-K for the year ended December 31, 2008. The results for the three and six months ended June 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009 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, goodwill, intangible assets, income taxes, stock-based compensation and the fair value of financial instruments. Actual results may differ from these estimates under different assumptions or conditions.

Basis of Consolidation.The Unaudited Condensed Consolidated Financial Statements include, after all intercompany balances and transactions have been eliminated, the accounts of the Company and its principal wholly owned subsidiary, Sun National Bank (the “Bank”), and the Bank’s wholly owned subsidiaries, Med-Vine, Inc., Sun Financial Services, L.L.C., 2020 Properties, L.L.C., Sun Home Loans, Inc. and Del-Vine, Inc.  In accordance with the Financial Accounting Standards Board (the “FASB”) Interpretation (“FIN”) No. 46, Consolidation of Variable Interest Entities - an interpretation of  ARB No. 51, and FIN 46 (R),Consolidation of Variable Interest Entities (revised December 2003) - an interpretation of ARB No. 51, Sun Capital Trust V, Sun Capital Trust VI, Sun Capital Trust VII, Sun Statutory Trust VII, Sun Capital Trust VIII, and CBNJ Trust I, are presented on a deconsolidated basis. 

Segment Information.As defined in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosures about Segments of an Enterprise and Related Information, 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. 

Subsequent Events.The Company evaluated subsequent events for reporting and disclosure in the Unaudited Condensed Consolidated Financial Statements through August 10, 2009, which is the date the June 30, 2009 Form 10-Q was available to be issued.

Stock Dividend.On April 16, 2009, the Company’s Board of Directors declared a 5% stock dividend which was issued on May 14, 2009 to shareholders of record on April 30, 2009. Accordingly, share data has been adjusted for all periods presented.

Loans Held for Sale.Included in loans receivable is approximately $15.5 million and $4.4 million of loans held for sale at June 30, 2009 and December 31, 2008, respectively. These loans are carried at the lower of cost or estimated fair value, on an aggregate basis.

7

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.  While the Company tests goodwill for impairment annually, it recognizes that there has been turmoil in the capital markets, especially bank stocks and including the Company’s stock, as well as declines in credit quality, and, as a result deemed it appropriate to perform a goodwill analysis at June 30, 2009. SFAS No. 142, Goodwill and Other Intangible Assets, 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.  A reporting unit is an operating segment as defined in SFAS No. 131.   If the fair value of a reporting unit exceeds its 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 its implied fair value, the second step is performed to measure the amount of the impairment loss, if any.  An implied loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value.  The Company believes that its goodwill was not impaired at June 30, 2009 and December 31, 2008.

Other Comprehensive Income (Loss).The Company classifies items of other comprehensive income (loss) by their nature and displays the accumulated balance of other comprehensive income (loss) separately from retained earnings and additional paid-in capital in the equity section of the Unaudited Condensed Consolidated Statements of Financial Condition.  Amounts categorized as other comprehensive income (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 in comprehensive income (loss) items which are displayed as part of net income for the period. These reclassifications are as follows:

Disclosure of Reclassification Amounts, Net of Tax

	For the Six Months Ended June 30,
	2009									2008
	Pre-tax			Tax			After-tax			Pre-tax			Tax		After-tax
Unrealized holding gain (loss) on securities available for sale during the period	$	8,937		$	(3,086	)	$	5,851		$	(8,926	)	$	3,146	$	(5,780	)
Less:
Reclassification adjustment for gain recognized in earnings (1)		(18	)		6			(12	)		(72	)		25		(47	)
Reclassification adjustment for net impairment loss recognized in earnings		4,836			(1,976	)		2,860			-			-		-
Reclassification adjustment for portion of impairment loss transferred to earnings		(3,387	)		1,386			(2,001	)		-			-		-
Net unrealized gain (loss) on securities available for sale	$	10,368		$	(3,670	)	$	6,698		$	(8,998	)	$	3,171	$	(5,827	)
(1) Amount represents gain on securities called prior to maturity which is included in other non-interest income in the Unaudited Condensed Consolidated Statements of Income.

8

RecentAccountingPrinciples.In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No. 162.  Upon the effective date of SFAS No. 168, the codification will become the sole source of authoritative GAAP recognized by the FASB. Rules and interpretive guidance of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants.  SFAS No. 168 is effective for fiscal years and interim periods ending after September 15, 2009.  SFAS No. 168 will impact the reference to accounting pronouncements within the Company’s Notes to Unaudited Condensed Consolidated Financial Statements, but will have no impact on its financial condition, results of operations or cash flows.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R).  SFAS No. 167 significantly changes the criteria for determining whether the consolidation of a variable interest entity is required. SFAS No. 167 also addresses the effect of changes required by SFAS No. 166, Consolidation of Variable Interest Entities, on FASB Interpretation No. 46(R), and address concerns regarding the application of certain provisions of Interpretation No. 46(R), including concerns that the accounting and disclosures do not always provide timely and useful information about an entity’s involvement in a variable interest entity. SFAS No. 167 is effective for interim and annual reporting periods that begin after November 15, 2009. The Company is continuing to evaluate the impact of SFAS No. 167, but does not expect the guidance will have a material impact on the Company’s financial condition or results of operations.

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets - an amendment of FASB Statement No. 140. SFAS No. 166 amends SFAS No. 140 to improve the relevance and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and the transferor’s continuing involvement, if any, in transferred financial assets. SFAS No. 166 is effective for interim and annual reporting periods that begin after November 15, 2009. The Company is continuing to evaluate the impact of SFAS No. 166, but does not expect the guidance will have a material impact on the Company’s financial condition or results of operations.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events. SFAS No. 165 establishes standards under which an entity shall recognize and disclose events that occur after a balance sheet date, but before the related financial statements are issued or are available to be issued. SFAS No. 165 is effective for fiscal years and interim periods ending after June 15, 2009. The Company adopted SFAS No. 165 effective June 30, 2009 and the guidance did not have an impact on the Company’s financial condition or results of operations.

In April 2009, the FASB issued FASB Staff Position (“FSP”) SFAS No. 107-1 and Accounting Principles Board (“APB”) No. 28-1, Interim Disclosures about Fair Value of Financial Instruments.  FSP SFAS No. 107-1 and APB No. 28-1 require a public entity to provide disclosures about fair value of financial instruments in interim financial information.  FSP SFAS No. 107-1 and APB No. 28-1 is effective for interim and annual financial periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  An entity adopting this FSP early must also adopt FSP SFAS No. 157-4 and FSP SFAS No. 115-2 and SFAS No. 124-2.  The Company adopted FSP SFAS No. 107-1 and APB No. 28-1 effective June 30, 2009 and the guidance did not have an impact on the Company’s financial condition or results of operations.  See Note 14 for disclosures pertaining to fair value of the Company’s financial instruments.

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In April 2009, the FASB issued FSP SFAS No. 115-2 and SFAS No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments.  FSP SFAS No. 115-2 and SFAS No. 124-2 amends existing guidance for determining whether an impairment is other-than-temporary to debt securities and replaces the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; (b) it is more likely than not it will not have to sell the security before recovery of its cost basis; and (c) it does expect to recover the entire amortized cost basis of the security.  Under FSP SFAS No. 115-2 and SFAS No. 124-2, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses.  The amount of impairment related to other factors is recognized in other comprehensive income.  For debt securities held at the beginning of the period, the FSP requires the Company to recognize a cumulative-effect adjustment, net of tax, to the opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive income for the amount of the OTTI which should have been recognized in other comprehensive income had the FSP been in effect at the beginning of the period.  The Company elected to early adopt this FSP on January 1, 2009 and recorded a cumulative-effect adjustment, net of tax, to retained earnings of $3.1 million with the corresponding offset to other comprehensive income in the Unaudited Condensed Consolidated Statements of Financial Condition. See Note 3 for more information on credit losses recognized in earnings pertaining to the Company’s investment portfolio.

In April 2009, the FASB issued FSP SFAS No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.  FSP SFAS No. 157-4includes 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. FSP SFAS No. 157-4 will be effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  An entity adopting FSP SFAS No. 157-4 early must also adopt FSP SFAS No. 115-2 and SFAS No. 124-2.  The Company adopted FSP SFAS No. 157-4 effective March 31, 2009 and the guidance did not have a material impact on the Company’s financial condition or results of operations.

In January 2009, the FASB issued FSP EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20. Effective for interim and annual reporting periods ending after December 15, 2008, FSP EITF 99-20-1 amended EITF 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, to achieve a more consistent evaluation of whether there is an OTTI for the debt securities under the scope of EITF 99-20 and the debt securities not within the scope of EITF 99-20 that would fall under the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Company adopted FSP EITF 99-20-1 effective December 31, 2008 and the guidance did not have an impact on the Company’s financial condition or results of operations. 

In September 2008, the FASB issued FSP SFAS No. 133-1 and FIN No. 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; And Clarification of the Effective Date of FASB Statement No. 161. This statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, to require disclosures by sellers of credit derivatives, including credit derivatives embedded in a hybrid instrument and amends FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, to require an additional disclosure about the current status of the payment/performance risk of a guarantee.  The provisions of this statement are effective for annual or interim reporting periods ending after November 15, 2008. The Company adopted FSP SFAS No. 133-1 and FIN No. 45-4 on December 31, 2008 and the guidance did not have an impact on the Company’s financial condition or results of operations. 

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In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an Amendment of FASB Statement No. 133. SFAS No. 161 enhances the required disclosures regarding derivatives and hedging activities, including disclosures regarding how an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133 and how derivative instruments and related hedged items affect an entity’s financial condition, results of operations, and cash flows. SFAS No. 161 is effective for quarterly interim periods beginning after November 15, 2008, and fiscal years that include those quarterly interim periods. The Company adopted SFAS No. 161 on January 1, 2009 and the guidance did not have an impact on the Company's financial condition or results of operations.  Please see Note 8 for more information on the Company’s financial derivative instruments.

FSP SFAS No. 157-2, Effective Date of FASB Statement No. 157, issued in February 2008, delays the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in an entity’s financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008. The Company adopted FSP SFAS No. 157-2 on January 1, 2009 and the guidance did not have an impact on the Company’s financial condition or results of operations. Please see Note 14 for more information on the Company’s non-financial assets measured at fair value.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements – an amendment of ARB No. 51. SFAS No. 160 requires that a non-controlling interest in a subsidiary be reported separately within equity and the amount of consolidated net income specifically attributable to the non-controlling interest be identified in the consolidated financial statements. SFAS No. 160 also calls for consistency in the manner of reporting changes in the parent’s ownership interest and requires fair value measurement of any non-controlling equity investment retained in a deconsolidation.  The Company adopted SFAS No. 160 on January 1, 2009 and the guidance did not have an impact on the Company’s financial condition or results of operations.

In December 2007, the FASB issued SFAS No. 141 (revised 2007) (“SFAS No. 141(R)”), Business Combinations, which replaces SFAS No. 141, Business Combinations. SFAS No. 141(R) retains the fundamental requirements in SFAS No. 141 that the acquisition method of accounting (formerly referred to as purchase method) be used for all business combinations and that an acquirer be identified for each business combination. SFAS No. 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as of the date that the acquirer achieves control. SFAS No. 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquired at the acquisition date, measured at their fair values. SFAS No. 141(R) requires the acquirer to recognize acquisition related costs and restructuring costs separately from the business combination as period expense. The Company adopted SFAS No. 141(R) on January 1, 2009 and the guidance did not have an impact on the Company’s financial condition or results of operations.

(2) Stock-Based Compensation

Stock-based compensation issued to employees, and when appropriate non-employees, is accounted for in accordance with SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”), Share-Based Payment. The Company establishes the fair value for its equity awards to determine their cost. The Company determines the stock-based compensation cost at grant date based on the fair value of the award and it is recognized as expense over the appropriate vesting period, or when applicable, service period, using the straight-line method. However, consistent with SFAS No. 123(R), the amount of stock-based compensation 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 SFAS No. 123(R) should generally be applied to non-employees, Emerging Issues Task Force (“EITF”) No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees, is used in determining the measurement date of the compensation expense for non-employees.  

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The Company’s Stock 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 Plans, options 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.

A summary of option activity under the Stock Plans during the six months ended June 30, 2009 is presented below:

Summary of Stock Option Activity

	Number of Options			Weighted Average Exercise Price Per Share		Number of Options Exercisable
January 1, 2009		2,645,869		$	9.78		2,046,740
Granted		7,907			6.18
Exercised		-			-
Forfeited		(5,257	)		15.55
Expired		(55,209	)		10.96
June 30, 2009		2,593,310			9.73		2,078,130

The weighted average remaining contractual term was approximately 3.6 years for options outstanding and 2.4 years for options exercisable as of June 30, 2009.

At June 30, 2009, the aggregate intrinsic value was $18,000 for both options outstanding and options exercisable.

During the six months ended June 30, 2009 and 2008, the Company granted 7,907 options and 358,384 options, respectively. The fair value of the options granted is estimated on the date of grant using the Black-Scholes option valuation model, which uses the assumptions noted in the following table. The risk-free rate of return is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life of the option is estimated using the historical exercise behavior of employees at a particular level of management who were granted options with a ten-year term. Options have historically been granted with this term, and therefore information necessary to make this estimate was available. The expected volatility is based on the historical volatility for a period dating back to January 1, 2002 through the date of grant. Utilizing a period greater than this is not representative of the Company’s view of its current stock volatility.

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Significant weighted average assumptions used to calculate the fair value of the options for the six months ended June 30, 2009 and 2008 are as follows:

Weighted Average Assumptions Used in Black-Scholes Option Pricing Model

	For the Six Months Ended June 30,
	2009			2008
Weighted average fair value of options granted	$	2.86		$	3.44
Weighted average risk-free rate of return		3.00	%		3.34	%
Weighted average expected option life in months		120			80
Weighted average expected volatility		39	%		30	%
Expected dividends (1)	$	-		$	-
(1) To date, the Company has not paid cash dividends on its common stock.

A summary of the Company’s nonvested restricted stock awards activity for the six months ended June 30, 2009 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, 2009		105,976		$	13.43
Issued		59,655			4.19
Vested		(19,336	)		15.85
Nonvested stock awards outstanding, June 30, 2009		146,295		$	9.34

During the six months ended June 30, 2009 and 2008, the Company issued 59,655 shares and 67,864 shares, respectively, of restricted stock valued at $250,000 and $817,000, respectively, at the time of grant. The value of these shares is based upon the closing price of the common stock on the date of grant. All 59,655 shares issued during the first half of 2009 will cliff vest after 4 years. Compensation expense will be recognized on a straight-line basis over the service period for all of the shares issued during 2009. The compensation expense recognized for the three and six months ended June 30, 2009 was $102,000 and $193,000, respectively, as compared to $157,000 and $319,000 for the three and six months ended June 30, 2008, respectively.

