Sun Bancorp (SNBC) 10-Q 2011 Q3 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 September 30, 2011

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 [x ] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 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 – 85,562,301 Shares Outstanding at November 3, 2011

TABLE OF CONTENTS

		Page Number
PART I - FINANCIAL INFORMATION
	Item 1. Financial Statements
Unaudited Condensed Consolidated Statements of Financial Condition at September 30, 2011 and December 31, 2010		2
Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010		3
Unaudited Condensed Consolidated Statements of Shareholders’ Equity for the Nine Months Ended September 30, 2011 and 2010		4
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010		5
Notes to Unaudited Condensed Consolidated Financial Statements		6
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
	Item 3. Quantitative and Qualitative Disclosures about Market Risk	49
	Item 4. Controls and Procedures	50
PART II - OTHER INFORMATION
	Item 1. Legal Proceedings	51
	Item 1A. Risk Factors	51
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	51
	Item 3. Defaults upon Senior Securities	51
	Item 4. Reserved	51
	Item 5. Other Information	51
	Item 6. Exhibits	52
	Signatures	53
	Certifications
	Exhibit 31(a) Section 302 Certification of CEO	54
	Exhibit 31(b) Section 302 Certification of CFO	55
	Exhibit 32 Section 906 Certifications	56
	Exhibit 101.INS XBRL Instance Document
	Exhibit 101.SCH XBRL Taxonomy Extension Schema Document
	Exhibit 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
	Exhibit 101.LAB XBRL Taxonomy Extension Label Linkbase Document
	Exhibit 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
	Exhibit 101.DEF XBRL Taxonomy Definition Linkbase Document

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SUN BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except par value amounts)
	September 30, 2011			December 31, 2010
ASSETS
Cash and due from banks	$	73,006		$	36,522
Interest-earning bank balances		61,203			150,704
Cash and cash equivalents		134,209			187,226
Investment securities trading (amortized cost of $4,970 at September 30, 2011)		5,138			-
Investment securities available for sale (amortized cost of $536,817 and $483,255 at September 30, 2011 and December 31, 2010, respectively)		534,768			472,864
Investment securities held to maturity (estimated fair value of $1,787 and $3,155 at September 30, 2011 and December 31, 2010, respectively)		1,714			3,039
Loans receivable (net of allowance for loan losses of $55,227 and $81,713 at September 30, 2011 and December 31, 2010, respectively)		2,251,176			2,439,633
Loans held-for-sale		20,868			13,824
Restricted equity investments		15,760			17,590
Bank properties and equipment, net		55,544			53,428
Real estate owned		4,893			3,913
Accrued interest receivable		8,692			10,004
Goodwill		38,188			38,188
Intangible assets, net		7,868			10,631
Deferred taxes, net		837			4,245
Bank owned life insurance (BOLI)		74,752			74,656
Other assets		81,812			88,305
Total assets	$	3,236,219		$	3,417,546
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits	$	2,727,650		$	2,940,460
Securities sold under agreements to repurchase – customers		6,026			6,307
Advances from the Federal Home Loan Bank of New York (FHLBNY)		3,054			3,999
Securities sold under agreements to repurchase – FHLBNY		15,000			15,000
Obligations under capital lease		7,930			8,111
Junior subordinated debentures		92,786			92,786
Other liabilities		75,718			82,641
Total liabilities		2,928,164			3,149,304
Commitments and contingencies (see Note 10)
Shareholders’ equity:
Preferred stock, $1 par value, 1,000,000 shares authorized; none issued		-			-
Common stock, $1 par value, 200,000,000 shares authorized; 87,642,852 shares issued and 85,536,129 shares outstanding at September 30, 2011; 52,463,594 shares issued and 50,356,871 shares outstanding at December 31, 2010		87,643			52,464
Additional paid-in capital		503,938			438,335
Retained deficit		(256,001	)		(190,015	)
Accumulated other comprehensive loss		(1,212	)		(6,146	)
Deferred compensation plan trust		(151	)		(234	)
Treasury stock at cost, 2,106,723 shares at  September 30, 2011 and December 31, 2010		(26,162	)		(26,162	)
Total shareholders’ equity		308,055			268,242
Total liabilities and shareholders’ equity	$	3,236,219		$	3,417,546
See Notes to Unaudited Condensed Consolidated Financial Statements.

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SUN BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share and per share amounts)
	For the Three Months Ended  September 30,								For the Nine Months Ended  September 30,
	2011				2010				2011				2010
INTEREST INCOME
Interest and fees on loans	$		28,149		$		32,664		$		85,115		$		97,976
Interest on taxable investment securities			2,603				2,963				8,086				9,002
Interest on non-taxable investment securities			542				741				1,984				2,634
Dividends on restricted equity investments			216				204				679				637
Total interest income			31,510				36,572				95,864				110,249
INTEREST EXPENSE
Interest on deposits			4,298				7,260				14,696				22,123
Interest on funds borrowed			356				372				1,067				1,352
Interest on junior subordinated debentures			675				1,054				2,302				3,085
Total interest expense			5,329				8,686				18,065				26,560
Net interest income			26,181				27,886				77,799				83,689
PROVISION FOR LOAN LOSSES			2,321				42,429				67,440				66,007
Net Interest income (loss) after provision for loan losses			23,860				(14,543	)			10,359				17,682
NON-INTEREST INCOME
Service charges on deposit accounts			2,838				2,869				8,090				8,857
Other service charges			85				92				259				270
Gain on sale of loans			708				921				2,341				2,236
Net impairment losses on available for sale securities
Total (impairment) recovery	$	-			$	(4,005)			$	270			$	(4,005)
Portion of loss (gain) recognized in other comprehensive income (before taxes)		-				3,055				(520)				3,055
Net impairment losses recognized in operations			-				(950	)			(250	)			(950	)
Gain on sale of investment securities			-				-				1,408				145
Investment products income			562				708				2,460				2,103
BOLI income			549				545				1,655				1,622
Derivative credit valuation adjustment			(309	)			(7,498	)			(12,324	)			(9,509	)
Other			1,337				961				3,025				2,941
Total non-interest income (loss)			5,770				(2,352	)			6,664				7,715
NON-INTEREST EXPENSE
Salaries and employee benefits			13,619				15,079				39,490				42,299
Occupancy expense			3,021				3,030				9,730				9,465
Equipment expense			1,899				1,663				5,484				5,149
Data processing expense			1,058				1,039				3,234				3,226
Amortization of intangible assets			922				922				2,764				2,764
Goodwill impairment			-				-				-				89,706
Insurance expense			1,479				2,105				4,753				5,632
Professional fees			879				461				2,859				1,504
Advertising expense			395				833				2,282				1,945
Problem loan expense			1,506				956				6,476				3,240
Real estate owned expense, net			448				93				1,078				403
Office supplies expense			315				377				984				1,163
Other			1,432				2,783				3,865				6,607
Total non-interest expense			26,973				29,341				82,999				173,103
INCOME (LOSS) BEFORE INCOME TAXES			2,657				(46,236	)			(65,976	)			(147,706	)
INCOME TAX (BENEFIT) EXPENSE			(23	)			28,757				10				9,219
NET INCOME (LOSS)			2,680				(74,993	)			(65,986	)			(156,925	)
Preferred stock dividends and discount accretion			-				274				-				274
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS	$		2,680		$		(75,267	)	$		(65,986	)	$		(157,199	)
Basic earnings (loss) per share	$		0.03		$		(3.14	)	$		(0.90	)	$		(6.66	)
Diluted earnings (loss) per share	$		0.03		$		(3.14	)	$		(0.90	)	$		(6.66	)
Weighted average shares – basic		84,429,644			23,960,691				73,643,303				23,587,981
Weighted average shares – diluted		84,538,449			23,960,691				73,643,303				23,587,981
See Notes to Unaudited Condensed Consolidated Financial Statements.

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SUN BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Dollars in thousands)
		Preferred Stock		Common Stock		Additional Paid-In Capital			Retained Deficit			Accumulated Other Comprehensive Loss			Deferred Compensation			Treasury Stock			Total
BALANCE, JANUARY 1, 2010	$	-	$	25,436	$	362,189		$	(4,597	)	$	(149	)	$	(124	)	$	(26,162	)	$	356,593
Comprehensive loss:
Net loss		-		-		-			(156,925	)		-			-			-			(156,925	)
Unrealized gain on available for sale securities net of reclassification adjustment, net of tax		-		-		-			-			1,293			-			-			1,293
Comprehensive loss																					(155,632	)
Issuance of preferred stock		88,009		-		-			-			-			-			-			88,009
Issuance of common stock		-		4,861		14,672			-			-			(90	)		-			19,443
Preferred and common stock issuance costs		-		-		(7,488	)		-			-			-			-			(7,488	)
Stock-based compensation		-		36		2,077			-			-			-			-			2,113
BALANCE, September 30, 2010	$	88,009	$	30,333	$	371,450		$	(161,522	)	$	1,144		$	(214	)	$	(26,162	)	$	303,038
BALANCE, JANUARY 1, 2011	$	-	$	52,464	$	438,335		$	(190,015	)	$	(6,146	)	$	(234	)	$	(26,162	)	$	268,242
Comprehensive loss:
Net loss		-		-		-			(65,986	)		-			-			-			(65,986	)
Unrealized gain on available for sale securities, net of tax (See Note 1)		-		-		-			-			5,620			-			-			5,620
Reclassification adjustment for net loss included in net income, net of tax (See Note 1)		-		-		-			-			(834	)		-			-			(834	)
Portion of reclassification adjustment recognized in earnings, net of tax (See Note 1)		-		-		-			-			148			-			-			148
Comprehensive loss																					(61,052	)
Stock issuance costs		-		-		(607	)		-			-			-			-			(607	)
Issuance of common stock (See Note 13)		-		35,144		65,151			-			-			83			-			100,378
Stock-based compensation		-		35		1,059			-			-			-			-			1,094
BALANCE, SEPTEMBER 30, 2011	$	-	$	87,643	$	503,938		$	(256,001	)	$	(1,212	)	$	(151	)	$	(26,162	)	$	308,055
See Notes to Unaudited Condensed Consolidated Financial Statements.

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SUN BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
	For the Nine Months Ended September 30,
	2011			2010
OPERATING ACTIVITIES
Net loss	$	(65,986	)	$	(156,925	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for loan losses		67,440			66,007
Reserve for unfunded commitments		(1,142	)		-
Depreciation, amortization and accretion		5,101			9,511
Goodwill impairment		-			89,706
Write down of book value of bank properties and equipmentand real estate owned		1,298			12
Other-than-temporary impairment on investment securities		250			950
Net gain on sale of investment securities available-for-sale		(1,408	)		(102	)
Mark-to-market on trading securities		(168	)		-
Net loss on sale of real estate owned		76			9
Gain on sale of mortgage loans		(2,341	)		(2,236	)
Derivative credit valuation adjustments		12,324			9,509
Increase in cash surrender value of BOLI		(1,655	)		(1,622	)
Deferred income taxes		-			20,340
Stock-based compensation		1,094			2,113
Shares contributed to employee benefit plans		744			509
Mortgage loans originated for sale		(93,562	)		(128,020	)
Proceeds from the sale of mortgage loans		94,059			120,326
Change in assets and liabilities which provided (used) cash:
Accrued interest receivable		1,312			1,441
Other assets		4,223			79
Other liabilities		(11,835	)		491
Purchases of trading securities		(41,371	)		-
Proceeds from sale of trading securities		36,396			-
Net cash provided by operating activities		4,849			32,098
INVESTING ACTIVITIES
Purchases of available-for-sale securities		(202,560	)		(234,892	)
Net redemption of restricted equity securities		1,830			573
Proceeds from maturities, prepayments or calls of investment securities available for sale		104,697			184,332
Proceeds from maturities, prepayments or calls of investment securities held to maturity		1,323			3,067
Proceeds from sale of available-for-sale securities		42,136			22,619
Proceeds from death benefit from BOLI		1,559			5,171
Proceeds from sale of loans		99,162			-
Net decrease (increase) in loans		14,150			(10,354	)
Purchases of bank properties and equipment		(7,078	)		(3,647	)
Proceeds from insurance on real estate owned		-			154
Proceeds from sale of real estate owned		1,202			8,022
Net cash provided by investing activities		56,421			(24,955	)
FINANCING ACTIVITIES
Net (decrease) increase in deposits		(212,432	)		142,626
Net repayments of federal funds purchased		-			(89,000	)
Net repayments of securities sold under agreements to repurchase – customer		(281	)		(2,975	)
Repayment of advances from FHLBNY		(945	)		(10,907	)
Repayment of obligations under capital leases		(181	)		(132	)
Proceeds from issuance of preferred stock, series B		-			88,009
Preferred and common stock issuance costs		-			(7,417	)
Proceeds from issuance of common stock		99,552			18,798
Net cash used in financing activities		(114,287	)		139,002
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(53,017	)		146,145
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		187,226			59,120
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	134,209		$	205,265
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid	$	19,913		$	18,485
Income taxes paid		154			110
Income tax refunds		-			2,724
SUPPLEMENTAL DISCLOSURE OF NON-CASH ITEMS
Receivable on principal pay downs of mortgage-backed securities	$	-		$	2,587
Transfer of loans to held-for-sale		5,096			-
Transfer of real estate owned to bank property		-			1,900
Transfer of loans to real estate owned		2,925			4,854
See Notes to Unaudited Condensed Consolidated Financial Statements.

-5-

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”).

All normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the unaudited condensed consolidated financial statements have been included. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the accompanying notes thereto included in the Annual Report on Form 10-K of Sun Bancorp, Inc. (the “Company”) for the year ended December 31, 2010. The results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011 or any other period. The preparation of the unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the reporting period. The significant estimates include the allowance for loan losses, other-than-temporary impairment on investment securities, income taxes and the fair value of financial instruments. Actual results may differ from these estimates under different assumptions or conditions.

Basis of Consolidation.The unaudited condensed consolidated financial statements include, after all intercompany balances and transactions have been eliminated, the accounts of the Company, its principal wholly owned subsidiary, Sun National Bank (the “Bank”), and the Bank’s wholly owned subsidiaries, Sun Financial Services, L.L.C., 2020 Properties, L.L.C., and 4040 Properties, L.L.C.. The Bank’s former subsidiary, Sun Home Loans, Inc. was merged into the Bank on September 16, 2011. In accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 810-10, Consolidation, Sun Capital Trust V, Sun Capital Trust VI, Sun Capital Trust VII, Sun Statutory Trust VII, Sun Capital Trust VIII, Sun Capital Trust IX and Sun Capital Trust X, collectively, the “Issuing Trusts”, are presented on a deconsolidated basis. 

Segment Information.As defined in accordance with FASB ASC 280, Segment Reporting, (“FASB ASC 280”) 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. 

Investment Securities Trading. Debt securities which the Company has purchased principally for the purpose of selling in the near-term are classified as held-for-trading and accounted for at fair value. Realized and unrealized gains and losses on trading securities are included in other income on the unaudited condensed consolidated statements of operations. Fair values of trading securities are based on quoted market prices, pricing models (utilizing indicators of general market conditions or other economic measurements), or management's estimates of amounts to be realized on settlement, assuming current market conditions and an orderly disposition over a reasonable period of time.

Loans Held-for-sale.Loans held-for-sale totaled $20.9 million and $13.8 million at September 30, 2011 and December 31, 2010, respectively. The balance at September 30, 2011 includes $5.2 million relating to one commercial loan transferred at fair value during the year. The remaining balance of $15.7 million at September 30, 2011 and $13.8 million at December 31, 2010, represents mortgage loans held-for-sale which are carried at the lower of cost or estimated fair value, on an aggregate basis.

Accumulated Other Comprehensive Loss.The Company classifies items of accumulated comprehensive loss by their nature and displays the balance of accumulated other comprehensive loss separately from retained deficit and additional paid-in capital in the equity section of the unaudited condensed consolidated statements of financial condition. Amounts categorized as accumulated other comprehensive loss represent net unrealized gains or losses on investment securities available for sale, net of tax and the non-credit portion of any other-than-temporary impairment ("OTTI") loss not recorded in earnings. Reclassifications are made to avoid double counting items which are displayed as part of net income for the period. These reclassifications for the nine months ended September 30, 2011 and 2010 are as follows:

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	For the Nine Months Ended September 30,
	2011									2010
	Pre-tax			Tax			After-tax			Pre-tax			Tax			After-tax
Unrealized holding gain on securities available for sale during the period	$	10,020		$	(4,092	)	$	5,928		$	4,173		$	(1,411	)	$	2,762
Reclassification adjustment for net gains included in net income(1)(2)		(1,408	)		574			(834	)		(101	)		-			(101	)
Reclassification adjustment for net impairment loss recognized in earnings(1)		250			(102	)		148			950			(333	)		618
Reclassification adjustment for portion of impairment loss recognized in other comprehensive loss		(520	)		212			(308	)		(3,055	)		1,069			(1,986	)
Net unrealized gain on securities available for sale	$	8,342		$	(3,408	)	$	4,934		$	1,967		$	(674	)	$	1,293
(1) All amounts are included in non-interest income in the unaudited condensed consolidated statements of operations.
(2) Reclassification adjustment for the nine months ended September 30, 2010 is tax exempt as all sales/calls during the period were for tax-exempt securities.

Recent Accounting Principles. In September 2011, the FASB issued Accounting Standards Update (“ASU”) 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This guidance allows an entity to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit. If, after assessing the totality of events or circumstances, an entity determines it is not more likely that not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step goodwill impairment test is unnecessary. This guidance is effective for public entities for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of this guidance is not expected to have any impact on the Company’s financial condition or results of operations.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This guidance eliminates the presentation option of presenting the component of other comprehensive income as part of the statement of changes in stockholders’ equity. In addition, the guidance requires the consecutive presentation of the statement of net income and other comprehensive income and requires the entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. These changes will apply to both annual and interim financial statements. This guidance is effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. As this guidance amends only presentation requirements, the adoption will not impact the Company’s financial condition or results of operations.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”). This amendment results in common fair value measurement and disclosure requirements in GAAP and IFRS. This guidance is not intended to change the application requirements in Topic 820. This guidance is effective for public entities during interim and annual periods beginning after December 15, 2011. As this guidance amends only the disclosure requirements and not the application of the accounting standard, the adoption will not impact the Company’s financial condition or results of operations.