As of June 30 2009, there was approximately $1.3 million and $1.1 million of total unrecognized compensation cost related to options and nonvested stock awards, respectively, granted under the Stock Plans. The cost of the options and stock awards is expected to be recognized over a weighted average period of 2.6 years and 3.1 years, respectively.

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(3) Investment Securities

The amortized cost of investment securities and the approximate fair value at June 30, 2009 and December 31, 2008 were as follows:

Summary of Investment Securities

		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
June 30, 2009
Available for sale:
U.S. Treasury obligations	$	2,005	$	-	$	-		$	2,005
U.S. Government agencies		51,309		216		(295	)		51,230
U.S. Government agency mortgage-backed securities		230,909		6,076		(4	)		236,981
Other mortgage-backed securities		10,328		-		(3,854	)		6,474
State and municipal obligations		92,367		733		(1,433	)		91,667
Trust preferred securities (1)		30,742		-		(14,057	)		16,685
Other		1,040		-		-			1,040
Total available for sale		418,700		7,025		(19,643	)		406,082
Held to maturity:
U.S. Government agency mortgage-backed securities		6,945		138		-			7,083
Other mortgage-backed securities		2,694		-		(131	)		2,563
Total held to maturity		9,639		138		(131	)		9,646
Total investment securities	$	428,339	$	7,163	$	(19,774	)	$	415,728
December 31, 2008
Available for sale:
U.S. Treasury obligations	$	1,988	$	11	$	-		$	1,999
U.S. Government agencies		61,273		28		(358	)		60,943
U.S. Government agency mortgage-backed securities		258,448		2,769		(196	)		261,021
Other mortgage-backed securities		10,863		-		(4,308	)		6,555
State and municipal obligations		80,304		64		(3,292	)		77,076
Trust preferred securities		30,315		-		(15,833	)		14,482
Other		1,437		-		-			1,437
Total available for sale		444,628		2,872		(23,987	)		423,513
Held to maturity:
U.S. Government agency mortgage-backed securities		7,762		23		(1	)		7,784
Other mortgage-backed securities		6,003		-		(186	)		13,601
Total held to maturity		13,765		23		(187	)		13,601
Total investment securities	$	458,393	$	2,895	$	(24,174	)	$	437,114
(1) Gross unrealized losses include $1.9 million of impairment losses not recognized in the Unaudited Condensed Consolidated Statement of Income.

During the six months ended June 30, 2009, securities called prior to maturity of $3.1 million resulted in a gross realized gain of $18,000.

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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 June 30, 2009 and December 31, 2008:  

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
June 30, 2009
U.S. Government agencies	$	22,097	$	(295	)	$	-	$	-		$	22,097	$	(295	)
U.S. Government agency mortgage-backed securities		3,667		(4	)		-		-			3,667		(4	)
Other mortgage-backed securities		-		-			9,036		(3,985	)		9,036		(3,985	)
State and municipal obligations		32,406		(1,080	)		4,616		(353	)		37,022		(1,433	)
Trust preferred securities		54		(1,875	)		16,631		(12,182	)		16,685		(14,057	)
Total	$	58,224	$	(3,254	)	$	30,283	$	(16,520	)	$	88,507	$	(19,774	)
December 31, 2008
U.S. Government agencies	$	34,853	$	(358	)	$	-	$	-		$	34,853	$	(358	)
U.S. Government agency mortgage-backed securities		53,147		(78	)		7,064		(121	)		60,211		(199	)
Other mortgage-backed securities		10,264		(4,452	)		416		(40	)		10,680		(4,492	)
State and municipal obligations		60,440		(3,206	)		1,600		(86	)		62,040		(3,292	)
Trust preferred securities		-		-			12,980		(15,833	)		12,980		(15,833	)
Total	$	158,704	$	(8,094	)	$	22,060	$	(16,080	)	$	180,764	$	(24,174	)

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Management's review of its investment securities at June 30, 2009 resulted in the recognition of $4.6 million of additional OTTI credit losses on one pooled trust preferred security classified as available for sale as a result of further deterioration of underlying collateral.  This security, which had an original cost basis of $7.0 million, had been previously written down $515,000.   The Company determines whether the unrealized losses are temporary in accordance with Emerging Issues Task Force (“EITF”) No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Asset, as amended by FSP EITF 99-20-1, when applicable, and FSP SFAS No. 115-1 and SFAS No. 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, and FSP SFAS No. 115-2 and SFAS No. 124-2.  The evaluation is based upon factors such as the creditworthiness of the issuers/guarantors, the underlying collateral, if applicable, and the continuing performance of the securities.  Management also evaluates other facts and circumstances that may be indicative of an OTTI condition.  This includes, but is 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.

FSP SFAS No. 115-2 and SFAS No. 124-2 requires the Company to assess if an OTTI exists by considering whether (a) the Company has the intent to sell the security, (b) it is more likely than not that it will be required to sell the security before recovery, and (c) it does not expect to recover the entire amortized cost basis of the security. The guidance allows the Company to bifurcate the OTTI on securities not expected to be sold or where the entire amortized cost of the security is not expected to be recovered, into two components representing credit loss and the component representing loss related to other factors. The portion of the fair value decline attributable to credit loss must be recognized through earnings. The credit component is determined by comparing the present value of the cash flows expected to be collected, discounted at the rate in effect before recognizing any other-than-temporary with the amortized cost basis of the debt security.  The Company uses the cash flow expected to be realized from the security, which includes assumptions about interest rates, timing and severity of defaults, estimates of potential recoveries, the cash flow distribution from the bond indenture and other factors, then applies a discounting rate equal to 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.  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 credit loss is recognized in other comprehensive income.

FSP SFAS No. 115-2 and SFAS No. 124-2 was adopted by the Company during the quarter ended March 31, 2009. Upon adoption, a$5.3 million, before tax (or $3.1 million, net of tax) cumulative effect adjustment was recorded to beginning retained earnings. This amount represented the non-credit related impairment loss related to the pooled trust preferred securities included in the Company’s investment portfolio as of January 1, 2009 which had previously incurred an OTTI charge.

For the six months ended June 30, 2009, the Company’s review of its unrealized losses on securities and whether those losses were temporary in nature, determined additional credit losses of $4.8 million on the two pooled trust preferred securities which the Company had previously recorded an OTTI charge at 2008 year-end. Application of the guidance did not have an impact on any other securities in unrealized loss position.

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The following is a roll-forward for the three and six months ended June 30, 2009 of the amounts recognized in earnings for credit losses on investments held for which a portion of the OTTI recorded in other comprehensive income:

		For the Three Months Ended June 30, 2009
Beginning balance, April 1, 2009	$	2,514
Additional increase as a result of net impairment charge recognized on investments for which an OTTI was previously recognized		4,558
Ending balance, June 30, 2009	$	7,072

		For the Six Months Ended June 30, 2009
Beginning balance, January 1, 2009	$	2,236
Additional increase as a result of net impairment charge recognized on investments for which an OTTI was previously recognized		4,836
Ending balance, June 30, 2009	$	7,072

U.S. Government Agencies.  At June 30, 2009, the gross unrealized loss in the category of less than 12 months of $295,000 consisted of 1 security with an estimated fair value of $22.1 million that is issued and guaranteed by a U.S. Government sponsored agency. The Company believes the unrealized loss is due to an increase in market interest rates since the time the underlying security was purchased. As of June 30, 2009, 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, as management expects to recover the entire amortized cost basis of this security.

U.S. Government Agency and Other Mortgage-Backed Securities.  At June 30, 2009, the gross unrealized loss in the category 12 months or longer of $4.0 million consisted of 3 investment grade and 1 non-investment grade non-agency mortgage-backed securities with an estimated fair value of $9.0 million. The gross unrealized loss in the category of less than 12 months of $4,000 consisted of 3 securities with an estimated fair value of $3.7 million that are issued or guaranteed by a U.S. Government sponsored agency or carrying the full faith and credit of the United States through a government agency. The Company believes the unrealized losses are due to increases in market interest rates since the time the underlying securities were purchased.  The fixed income markets, in particular those segments that include a credit spread, such as mortgage-backed issues, have been negatively impacted since 2008 as credit spreads widened dramatically.  The Company monitors key credit metrics such as delinquencies, defaults, cumulative losses and credit support levels to determine if an OTTI exists.  As of June 30, 2009, 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 to sell the securities, and that it is not more likely than not it will be required to sell the securities, before their recovery, which may be maturity, as management expects to recover the entire amortized cost basis of these securities.

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State and Municipal Obligations.  At June 30, 2009, the gross unrealized loss in the category 12 months or longer of $353,000 consisted of 16 municipal securities with an estimated fair value of $4.6 million.   The category consisted of 14 securities rated investment grade by at least one nationally recognized rating agency with a fair market value of $3.6 million, and 2 non-rated municipal securities with an estimated fair value of $1.0 million.  The $1.1 million gross unrealized loss in the category of less than 12 months consisted of 65 municipal securities with an estimated fair value of $32.4 million. Of these municipal securities, 53 were rated investment grade or better by at least one nationally recognized rating agency and had an estimated fair value of $22.3 million and 12 were non-rated with an estimated fair value of $10.2 million. 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 rating changes in those issues rated by a nationally recognized rating agency and performs in-house credit reviews on those non-rated issues.  The Company believes recovery of fair value is expected as the securities approach their maturity date or as valuations for such securities improve as market yields change.   As of June 30, 2009, 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 to sell the securities, and that it is not more likely than not it will be required to sell the securities, before their recovery, which may be maturity, as management expects to recover the entire amortized cost basis of these securities.

Trust Preferred Securities.  At June 30, 2009, the gross unrealized loss in the category of 12 months or longer of $12.2 million consisted of 3 trust preferred securities. The trust preferred securities are comprised of 2 non-rated single issuer securities with an estimated fair value of $13.7 million and 1 investment grade rated pooled security with an estimated fair value of $2.9 million.  The Company believes the unrealized loss on the two single issuer trust preferred securities and the investment grade pooled security are related to general market conditions and the resulting lack of liquidity in the market. As of June 30, 2009, 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 to sell the securities, and that it is not more likely than not it will be required to sell the securities, before their recovery, which may be maturity, as management expects to recover the entire amortized cost basis of these securities. The $1.9 million gross unrealized loss in the category of less than 12 months consisted of 1 non-investment grade rated pooled security with an estimated fair value of $54,000 and represents impairment losses related to other factors besides credit. These trust preferred securities were valued in accordance with FSP SFAS No. 157-3 and FSP SFAS No. 157-4, which clarify the application of SFAS No. 157 in an inactive market.  The Company reviews projected cash flow analysis and industry standard risk metrics to determine whether the unrealized losses for certain trust preferred securities are temporary in accordance with EITF No. 99-20, as amended by FSP EITF No. 99-20-1, when applicable, and FSP SFAS No. 115-1 and SFAS No. 124-1. Any adverse change in the present value of projected future cash flows may result in an other-than-temporary credit impairment recognized through earnings.

(4) Restricted Equity Investments

The Company, through the Bank, is a member of the Federal Reserve Bank of Philadelphia (“FRB”), the Federal Home Loan Bank of New York (“FHLBNY”), and Atlantic Central Bankers Bank and is required to maintain an investment in the capital stock of each. The FRB, FHLBNY and other bank stock are restricted in that they can only be redeemed by the issuer at par value. These securities are carried at cost and the Company did not identify any events or changes in circumstances that may have had an adverse effect on the value of the investment in accordance with Statement of Position  (“SOP”) No. 01-6, Accounting by Certain Entities (Including Entities With Trade Receivables) That Lend to or Finance the Activities of Others.  As of June 30, 2009, management does not believe that an OTTI of its holdings exists and expects to recover the entire cost of these securities. 

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The Company's restricted equity investments at June 30, 2009 and December 31, 2008 were as follows:

Restricted Equity Investments (1)

	June 30, 2009		December 31, 2008
Federal Reserve Bank stock	$	9,380	$	9,364
Federal Home Loan Bank of New York stock		5,982		6,794
Atlantic Central Bankers Bank stock		148		148
Total	$	15,510	$	16,306
(1) Included as held in restricted equity investments at June 30, 2009 and December 31, 2008 are 7,672 shares of Class B stock in Visa, received at no cost by the Company as a result of the Visa, Inc. restructuring in exchange for the Company's membership interest.

(5) Loans

The components of loans as of June 30, 2009 and December 31, 2008 were as follows:

Loan Components

	June 30, 2009			December 31, 2008
Commercial and industrial	$	2,240,368		$	2,234,202
Home equity		265,407			274,360
Second mortgages		73,856			84,388
Residential real estate		79,627			67,473
Other		74,714			79,402
Total gross loans		2,733,972			2,739,825
Allowance for loan losses		(44,316	)		(37,309	)
Net loans receivable	$	2,689,656		$	2,702,516
Non-accrual loans	$	55,801		$	42,233

The Company’s commercial and industrial loan portfolio represents 81.9% of total loans outstanding at June 30, 2009.  Commercial and industrial loans increased $6.2 million, or 0.3%, from December 31, 2008 to $2.24 billion at June 30, 2009.  Many of the Company’s commercial and industrial loans have a real estate component as part of the collateral securing the accommodation. 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.  At June 30, 2009, the Company’s commercial real estate portfolio was $1.72 billion of which $766.7 million, or 44.6%, were classified as owner-occupied and $952.3 million, or 55.4%, were classified as non-owner-occupied.

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The Company’s residential construction loan portfolio, which is part of the Company’s overall commercial and industrial loan portfolio, consists of short-term loans generally for building 1-to-4 family residential properties and is secured by parcels of land on which the properties are to be constructed, as well as any properties in the process of being constructed.  Upon completion of construction, these loans are typically replaced with some form of permanent financing. The significant decline in activity in the residential construction market has impacted the Company’s residential construction loan business. In the course of the periodic credit review process, a number of the Company’s residential construction borrowers received a more adverse risk rating and were assigned classified loan status due to highly diminished activity and strained liquidity and cash flow.  At the present time, new residential lending opportunities are limited. At June 30, 2009, there were 80 residential construction loans with outstanding loan balances of $60.9 million, or 2.7% of the Company’s commercial and industrial loan portfolio.

The Company’s home equity portfolio, which includes second mortgages, represents 12.4% of total loans outstanding at June 30, 2009 and is the largest component of the Company's non-commercial portfolio.  The home equity portfolio decreased $19.5 million, or 5.4%, from December 31, 2008.  Usage of home equity lines of credit has remained constant, at approximately 52% over the past year.