In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. This guidance removes from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. The update also eliminates the requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets. This guidance is effective for public entities for the first interim or annual period beginning on or after December 15, 2011. The Company is continuing to evaluate the impact of the new guidance, but does not expect the guidance will have a material impact on the Company’s financial condition or results of operations.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This guidance clarifies the guidance from ASU 2010-20, Receivables (Topic 310) on a creditor’s evaluation of whether a concession has been granted and whether a debtor is experiencing financial difficulties. This guidance also requires the disclosures related to troubled debt restructurings from Update 2010-20 as effective for public entities for the first interim or annual period beginning on or after June 15, 2011. This guidance was adopted by the Company and applied retroactively to January 1, 2011. The guidance did not have an impact on the Company’s financial condition or results of operations.

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(2) Stock-Based Compensation

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

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

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

Activity in the stock option plans for the nine months ended September 30, 2011 was as follows:

Summary of Stock Option Activity

	Number of Options			Weighted Average Exercise Price		Number of Options Exercisable
January 1, 2011		2,728,139		$	8.29		1,750,189
Granted		242,500			4.28
Exercised		-			-
Forfeited		(59,911	)		4.86
Expired		(73,670	)		11.76
September 30, 2011		2,837,058		$	7.93		1,908,724
Stock options vested or expected to vest(1)		2,767,091		$	8.00
(1) Includes vested shares and nonvested shares after the application of a forfeiture rate, which is based upon historical data.

The weighted average remaining contractual term was approximately 4.8 years for options outstanding and 3.0 years for options exercisable as of September 30, 2011.

At September 30, 2011, the aggregate intrinsic value was $0 for options outstanding and exercisable.

During the nine months ended September 30, 2011 and 2010, the Company granted 242,500 options and 751,494 options, respectively. In accordance with FASB ASC 718, the fair value of the stock options granted are estimated on the date of grant using the Black-Scholes option pricing model which uses the assumptions in the table below. The expected term of the stock option is estimated using historical exercise behavior of employees at a particular level of management who were granted options with a 10-year term. The stock options have historically been granted with this term, and therefore, information necessary to make this estimate was available. The use of an expected term assumption shorter than the contractual term is not deemed appropriate for non-employees. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected volatility is based on the historical volatility of the Company’s stock price.

Significant weighted average assumptions used to calculate the fair value of the options for the nine months ended September 30, 2011 and 2010 are as follows:

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 Weighted Average Assumptions Used in Black-Scholes Option Pricing Model

	For the Nine Months Ended September 30,
	2011			2010
Weighted average fair value of options granted	$	2.11		$	2.76
Weighted average risk-free rate of return		2.72	%		3.06	%
Weighted average expected option life in months		78			112
Weighted average expected volatility		47	%		45	%
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 award activity during the nine months ended September 30, 2011 is presented in the following table:

Summary of Nonvested Restricted Stock Award Activity

	Number of Shares			Weighted Average Grant Date Fair Value
Nonvested stock awards outstanding, January 1, 2011		309,481		$	6.16
Issued		-			-
Vested		(38,636	)		6.95
Forfeited		(17,813	)		4.81
Nonvested stock awards outstanding, September 30, 2011		253,032		$	6.13

There were no shares of restricted stock issued during the nine months ended September 30, 2011. During the nine months ended September 30, 2010, there were 176,250 shares of restricted stock issued that were valued at $838,525, in the aggregate, at the grant date. The value of these shares is based upon the closing price of the common stock on the date of grant. Compensation expense is recognized on a straight-line basis over the service period for all of the restricted stock awards issued.

Total compensation expense recognized related to options and restricted stock awards, including that for non-employee directors, during the three and nine months ended September 30, 2011 was $318,000 and $1.1 million, respectively, as compared to $1.5 million and $2.1 million for the three and nine months ended September 30, 2010, respectively. As of September 30, 2011, there was approximately $1.6 million and $492,000 of total unrecognized compensation cost related to options and nonvested stock awards, respectively, granted by the Company. The cost of the options and stock awards is expected to be recognized over a weighted average period of 2.5 years and 1.6 years, respectively.

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(3) Investment Securities

The amortized cost of investment securities and the approximate fair value at September 30, 2011 and December 31, 2010 were as follows:

		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
September 30, 2011
Available for sale:
U.S. Treasury securities	$	11,999	$	90	$	-		$	12,089
U.S. Government agency mortgage-backed securities		442,171		5,555		(1,967	)		445,759
Other mortgage-backed securities		325		-		(17	)		308
State and municipal securities		59,724		2,504		(14	)		62,214
Trust preferred securities		12,619		-		(8,061	)		4,558
Corporate bonds		9,479		-		(139	)		9,340
Other securities		500		-		-			500
Total available for sale		536,817		8,149		(10,198	)		534,768
Held to maturity:
U.S. Government agency mortgage-backed securities		1,714		73		-			1,787
Total held to maturity		1,714		73		-			1,787
Total investment securities	$	538,531	$	8,222	$	(10,198	)	$	536,555
December 31, 2010
Available for sale:
U.S. Treasury securities	$	47,017	$	2	$	-		$	47,019
U.S. Government agency mortgage-backed securities		329,973		2,862		(4,348	)		328,487
Other mortgage-backed securities		7,472		-		(1,335	)		6,137
State and municipal securities		82,744		593		(940	)		82,397
Trust preferred securities		12,867		-		(7,225	)		5,642
Other securities		3,182		-		-			3,182
Total available for sale		483,255		3,457		(13,848	)		472,864
Held to maturity:
U.S. Government agency mortgage-backed securities		2,887		116		-			3,003
Other mortgage-backed securities		152		-		-			152
Total held to maturity		3,039		116		-			3,155
Total investment securities	$	486,294	$	3,573	$	(13,848	)	$	476,019

During the three months ended September 30, 2011, the Company had three state and municipal securities called prior to maturity at an aggregate par value of $2.4 million, resulting in gross realized gains of $14,000, and three securities matured which had an aggregate value of $1.2 million. 

During the nine months ended September 30, 2011, the Company had one U.S. government agency mortgage-backed security and six state and municipal securities called prior to maturity at an aggregate par value of $20.0 million and $4.4 million, respectively, resulting in gross realized gains of $0 and $32,000, respectively. During the same period, 22 securities were sold prior to maturity for gross proceeds of $77.9 million, which resulted in gross realized gains and losses of $2.4 million and $1.0 million, respectively, and 11 securities matured which had an aggregate value of $51.7 million. 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 September 30, 2011 and December 31, 2010:

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 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

September 30, 2011
U.S. Government agency mortgage-backed securities	$	121,345	$	(1,967	)	$	-	$	-		$	121,345	$	(1,967	)
Other mortgage-backed securities		-		-			308		(17	)		308		(17	)
State and municipal securities		-		-			231		(14	)		231		(14	)
Trust preferred securities		-		-			4,558		(8,061	)		4,558		(8,061	)
Corporate bonds		9,340		(139	)							9,340		(139	)
Total	$	130,685	$	(2,106	)	$	5,097	$	(8,092	)	$	135,782	$	(10,198	)

December 31, 2010
U.S. Government agency mortgage-backed securities	$	158,432	$	(4,348	)	$	-	$	-		$	158,432	$	(4,348	)
Other mortgage-backed securities		-		-			6,289		(1,335	)		6,289		(1,335	)
State and municipal securities		34,135		(940	)		-		-			34,135		(940	)
Trust preferred securities		-		-			5,642		(7,225	)		5,642		(7,225	)
Total	$	192,567	$	(5,288	)	$	11,931	$	(8,560	)	$	204,498	$	(13,848	)

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

FASB ASC 320-10 requires the Company to assess if an OTTI exists by considering whether the Company has the intent to sell the security or it is more likely than not that it will be required to sell the security before recovery. If either of these situations apply, the guidance requires the Company to record an OTTI charge to earnings for the difference between the amortized cost basis of the security and the fair value of the security. If neither of these situations apply, the Company is required to assess whether it is expected to recover the entire amortized cost basis of the security. If the Company is not expected to recover the entire amortized cost basis of the security, the guidance requires the Company to bifurcate the identified OTTI into a credit loss component and a component representing loss related to other factors. A discount rate is applied which equals the effective yield of the security. The difference between the present value of the expected cash flows and the amortized book value is considered a credit loss. The market value of the security is determined using the same expected cash flows; the discount rate is a rate the Company determines from open market and other sources as appropriate for the security. The difference between the market value and the present value of cash flows expected to be collected is recognized in accumulated other comprehensive loss on the consolidated statements of financial condition. Application of this guidance resulted in a credit related OTTI charge of $250,000 on a single issuer trust preferred security for the nine months ended September 30, 2011.

The following is a roll-forward for the three and nine months ended September 30, 2011 and 2010 of OTTI charges recognized in earnings as a result of credit losses on investments:

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 Cumulative OTTI Recognized in Earnings

	For the Three Months Ended September 30,
	2011		2010
Cumulative OTTI, beginning of period	$	10,203	$	351
Additional increase as a result of net impairment losses recognized on investments		-		950
Decrease as a result of the sale of an investment with net impairment losses		-		-
Cumulative OTTI, end of period	$	10,203	$	1,301

	For the Nine Months Ended September 30,
	2011		2010
Cumulative OTTI, beginning of period	$	10,683	$	351
Additional increase as a result of net impairment losses recognized on investments		250		950
Decrease as a result of the sale of an investment with net impairment losses		(730	)	-
Cumulative OTTI, end of period	$	10,203	$	1,301

U.S. Government Agency Mortgage-Backed Securities. At September 30, 2011, the gross unrealized loss in the category of less than 12 months of $2.0 million consisted of 11 mortgage-backed securities with an estimated fair value of $121.3 million issued and guaranteed by a U.S. Government sponsored agency. The Company believes the unrealized losses are due to increases in market interest rates since the time the underlying securities were purchased. The Company monitors key credit metrics such as delinquencies, defaults, cumulative losses and credit support levels to determine if an OTTI exists. As of September 30, 2011, management concluded that an OTTI did not exist on any of the aforementioned securities based upon its assessment. Management also concluded that it does not intend nor will be required to sell the securities, before their recovery, which may be maturity, and management expects to recover the entire amortized cost basis of these securities.

Other Mortgage-Backed Securities. At September 30, 2011, the gross unrealized loss in the category 12 months or longer of $17,000 consisted of one non-agency mortgage-backed security with an estimated fair value of $308,000. This security was rated “AAA” by at least one nationally recognized rating agency. 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 September 30, 2011, management concluded that an OTTI did not exist on this security and believes the unrealized losses are due to increases in market interest rates since the time the underlying security was purchased. Management also concluded that it does not intend to sell the security, and that it is not more likely than not it will be required to sell the security before its recovery, which may be maturity, and management expects to recover the entire amortized cost basis of this security. During the nine months ended September 30, 2011, the Company sold one private label mortgage-backed security with a book value of $6.9 million for a loss of $1.0 million.

State and Municipal Securities. At September 30, 2011, the gross unrealized loss in the category 12 months or longer was $14,000 and consisted of one municipal security with an estimated fair value of $231,000. This security was rated investment grade by at least one nationally recognized rating agency. The Company believes the unrealized loss is due to an increase in the market interest rate since the time the underlying security was 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 security approaches its maturity date or as a valuation for the security improves as market yields change.  As of September 30, 2011 management concluded that an OTTI did not exist on the aforementioned security. Management also concluded that it does not intend to sell the security, and that it is not more likely than not it will be required to sell the security, before its recovery, which may be maturity, and management expects to recover the entire amortized cost basis of this security.

Trust Preferred Securities. The gross unrealized loss in the category of 12 months or longer of $8.1 million at September 30, 2011 consisted of two trust preferred securities. The trust preferred securities are comprised of one non-investment grade rated pooled security with an amortized cost of $8.8 million and estimated fair value of $3.5 million and one non-rated single issuer security with an amortized cost of $3.8 million and an estimated fair value of $1.0 million.

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For the pooled security, the Company monitors each issuer in the collateral pool with respect to financial performance using data from the issuers’ most recent regulatory reports as well as information on issuer deferrals and defaults. Also, the security structure is monitored with respect to collateral coverage and current levels of subordination. Expected future cash flows are projected assuming senior position in the capital structure. The security had a 1.87 times principal coverage at September 30, 2011. As of the most recent reporting date, interest has been paid in accordance with the terms of the security. The Company reviews a projected cash flow analysis for adverse changes in the present value of project future cash flows that may result in an OTTI credit impairment to be recognized through earnings. The most recent valuations assumed no recovery on any defaulted collateral, no recovery on any deferring collateral and an additional 3.6% default or deferral rate every three years with no recovery. As of September 30, 2011, management concluded that an OTTI did not exist on the aforementioned security. Management also concluded that it does not intend to sell the security, and that it is not more likely than not it will be required to sell the security, before its recovery, which may be maturity, and management expects to recover the entire amortized cost basis of this security.

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

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

During the nine months ended September 30, 2011, the Company recorded an OTTI credit related charge of $250,000 related to this deferring single issuer trust preferred security. The Company had previously recorded a credit related charge of $950,000 in 2010.  Based on the Company’s most recent evaluation, the Company does not expect the issuer to default on the security based primarily on the issuer’s subsidiary bank reporting that it meets the minimum regulatory requirements to be considered a “well capitalized” institution. However, the Company recognized that the length of time the issuer has been in deferral, the difficult economic environment and a continuing high level of non-performing assets increases the probability that a full recovery of principal and anticipated dividends may not be realized. In recognition of that increased probability, the Company recorded an additional credit related impairment in the nine month period ended September 30, 2011.

Corporate Bonds. At September 30, 2011, the gross unrealized loss in the category of less than 12 months of $139,000 consisted of two corporate bonds with an estimated fair value of $9.3 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 corporate debt ratings as well as evaluates the credit quality of the issuer to determine if an OTTI exists. As of September 30, 2011, management concluded that an OTTI did not exist on 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, and management expects to recover the entire amortized cost basis of these securities.

The amortized cost and estimated fair value of the investment securities, by contractual maturity, at September 30, 2011 and December 31, 2010 are shown below. Actual maturities will differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

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 Contractual Maturities of Investment Securities

September 30, 2011	Available for Sale					Held to Maturity
		Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Due in one year or less	$	18,702	$	18,776	$	-	$	-
Due after one year through five years		21,853		21,805		-		-
Due after five years through ten years		10,218		10,839		-		-
Due after ten years		43,548		37,281		-		-
Total investment securities, excluding mortgage-backed securities		94,321		88,701		-		-
U.S. Government agency mortgage-backed securities		442,171		445,759		1,714		1,787
Other mortgage-backed securities		325		308		-		-
Total investment securities	$	536,817	$	534,768	$	1,714		1,787
December 31, 2010
Due in one year or less	$	66,245	$	66,268	$	-	$	-
Due after one year through five years		5,622		5,626		-		-
Due after five years through ten years		3,379		3,423		-		-
Due after ten years		70,564		62,923		-		-
Total investment securities, excluding mortgage-backed securities		145,810		138,240		-		-
U.S. Government agency mortgage-backed securities		329,973		328,487		2,887		3,003
Other mortgage-backed securities		7,472		6,137		152		152
Total investment securities	$	483,255	$	472,864	$	3,039	$	3,155

At September 30, 2011, the Company had $144.9 million, amortized cost, and $148.0 million, estimated fair value, of investment securities pledged to secure public deposits. As of September 30, 2011, the Company had $50.3 million, amortized cost, and $50.9 million, estimated fair value, of investment securities pledged as collateral on secured borrowings.

(4) Loans

The components of loans as of September 30, 2011 and December 31, 2010 were as follows:

Loan Components

		September 30, 2011			December 31, 2010
Commercial:
Commercial and industrial	$	518,432		$	530,462
CRE owner occupied		637,164			713,587
CRE non-owner occupied		638,817			685,587
Land and development		104,818			173,856
Consumer:
Home equity lines of credit		230,098			239,729
Home equity term loans		45,030			53,912
Residential real estate		82,967			65,250
Other		49,077			58,963
Total gross loans held-for-investment		2,306,403			2,521,346
Allowance for loan losses		(55,227	)		(81,713	)
Net loans held-for-investment	$	2,251,176		$	2,439,633
Loans held-for-sale	$	20,868		$	13,824
Loans past due 90 days and accruing		744			2,554
Troubled debt restructuring, accruing		-			20,341

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 Loans on Non-Accrual Status

		September 30, 2011		December 31, 2010
Commercial:
Commercial & industrial	$	4,927	$	25,178
CRE owner occupied		44,095		30,920
CRE non-owner occupied		13,527		44,295
Land and development		34,469		48,124
Consumer:
Home equity lines of credit		5,706		4,616
Home equity term loans		1,424		1,134
Residential real estate		2,331		4,243
Other		1,185		916
Total non-accrual loans held-for-investment	$	107,664	$	159,426
Loans held-for-sale, non-accrual	$	5,186	$	-
Troubled debt restructuring, non-accrual		22,353		11,796

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.

As of September 30, 2011, the Company had $38.5 million outstanding on 18 residential construction, commercial construction and land development relationships which agreements included interest reserves. As of December 31, 2010, the Company had $81.1 million outstanding on 25 residential construction, commercial construction and land development relationships which agreements included interest reserves. The total amount available in those reserves to fund interest payments was $1.4 million and $2.4 million at September 30, 2011 and December 31, 2010, respectively. As of September 30, 2011, the Company had six residential construction relationships with interest reserves of $2.4 million in the aggregate on non-accrual status and one commercial construction relationship with an interest reserve of $140,000 on non-accrual status. As of December 31, 2010, the Company had six residential construction relationships with interest reserves of $3.4 million on non-accrual status. As these relationships are in technical default, no additional fundings of interest will be made. Construction projects are monitored throughout their lives by professional inspectors engaged by the Company. The budgets for loan advances and borrower equity injections are developed at underwriting time in conjunction with the review of the plans and specifications for the project being financed.  Advances of the Company’s funds are based on the prepared budgets and will not be made unless the project has been inspected by the Company’s professional inspector who must certify that the work related to the advance is in place and properly complete. As it relates to construction project financing, the Company does not extend, renew or restructure terms unless its borrower posts cash collateral in an interest reserve.