 (6) Allowance for Loan Losses

Changes in the allowance for loan losses were as follows:

Allowance for Loan Losses

	For the Six Months Ended June 30,							For the  Year Ended December 31,
		2009			2008			2008
Balance, beginning of period	$	37,309		$	27,002		$	27,002
Charge-offs		(4,441	)		(4,722	)		(10,728	)
Recoveries		498			550			1,035
Net charge-offs		(3,943	)		(4,172	)		(9,693	)
Provision for loan losses		10,950			8,660			20,000
Balance, end of period	$	44,316		$	31,490		$	37,309

The allowance for loan losses was $44.3 million and $37.3 million at June 30, 2009 and December 31, 2008, respectively.  The increase in the allowance for loan losses of $7.0 million to $44.3 million during the first half of 2009 reflects the Company’s continued aggressive review of its loan portfolio which resulted in loan downgrades and non-accruals.  As a result, the Company has continued to maintain adequate reserve coverage as the ratio of allowance for loan losses to gross loans was 1.62% at June 30, 2009 as compared to 1.36% at December 31, 2008.

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The provision for loan losses charged to expense is based upon a series of qualitative factors and historical loss experience, and an evaluation of estimated losses in the current commercial loan portfolio, including the evaluation of impaired loans under SFAS No. 114, Accounting by Creditors for  Impairment of a Loan - an amendment of FASB Statements No. 5 and 15 and SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures - an amendment of FASB Statement No. 114.  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. The amount of the specific allowance is determined through a loan-by-loan analysis of certain large dollar commercial loans. Loans not individually reviewed are evaluated as a group using reserve factor percentages based on historic loss experience and the qualitative factors. 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.

Loans collectively evaluated for impairment include consumer loans and residential real estate loans, and are not included in the data that follow:

Components of Impaired Loans

	June 30, 2009		December 31, 2008
Impaired loans with specific allowance for loan losses calculated under SFAS No. 114	$	15,741		$	4,307
Impaired loans with no specific allowance for loan losses calculated under SFAS No. 114		34,828			33,435
Total impaired loans	$	50,569		$	37,742
Valuation allowance related to impaired loans	$	5,043		$	1,679

In accordance with SFAS No. 114, those impaired loans which are fully collateralized do not result in a specific allowance for loan losses.

Analysis of Impaired Loans

	For the Six Months Ended June 30,
	2009			2008
Average impaired loans	$	44,900	$	24,322
Interest income recognized on impaired loans		68		45
Cash basis interest income recognized on impaired loans		68		45

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(7) Real Estate Owned

Real estate owned at June 30, 2009 and December 31, 2008 was as follows:

Summary of Real Estate Owned

	June 30, 2009		December 31, 2008
Commercial properties	$	9,114	$	139
Residential properties		531		848
Bank properties		975		975
Total	$	10,620	$	1,962

Summary of Real Estate Owned Activity

		Commercial Properties		Residential Properties			Bank Properties		Total
Beginning balance, January 1, 2009	$	139	$	848		$	975	$	1,962
Transfers from loans		8,975		81			-		9,056
Sale of real estate owned		-		(248	)		-		(248	)
Write down of real estate owned		-		(150	)		-		(150	)
Ending balance, June 30, 2009	$	9,114	$	531		$	975	$	10,620

During the six months ended June 30, 2009, the Company had five properties transferred from loans, which included one commercial property for $8.8 million.

(8) Derivative Financial Instruments.

Effective January 1, 2009, the Company adopted SFAS No. 161, which enhances the required disclosures regarding derivatives and hedging activities, including disclosures regarding how an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133 and how derivative instruments and related hedged items affect an entity’s financial condition, results of operations, and cash flows. 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 SFAS No. 133 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 SFAS No. 133, which assumes there is no ineffectiveness 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 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 SFAS No. 157. The fair value adjustments related to credit quality are recognized in other income and were not material as of June 30, 2009.

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The following tables provide information pertaining to interest rate swaps designated as fair value hedges under SFAS No. 133 at June 30, 2009 and December 31, 2008:

Summary of Interest Rate Swaps Designated As Fair Value Hedges

	June 30, 2009					December 31, 2008
Balance Sheet Location		Notional		Fair Value			Notional		Fair Value
Other liabilities	$	45,487	$	(4,170	)	$	47,434	$	(6,821	)

	June 30, 2009		December 31, 2008
Weighted average pay rate	6.81	%	6.80	%
Weighted average receive rate	2.31	%	3.89	%
Weighted average maturity in years	4.9		5.3

Customer Derivatives – Interest Rate Swaps/Caps. 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 SFAS No. 133 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 SFAS No. 157. The fair value adjustments related to credit quality are recognized in other income and were not material as of June 30, 2009.

Summary of Interest Rate Swaps Not Designated As Hedging Instrument

	June 30, 2009					December 31, 2008
Balance Sheet Location		Notional		Fair Value			Notional		Fair Value
Other assets	$	613,786	$	56,139		$	610,406	$	90,890
Other liabilities		613,786		(56,219	)		610,406		(91,033	)

In addition, the Company has entered into an interest rate cap sale transaction with one commercial customer. The Company entered into a corresponding interest rate cap purchase transaction with a third party in order to offset its exposure on the variable and fixed components of the customer agreement.  As the interest rate caps with both the customer and the third party are not designated as hedges under SFAS No. 133, the instruments are marked to market through earnings. As the interest rate caps 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 SFAS No. 157. The combined notional amount of the two interest rate caps was $12.7 million and $12.9 million at June 30, 2009 and December 31, 2008, respectively.

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The Company has an International Swaps and Derivatives Association agreement with a third party that requires a minimum dollar transfer amount upon a margin call.  This requirement is dependent on certain specified credit measures.  The amount of collateral posted with the third party at June 30, 2009 and December 31, 2008 was $88.7 million and $111.2 million, respectively.  The amount of collateral posted with the third party is deemed to be sufficient to collateralize both the fair market value change as well as any additional amounts that may be required as a result of a change in the specified credit measures.  The aggregate fair value of all derivative financial instruments in a liability position with credit measure contingencies and entered into with the third party was $59.8 million and $97.9 million at June 30, 2009 and December 31, 2008, respectively.

(9) Deposits

Deposits consist of the following major classifications:

Summary of Deposits

	June 30, 2009		December 31, 2008
Interest-bearing demand deposits	$	1,012,601	$	1,003,517
Non-interest-bearing demand deposits		452,217		397,492
Savings deposits		295,236		301,278
Time certificates under $100,000		575,793		639,354
Time certificates $100,000 or more		396,709		367,679
Brokered time deposits		142,946		187,044
Total	$	2,875,502	$	2,896,364

(10) Advances from Federal Home Loan Bank of New York (“FHLBNY”)

Advances from FHLBNY at June 30, 2009 and December 31, 2008 were $15.8 million and $42.1 million, respectively.  The decrease in advances from FHLBNY was primarily the result of $25.7 million in repayments to the FHLBNY as these borrowings matured during the first quarter of 2009.

(11) Preferred Stock

On January 9, 2009, the Company entered into a Letter Agreement with the U.S. Treasury under the Troubled Asset Relief Program Capital Purchase Program (“TARP CPP”), pursuant to which the Company issued and sold 89,310 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A and a warrant to purchase 1,620,545 shares (adjusted for a 5% stock dividend declared in April 2009) of the Company's common stock, for an aggregate purchase price of $89.3 million in cash.

In March 2009, the Board of Directors of the Company determined that continuing to participate in the TARP CPP was contrary to the best interests of the Company, it's shareholders and it's employees. Accordingly, the Board of Directors approved the repurchase of the preferred stock as authorized under recent amendments to the TARP CPP that were a part of the American Recovery and Reinvestment Act of 2009. On April 8, 2009, the Company returned to the U.S. Treasury approximately $90.0 million, which includes the original investment amount of $89.3 million plus accrued but unpaid dividends of $657,000, and received in return, and cancelled, the share certificate for the preferred stock. In connection with this transaction, the Company and the U.S. Treasury entered into a Redemption Letter Agreement dated April 8, 2009. Pursuant to the terms of the Redemption Letter Agreement, the Company notified the U.S. Treasury on April 21, 2009 of its intention to repurchase the warrant from the U.S. Treasury.  On May 27, 2009, the Company completed the repurchase of the warrant from the U.S. Treasury for $2.1 million ending the Company’s participation in the TARP CPP.

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(12) Earnings Per Share

Basic earnings 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. Retroactive recognition has been given to market values, common stock outstanding and potential common shares for periods prior to the date of the Company’s stock dividends.

The following table presents the earnings per share calculation for the three and six months ended June 30, 2009 and 2008:

Earnings Per Share Calculation

		For the Three Months Ended June 30,					For the Six Months Ended June 30,
		2009			2008		2009			2008
Net (loss) income	$	(4,634	)	$	2,329	$	(4,249	)	$	6,512
Preferred stock dividend and discount accretion		4,146			-		5,351			-
Net (loss) income available to common shareholders	$	(8,780	)	$	2,329	$	(9,600	)	$	6,512
Average common shares outstanding		23,103,975			23,830,980		23,073,683			23,878,272
Net effect of dilutive common stock equivalents		-			540,350		-			602,834
Adjusted average shares outstanding - dilutive		23,103,975			24,371,330		23,073,683			24,481,106
Basic (loss) earnings per share	$	(0.38	)	$	0.10	$	(0.42	)	$	0.27
Diluted (loss) earnings per share	$	(0.38	)	$	0.10	$	(0.42	)	$	0.27
Dilutive common stock equivalents		163,491			1,924,512		123,818			2,019,754
Average exercise price	$	5.29		$	8.08	$	4.85		$	8.15
Average market price	$	6.27		$	10.49	$	5.76		$	11.26

There were 3.6 million weighted average common stock equivalents and 977,206 weighted average common stock equivalents outstanding during the three months ended June 30, 2009 and 2008, respectively, and 3.9 million weighted average common stock equivalents and 832,868 weighted average common stock equivalents outstanding during the six months ended June 30, 2009 and 2008, respectively, which were not included in the computation of diluted earnings per share as a result of the stock options’ exercise price or stock awards value at issuance being greater than the average market price of the common shares for the respective periods.  Of the 3.6 million weighted average common stock equivalents and 3.9 million weighted average common stock equivalents not included in the computation of diluted EPS during the three and six months ended June 30, 2009, respectively, 1.0 million common stock equivalents and 1.2 million common stock equivalents related to the issuance of the warrant under the TARP CPP for the same periods, respectively.  

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(13) Commitments and Contingent Liabilities

Visa Litigation

In October 2007, Visa Inc. (“Visa”) announced that it had completed a restructuring in preparation of its initial public offering (“IPO”) planned for the first quarter 2008. At the time of the announcement, the Company was a member of the Visa USA network.  As part of Visa’s restructuring, the Company received 13,325 shares of restricted Class USA stock in Visa in exchange for the Company’s membership interests.  The Company did not recognize a gain or loss upon receipt of Class USA shares in October 2007.  In November 2007, Visa announced that it had reached an agreement with American Express, related to its claim that Visa and its member banks had illegally blocked American Express from the bank-issued card business in the U.S. The Company was not a named defendant in the lawsuit and, therefore, was not directly liable for any amount of the settlement. However, in accordance with Visa’s by-laws, the Company and other Visa USA, Inc. (a wholly-owned subsidiary of Visa) members were obligated to indemnify Visa for certain losses, including the settlement of the American Express matter. The Company's indemnification obligation is limited to its proportionate interest in Visa USA, Inc. The Company determined that its potential indemnification obligations based on its proportionate share of ownership in Visa USA was not material at June 30, 2009.

On July 16, 2009, Visa deposited an additional $700 million into the litigation escrow account previously established to satisfy specific settlement obligations.  Visa funded the additional amount in to the escrow account by reducing each Class B shareholders’ conversion ratio to Visa Class A shares from 0.6296 to 0.5824.  The Company currently has 7,672 Class B shares, with a zero cost basis.

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 SOP No. 01-6. As of the balance sheet date, the Company records estimated losses inherent with unfunded loan commitments in accordance with SFAS No. 5, Accounting for Contingencies, and estimated future obligations under letters of credit in accordance with FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. 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 as of June 30, 2009 and December 31, 2008 was $651,000 and $437,000, respectively. Management believes this reserve level is sufficient to absorb estimated probable losses related to these commitments.

(14) Fair Value Measurement

The Company accounts for fair value measurement in accordance with SFAS No. 157, Fair Value Measurements, and FSP SFAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active.  SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  SFAS No. 157 does not require any new fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value. SFAS No. 157 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). SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement.  FSP SFAS No. 157-3 clarifies the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.  

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SFAS No. 157 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.

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SFAS No. 157 requires the Company to disclose the fair value for financial assets on both a recurring and non-recurring basis.  Those assets and liabilities which will continue to be measured at fair value on a recurring basis are as follows:

Summary of Recurring Fair Value Measurements

			Category Used for Fair Value Measurement
June 30, 2009		Total		Level 1		Level 2		Level 3
Assets:
Investment securities available for sale:
U.S. Treasury obligations	$	2,005	$	2,005	$	-	$	-
U.S. Government agencies		51,230		-		51,230		-
U.S. Government agency mortgage-backed securities		236,981		-		236,981		-
Other mortgage-backed securities		6,474		-		6,474		-
State and municipal obligations		91,667		-		91,667		-
Trust preferred securities		16,685		-		-		16,685
Other		1,040		-		1,040		-
Fair value adjustment on hedged commercial loans		4,167		-		4,167		-
Interest rate swaps		56,139		-		56,139		-
Liabilities:
Fair value interest rate swaps		4,170		-		4,170		-
Interest rate swaps		56,219		-		56,219		-

			Category Used for Fair Value Measurement
December 31, 2008		Total		Level 1		Level 2		Level 3
Assets:
Investment securities available for sale:
U.S. Treasury obligations	$	1,999	$	1,999	$	-	$	-
U.S. Government agencies		60,943		-		60,943		-
U.S. Government agency mortgage-backed securities		261,021		-		261,021		-
Other mortgage-backed securities		6,555		-		6,555		-
State and municipal obligations		77,076		-		77,076		-
Trust preferred securities		14,482		-		-		14,482
Other		1,437		-		1,437		-
Fair value adjustment on hedged commercial loans		6,812		-		6,812		-
Interest rate swaps		90,890		-		90,890		-
Liabilities:
Fair value interest rate swaps		6,821		-		6,821		-
Interest rate swaps		91,033		-		91,033		-

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The following provides details of the fair value measurement activity for Level 3 for the three and six months ended June 30, 2009:

Fair Value Measurement Activity – Level 3 (only)

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Trust Preferred Securities
Three months ended June 30, 2009
Balance, April 1, 2009	$	12,186
Total gains (losses), realized/unrealized:
Included in earnings (1)		(4,558	)
Included in accumulated other comprehensive loss		9,057
Purchases, maturities, prepayments and calls, net		-
Transfers into Level 3 (2)		-
Balance, June 30, 2009	$	16,685
Six months ended June 30, 2009
Balance, January 1, 2009	$	14,482
Total gains (losses), realized/unrealized:
Included in earnings (1)		(4,836	)
Included in accumulated other comprehensive loss		7,039
Purchases, maturities, prepayments and calls, net		-
Transfers into Level 3 (2)		-
Balance, June 30, 2009	$	16,685
(1) Amount included in net impairment losses on available for sale securities of the Unaudited Condensed Consolidated Statements of Income. (2) Transfers into Level 3 are assumed to occur at the end of the quarter in which the transfer occurred.

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 loans held for sale, impaired loans, Small Business Administration ("SBA") servicing assets, restricted equity investments and loans or bank properties transferred into other real estate owned at fair value on a non-recurring basis.  At June 30, 2009 and 2008, these assets were valued in accordance with GAAP and, except for impaired loans, SBA servicing assets and real estate owned included in the following table, did not require fair value disclosure under the provisions of SFAS No. 157.  

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Summary of Non-Recurring Fair Value Measurements

			Category Used for Fair Value Measurement							Total (Losses) Gains or Changes in Net Assets During the Six Months Ended June 30, 2009
June 30, 2009		Total		Level 1		Level 2		Level 3
Assets
Impaired loans	$	19,495	$	-	$	-	$	19,495	$	(4,081	)
SBA servicing assets		518		-		518		-		74
Real estate owned		450		-		450		-		(150	)

			Category Used for Fair Value Measurement							Total (Losses) Gains or Changes in Net Assets During the Six Months Ended June 30, 2008
June 30, 2008		Total		Level 1		Level 2		Level 3
Assets
Impaired loans	$	8,456	$	-	$	-	$	8,456	$	(1,647	)

Under SFAS No. 114, collateral dependent impaired loans are based on the fair value of the collateral which is based on appraisals.  In some cases, adjustments are made to the appraised values for various factors including age of the appraisal, age of the comparables included in the appraisal, and known changes in the market and in the collateral  These adjustments are based upon unobservable inputs, and therefore, the fair value measurement has been categorized as a Level 3 measurement. Specific reserves were calculated for impaired loans with an aggregate carrying amount of $12.2 million at June 30, 2009. The collateral underlying these loans had a fair value of $8.5 million, resulting in a charge-off of $300,000 during the six months ended June 30, 2009 and a specific reserve in the allowance for loan losses of $3.6 million at June 30, 2009.  No specific reserve was calculated for impaired loans with an aggregate carrying amount of $11.0 million at June 30, 2009, as the underlying collateral was not below the carrying amount; however, these loans did include a charge-off of $176,000 during the six months ended June 30, 2009.

The SBA servicing assets are reviewed for impairment in accordance with SFAS No. 140.  Because loans are sold individually and not pooled, the Company does not stratify groups of loans based on risk characteristics for purposes of measuring impairment. The Company measures the loan servicing assets by estimating the present value expected future cash flows for each servicing asset, based on their unique characteristics and market-based assumptions for prepayment speeds and records a valuation allowance for the amount by which the carrying amount of the servicing asset exceeds the fair value.  As of June 30, 2009, the Company does not believe the loan servicing assets were other than temporarily impaired.  The Company recorded a valuation allowance of $53,000 and $127,000 at June 30, 2009 and December 31, 2008, respectively.

Once a loan is determined to be uncollectible, the underlying collateral is repossessed and reclassified to real estate owned. 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 the comparables included in the appraisal, and known changes in the market and in the collateral. During the six months ended June 30, 2009, the Company recorded a $150,000 decrease to the fair value of one property held in its real estate owned portfolio.  This adjustment was based upon observable inputs, such as quoted prices for similar assets in active markets, and therefore, the fair value measurement has been categorized as a Level 2 measurement.  At June 30, 2009, the property was carried on the Unaudited Condensed Consolidated Statement of Condition at a fair value, less estimated selling cost, of $450,000. 

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Carrying Amounts and Estimated Fair Values of Financial Assets and Liabilities

	June 30, 2009				December 31, 2008
		Carrying Amount	Estimated Fair Value			Carrying Amount	Estimated Fair Value
Assets:
Cash and cash equivalents	$	55,866	$	55,866	$	58,433	$	58,433
Investment securities available for sale		406,082		406,082		423,513		423,513
Investment securities held to maturity		9,639		9,646		13,765		13,601
Loans receivable, net		2,640,054		2,420,723		2,648,328		2,406,471
Hedged commercial loans (1)		49,602		49,654		54,188		54,188
Restricted equity investments		15,510		15,510		16,306		16,306
Interest rate swaps		56,139		56,139		90,890		90,890
Liabilities:
Demand deposits		1,464,818		1,464,818		1,401,009		1,401,009
Savings deposits		295,236		295,236		301,278		301,278
Time deposits		1,115,448		1,124,905		1,194,077		1,201,256
Federal funds purchased		87,500		87,500		71,500		71,500
Securities sold under agreements to repurchase – customers		17,398		17,398		20,327		20,327
Advances from FHLBNY		15,805		16,455		42,081		42,113
Securities sold under agreements to repurchase – FHLBNY		15,000		16,329		15,000		16,581
Junior subordinated debentures		92,786		42,680		92,786		27,758
Fair value interest rate swaps		4,170		4,170		6,821		6,821
Interest rate swaps		56,219		56,219		91,033		91,033
(1) Includes positive market value adjustment of $4.2 million and $6.8 million at June 30, 2009 and December31, 2008, 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 SFAS No. 133.

In accordance with SFAS No. 107, Disclosures about Fair Value of Financial Instruments, and FSP SFAS No. 107-1 and APB No. 28-1, the Company is required to disclose the fair value of financial instruments.  The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a distressed sale.  Fair value is best determined using market observable market prices; however, for many of the Company’s financial instruments no quoted market prices are readily available.  In instances where quoted market prices are not readily available, fair value is determined using present value or other techniques appropriate for the particular instrument.  These techniques involve some degree of judgment and as a result are not necessarily indicative of the amounts the Company would realize in a current market exchange.  Different assumptions or estimation techniques may have a material effect on the estimated fair value

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

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 pricing 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.

Loans receivable. The fair value of loans receivable is estimated using discounted cash flow analysis.  Projected future cash flows are projected using loan characteristics, and assumptions of voluntary and involuntary prepayment speeds.  Projected cash flows are discounted using rates believed to represent estimates of fair value.  Fair value is established based on the Company’s estimate of most likely trade execution.

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Hedged commercial loans. The Hedged Commercial Loans are one component of a declared hedging relationship as defined under SFAS No. 133.  The Interest Rate Swap component of the declared hedging relationship is carried at their fair value and the carrying value of the commercial loans includes a similar change in fair values

Restricted equity securities. Ownership in equity securities of bankers’ bank is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value.

Interest rate swaps 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 SFAS No. 157.

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.  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.

Federal funds purchased.  The carrying amount is a reasonable estimate of fair value.

Securities sold under agreements to repurchase - customer. The fair value is estimated to be the amount payable at the reporting date.

Securities sold under agreements to repurchase – FHLBNY and FHLBNY advances.The fair value was estimated 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 fair value estimates presented herein are based on pertinent information available to management as of June 30, 2009 and December 31, 2008. 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 consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amount presented herein.

(15) Income Taxes

The Company accounts for uncertain tax positions in accordance with FIN No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109. FIN No. 48 clarifies the accounting for income taxes by prescribing a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. The minimum threshold is defined in FIN No. 48 as a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that has greater than fifty percent likelihood of being realized upon ultimate settlement. FIN No. 48 was applied to all existing tax positions upon initial adoption. There is currently no liability for uncertain tax positions and no known unrecognized tax benefits. The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the Unaudited Condensed Consolidated Income Statement. As of June 30, 2009, there were no audits in process by any tax jurisdiction.  

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(16) Regulatory Matters

The Company is subject to risk-based capital guidelines adopted by the Federal Reserve Board 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 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 Bank’s capital amounts and classifications are also subject to qualitative judgments by the federal bank regulators about components, risk weightings and other factors. At June 30, 2009 and December 31, 2008, the Company’s and the Bank’s capital exceeded all minimum regulatory requirements to which they are subject, and the Bank was “well capitalized” as defined under the federal bank regulatory guidelines. The risk-based capital ratios have been computed in accordance with regulatory practices.

In December 2008, the FDIC voted to increase initial base assessment rates uniformly by 7 basis points (“bps”) (7 cents for every $100 of deposits), beginning with the first quarter of 2009 in an initial effort to restore the reserve ratio of the Deposit Insurance Fund to at least 1.15% of estimated insured deposits as required under the FDIC’s Restoration Plan. On February 27, 2009, the FDIC adopted a final rule to modify the risk-based assessment system and to reset initial base assessment rates. Effective April 1, 2009, initial base assessment rates will range from 12 bps to 45 bps across all risk categories with possible adjustments to these rates based on certain debt-related components.  The FDIC also extended the period of the Restoration Plan from five years to seven years.  Furthermore, the FDIC imposed a special assessment of 5 bps on all insured depository institutions based on assets minus Tier 1 capital as of June 30, 2009.  As a result of the special assessment, the Company recognized a charge to insurance expense of $1.6 million for the three and six months ended June 30, 2009.  The special assessment is payable on September 30, 2009.  The FDIC has indicated that an additional special assessment of up to 5 basis points may occur in the third and fourth quarter of 2009; however, no additional assessment has been announced.

The Company’s capital securities are deconsolidated in accordance with GAAP and 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 Federal Reserve Board. In March 2005, the Federal Reserve Board 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 Federal Reserve’s amended rule was to become effective March 31, 2009, and would have limited capital securities and other restricted core capital elements to 25% of all core capital elements, net of goodwill less any associated deferred tax liability.  On March 16, 2009, the Federal Reserve Board extended for two years the ability of bank holding companies to include restricted core capital elements as Tier 1 capital up to 25% of all core capital elements, including goodwill. The portion that exceeds the 25% capital limitation qualifies as Tier 2, or supplementary capital of the Company. At June 30, 2009, the entire $90.0 million in capital securities qualify as Tier 1.

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FORWARD-LOOKING STATEMENTS

THE COMPANY MAY FROM TIME TO TIME MAKE WRITTEN OR ORAL “FORWARD-LOOKING STATEMENTS,” INCLUDING STATEMENTS CONTAINED IN THE COMPANY’S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION, IN ITS REPORTS TO SHAREHOLDERS AND IN OTHER COMMUNICATIONS BY THE COMPANY, WHICH ARE MADE IN GOOD FAITH BY THE COMPANY PURSUANT TO THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.  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,” “COULD.”

THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF THE COMPANY’S PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS, THAT ARE SUBJECT TO CHANGE BASED ON VARIOUS IMPORTANT FACTORS (SOME OF WHICH ARE BEYOND THE COMPANY’S CONTROL).  THE FOLLOWING FACTORS, AMONG OTHERS, COULD CAUSE THE COMPANY’S FINANCIAL PERFORMANCE TO DIFFER MATERIALLY FROM THE PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS EXPRESSED IN SUCH FORWARD-LOOKING STATEMENTS:  THE STRENGTH OF THE UNITED STATES ECONOMY IN GENERAL AND THE STRENGTH OF THE LOCAL ECONOMIES IN WHICH THE COMPANY CONDUCTS 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 EFFECTS OF, AND CHANGES IN, MONETARY AND FISCAL POLICIES AND LAWS, INCLUDING INTEREST RATE POLICIES OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM; 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; RESULTS OF EXAMINATIONS OF THE BANK BY THE OFFICE OF THE COMPTROLLER OF THE CURRENCY (“OCC”), INCLUDING THE POSSIBILITY THAT THE OCC MAY, AMONG OTHER THINGS, REQUIRE US TO INCREASE OUR 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; COSTS OF LITIGATION, INCLUDING SETTLEMENTS AND JUDGMENTS; INCREASED COMPETITIVE PRESSURES AMONG FINANCIAL SERVICES COMPANIES; THE TIMELY DEVELOPMENT OF AND ACCEPTANCE OF NEW PRODUCTS AND SERVICES OF THE COMPANY AND THE PERCEIVED OVERALL VALUE OF THESE PRODUCTS AND SERVICES BY USERS, INCLUDING THE FEATURES, PRICING AND QUALITY COMPARED TO COMPETITORS’ PRODUCTS AND SERVICES; THE IMPACT OF CHANGES IN FINANCIAL SERVICES’ LAWS AND REGULATIONS (INCLUDING LAWS CONCERNING TAXES, BANKING, SECURITIES AND INSURANCE); CHANGES IN LAWS AND REGULATIONS OF THE U.S. GOVERNMENT, INCLUDING THE U.S. TREASURY AND ANY OTHER GOVERNMENT AGENCIES; TECHNOLOGICAL CHANGES; ACQUISITIONS; CHANGES IN CONSUMER AND BUSINESS SPENDING, BORROWINGS AND SAVING HABITS AND DEMAND FOR FINANCIAL SERVICES IN OUR MARKET AREA; ADVERSE CHANGES IN SECURITIES MARKETS; 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 PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD OR THE FINANCIAL ACCOUNTING STANDARDS BOARD; WAR OR TERRORIST ACTIVITIES; AND THE SUCCESS OF THE COMPANY AT MANAGING THE RISKS INVOLVED IN THE FOREGOING.

THE COMPANY CAUTIONS THAT THE FOREGOING LIST OF IMPORTANT FACTORS IS NOT EXCLUSIVE.  THE COMPANY DOES NOT UNDERTAKE TO UPDATE ANY FORWARD-LOOKING STATEMENT, WHETHER WRITTEN OR ORAL, THAT MAY BE MADE FROM TIME TO TIME BY OR ON BEHALF OF THE COMPANY UNLESS REQUIRED TO DO SO BY LAW OR REGULATION.

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

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

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 Generally Accepted Accounting Principles in the United States of America (“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 expense. Management evaluates these estimates and assumptions on an ongoing basis, including those related to 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 Sun National Bank (the "Bank"), Sun Bancorp, Inc. (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. 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 at least quarterly and makes adjustments to the allowance through the provision for loan losses as economic conditions and other pertinent factors indicate. 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 modification

● Nature and volume of loans

● 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

● Concentrations of credit by industry, geography and collateral type, with a specific emphasis on real estate, and changes in levels of such concentrations

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

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Additionally, historic loss experience over the more conservative of either the trailing four or eight quarters is taken into account. 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 Statement of Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for Impairment of a Loan – an amendment of FASB Statements No. 5 and 15, reserves (specific allowance). The amount of the specific allowance is determined through a loan-by-loan analysis of certain large dollar commercial 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 decline in the national economy and the local economies of the areas in which the loans are concentrated 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 Office of the Comptroller of the Currency (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 SFAS No. 109, Accounting for Income Taxes, and Financial Accounting Standards Board (the “FASB”) Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109. SFAS No. 109 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 Statement of Income. Assessment of uncertain tax positions under FIN No. 48 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 FIN No. 48.

Management expects that the Company’s adherence to FIN No. 48 may result in increased volatility in quarterly and annual effective income tax rates as FIN No. 48 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.