Included in the Company’s loan portfolio are modified commercial loans. Per FASB ASC 310-40, Troubled Debt Restructuring, (“FASB ASC 310-40”), a modification is one in which the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider, such as providing a below market interest rate and/or forgiving principal or previously accrued interest; this modification may stem from an agreement or be imposed by law or a court, and may involve a multiple note structure. Generally, prior to the modification, the loans which are modified as a troubled debt restructuring (“TDR”) are already classified as non-performing. These loans may only be returned to performing (i.e. accrual status) after considering the borrower’s sustained repayment performance for a reasonable amount of time, generally six months; this sustained repayment performance may include the period of time just prior to the restructuring. During the first quarter of 2011, the Company entered into a TDR agreement with one commercial relationship. At September 30, 2011, the carrying value of that TDR was $708,000. The Company granted a concession by deferring interest on the borrowing and extending the term. The TDR is currently on non-accrual status. During the second quarter of 2011, the Company returned a TDR that was on accrual status back to non-accrual for lack of repayment performance. At September 30, 2011, the total carrying value of loans in TDR status was $22.4 million, all of which are on non-accrual status.

-15-

  (5) Allowance for Loan Losses

Changes in the allowance for loan losses were as follows:

Allowance for Loan Losses and Recorded Investment in Financing Receivables

		For the Nine Months Ended September 30, 2011
		Commercial and industrial			Home Equity(1)			Residential Real Estate			Other(2)			Total
Allowance for loan losses:
Beginning balance		76,759		$	2,883		$	661		$	1,410		$	81,713
Charge-offs		(92,184	)		(2,181	)		(993	)		(826	)		(96,184	)
Recoveries		1,553			70			30			218			1,871
Net charge-offs		(90,631	)		(2,111	)		(963	)		(608	)		(94,313	)
Provision for loan losses		63,290			1,916			1,018			1,216			67,440
Reserves transferred		-			-			-			387			387
Ending balance	$	49,418		$	2,688		$	716		$	2,405		$	55,227
Ending balance: individually evaluated for impairment	$	20,505		$	-		$	-		$	49		$	20,554
Ending balance: collectively evaluated for impairment	$	28,936		$	2,665		$	716		$	2,356		$	34,673
Financing Receivables:
Ending balance	$	1,899,231		$	275,128		$	82,967		$	49,077		$	2,306,403
Ending balance: individually evaluated for impairment	$	119,370		$	292		$	293		$	49		$	120,004
Ending balance: collectively evaluated for impairment	$	1,779,861		$	274,836		$	82,674		$	49,028		$	2,186,399
(1) Amount includes both home equity lines of credit and term loans
(2) Includes the unallocated portion of the allowance for loan losses.

		For the Nine Months Ended September 30, 2010
Balance, beginning of period	$	59,953
Charge-offs		(51,964	)
Recoveries		583
Net charge-offs		(51,381	)
Provision for loan losses		66,007
Balance, end of period	$	74,579

The allowance for loan losses was $55.2 million and $81.7 million at September 30, 2011 and December 31, 2010, respectively. The ratio of allowance for loan losses to gross loans held-for-investment was 2.39% at September 30, 2011 and 3.24% at December 31, 2010.

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

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

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

-16-

	Recorded Investment			Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Accrued Interest Income Recognized		Cash Interest Income Recognized
For the Nine Months Ended September 30, 2011
With no related allowance:
Commercial:
Commercial & industrial	$	2,976	$	6,768	$	-	$	10,191	$	67	$	67
CRE owner occupied		21,952		30,757		-		25,836		345		345
CRE non-owner occupied		8,407		8,521		-		15,060		-		-
Land and development		22,059		22,595		-		24,061		-		-
Consumer:
Home equity lines of credit		293		451		-		56		-		-
Home equity term loans		220		366		-		24		-		-
Residential real estate		72		88		-		84		-		-
With an allowance recorded:
Commercial:
Commercial & industrial	$	10,250	$	13,611	$	3,136	$	15,290	$	336	$	336
CRE owner occupied		35,488		51,436		14,660		28,960		212		201
CRE non-owner occupied		5,120		5,252		829		8,894		438		438
Land and development		13,118		13,118		1,880		14,286		-		-
Consumer:
Other		49		49		49		10		-		-
Total commercial	$	119,370	$	152,058	$	20,505	$	142,578	$	1,398	$	1,387
Total consumer	$	634	$	954	$	49	$	174	$	-	$	-
For the Year Ended December 31, 2010
With no related allowance:
Commercial:
Commercial & industrial	$	8,650	$	9,570	$	-	$	5,387	$	58	$	58
CRE owner occupied		32,325		65,398		-		37,502		18		18
CRE non-owner occupied		24,047		33,445		-		9,398		-		-
Land and development		21,044		33,387		-		12,343		9		9
Consumer:
Residential real estate		-		-		-		23		-		-
Other		-		-		-		644		-		-
With an allowance recorded:
Commercial:
Commercial & industrial	$	26,938	$	32,365	$	6,109	$	20,959	$	454	$	438
CRE owner occupied		20,365		25,099		4,800		22,463		433		420
CRE non-owner occupied		20,275		26,512		4,770		8,998		-		-
Land and development		27,085		28,460		5,401		9,209		29		29
Consumer:
Other		-		-		-		323		-		-
Total commercial	$	180,729	$	254,236	$	21,080	$	126,259	$	1,001	$	972
Total consumer	$	-	$	-	$	-	$	990	$	-	$	-

The unaudited condensed consolidated statements of operations for the nine months ended September 30, 2011 include $1.4 million of recognized interest income (on the accrual and cash basis) on average impaired loans of $142.8 million.

In accordance with FASB ASC 310, those impaired loans which are fully collateralized do not result in a specific allowance for loan losses. Included in impaired loans at September 30, 2011 were three TDRs, two of which were fully collateralized and one of which had specific reserves totaling $4.3 million. In addition, one of the TDRs at September 30, 2011 included a $6.5 million line of credit, of which $5.2 million was utilized and $1.3 million was available.

-17-

The following table presents an analysis of the Company’s TDR agreements entered into during the twelve months ended September 30, 2011:

		Troubled Debt Restructurings
		As of September 30, 2011
	Number of Contracts			Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
CRE owner occupied	1		$	11,667	$	11,667
Land and development	1			1,745		1,745

		Troubled Debt Restructurings That Subsequently Defaulted
		As of September 30, 2011
	Number of Contracts			Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial & industrial(1)	1		$	123	$	123
(1) The above contract was charged off during the nine months ended September 30, 2011.  The recorded investment on this contract is now $0.

The following table presents the Company’s distribution of risk ratings within the held-for-investment loan portfolio, segregated by class, as of September 30, 2011 and December 31, 2010:

Credit Quality Indicators by Internally Assigned Grade

	Commercial & industrial			CRE owner occupied	CRE non-owner occupied		Land and development		Home Equity Lines of Credit			Home Equity Term Loans	Residential Real Estate		Other
As of September 30, 2011
Grade:
Pass	$	478,609	$	530,788	$	575,120	$	54,386	$	221,592	$	43,517	$	77,127	$	47,220
Special Mention		18,342		25,847		24,735		7,927		-		-		-		-
Substandard		21,481		80,529		38,962		42,505		8,506		1,513		5,840		1,857
Total	$	518,432	$	637,164	$	638,817	$	104,818	$	230,098	$	45,030	$	82,967	$	49,077
As of December 31, 2010
Grade:
Pass	$	470,278	$	578,444	$	575,713	$	87,576	$	232,024	$	52,414	$	62,019	$	56,964
Special Mention		12,753		21,311		14,338		6,520		-		-		-		-
Substandard		47,431		113,832		95,536		79,760		7,705		1,498		7,292		1,999
Total	$	530,462	$	713,587	$	685,587	$	173,856	$	239,729	$	53,912	$	69,311	$	58,963

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

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

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

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

-18-

The following table presents the Company’s analysis of past due held-for-investment loans, segregated by class of loans, as of September 30, 2011 and December 31, 2010:

Aging of Receivables Held-for-Investment

		30-59 Days Past Due		60-89 Days Past Due		90 Days Past Due		Total Past Due		Current		Total Financing Receivables		Loans 90 Days Past Due and Accruing
As of September 30, 2011
Commercial:
Commercial & industrial	$	254	$	2,132	$	5,059	$	7,445	$	510,987	$	518,432	$	573
CRE owner occupied		4,041		6,680		46,215		56,936		580,228		637,164		39
CRE non-owner occupied		2,122		6,399		11,443		19,964		618,853		638,817		13
Land and development		-		-		34,469		34,469		70,349		104,818		-
Consumer:
Home equity lines of credit		2,250		866		4,798		7,914		222,184		230,098		112
Home equity term loans		644		210		1,243		2,097		42,933		45,030		-
Residential real estate		-		3,189		2,207		5,396		77,571		82,967		-
Other		581		165		944		1,690		47,387		49,077		7
Total	$	9,892	$	19,641	$	106,378	$	135,911	$	2,170,492	$	2,306,403	$	744
As of December 31, 2010
Commercial:
Commercial & industrial	$	6,743	$	815	$	25,152	$	32,710	$	497,752	$	530,462	$	558
CRE owner occupied		8,478		2,072		40,063		50,613		662,974		713,587		609
CRE non-owner occupied		8,655		13,119		18,436		40,210		645,377		685,587		-
Land and development		11,748		9,797		36,359		57,904		115,952		173,856		-
Consumer:
Home equity lines of credit		2,667		817		4,292		7,776		231,953		239,729		379
Home equity term loans		340		111		1,134		1,585		52,327		53,912		-
Residential real estate		1,901		2,870		4,242		9,013		56,237		65,250		72
Other		1,027		535		1,737		3,299		55,664		58,963		936
Total	$	41,559	$	30,136	$	131,415	$	203,110	$	2,318,236	$	2,521,346	$	2,554

 (6) Real Estate Owned

Real estate owned at September 30, 2011 and December 31, 2010 was as follows:

	September 30, 2011		December 31, 2010
Commercial properties	$	1,357	$	1,261
Residential properties		1,976		497
Bank properties		1,560		2,155
Total	$	4,893	$	3,913

Summary of Real Estate Owned Activity

		Commercial Properties			Residential Properties			Bank Properties			Total
Beginning balance, January 1, 2011	$	1,261		$	497		$	2,155		$	3,913
Transfers from loans		390			2,535			-			2,925
Sale of real estate owned		(33	)		(1,056	)		(189	)		(1,278	)
Write down of real estate owned		(261	)		-			(406	)		(667	)
Ending balance, September 30, 2011	$	1,357		$	1,976		$	1,560		$	4,893

-19-

During the nine months ended September 30, 2011, the Company transferred into real estate owned one commercial property and nine residential properties from loans in the amounts of $390,000 and $2.5 million, respectively. During the three and nine months ended September 30, 2011, the Company recorded $188,000 and $667,000 of write-downs, respectively, of real estate owned, including $260,000 on the carrying value of two commercial properties and $407,000 on the carrying value of five bank properties. There were two commercial properties with a carrying amount of $33,000 in the aggregate sold resulting in a gain of $81,000, three residential properties with a carrying amount of $1.1 million in the aggregate sold resulting in a net loss of $147,000, and one bank property with a carrying amount of $189,000 sold resulting in a loss of $10,000 during the nine months ended September 30, 2011. The net loss from the sale of these properties is included in non-interest expense in the unaudited condensed consolidated statements of operations. The Company currently maintains 17 properties in the real estate owned portfolio, five of which are former bank branches.  

(7) Derivative Financial Instruments and Hedging Activities

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

Fair Value Hedges – Interest Rate Swaps. The Company has entered into interest rate swap arrangements to exchange the periodic payments on fixed-rate commercial loan agreements for variable-rate payments based on the one-month London Interbank Offered Rate (“LIBOR”) without the exchange of the underlying principal. The interest rate swaps are designated as fair value hedges under FASB ASC 815, Derivatives and Hedging, (“FASB ASC 815”) and are executed for periods and terms that match the related underlying fixed-rate loan agreements. The Company applies the “shortcut” method of accounting under FASB ASC 815, which assumes there is no ineffectiveness as changes in the interest rate component of the swaps’ fair value are expected to exactly offset the corresponding changes in the fair value of the underlying commercial loan agreements. Because the hedging arrangement is considered highly effective, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in a net impact to earnings; however, there may be fair value adjustments related to credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820, Fair Value Measurements and Disclosures, (“FASB ASC 820”). The fair value adjustments related to credit quality were not material as of September 30, 2011 and December 31, 2010.

The following tables provide information pertaining to interest rate swaps designated as fair value hedges under FASB ASC 815 at September 30, 2011 and December 31, 2010:

Summary of Interest Rate Swaps Designated As Fair Value Hedges

	September 30, 2011					December 31, 2010
Balance Sheet Location		Notional		Fair Value			Notional		Fair Value
Other liabilities	$	34,174	$	(4,753	)	$	39,663	$	(4,721	)

Summary of Interest Rate Swap Components

	September 30, 2011		December 31, 2010
Weighted average pay rate	6.82	%	6.83	%
Weighted average receive rate	2.22	%	2.27	%
Weighted average maturity in years	3.6		4.2

Customer Derivatives – Interest Rate Swaps/Floors. The Company enters into interest rate swaps that allow our commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to an interest rate swap agreement, which serves to effectively swap the customer’s variable-rate loan into a fixed-rate loan. The Company then enters into a corresponding swap agreement with a third party in order to economically hedge its exposure on the variable and fixed components of the customer agreement. The interest rate swaps with both the customers and third parties are not designated as hedges under FASB ASC 815 and are marked to market through earnings. As the interest rate swaps are structured to offset each other, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in an impact to earnings; however, there may be fair value adjustments related to credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820. The Company recognized $309,000 and $12.3 million in fair value adjustment charges during the three and nine months ended September 30, 2011, respectively, which were included in the derivative credit valuation adjustment in the unaudited condensed consolidated statements of operations as a reduction to other income.

-20-

	September 30, 2011					December 31, 2010
Balance Sheet Location		Notional		Fair Value			Notional		Fair Value
Other assets	$	412,762	$	53,084		$	520,921	$	56,637
Other liabilities		412,762		(54,282	)		520,921		(58,779	)

In addition, the Company has entered into an interest rate floor sale transaction with one commercial customer. The Company entered into corresponding interest rate floor purchase transactions with a third party in order to offset its exposure on the variable and fixed components of the customer agreements. As the interest rate floors with both the customer and the third party are not designated as hedges under FASB ASC 815, the instruments are marked to market through earnings. As the interest rate floors are structured to offset each other, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in a net impact to earnings; however, there may be fair value adjustments related to credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820. The combined notional amount of the two interest rate floors was $16.8 million and $17.2 million at September 30, 2011 and December 31, 2010, respectively.

-21-

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 September 30, 2011 and December 31, 2010 was $67.8 million and $78.0 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 $59.0 million and $63.5 million at September 30, 2011 and December 31, 2010, respectively.

(8) Deposits

Deposits consist of the following major classifications:

	September 30, 2011		December 31, 2010
Interest-bearing demand deposits	$	1,278,276	$	1,364,858
Non-interest-bearing demand deposits		562,082		498,082
Savings deposits		267,076		279,086
Time certificates under $100,000		389,069		480,993
Time certificates $100,000 or more		162,774		228,121
Brokered time deposits		68,373		89,320
Total	$	2,727,650	$	2,940,460

 (9) Earnings (Loss) Per Share

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

            Earnings (Loss) Per Share Computation

		For the Three Months Ended September 30,					For the Nine Months Ended September 30,
		2011		2010			2011			2010
Net income (loss)	$	2,680	$	(74,993	)	$	(65,986	)	$	(156,925	)
Preferred stock dividend and discount accretion		-		274			-			274
Net income (loss) available to common shareholders		2,680	$	(75,267	)		(65,986	)	$	(157,199	)
Average common shares outstanding		84,429,644		23,960,691			73,643,303			23,587,981
Net effect of dilutive common stock equivalents		108,805		-			-			-
Adjusted average shares outstanding - dilutive		84,538,449		23,960,691			73,643,303			23,587,981
Basic earnings (loss) per share	$	0.03	$	(3.14	)	$	(0.90	)	$	(6.66	)
Diluted earnings (loss) per share	$	0.03	$	(3.14	)	$	(0.90	)	$	(6.66	)

There were 2.8 million and 2.7 million weighted average common stock equivalents for the three months ended September 30, 2011 and 2010, respectively, and 3.1 million and 2.5 million weighted average common stock equivalents for the nine months ended September 30, 2011 and 2010, respectively, which were not included in the computation of diluted loss per share as the result would have been anti-dilutive under the “if converted” method.

-22-

(10) Commitments and Contingent Liabilities

Letters of Credit

In the normal course of business, the Company has various commitments and contingent liabilities, such as customers’ letters of credit (including standby letters of credit of $53.5 million and $57.5 million at September 30, 2011 and December 31, 2010, respectively) which are not reflected in the accompanying unaudited condensed consolidated financial statements. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In the judgment of management, the financial condition of the Company will not be affected materially by the final outcome of any letters of credit.

Reserve for Unfunded Commitments

The Company maintains a reserve for unfunded loan commitments and letters of credit which is reported in other liabilities in the unaudited condensed consolidated statements of financial condition consistent with FASB ASC 825. As of September 30, 2011, the Company recorded estimated losses inherent with unfunded loan commitments in accordance with FASB ASC 450, Contingencies, and estimated future obligations under letters of credit in accordance with FASB ASC 460, Guarantees. The methodology used to determine the adequacy of this reserve is integrated in the Company’s process for establishing the allowance for loan losses and considers the probability of future losses and obligations that may be incurred under these off-balance sheet agreements. The reserve for unfunded loan commitments and letters of credit at September 30, 2011 and December 31, 2010 was $348,000 and $1.5 million, respectively. Management believes this reserve level is sufficient to absorb estimated probably losses related to these commitments.