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Fair Value Measurement. The Company adopted SFAS No. 157, Fair Value Measurements, on January 1, 2008, FASB Staff Position (“FSP”) SFAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, on September 30, 2008 and FSP SFAS No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, on March 31, 2009.  SFAS No. 157 establishes a framework for measuring fair value.  SFAS No. 157 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.  FSP SFAS No. 157-3 clarifies the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.  FSP SFAS No. 157-4 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. SFAS No. 157 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 prices or relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach involves converting future amounts to a single present amount. 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.

SFAS No. 157 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 (unadjusted) 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. 

The Company measures financial assets and liabilities at fair value in accordance with SFAS No. 157, FSP SFAS No. 157-3 and FSP SFAS No. 157-4. These measurements involve various valuation techniques and models, which involve inputs that are observable, when available, and include the following significant financial instruments: investment securities available for sale and derivative financial instruments.  The following is a summary of valuation techniques utilized by the Company for its significant financial assets and liabilities which are valued on a recurring basis.

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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 London Interbank Offered Rate (“LIBOR”) swap curve, and are classified within Level 2 of the valuation hierarchy.

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 loans held for sale, impaired loans, Small Business Administration ("SBA") servicing assets, restricted equity investments and loans or bank properties transferred into 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.  While the Company tests goodwill for impairment annually, it recognizes that there has been turmoil in the capital markets, especially bank stocks and including the Company’s stock, as well as declines in credit quality, and, as a result deemed it appropriate to perform a goodwill analysis at June 30, 2009. SFAS No. 142, Goodwill and Other Intangible Assets, 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 SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, a reporting unit is an operating segment, which the Company has one reportable operating segment, “Community Banking” defined in Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements.  If the fair value of a reporting unit exceeds its 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 its implied fair value, the second step is performed to measure the amount of the impairment loss, if any.  An implied loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value.

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In performing step one and step two of the impairment analysis, the Company estimated the fair value of the Company through the consideration of its quoted market valuation, market earnings multiples of peer companies, market earnings multiples of peer companies adjusted to include a control premium (i.e., its acquisition value relative to its peers) and a discounted economic value which is based on internal forecasts, recent financials and the projected outlook for the industry.  The considerations above are sensitive to both the fluctuation of the Company’s stock price and the stock price of peer companies.  As a result of the deterioration in the stock prices of many financial institutions throughout the year, including the Company’s, the Company’s estimate of its fair value decreased. In performing the second step of the analysis to determine the implied fair value of goodwill, the estimated fair value of the Company was allocated to all assets and liabilities including any recognized or unrecognized intangible assets. The allocation is done as if the Company had been acquired in a business combination, and the fair value was the price paid to acquire the Company. A hypothetical purchase price allocation involves the assessment of core deposit intangibles, the fair value of outstanding advances and other borrowings, and assessing the fair value of our loan portfolio.  These assessments involve valuation techniques that require the use of, among other things, Level 2 and Level 3 market inputs.  For example, the fair value adjustment on our outstanding advances and borrowings is based upon observable trades or modeled prices using current yield curves and market spreads. The valuation of our loan portfolio included consideration of discounts that we believe were consistent with transactions occurring in the marketplace.  Given the turmoil in the credit markets, increases in credit spreads, and certain market illiquidity, significant judgment is required in assessing fair value.

The results of this analysis at June 30, 2009, indicated the implied fair value of the Company’s goodwill exceeded the carrying amount of goodwill, and therefore, goodwill was not impaired.

Given the continued turmoil in the capital markets and with bank stocks in general, it is possible that our assumptions and conclusions regarding the valuation of our Company could change adversely and could result in impairment of our goodwill.   While any charge resulting from a partial or full write down of goodwill would be a non-cash charge and have no impact on the Company’s regulatory capital, the charge could have a material adverse impact on our financial position and results of operations.  For more information on goodwill, see Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements.

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 SFAS No. 123(R), Share-Based Payment.  Under the fair value provisions of SFAS No. 123(R), stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the appropriate vesting period using the straight-line method. However, consistent with SFAS No. 123(R), the amount of stock-based compensation 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 SFAS No. 123(R) should generally be applied to non-employees, Emerging Issues Task Force (“EITF”) No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees, is used in determining the measurement date of the compensation expense for non-employees.  

Determining the fair value of stock-based awards at the date of grant 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.  See Note 2 of the Notes to Unaudited Condensed Consolidated Financial Statements for additional information regarding stock-based compensation.

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Market Overview

During 2008, the U.S. and global economy declined more than many economists had originally expected. Economists predicted in the early part of 2009 that the recession, which started in December 2007, would be the longest recession since World War II.  While this recession is often compared to the Great Depression, the aggressiveness of policy measures by the government is thought to have significantly reduced the probability of a near-depression.  In addition to the actions taken during 2008 to stabilize the housing market and the banking system, the U.S. Treasury implemented a series of initiatives in 2009 as part of its Financial Stability Plan that along with the American Recovery and Reinvestment Act of 2009 (“ARRA”) would lay the foundations for economic recovery.  The components of the Financial Stability Plan include investments made by the Treasury under the Public-Private Investment Program (“PPIP”), the Financial Stability Trust, and the Homeowner Affordability and Stability Plan (“HASP”).

The ARRA is intended to provide a stimulus to the U.S. economy in the wake of the economic downturn brought about by the sub-prime mortgage crisis and the resulting credit crunch.  The bill includes federal tax cuts, expansion of unemployment benefits and other social welfare provisions, and domestic spending in education, healthcare, and infrastructure, including the energy structure.  The new law also includes numerous non-economic recovery related items, including a limitation on executive compensation in federally aided banks.

Troubled real estate-related assets, comprised of legacy loans and securities, are at the forefront of the issues currently impacting the U.S. financial system.  The PPIP is a program by which the Treasury will make targeted investment in multiple PPIP’s that will purchase legacy real estate-related assets which should help improve the health of the financial institutions where they are held, leading to increased flow of credit throughout the economy and helping improve market functioning in the near-term.

The Financial Stability Trust includes a comprehensive stress test for major banks, increased balance sheet transparency and disclosure and the Capital Assistance Program (“CAP”).  It is intended to restore confidence throughout the financial system that the nation’s largest banking institutions have a sufficient capital cushion against larger than expected future losses, should they occur due to a more severe economic environment and, and to support lending to creditworthy borrowers.  The federal banking regulators will conduct forward-looking assessments to evaluate the capital needs of major U.S. banking institutions under a more challenging economic environment.  While banks will be encouraged to access private markets to raise any additional capital needed to establish this buffer, a financial institution that has undergone a comprehensive “stress test” will have access to a Treasury provided “capital buffer.”

The HASP is intended to stem home foreclosures and to provide low cost mortgage refinancing opportunities for certain homeowners suffering from declining home prices, including but not limited to the creation of financial incentives for homeowners, investors, and servicers, to refinance or modify certain existing mortgages which are delinquent or at risk of becoming delinquent.

The Federal Reserve has also responded aggressively to the downturn since it emerged in 2007, including reducing the Federal Funds Target rate by 450 basis points since September 2007 to a historical low, or range of 0.00% to 0.25%, in late December 2008, where it still remains today and is expected to remain into 2010.  Although the Federal Reserve does not normally try to influence long term rates, it announced a plan in 2009 committed through its open market activities to purchasing up to $1.25 trillion in mortgage-backed securities, $200 billion in federal agency debt and $300 billion to purchase long-term Treasury bonds, in an attempt to lift the country out of recession by reducing rates on mortgages and consumer debt. 

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While analysts say there are several challenges ahead, including decreased consumption and a reduction of wealth as a result of declines in the stock and housing markets, the general consensus of analysts is that the recession could end sometime in the second half of 2009, with growth expected to reenter positive territory, while still sluggish, sometime in 2010.  The Industrial Price Index (“IPI”), which is a leading indicator of industrial demand and of inflation rates, has been rising since March 2009 and subsequent to second quarter 2009 reached its highest point since October 2008 in July.  The gross domestic product (“GDP”) of the U.S. which fell sharply for two consecutive quarters - in the fourth quarter 2008 and first quarter 2009 - by 6.3% and 5.5%, respectively - indicated that the rate of decline was no longer increasingly negative.  Furthermore, preliminary estimates for second quarter 2009 GDP indicate a smaller decline of 1.2% which would appear to confirm that the economy is falling at a much slower pace.  While the national unemployment rate at June 30, 2009 is the highest it has ever been since 1983, at 9.5% (9.2% in New Jersey), the pace of job loss during the second quarter appears to be slowing from what it had been doing.

The above actions, together with the overall economy, will continue to affect the markets in which the Company and its customers do business and may adversely impact the Company’s results in the future, depending upon the duration and severity of such conditions. The following discussion provides further detail on the financial condition and results of operations of the Company at and for the three and six months ended June 30, 2009.

Financial Condition

Total assets were $3.56 billion at June 30, 2009 as compared to $3.62 billion at December 31, 2008. Investment securities decreased $21.6 million, or 4.9%, to $415.7 million and other assets decreased $33.3 million, or 31.4%, to $72.6 million.  These decreases were offset by an increase in real estate owned of $8.7 million, or 441.3%, to $10.6 million. Total liabilities decreased $63.2 million, or 1.9%, to $3.20 billion at June 30, 2009 primarily due to a decrease in advances from the Federal Home Loan Bank of New York (“FHLBNY”), of $26.3 million, or 62.4%, combined with a decrease in other liabilities of $32.3 million, or 26.8%.  

Total loans receivable before allowance for loan losses decreased $5.9 million, or 0.2%, to $2.73 billion at June 30, 2009. Organic loan growth for the first six months of 2009, adjusted for approximately $43.4 million in prepayments, was approximately 1.4%. Despite various economic challenges and an overall softened loan demand, the Company continues to maintain a healthy lending channel.

Total non-performing loans were $63.5 million at June 30, 2009, or 2.3% of total loans, compared to $46.8 million, or 1.7%, at December 31, 2008. Non-performing loans primarily increased as a result of an increase in non-accrual loans of $13.6 million, or 32.1%, and an increase in loans past due 90 days and still accruing of $3.1 million, or 67.3%, at June 30, 2009 as compared to December 31, 2008.  Non-accrual loans increased $24.0 million, offset by reductions of $10.4 million, resulting in a net increase of $13.6 million.  The increase in non-accrual loans during the first six months of 2009 was primarily due to the addition of 18 separate commercial real estate relationships spread among several different industries whose loans totaled $12.2 million, the addition of 10 separate construction and land development relationships with an aggregate loan balance of $6.0 million and $1.6 million in home equity lines of credit.  The reduction to non-accrual loans during the same period was primarily the result of one commercial property foreclosure for $8.8 million which is included in real estate owned at June 30, 2009.  The ratio of allowance for loan losses to total non-performing loans was 69.82% at June 30, 2009 compared to 79.69% at December 31, 2008. Non-performing assets were $74.1 million at June 30, 2009 compared to $48.8 million at December 31, 2008.

The allowance for loan losses was $44.3 million and $37.3 million at June 30, 2009 and December 31, 2008, respectively.  The increase in the allowance for loan losses of $7.0 million to $44.3 million during the first half of 2009 reflects the Company’s continued aggressive review of its loan portfolio which resulted in loan downgrades and non-accruals.  Net charge-offs for the six months ended June 30, 2009 were $3.9 million, or 0.14% of average loans outstanding, and primarily consisted of $2.1 million in commercial loans, which included one unsecured commercial line of credit for $600,000, three unrelated home equity line of credit relationships totaling $886,000 and 13 unrelated small business loans with an aggregate loan balance of $796,000.  In addition, the Company further increased a number of its qualitative factors used in determining the appropriate level of allowance for loan losses. As a result, the Company has continued to maintain adequate reserve coverage as the ratio of allowance for loan losses to gross loans was 1.62% at June 30, 2009 as compared to 1.36% at December 31, 2008.

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Real estate owned increased $8.7 million to $10.6 million at June 30, 2009 as compared to December 31, 2008. During the first six months of 2009, the Company added five properties to the real estate owned portfolio, which included three commercial properties and two residential properties acquired through foreclosure at a total cost of $9.1 million.  All five of these properties were previously classified as non-accrual loans at December 31, 2008.  During the second quarter 2009, the Company sold one residential property with a carrying value of $247,000 and recognized a loss of $59,000. In addition, the Company also recognized a write-down of $150,000 during the first quarter 2009 on one property as the appraised value less cost to sell of this property was less than the carrying amount. 

Investment securities available for sale decreased $17.4 million, or 4.1%, from $423.5 million at December 31, 2008 to $406.1 million June 30, 2009. Investment securities held to maturity decreased $4.1 million, or 30.0%, from $13.8 million at December 31, 2008 to $9.6 million at June 30, 2009. The investment securities portfolio decreased primarily as a result of calls, maturities, prepayments and changes in fair value.  The reinvestment strategy for the remainder of 2009 is to maintain the average life and duration at approximately the same levels as June 30, 2009.

Bank owned life insurance (“BOLI”) increased from $75.5 million at December 31, 2008, to $76.6 million at June 30, 2009. The increase of $1.1 million represents the increase in the cash surrender value of the policies during the six months ended June 30, 2009.

Other assets decreased $33.3 million, or 31.4%, to $72.6 million at June 30, 2009 from $105.9 million at December 31, 2008.  This decrease was primarily the result of a $34.8 million decline in the fair value of the Company’s financial derivative instruments offered to commercial customers due to an increase in forward-looking benchmark interest rates and a reduction in underlying notional values applied in the valuation of these instruments.  This decrease is offset with a $34.8 million decline in the fair value of related financial derivative instruments recorded in the other liabilities section of the Unaudited Condensed Consolidated Statements of Financial Condition.  For more information on the Company’s financial derivative instruments, please see Note 8 of the Notes to Unaudited Condensed Consolidated Statements.

Total deposits were $2.88 billion at June 30, 2009, reflecting a $20.9 million decrease from December 31, 2008.  Core deposits, which exclude all certificates of deposit, increased $57.8 million to $1.76 billion, or 61.2% of total deposits at June 30, 2009, as compared to $1.70 billion, or 58.8% of total deposits at December 31, 2008.  This increase was offset with a decrease in certificates of deposit, including those placed through brokers, of $78.6 million for the same period.  During the second quarter 2009, the Company aggressively lowered interest rates on deposits while managing overall funding and liquidity. As a result of this strategy and a continued effort to balance deposit growth and net interest margin, the Company expects a further decline in certificates of deposit balances and will continue to evaluate other funding sources for funding cost efficiencies.

Total borrowings were $144.1 million at June 30, 2009, a decrease of $10.1 million, or 6.5%, from December 31, 2008.  The decrease was primarily a result of a reduction in advances from the FHLBNY of $26.3 million, offset by an increase of $16.0 million in federal funds purchased.

Total shareholders’ equity increased $2.2 million, or 0.6%, from $358.5 million at December 31, 2008 to $360.7 million at June 30, 2009. The increase was primarily the result of an overall net increase in comprehensive income of $4.5 million, which included a net loss of $4.2 million recognized for the six months ended June 30, 2009 offset with an increase in unrealized gains and a net change in impairment losses on available for sale securities of $8.7 million.  Furthermore, additional paid-in capital increased $2.0 million as a result of the remaining original cost of the warrant repurchased from the U.S. Treasury on May 27, 2009.  

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Comparison of Operating Results for the Three Months Ended June 30, 2009 and 2008

Overview. The Company recognized a net loss available to common shareholders for the three months ended June 30, 2009 of $8.8 million, or a $0.38 net loss per share, compared to net income of $2.3 million, or $0.10 per share, for the same period in 2008.  During the quarter, the Company repurchased all 89,310 shares of preferred stock issued under the U.S. Treasury’s Troubled Asset Relief Program Capital Purchase Program (“TARP CPP”). As a result, the Company recognized a $4.0 million acceleration of the accretion of original issuance discount and deferred issuance costs, in addition to the second quarter preferred dividend earned through the date of repurchase of $87,000, for a combined $4.1 million, or $0.18 per share, charge to earnings available to common shareholders.  Furthermore, the Company recognized a charge of $1.6 million, or $0.04 per share, as a result of the Federal Deposit Insurance Corporation’s (“FDIC”) five-basis point special assessment and a $4.6 million impairment charge, or $0.12 per share, due to further deterioration of underlying collateral on a pooled trust preferred security.  All per share amounts are presented on a diluted basis and have been adjusted for the 5% stock dividend issued on May 14, 2009.

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 $759,000 to $24.3 million for the three months ended June 30, 2009, from $25.0 million for the same period in 2008.  Interest income (on a tax-equivalent basis) decreased $5.1 million from the prior period to $38.3 million while interest expense decreased $4.3 million from the prior period to $14.0 million.  The interest rate spread and net interest margin (on a tax-equivalent basis) for the three months ended June 30, 2009 was 2.68% and 3.01%, respectively, compared to 2.82% and 3.30%, respectively, for the same period in 2008. Due to historically low interest rates, the margin compression for the three months ended June 30, 2009 was the result of the Company’s yields on interest-earning assets re-pricing downward more quickly than the cost of the Company’s interest-bearing liabilities.  Approximately 50% of the Company’s loan portfolio is indexed to a variable rate such as the 1-month LIBOR or Prime Rate.  On average, the 1-month LIBOR and Prime Rate for the three months ended June 30, 2009 was 0.37% and 3.25%, respectively, compared to 2.59% and 5.08%, respectively, for the same period in 2008.

Interest income (on a tax-equivalent basis) decreased $5.1 million, or 11.7%, for the three months ended June 30, 2009, compared to the same period in 2008. Interest income on loans decreased $6.9 million as yields earned on average loans receivable decreased 103 basis points.  This decrease was offset by an increase in interest income of $2.0 million as average loans receivable grew $146.2 million, or 5.7%. The increase in average loans receivable was primarily funded by an increase in deposits. The Company will continue to rely primarily on core deposit growth supplemented with wholesale borrowings to support its loan funding during 2009.  

Interest expense decreased $4.3 million, or 23.5%, for the three months ended June 30, 2009, compared to the same period in 2008.  Interest expense decreased $5.0 million as the cost of average interest-bearing deposit accounts decreased 80 basis points.  This decrease was offset by an increase in interest expense of $1.4 million as average interest-bearing deposits grew $218.3 million, or 9.4%.   In addition, the decrease in average FHLBNY advances of $21.7 million and the decrease in cost of junior subordinated debentures of 96 basis points resulted in a combined decrease in interest expense of $471,000.

On a positive note, net interest income (on a tax-equivalent basis) increased $2.0 million to $24.3 million for the three months ended June 30, 2009, from $22.3 million for the three months ended March 31, 2009.  Interest income (on a tax-equivalent basis) increased $382,000 over the previous linked quarter to $38.3 million while interest expense decreased $1.6 million to $14.0 million over the same period.  The net interest margin (on a tax-equivalent basis) for the second quarter 2009 increased to 3.01% compared to a net interest margin for the first quarter of 2009 of 2.74%, or the lowest net interest margin percentage realized by the Company to-date.  Interest income on loans increased $814,000 as yields earned on average loans increased 11 basis points as a result of improved loan pricing and the implementation of interest rate floors on new and renewable variable rate loans.  This increase was offset by an overall decrease in interest income earned on investment securities of $408,000 as average investment securities decreased $21.4 million and yields earned on average investment securities decreased 13 basis points during the second quarter 2009.  Interest expense decreased $1.4 million as the cost of average interest-bearing deposit accounts, particularly certificates of deposit, decreased 24 basis points, due to the Company aggressively lowering interest rates on deposits during the second quarter 2009.

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Table 1 provides detail regarding the Company’s average balances with corresponding interest income (on a tax-equivalent basis) and interest expense as well as yield and cost information for the periods presented. Average balances are derived from daily balances.

Table 1: Quarterly Statements of Average Balances, Income or Expense, Yield or Cost

	For The Three Months Ended June 30, 2009							For the Three Months Ended June 30, 2008
	Average		Income/		Yield/			Average		Income/		Yield/
	Balance		Expense		Cost			Balance		Expense		Cost
Interest-earning assets:
Loans receivable (1),(2):
Commercial and industrial	$	2,236,745	$	26,107		4.67	%	$	2,099,090	$	30,340		5.78	%
Home equity		268,276		3,332		4.97			265,481		3,925		5.91
Second mortgage		75,967		1,226		6.46			82,604		1,335		6.46
Residential real estate		75,812		1,095		5.78			52,332		818		6.25
Other		75,133		1,236		6.58			86,198		1,472		6.83
Total loans receivable		2,731,933		32,996		4.83			2,585,705		37,890		5.86
Investment securities (3)		445,456		5,258		4.72			426,652		5,331		5.00
Interest-earning deposit with banks		45,892		22		0.19			9,929		50		2.01
Federal funds sold		-		-		-			14,307		66		1.85
Total interest-earning assets		3,223,281		38,276		4.75			3,036,593		43,337		5.71
Non-interest-earning assets:
Cash and due from banks		48,777							58,723
Bank properties and equipment		48,343							48,371
Goodwill and intangible assets		145,033							149,746
Other assets		146,245							75,090
Total non-interest-earning assets		388,398							331,930
Total assets	$	3,611,679						$	3,368,523
Interest-bearing liabilities:
Interest-bearing deposit accounts:
Interest-bearing demand deposits	$	1,019,000		2,565		1.01	%	$	801,486		3,047		1.52	%
Savings deposits		295,010		725		0.98			422,807		1,866		1.77
Time deposits		1,229,512		9,115		2.97			1,100,917		11,044		4.01
Total interest-bearing deposit accounts		2,543,522		12,405		1.95			2,325,210		15,957		2.75
Short-term borrowings:
Federal funds purchased		16,632		20		0.48			28,256		172		2.43
Securities sold under agreements to repurchase - customers		15,996		10		0.25			35,839		108		1.21
Long-term borrowings:
FHLBNY advances (4)		30,903		355		4.60			52,561		633		4.82
Obligation under capital lease		5,230		94		7.19			5,230		95		7.27
Junior subordinated debentures		92,786		1,133		4.88			92,786		1,354		5.84
Total borrowings		161,547		1,612		3.99			214,672		2,362		4.40
Total interest-bearing liabilities		2,705,069		14,017		2.07			2,539,882		18,319		2.89
Non-interest-bearing liabilities:
Non-interest-bearing demand deposits		431,836							430,568
Other liabilities		104,578							30,249
Total non-interest-bearing liabilities		536,414							460,817
Total liabilities		3,241,483							3,000,699
Shareholders’ equity		370,196							367,824
Total liabilities and shareholders’ equity	$	3,611,679						$	3,368,523
Net interest income			$	24,259						$	25,018
Interest rate spread (5)						2.68	%						2.82	%
Net interest margin (6)						3.01	%						3.30	%
Ratio of average interest-earning assets to average interest-bearing liabilities						119.16	%						119.56	%
(1)  Average balances include non-accrual loans.
(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 adjustment for the three months ended June 30, 2009 and 2008 was $475,000 and $454,000, 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.

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Table 2 provides certain information regarding changes in interest income and interest expense of the Company for the periods presented.

Table 2: Quarterly Rate-Volume Variance Analysis (1)

	For the Three Months Ended June 30, 2009 vs. 2008
	Increase (Decrease) Due To
	Volume			Rate			Net
Interest income:
Loans receivable:
Commercial and industrial	$	1,880		$	(6,113	)	$	(4,233	)
Home equity		40			(633	)		(593	)
Second mortgage		(109	)		-			(109	)
Residential real estate		342			(65	)		277
Other		(184	)		(52	)		(236	)
Total loans receivable		1,969			(6,863	)		(4,894	)
Investment securities		230			(303	)		(73	)
Interest-bearing deposit accounts		50			(78	)		(28	)
Federal funds sold		(33	)		(33	)		(66	)
Total interest-earning assets		2,216			(7,277	)		(5,061	)
Interest expense:
Interest-bearing deposit accounts:
Interest-bearing demand deposits		696			(1,178	)		(482	)
Savings deposits		(461	)		(680	)		(1,141	)
Time deposits		1,174			(3,103	)		(1,929	)
Total interest-bearing deposit accounts		1,409			(4,961	)		(3,552	)
Short-term borrowings:
Federal funds purchased		(52	)		(100	)		(152	)
Securities sold under agreements to repurchase - customers		(40	)		(58	)		(98	)
Long-term borrowings:
FHLBNY advances(2)		(250	)		(28	)		(278	)
Obligation under capital lease		-			(1	)		(1	)
Junior subordinated debentures		-			(221	)		(221	)
Total borrowings		(342	)		(408	)		(750	)
Total interest-bearing liabilities		1,067			(5,369	)		(4,302	)
Net change in net interest income	$	1,149		$	(1,908	)	$	(759	)
(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 old rate) and (ii) changes in rate (changes in rate multiplied by old 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. Provision for loan losses for the second quarter 2009 continues to reflect the weakness in the broader economic environment. For the three months ended June 30, 2009, the provision for loan losses was $7.0 million compared to $6.5 million for the same period in 2008, which increased the allowance for loan losses to total gross loans at June 30, 2009 to 1.62% as compared to 1.36% at December 31, 2008.  The Company’s gross loans receivable grew $96.6 million, or 3.7%, to $2.73 billion at June 30, 2009 as compared to the same period in 2008.  Net charge-offs totaled $2.0 million for the three months ended June 30, 2009 compared to $2.9 million during the same period in 2008.  Net charge-offs for the quarter primarily consisted of $895,000 in commercial loans and two unrelated home equity line of credit relationships totaling $776,000. As a result of continued distressed economic conditions the Company has provided for higher provision levels and will likely continue to do so for the remainder of the year in anticipation of higher levels of troubled credits and ongoing stress on our portfolio.

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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 quarterly, management performs an analysis to identify the inherent risk of loss in the Company’s loan portfolio. This analysis includes a qualitative evaluation of concentrations of credit, past loss experience, current economic conditions, amount and composition of the loan portfolio (including loans being specifically monitored by management), estimated fair value of underlying collateral, delinquencies, and other factors.

Non-Interest Income. Non-interest income decreased $6.1 million, or 77.8%, for the three months ended June 30, 2009 to $1.7 million, as compared to the same period in 2008. The decrease was primarily attributable to an impairment loss of $4.6 million recognized on a pooled trust preferred security due to the further deterioration of underlying collateral.  In addition, gains on commercial derivative products decreased $952,000 due to a planned decline in transaction volume, service charges on deposits, such as non-sufficient funds and overdraft fees, decreased $465,000, and bank owned life insurance (“BOLI”) income decreased $211,000 due to lower yields earned on the Company’s separate account policy.  

Non-Interest Expense. Non-interest expense increased $4.7 million, or 20.7%, for the three months ended June 30, 2009 as compared to the same period in 2008. The increase was primarily attributable to an increase in FDIC insurance of $2.4 million, which includes the $1.6 million special assessment and $770,000 as a result of an increase in assessment rates, additional coverage under the Temporary Liquidity Guarantee Program (“TLGP”) and an overall increase in assessable deposits.  Salaries and benefits increased $933,000 primarily due to the addition of several key management and business line staff, and increases in commissions and healthcare costs.  In addition, cost of real estate owned increased $627,000, which was primarily due to the recognition of a $558,000 net gain on the sale of three properties during the second quarter of 2008 and advertising expense increased $387,000 due to the recent “Switch to Sun” campaign.

Income Tax (Benefit) Expense.  Income taxes decreased $5.0 million to a tax benefit position of $4.5 million for the three months ended June 30, 2009 as compared to the same period in 2008. The income tax benefit recognized during the second quarter 2009 was the result of the Company recognizing a pre-tax loss of $9.1 million in combination with the relatively large levels of tax-free income earned on tax-exempt securities and BOLI polices.

Comparison of Operating Results for the Six Months Ended June 30, 2009 and 2008

Overview. The Company recognized a net loss available to common shareholders for the six months ended June 30, 2009 of $9.6 million, or a $0.42 net loss per share, compared to net income of $6.5 million, or $0.27 per share, for the same period in 2008. Net loss available to common shareholders for the first half of 2009 included $5.4 million, or $0.23 per share, in dividends, accretion of the original issuance discount and deferred issuance costs on preferred shares issued, and later repurchased on April 8, 2009, under the U.S. Treasury’s CPP of the TARP.  Furthermore, the Company recognized a charge of $1.6 million, or $0.04 per share, as a result of the Federal Deposit Insurance Corporation’s (“FDIC”) 5-basis point special assessment and a $4.8 million net impairment charge, or $0.12 per share, on two pooled trust preferred securities due to further deterioration of underlying collateral. All per share amounts are presented on a diluted basis and have been adjusted for the 5% stock dividend issued on May 14, 2009.

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.

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Net interest income (on a tax-equivalent basis) decreased $3.5 million to $46.6 million for the six months ended June 30, 2009, from $50.1 million for the same period in 2008.  Interest income (on a tax-equivalent basis) decreased $13.2 million from the prior period to $76.2 million while interest expense decreased $9.7 million from the prior period to $29.6 million. The interest rate spread and net interest margin (on a tax-equivalent basis) for the six months ended June 30, 2009 was 2.51% and 2.87%, respectively, compared to 2.82% and 3.32% respectively, for the same period in 2008.  Due to historically low interest rates, the margin compression during the six months ended June 30, 2009 was the result of the Company’s yields on interest-earning assets re-pricing downward more quickly than the cost of the Company’s interest-bearing liabilities.  Approximately 50% of the Company’s loan portfolio is indexed to a variable rate such as the 1-month LIBOR or Prime Rate.  On average, the 1-month LIBOR and Prime Rate for the six months ended June 30, 2009 was 0.42% and 3.25%, respectively, compared to 2.95% and 5.64%, respectively, for the same period in 2008.