(11) Fair Value of Financial Instruments

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

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

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

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

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

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

-23-

			Category Used for Fair Value Measurement
September 30, 2011		Total		Level 1		Level 2		Level 3
Assets:
Investment securities available for sale:
U.S. Treasury securities	$	12,089	$	12,089	$	-	$	-
U.S. Government agency mortgage-backed securities		445,759		-		445,759		-
Other mortgage-backed securities		308		-		308		-
State and municipal securities		62,214		-		62,214		-
Trust preferred securities		4,558		-		-		4,558
Corporate bonds		9,340		-		9,340		-
Other securities		500		-		500		-
Investment securities trading
U.S. Treasury securities		5,138		-		5,138		-
Interest rate floor		396		-		396		-
Liabilities:
Fair value interest rate swaps		4,753		-		4,753		-
Interest rate swaps		54,282		-		54,282		-
Interest rate floor		396		-		396		-
December 31, 2010
Assets:
Investment securities available for sale:
U.S. Treasury securities	$	47,019	$	47,019	$	-	$	-
U.S. Government agency mortgage-backed securities		328,487		-		328,487		-
Other mortgage-backed securities		6,137		-		6,137		-
State and municipal securities		82,397		-		82,397		-
Trust preferred securities		5,642		-		-		5,642
Other securities		3,182		-		3,182		-
Interest rate swaps		56,637		-		56,637		-
Interest rate floor		344		-		344		-
Liabilities:
Fair value interest rate swaps		4,721		-		4,721		-
Interest rate swaps		58,779		-		58,779		-
Interest rate floor		344		-		344		-

Level 1 Valuation Techniques and Inputs

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

Level 2 Valuation Techniques and Inputs

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

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

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

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

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

-24-

Agency collateralized mortgage obligations (“CMOs”) are evaluated based on nominal spread and OAS values of securities with comparable tranches type, average life, average life variance and prepayment characteristics of the underlying collateral.

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

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

Corporate bonds. The fair value measurements for corporate bonds consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit quality information and the bond's terms and conditions, among other things. If relevant and observable prices are available, those valuations would be classified as Level 2. If prices are not available, other valuation techniques would be used and the item would be classified as Level 3

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

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

 Level 3 Valuation Techniques and Inputs

Trust preferred securities.  The trust preferred securities are evaluated based on whether the security is an obligation of a single issuer or part of a securitization pool. For single issuer obligations, the Company uses discounted cash flow models which incorporate the contractual cash flow for each issue adjusted as necessary for any potential changes in amount or timing of cash flows. The cash flow model of a pooled issue incorporates anticipated loss rates and severities of the underlying collateral as well as credit support provided within the securitization. The cash flow model for the pooled issue owned by the Company at September 30, 2011 assumes no recovery on defaulted collateral, no recovery on securities in deferral and an additional 3.6% future default rate assumption on the remaining performing collateral every three years with no recovery rate.

For trust preferred securities, projected cash flows are discounted at a rate based on a trading group of similar securities quoted on the New York Stock Exchange (“NYSE”) or over-the-counter markets which is reviewed for market data points such as credit rating, maturity, price and liquidity. The Company indexes the securities to a comparable maturity interest rate swap to determine the market spread, which is then used as the discount rate in the cash flow models. As of the reporting date, the market spreads were 6.8% and 19.5%, respectively, for the two trust preferred securities. The 19.5% discount rate is reflective of the single issuer that is currently deferring interest rate payments.

-25-

The following provides details of the Level 3 fair value measurement activity for the three and nine months ended September 30, 2011 and 2010:

         Fair Value Measurements Using Significant Unobservable Inputs – Level 3

Trust Preferred Securities

		For the Three Months Ended September 30,					For the Nine Months Ended September 30,
		2011			2010			2011			2010
Balance, beginning of period	$	6,427		$	15,090		$	5,642		$	20,874
Total gains, realized/unrealized:
Included in earnings(1)		-			(950	)		(250	)		(950	)
Included in accumulated other comprehensive income		(1,869	)		5,060			(834	)		(724	)
Purchases		-			-			-			-
Maturities		-			-			-			-
Prepayments		-			-			-			-
Calls		-			(15,000	)		-			(15,000	)
Transfers into Level 3		-			-			-			-
Balance, end of period	$	4,558		$	4,200		$	4,558		$	4,200
(1) Amount included in net impairment losses on available for sale securities of the unaudited condensed consolidated statements of operations.

Certain assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The Company measures impaired loans, Small Business Administration (“SBA”) servicing assets, restricted equity investments, goodwill and loans or bank properties transferred into other real estate owned at fair value on a non-recurring basis. At September 30, 2011 and 2010, these assets were valued in accordance with GAAP and, except for impaired loans, loans held-for-sale and real estate owned included in the following table, did not require fair value disclosure under the provisions of FASB ASC 820.

			Category Used for Fair Value Measurement							Total (Losses) Gains Or Changes in Net Assets
		Total		Level 1		Level 2		Level 3
September 30, 2011
Assets:
Impaired loans	$	76,019	$	-	$	-	$	76,019	$	(39,007	)
Real estate owned		2,272		-		-		2,272		(667	)
September 30, 2010
Assets:
Impaired loans	$	125,986	$	-	$	-	$	125,986	$	(55,258	)

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

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

The most recent appraisal or reported value of the collateral securing a loan, net of a discount, is the Company’s basis for determining fair value. The discount is based on the age of the existing appraisal or evaluation and on the nature of the property, and includes an estimated cost of liquidation.

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

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

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

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

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

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

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

Impaired loan fair value measurements are based upon unobservable inputs, and therefore, are categorized as a Level 3 measurement. Specific reserves were calculated for impaired loans with an aggregate carrying amount of $63.9 million and $63.5 million at September 30, 2011 and 2010, respectively. The collateral underlying these loans had a fair value of $43.5 million and $47.8 million, including a specific reserve in the allowance for loan losses of $20.5 million and $15.7 million at September 30, 2011 and 2010, respectively. There were charge-offs of $6.6 million and $5.2 million for impaired loans with specific reserves during the nine months ended September 30, 2011 and 2010, respectively. No specific reserve was calculated for impaired loans with an aggregate carrying amount of $32.5 million and $131.5 million at September 30, 2011 and 2010, respectively, as the underlying collateral was not below the carrying amount; however, these loans did include charge-offs of $12.0 million and $34.4 million during the nine months ended September 30, 2011 and 2010, respectively.

Once a loan is determined to be uncollectible, the underlying collateral is repossessed and reclassified as other real estate owned. The balance of other real estate owned also includes bank properties transferred from operations. These assets are carried at lower of cost or fair value of the collateral, less cost to sell. In some cases, adjustments are made to the appraised values for various factors including age of the appraisal, age of comparable properties included in the appraisal, and known changes in the market and the collateral. During the nine months ended September 30, 2011, the Company recorded a decrease in fair value of $188,000 and $667,000 on five bank properties and two commercial properties, respectively. The adjustments to the bank properties and commercial properties were based upon unobservable inputs, and therefore categorized as Level 3 measurements.

-27-

In accordance with ASC 825-10-50-10, 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 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 cash flow models 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. Utilizing different assumptions or estimation techniques may have a material effect on the estimated fair value.

Carrying Amounts and Estimated Fair Values of Financial Assets and Liabilities

	September 30, 2011				December 31, 2010
		Carrying Amount	Estimated Fair Value			Carrying Amount	Estimated Fair Value
Assets:
Cash and due from banks	$	73,006	$	73,006	$	36,522	$	36,522
Interest-earning bank balances		61,203		61,203		150,704		150,704
Investment securities available for sale		534,768		534,768		472,864		472,864
Investment securities held to maturity		1,714		1,787		3,039		3,155
Loans receivable, net		2,216,994		2,029,737		2,399,964		2,210,243
Loans held-for-sale		20,868		21,147		13,824		13,510
Hedged commercial loans(1)		34,182		38,923		39,669		44,372
Restricted equity investments		15,760		15,760		17,590		17,590
Interest rate swaps		53,084		53,084		56,637		56,637
Interest rate floor		396		396		344		344
Liabilities:
Demand deposits		1,840,358		1,866,217		1,862,940		1,884,033
Savings deposits		267,076		269,746		279,086		281,512
Time deposits		620,215		626,129		798,434		810,299
Securities sold under agreements to repurchase – customers		6,026		6,026		6,307		6,307
Advances from FHLBNY		3,054		3,319		3,999		4,287
Securities sold under agreements to repurchase – FHLBNY		15,000		15,573		15,000		16,050
Junior subordinated debentures		92,786		52,757		92,786		47,730
Fair value interest rate swaps		4,753		4,753		4,721		4,721
Interest rate swaps		54,282		54,282		58,779		58,779
Interest rate floor		396		396		344		344
(1) Includes positive market value adjustment of $4.7 million at September 30, 2011 and December 31, 2010, respectively, which is equal to the change in value of related interest rate swaps designated as fair value hedges of these hedged loans in accordance with FASB ASC 815.