Interest income decreased $13.2 million, or 14.8%, for the six months ended June 30, 2009, compared to the same period in 2008. Interest income on loans decreased $18.1 million as yields earned on average loans receivable decreased 136 basis points.  This decrease was offset by an increase in interest income of $5.0 million as average loans receivable grew $176.7 million, or 6.9%. The increase in average loans receivable was primarily funded by an increase in deposits.  The Company will continue to rely primarily on core deposit growth supplemented with wholesale borrowings to support its loan funding during 2009.

Interest expense decreased $9.7 million, or 24.6%, for the six months ended June 30, 2009, compared to the same period in 2008. Interest expense decreased $11.2 million as the cost of average interest-bearing deposit accounts decreased 90 basis points. This decrease was offset by an increase in interest expense of $3.3 million as average interest-bearing deposits grew $236.3 million, or 10.2%.  In addition, the decrease in average FHLBNY advances of $27.3 million and the decrease in cost of junior subordinated debentures of 124 basis points resulted in a combined decrease in interest expense of $1.2 million.

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Table 3 provides detail regarding the Company’s average balances with corresponding interest income (on a tax-equivalent basis) and interest expense as well as yield and cost information for the periods presented. Average balances are derived from daily balances.

Table 3: Quarterly Statements of Average Balances, Income or Expense, Yield or Cost

	For The Six Months Ended June 30, 2009							For the Six Months Ended June 30, 2008
	Average		Income/		Yield/			Average		Income/		Yield/
	Balance		Expense		Cost			Balance		Expense		Cost
Interest-earning assets:
Loans receivable(1),(2):
Commercial and industrial	$	2,232,902	$	51,184		4.58	%	$	2,068,319	$	62,846		6.08	%
Home equity		268,597		6,832		5.09			266,659		8,080		6.06
Second mortgage		78,894		2,533		6.42			81,711		2,653		6.49
Residential real estate		73,354		2,165		5.90			51,172		1,636		6.39
Other		77,217		2,474		6.41			86,400		3,070		7.11
Total loans receivable		2,730,964		65,188		4.77			2,554,261		78,285		6.13
Investment securities(3)		456,118		10,924		4.79			441,009		10,867		4.93
Interest-earning deposit with banks		52,927		58		0.22			10,009		137		2.74
Federal funds sold		189		-		-			9,087		97		2.13
Total interest-earning assets		3,240,198		76,170		4.70			3,014,366		89,386		5.93
Non-interest-earning assets:
Cash and due from banks		48,955							57,639
Bank properties and equipment		48,406							48,132
Goodwill and intangible assets		145,618							150,335
Other assets		144,851							76,821
Total non-interest-earning assets		387,830							332,927
Total assets	$	3,628,028						$	3,347,293
Interest-bearing liabilities:
Interest-bearing deposit accounts:
Interest-bearing demand deposits	$	1,001,284		5,311		1.06	%	$	777,959		6,367		1.64	%
Savings deposits		296,293		1,571		1.06			442,378		4,671		2.11
Time deposits		1,243,804		19,453		3.13			1,084,777		23,232		4.28
Total interest-bearing deposit accounts		2,541,381		26,335		2.07			2,305,114		34,270		2.97
Short-term borrowings:
Federal funds purchased		10,133		25		0.49			23,001		302		2.63
Securities sold under agreements to repurchase - customers		16,302		20		0.25			37,269		341		1.83
Long-term borrowings:
FHLBNY advances(4)		33,922		729		4.30			61,224		1,293		4.22
Obligation under capital lease		5,204		189		7.26			5,239		191		7.29
Junior subordinated debentures		92,786		2,319		5.00			92,956		2,898		6.24
Total borrowings		158,347		3,282		4.15			219,689		5,025		4.57
Total interest-bearing liabilities		2,699,728		29,617		2.19			2,524,803		39,295		3.11
Non-interest-bearing liabilities:
Non-interest-bearing demand deposits		414,632							423,590
Other liabilities		106,257							31,788
Total non-interest-bearing liabilities		520,889							455,378
Total liabilities		3,220,617							2,980,181
Shareholders’ equity		407,411							367,112
Total liabilities and shareholders’ equity	$	3,628,028						$	3,347,293
Net interest income			$	46,553						$	50,091
Interest rate spread(5)						2.51	%						2.82	%
Net interest margin(6)						2.87	%						3.32	%
Ratio of average interest-earning assets to average interest-bearing liabilities						120.02	%						119.39	%
(1)  Average balances include non-accrual loans.
(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 adjustment for the six months ended June 30, 2009 and 2008 was $930,000 and $864,000, 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.

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Table 4 provides certain information regarding changes in interest income and interest expense of the Company for the periods presented.

Table 4: Quarterly Rate-Volume Variance Analysis (1)

	For the Six Months Ended June 30, 2009 vs. 2008
	Increase (Decrease) Due To
	Volume			Rate			Net
Interest income:
Loans receivable:
Commercial and industrial	$	4,639		$	(16,301	)	$	(11,662	)
Home equity		57			(1,305	)		(1,248	)
Second mortgage		(91	)		(29	)		(120	)
Residential real estate		660			(131	)		529
Other		(309	)		(287	)		(596	)
Total loans receivable		4,956			(18,053	)		(13,097	)
Investment securities		365			(308	)		57
Interest-bearing deposit accounts		140			(219	)		(79	)
Federal funds sold		(48	)		(49	)		(97	)
Total interest-earning assets		5,413			(18,629	)		(13,216	)
Interest expense:
Interest-bearing deposit accounts:
Interest-bearing demand deposits		1,526			(2,582	)		(1,056	)
Savings deposits		(1,237	)		(1,863	)		(3,100	)
Time deposits		3,022			(6,801	)		(3,779	)
Total interest-bearing deposit accounts		3,311			(11,246	)		(7,935	)
Short-term borrowings:
Federal funds purchased		(113	)		(164	)		(277	)
Securities sold under agreements to repurchase - customers		(127	)		(194	)		(321	)
Long-term borrowings:
FHLBNY advances(2)		(587	)		23			(564	)
Obligation under capital lease		(1	)		(1	)		(2	)
Junior subordinated debentures		(5	)		(574	)		(579	)
Total borrowings		(833	)		(910	)		(1,743	)
Total interest-bearing liabilities		2,478			(12,156	)		(9,678	)
Net change in net interest income	$	2,935		$	(6,473	)	$	(3,538	)
(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 old rate) and (ii) changes in rate (changes in rate multiplied by old 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. For the six months ended June 30, 2008, the provision for loan losses was $11.0 million compared to $8.7 million for the same period in 2008, which increased the allowance for loan losses to total gross loans at June 30, 2009 to 1.62% as compared to 1.36% at December 31, 2008. The Company’s gross loans receivable grew $96.6 million, 3.7% to $2.73 billion at June 30, 2009 as compared to the same period in 2008.  Net charge-offs totaled $3.9 million for the six months ended June 30, 2009 compared to $4.2 million during the same period in 2008.  Net charge-offs for the first half of 2009 primarily consisted of $2.1 million in commercial loans, which included one unsecured, commercial line of credit for $600,000, three unrelated home equity line of credit relationships totaling $886,000 and 13 unrelated small business loans with an aggregate loan balance of $796,000.  As a result of continued distressed economic conditions the Company has provided for higher provision levels and will likely continue to do so for the remainder of the year in anticipation of higher levels of troubled credits and ongoing stress on our portfolio.

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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. The Company focuses on its loan portfolio management and credit review process to address the current risk profile of the portfolio and manage troubled credits. This analysis includes evaluations of concentrations of credit, past loss experience, current economic conditions, amount and composition of the loan portfolio, estimated fair value of underlying collateral, loan commitments outstanding, delinquencies and other factors.

Non-Interest Income. Non-interest income decreased $8.1 million, or 53.5%, for the six months ended June 30, 2009, as compared to the same period in 2008. The decrease was primarily attributable to a net impairment loss of $4.8 million recognized on two pooled trust preferred securities due to the further deterioration of underlying collateral.  Furthermore, gains on commercial derivative products decreased $1.5 million due to a planned decline in transaction volume, service charges on deposits decreased $814,000, and BOLI income decreased $504,000 due to lower yields earned on the Company’s separate account policy.

Non-Interest Expense. Non-interest expense increased $4.6 million, or 9.8%, for the six months ended June 30, 2009, compared to the same period in 2008. The increase was primarily attributable to an increase in FDIC insurance of $3.1 million, which includes the $1.6 million special assessment and $1.5 million as a result of an increase in assessment rates, additional coverage under the Temporary Liquidity Guarantee Program (“TLGP”) and an overall increase in assessable deposits.  Cost of real estate owned increased $798,000, which was primarily due the recognition of a $577,000 net gain on the sale of four properties during the first half of 2008.  In addition, salaries and benefits increased $476,000 due to the addition of several key management and business line staff and increases in healthcare costs.

Income Tax (Benefit) Expense.  Income taxes decreased $7.8 million to a tax benefit position of $5.5 million for the six months ended June 30, 2009 as compared to the same period in 2008. The income tax benefit recognized during the first half of 2009 was the result of the Company recognizing a pre-tax loss of $9.7 million in combination with the relatively large levels of tax-free income earned on tax-exempt securities and BOLI polices.

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 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, maturities or calls of investment securities, as well as from a variety of wholesale funding sources including, but not limited to, brokered deposits, federal funds purchased, FHLBNY advances, securities sold under agreements to repurchase, and other secured and unsecured borrowings. Additional liquidity can be obtained from loan sales or participations. During the second quarter 2009, the Company aggressively lowered interest rates on deposits while managing overall funding and liquidity. As a result of this strategy and a continued effort to balance deposit growth and net interest margin, the Company expects a further decline in certificates of deposit balances and will continue to evaluate other funding sources for funding cost efficiencies. The Company has additional secured borrowing capacity with the Federal Reserve Bank of approximately $303.6 million and the FHLBNY of approximately $42.2 million. At June 30, 2009, $87.5 million and $30.8 million of the Company’s secured borrowing capacity through the Federal Reserve Bank and the FHLBNY, respectively, were utilized.  The Company has additional unsecured borrowing capacity through lines of credit with other financial institutions of approximately $85.0 million.  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 June 30, 2009, the Company had a par value of $366.6 million and $114.5 million in loans and securities, respectively, pledged as collateral on secured borrowings.

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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 June 30, 2010 total $978.4 million, or approximately 87.7% of total certificates of deposit.  As previously mentioned, the Company aggressively lowered interest rates on deposits, particularly on its certificates of deposit products, during the second quarter 2009.  Although certificates of deposit balances are expected to decline in the coming months, the Company will continue to closely monitor deposit retention.  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.

Total loans receivable before allowance for loan losses decreased $5.9 million, or 0.2%, during the first six months of 2009. 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.

Management currently operates under a capital plan for the Company and the Bank that is expected to allow the Company and the Bank to grow capital internally at levels sufficient for achieving its internal growth projections while managing its operating and financial risks. The principal components of the capital plan are to generate additional capital through retained earnings from internal growth, access the capital markets for external sources of capital, such as common equity and capital securities, when necessary or appropriate, redeem existing capital instruments and refinance such instruments at lower rates when conditions permit and maintain sufficient capital for safe and sound operations. As a result of recent market disruptions, the availability of capital, principally to financial services companies, has become significantly restricted. While some companies have been successful in raising additional capital, the cost of the capital has been substantially higher than the prevailing market rates prior to the market volatility. Management cannot predict when or if the markets will return to more favorable conditions.  Given the current market state, the Company continues to assess its plan for contingency capital needs, and when appropriate, the Company’s Board of Directors may consider various capital raising alternatives.

On January 9, 2009, the Company entered into a Letter Agreement with the U.S. Treasury under the TARP CPP, pursuant to which the Company issued and sold 89,310 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A and a warrant to purchase 1,620,545 shares of the Company's common stock, for an aggregate purchase price of $89.3 million in cash.

In March 2009, the Board of Directors of the Company determined that continuing to participate in the TARP CPP was contrary to the best interests of the Company, its shareholders and its employees. Accordingly, the Board of Directors approved the repurchase of the preferred stock as authorized under recent amendments to the TARP CPP that were a part of the American Recovery and Reinvestment Act of 2009. On April 8, 2009, the Company returned to the U.S. Treasury approximately $90.0 million, which includes the original investment amount of $89.3 million plus accrued but unpaid dividends of $657,000, and received in return, and cancelled, the share certificate for the preferred stock. In connection with this transaction, the Company and the U.S. Treasury entered into a Redemption Letter Agreement dated April 8, 2009. Pursuant to the terms of the Redemption Letter Agreement, the Company notified the U.S. Treasury on April 21, 2009 of its intention to repurchase the warrant from the U.S. Treasury. On May 27, 2009, the Company completed the repurchase of the warrant from the U.S. Treasury for $2.1 million ending the Company’s participation in the TARP CPP.

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The Company is subject to risk-based capital guidelines adopted by the Federal Reserve Board for bank holding companies.  The Bank is also subject to similar capital requirements adopted by the OCC.  Under these 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 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 financial statements. Under the 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 accounting practices. It is the Company’s intention to maintain “well capitalized” risk-based capital levels. 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. At June 30, 2009, the Company’s and the Bank’s capital exceeded all minimum regulatory requirements to which they are subject, and the Bank was “well capitalized” as defined under the federal bank regulatory guidelines. The risk-based capital ratios in Table 3 have been computed in accordance with regulatory accounting practices. At June 30, 2009, no conditions or events had occurred that changed the Company’s classification as “adequately capitalized” and the Bank’s classification as “well capitalized.”

Table 3: Regulatory Capital Levels

						For Capital Adequacy					To Be Well Capitalized Under Prompt Corrective
	Actual					Purposes					Action Provisions (1)
		Amount	Ratio				Amount	Ratio				Amount	Ratio
June 30, 2009
Total capital (to risk-weighted assets):
Sun Bancorp, Inc.	$	362,109		11.62	%	$	249,201		8.00	%		N/A
Sun National Bank		347,067		11.15			248,919		8.00		$	311,149		10.00	%
Tier I capital (to risk-weighted assets):
Sun Bancorp, Inc.		323,006		10.37			124,601		4.00			N/A
Sun National Bank		308,099		9.90			127,460		4.00			186,689		6.00
Leverage ratio:
Sun Bancorp, Inc.		323,006		9.29			139,049		4.00			N/A
Sun National Bank		308,099		8.88			138,837		4.00			173,546		5.00
December 31, 2008
Total capital (to risk-weighted assets):
Sun Bancorp, Inc.	$	357,720		11.37	%	$	254,575		8.00	%		N/A
Sun National Bank		340,815		10.84			251,430		8.00		$	314,288		10.00	%
Tier I capital (to risk-weighted assets):
Sun Bancorp, Inc.		319,974		10.17			127,287		4.00			N/A
Sun National Bank		303,069		9.64			125,715		4.00			188,573		6.00
Leverage ratio:
Sun Bancorp, Inc.		319,974		9.58			133,649		4.00			N/A
Sun National Bank		303,069		9.10			133,258		4.00			166,573		5.00
(1) Not applicable for bank holding companies.

The Company’s ratio of tangible equity to tangible assets was 6.33% at June 30, 2009 compared to 6.10% at December 31, 2008.

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The Company’s capital securities are deconsolidated in accordance with GAAP and 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 Federal Reserve Board. In March 2005, the Federal Reserve Board 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 Federal Reserve’s amended rule was to become effective March 31, 2009, and would have limited capital securities and other restricted core capital elements to 25% of all core capital elements, net of goodwill less any associated deferred tax liability.  On March 16, 2009, the Federal Reserve Board extended for two years the ability of bank holding companies to include restricted core capital elements as Tier 1 capital up to 25% of all core capital elements, including goodwill. The portion that exceeds the 25% capital limitation qualifies as Tier 2, or supplementary capital of the Company.  The Company does not anticipate that this amended rule will have a material impact on its capital ratios.  At June 30, 2009, the Company’s $90.0 million in capital securities qualify as Tier 1. 

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 June 30, 2009 was $67.6 million and the portion of the exposure not covered by collateral was approximately $1.4 million. 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 Statement of Position  (“SOP”) No. 01-6, Accounting by Certain Entities (Including Entities With Trade Receivables) That Lend to or Finance the Activities of Others.  As of the balance sheet date, the Company records estimated losses inherent with unfunded loan commitments in accordance with SFAS No. 5, Accounting for Contingencies, and estimated future obligations under letters of credit in accordance with FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. 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 June 30, 2009 and December 31, 2008 was $651,000 and $437,000, respectively. Management believes this reserve level is sufficient to absorb estimated probable losses related to these commitments.

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In October 2007, Visa Inc. (“Visa”) announced that it had completed a restructuring in preparation of its initial public offering (“IPO”) planned for the first quarter 2008. At the time of the announcement, the Company was a member of the Visa USA network.  As part of Visa’s restructuring, the Company received 13,325 shares of restricted Class USA stock in Visa in exchange for the Company’s membership interests.  The Company did not recognize a gain or loss upon receipt of Class USA shares in October 2007.  In November 2007, Visa announced that it had reached an agreement with American Express, related to its claim that Visa and its member banks had illegally blocked American Express from the bank-issued card business in the U.S. The Company was not a named defendant in the lawsuit and, therefore, was not directly liable for any amount of the settlement. However, in accordance with Visa’s by-laws, the Company and other Visa USA, Inc. (a wholly-owned subsidiary of Visa) members were obligated to indemnify Visa for certain losses, including the settlement of the American Express matter. The Company's indemnification obligation is limited to its proportionate interest in Visa USA, Inc. The Company determined that its potential indemnification obligations based on its proportionate share of ownership in Visa USA was not material at June 30, 2009.

On July 16, 2009, Visa deposited an additional $700 million into the litigation escrow account previously established to satisfy specific settlement obligations.  Visa funded the additional amount in to the escrow account by reducing each Class B shareholders’ conversion ratio to Visa Class A shares from 0.6296 to 0.5824.  The Company currently has 7,672 Class B shares, with a zero cost basis.

Recent Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No. 162.  Upon the effective date of SFAS No. 168, the codification will become the sole source of authoritative GAAP recognized by the FASB. Rules and interpretive guidance of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants.  SFAS No. 168 is effective for fiscal years and interim periods ending after September 15, 2009.  SFAS No. 168 will impact the reference to accounting pronouncements within the Company’s Notes to Unaudited Condensed Consolidated Financial Statements, but will have no impact on its financial condition, results of operations or cash flows.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R).  SFAS No. 167 significantly changes the criteria for determining whether the consolidation of a variable interest entity is required. SFAS No. 167 also addresses the effect of changes required by SFAS No. 166, Consolidation of Variable Interest Entities, on FASB Interpretation No. 46(R), and address concerns regarding the application of certain provisions of Interpretation No. 46(R), including concerns that the accounting and disclosures do not always provide timely and useful information about an entity’s involvement in a variable interest entity. SFAS No. 167 is effective for interim and annual reporting periods that begin after November 15, 2009. The Company is continuing to evaluate the impact of SFAS No. 167, but does not expect the guidance will have a material impact on the Company’s financial condition or results of operations.

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets - an amendment of FASB Statement No. 140. SFAS No. 166 amends SFAS No. 140 to improve the relevance and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and the transferor’s continuing involvement, if any, in transferred financial assets. SFAS No. 166 is effective for interim and annual reporting periods that begin after November 15, 2009. The Company is continuing to evaluate the impact of SFAS No. 166, but does not expect the guidance will have a material impact on the Company’s financial condition or results of operations.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events. SFAS No. 165 establishes standards under which an entity shall recognize and disclose events that occur after a balance sheet date, but before the related financial statements are issued or are available to be issued. SFAS No. 165 is effective for fiscal years and interim periods ending after June 15, 2009. The Company adopted SFAS No. 165 effective June 30, 2009 and the guidance did not have an impact on the Company’s financial condition or results of operations.

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In April 2009, the FASB issued FASB Staff Position (“FSP”) SFAS No. 107-1 and Accounting Principles Board (“APB”) No. 28-1, Interim Disclosures about Fair Value of Financial Instruments.  FSP SFAS No. 107-1 and APB No. 28-1 require a public entity to provide disclosures about fair value of financial instruments in interim financial information.  FSP SFAS No. 107-1 and APB No. 28-1 is effective for interim and annual financial periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  An entity adopting this FSP early must also adopt FSP SFAS No. 157-4 and FSP SFAS No. 115-2 and SFAS No. 124-2.  The Company adopted FSP SFAS No. 107-1 and APB No. 28-1 effective June 30, 2009 and the guidance did not have an impact on the Company’s financial condition or results of operations.  See Note 14 for disclosures pertaining to fair value of the Company’s financial instruments.

In April 2009, the FASB issued FSP SFAS No. 115-2 and SFAS No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments.  FSP SFAS No. 115-2 and SFAS No. 124-2 amends existing guidance for determining whether an impairment is other-than-temporary to debt securities and replaces the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; (b) it is more likely than not it will not have to sell the security before recovery of its cost basis; and (c) it does expect to recover the entire amortized cost basis of the security.  Under FSP SFAS No. 115-2 and SFAS No. 124-2, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses.  The amount of impairment related to other factors is recognized in other comprehensive income.  For debt securities held at the beginning of the period, the FSP requires the Company to recognize a cumulative-effect adjustment, net of tax, to the opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive income for the amount of the OTTI which should have been recognized in other comprehensive income had the FSP been in effect at the beginning of the period.  The Company elected to early adopt this FSP on January 1, 2009 and recorded a cumulative-effect adjustment, net of tax, to retained earnings of $3.1 million with the corresponding offset to other comprehensive income in the Unaudited Condensed Consolidated Statements of Financial Condition. See Note 3 for more information on credit losses recognized in earnings pertaining to the Company’s investment portfolio.

In April 2009, the FASB issued FSP SFAS No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.  FSP SFAS No. 157-4includes 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. FSP SFAS No. 157-4 will be effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  An entity adopting FSP SFAS No. 157-4 early must also adopt FSP SFAS No. 115-2 and SFAS No. 124-2.  The Company adopted FSP SFAS No. 157-4 effective March 31, 2009 and the guidance did not have a material impact on the Company’s financial condition or results of operations.

In January 2009, the FASB issued FSP EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20. Effective for interim and annual reporting periods ending after December 15, 2008, FSP EITF 99-20-1 amended EITF 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, to achieve a more consistent evaluation of whether there is an OTTI for the debt securities under the scope of EITF 99-20 and the debt securities not within the scope of EITF 99-20 that would fall under the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Company adopted FSP EITF 99-20-1 effective December 31, 2008 and the guidance did not have an impact on the Company’s financial condition or results of operations. 

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In September 2008, the FASB issued FSP SFAS No. 133-1 and FIN No. 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; And Clarification of the Effective Date of FASB Statement No. 161. This statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, to require disclosures by sellers of credit derivatives, including credit derivatives embedded in a hybrid instrument and amends FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, to require an additional disclosure about the current status of the payment/performance risk of a guarantee.  The provisions of this statement are effective for annual or interim reporting periods ending after November 15, 2008. The Company adopted FSP SFAS No. 133-1 and FIN No. 45-4 on December 31, 2008 and the guidance did not have an impact on the Company’s financial condition or results of operations. 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an Amendment of FASB Statement No. 133. SFAS No. 161 enhances the required disclosures regarding derivatives and hedging activities, including disclosures regarding how an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133 and how derivative instruments and related hedged items affect an entity’s financial condition, results of operations, and cash flows. SFAS No. 161 is effective for quarterly interim periods beginning after November 15, 2008, and fiscal years that include those quarterly interim periods. The Company adopted SFAS No. 161 on January 1, 2009 and the guidance did not have an impact on the Company's financial condition or results of operations.  Please see Note 8 for more information on the Company’s financial derivative instruments.

FSP SFAS No. 157-2, Effective Date of FASB Statement No. 157, issued in February 2008, delays the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in an entity’s financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008. The Company adopted FSP SFAS No. 157-2 on January 1, 2009 and the guidance did not have an impact on the Company’s financial condition or results of operations. Please see Note 14 for more information on the Company’s non-financial assets measured at fair value.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements – an amendment of ARB No. 51. SFAS No. 160 requires that a non-controlling interest in a subsidiary be reported separately within equity and the amount of consolidated net income specifically attributable to the non-controlling interest be identified in the consolidated financial statements. SFAS No. 160 also calls for consistency in the manner of reporting changes in the parent’s ownership interest and requires fair value measurement of any non-controlling equity investment retained in a deconsolidation.  The Company adopted SFAS No. 160 on January 1, 2009 and the guidance did not have an impact on the Company’s financial condition or results of operations.

In December 2007, the FASB issued SFAS No. 141 (revised 2007) (“SFAS No. 141(R)”), Business Combinations, which replaces SFAS No. 141, Business Combinations. SFAS No. 141(R) retains the fundamental requirements in SFAS No. 141 that the acquisition method of accounting (formerly referred to as purchase method) be used for all business combinations and that an acquirer be identified for each business combination. SFAS No. 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as of the date that the acquirer achieves control. SFAS No. 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquired at the acquisition date, measured at their fair values. SFAS No. 141(R) requires the acquirer to recognize acquisition related costs and restructuring costs separately from the business combination as period expense. The Company adopted SFAS No. 141(R) on January 1, 2009 and the guidance did not have an impact on the Company’s financial condition or results of operations.

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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, which meets monthly, 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 six months and one year maturities.

At June 30, 2009, the Company’s gap analysis showed an asset sensitive position with total interest-bearing assets maturing or re-pricing within one year exceeding interest-earning liabilities maturing or re-pricing during the same time period by $333.9 million, representing a positive one-year gap ratio of 9.4%. All amounts are categorized by their actual maturity, 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, rate change behaviors, level and composition of new balance sheet activity and new product lines 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 June 30, 2009, shows a position that is relatively neutral to interest rates with a slightly more negative bias as rates decline. 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, as well as a movement toward more floating or short-term adjustable loans.  The floating rate loans are indexed to both Prime Rate and LIBOR.  To the extent that primarily managed rates on liabilities and primarily indexed rates on assets do not move by the same amount, added basis risk will impact margin.

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 June 30, 2009. The Company anticipates that strong deposit pricing competition will continue to limit deposit pricing flexibility in an increasing and particularly in a decreasing rate environment.

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Table 4 provides the Company’s estimated earnings sensitivity profile versus the most likely rate forecast as of June 30, 2009:

Table 4: Sensitivity Profile

Change in Interest Rates	Percentage Change in Net Interest Income
(Basis Points)	Year 1
+200	-0.8%
+100	-0.6%
-100	-0.7%
-200	-1.1%

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 8 of the Notes to Unaudited Condensed Consolidated Statements.

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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 financial 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 are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is 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.

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PART II - OTHER INFORMATION

Item 1.	Legal Proceedings
	The Company is not engaged in any legal proceedings of a material nature at June 30, 2009. From time to time, the Company is a party to legal proceedings in the ordinary course of business wherein it enforces its security interest in loans.
Item 1A.	Risk Factors
	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, 2008, previously filed with the Securities and Exchange Commission except that those risks under the heading “Risks Related to Series A Preferred Stock” are no longer applicable as the Company redeemed all of the issued and outstanding shares of Series A Preferred Stock during the quarter.
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
	Not applicable
Item 3.	Defaults upon Senior Securities
	Not applicable
Item 4.	Submission of Matters to a Vote of Security Holders
	The Annual Meeting of the shareholders of the Company was held on July 16, 2009 and the following matters were voted on:
	1)Election of Directors

	Vote
	For	Withheld
Bernard A. Brown	19,996,332	1,224,135
Ike Brown	19,628,496	1,591,971
Jeffrey S. Brown	19,856,937	1,363,530
Sidney R. Brown	20,095,488	1,124,979
John A. Fallone	20,405,449	815,018
Peter Galetto, Jr.	20,369,458	851,009
Thomas X. Geisel	20,280,767	939,700
Douglas J. Heun	19,587,924	1,632,543
Anne E. Koons	19,664,678	1,555,789
Eli Kramer	20,218,309	1,002,158
Alfonse M. Mattia	20,284,393	936,074
George A. Pruitt	19,261,103	1,959,364
Anthony Russo, III	20,198,365	1,022,102
Edward H. Salmon	20,331,876	888,591

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2)The amendment to the Company’s Amended and Restated 2004 Stock-Based Incentive Plan.

	Vote
FOR	11,981,963
AGAINST	4,675,828
ABSTAIN	324,928

3)The amendment to the Company’s Directors’ Stock Purchase Plan, as amended and restated.

	Vote
FOR	15,705,575
AGAINST	948,892
ABSTAIN	328,252

4)The ratification of the appointment of Deloitte & Touche LLP as the Company’s registered public accounting firm for the fiscal year ending December 31, 2009.

	Vote
FOR	21,081,982
AGAINST	122,426
ABSTAIN	16,059

Item 5.	Other Information
	Not applicable
Item 6.	Exhibits
	Exhibit 31(a) Certification of Chief Executive Officer Pursuant to §302 of the Sarbanes-Oxley Act of 2002.
	Exhibit 31(b) Certification of Chief Financial Officer Pursuant to §302 of the Sarbanes-Oxley Act of 2002.
	Exhibit 32 Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to §906 of the Sarbanes-Oxley Act of 2002.

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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: August 10, 2009	/s/ Thomas X. Geisel
	Thomas X. Geisel
	President and Chief Executive Officer
Date: August 10, 2009	/s/ Dan A. Chila
	Dan A. Chila
	Executive Vice President and
	Chief Financial Officer

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