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

Investment securities.For investment securities, fair values are based on a combination of quoted prices for identical assets in active markets, quoted prices for similar assets in markets that are either actively or not actively traded and price models, discounted cash flow methodologies, or similar techniques that may contain unobservable inputs that are supported by little or no market activity and require significant judgment.

 Loans receivable.The fair value of loans receivable is estimated using discounted cash flow analysis. Projected future cash flows are calculated using loan characteristics, and assumptions of voluntary and involuntary prepayment speeds. Projected cash flows are prepared using discount rates believed to represent current market rates.

Loans held-for-sale. Loans held-for-sale includes residential mortgage loans that are originated with the intent to sell and one commercial real estate loan transferred to held-for-sale during the nine months ended September 30, 2011. These loans are recorded at the lower of amortized cost or fair value

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

Restricted equity securities.  Ownership in equity securities of Federal Reserve Bank, FHLBNY and Atlantic Central Bankers Bank is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value.

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

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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.

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 is 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 September 30, 2011 and December 31, 2010. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these condensed consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amount presented herein.

(12) Regulatory Matters

The Company is subject to risk-based capital guidelines adopted by the 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 (set forth in the table below) are maintained. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets and certain off-balance sheet items as calculated under regulatory practices.

The Company’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the federal bank regulators about components, risk weightings and other factors. The Company’s and the Bank’s risk-based capital ratios have been computed in accordance with regulatory practices. The Company and the Bank were in compliance with these regulatory capital requirements of the Federal Reserve Board and the OCC as of September 30, 2011. As discussed below and elsewhere herein, additional capital requirements have been imposed on the Bank by the OCC, which the Bank was also in full compliance with as of September 30, 2011.

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

The Bank also agreed to: (a) implement a program to protect the Bank’s interest in criticized or classified assets, (b) review and revise the Bank’s loan review program; (c) implement a program for the maintenance of an adequate allowance for loan losses; and (d) revise the Bank’s credit administration policies. During the second quarter of 2010, the Company revised and implemented changes to policies and procedures pursuant to the OCC Agreement. The Bank also agreed that its brokered deposits will not exceed 3.5% of its total liabilities unless approved by the OCC. Management does not expect this restriction will limit its access to liquidity as the Bank does not rely on brokered deposits as a major source of funding. As of September 30, 2011, the Bank’s brokered deposits represented 2.3% of its total liabilities.  

In October 2011, the Board of Directors of the Company resolved, among other things, not to declare or pay cash dividends, take dividends from the Bank or repurchase its stock, without the prior written approval of the Federal Reserve.  The Board also resolved not to make any distribution of interest, principal or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve if the Bank is less than well capitalized as defined in OCC regulations.

-29-

The Bank is also subject to individual minimum capital ratios established by the OCC for the Bank requiring the Bank to continue to maintain a Leverage ratio at least equal to 8.50% of adjusted total assets, to continue to maintain a Tier 1 Capital ratio at least equal to 9.50% of risk-weighted assets and to maintain a Total Capital ratio at least equal to 11.50% of risk-weighted assets. At September 30, 2011, the Bank met all of the three capital ratios established by the OCC as its Leverage ratio was 9.64%, its Tier 1 Capital ratio was 11.81% and its Total Capital ratio was 13.07%. At December 31, 2010, the Bank also met all of the three capital ratios established by the OCC as its Leverage ratio was 8.57%, its Tier 1 Capital ratio was 10.98% and its Total Capital ratio was 12.25%.

The following table provides both the Company’s and the Bank’s risk-based capital ratios as of September 30, 2011 and December 31, 2010:

Regulatory Capital Levels

	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provision(1)
		Amount	Ratio				Amount	Ratio				Amount	Ratio
September 30, 2011
Total capital (to risk-weighted assets):
Sun Bancorp, Inc.	$	385,939		14.85	%	$	207,895		8.00	%		N/A
Sun National Bank		339,017		13.07			207,497		8.00		$	259,372		10.00	%
Tier I capital (to risk-weighted assets):
Sun Bancorp, Inc.		353,170		13.59			103,947		4.00			N/A
Sun National Bank		306,309		11.81			103,749		4.00			155,623		6.00
Leverage ratio:
Sun Bancorp, Inc.		353,170		11.08			127,535		4.00			N/A
Sun National Bank		306,309		9.64			127,121		4.00			158,902		5.00
December 31, 2010
Total capital (to risk-weighted assets):
Sun Bancorp, Inc.	$	350,697		12.68	%	$	221,242		8.00	%		N/A
Sun National Bank		338,196		12.25			220,904		8.00		$	276,131		10.00	%
Tier I capital (to risk-weighted assets):
Sun Bancorp, Inc.		315,523		11.41			110,621		4.00			N/A
Sun National Bank		303,074		10.98			110,452		4.00			165,678		6.00
Leverage ratio:
Sun Bancorp, Inc.		315,523		8.93			141,351		4.00			N/A
Sun National Bank		303,074		8.57			141,407		4.00			176,759		5.00
(1) Not applicable for bank holding companies.

The Bank’s deposits are insured to applicable limits by the Federal Deposit Insurance Corporation (“FDIC”). As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) which was signed into law on July 21, 2010, the maximum deposit insurance limit was permanently increased to $250,000.

In addition, the Dodd-Frank Act amended the Federal Deposit Insurance Act to provide for full deposit insurance coverage for non-interest-bearing transaction accounts for a two year period beginning December 31, 2010. This applies to insured depository institutions with no opt in or opt out requirements.

In November 2009, instead of imposing additional special assessments, the FDIC amended the assessment regulations to require all insured depository institutions to prepay their estimated risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012 on December 30, 2009. For purposes of estimating the future assessments, each institution’s base assessment rate in effect on September 30, 2009 was used, assuming a 5 percent annual growth rate in the assessment base and a 3 basis point increase in the assessment rate in 2011 and 2010. The prepaid assessment will be applied against actual quarterly assessments until exhausted. Any funds remaining after September 30, 2013 will be returned to the institution. If the prepayment would impair an institution’s liquidity or otherwise create significant hardship, it was able to apply for an exemption. Requiring this prepaid assessment did not preclude the FDIC from changing assessment rates or from further revising the risk-based assessment system. On December 31, 2009, the Company paid the FDIC prepaid assessment of $18.3 million. At September 30, 2011, the Company’s prepaid assessment balance was $7.5 million, with $3.9 million being recognized in expense during the nine months ended September 30, 2011.

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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 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 for 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 September 30, 2011, all $90.0 million in capital securities qualified as Tier 1 capital.

The ability of the Bank to pay dividends to the Company is controlled by certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock. In addition, a national bank may not pay any dividends in an amount greater than its undivided profits and a national bank may not declare any dividends if such declaration would leave the bank inadequately capitalized. Therefore, the ability of the Bank to declare dividends will depend on its future net income and capital requirements. Also, banking regulators have indicated that national banks should generally pay dividends only out of current operating earnings. Following this guidance, the amount available for payment of dividends to the Company by the Bank totaled $0 at September 30, 2011.  Per the OCC Agreement and the Board resolutions referenced above, a dividend may only be declared if it is in accordance with the approved capital plan, the Bank remains in compliance with the capital plan following the payment of the dividend and the dividend is approved by the OCC and the Federal Reserve.

 (13) Common Stock Offering and Private Placements

On March 22, 2011, the Company completed a public offering of 28,750,000 shares of common stock at a public offering price of $3.00 per share, which included the full exercise of the over-allotment option granted to the underwriters to purchase an additional 3,750,000 shares of common stock. After deducting the underwriting discount and offering expenses payable by the Company, the net proceeds were $81.4 million.

The Company’s three largest shareholders, WL Ross, Siguler Guff, and the Brown family, along with certain officers and directors, purchased an aggregate of 10,193,224 shares in the offering. WL Ross and Siguler Guff maintained their percentage interest in the Company in the offering. Pursuant to the terms of the securities purchase agreements entered into between WL Ross, Siguler Guff, and the Brown family and the Company in connection with the private placement of Company securities in the Fall of 2010, each of these investors was entitled to purchase shares in the offering at $2.85 per share which represented the public offering price less the underwriting discount of $0.15 per share paid to the underwriters on the other shares sold.

On April 11, 2011, the Company issued and sold in a private placement transaction an additional 3,802,131 shares at $2.85 per share totaling $10.8 million in additional stock proceeds pursuant to the exercise of gross-up rights contained in the previously executed security purchase agreements with the three investors noted above. The gross-up rights were triggered by the underwriters’ exercise of the over-allotment option in the public offering. On August 8, 2011, the Company issued approximately 2,378,232 additional shares at $2.85 per share totaling $6.8 million in stock proceeds pursuant to the exercise of gross-up rights. The transactions were triggered pursuant to the gross-up rights issued to Anchorage Capital Group, LLC, in connection with its purchase of shares in the public offering.

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Forward-Looking Statements

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

● ·statements and assumptions relating to financial performance;

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

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

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

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

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

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

● ·market volatility;

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

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

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

● ·legislative and regulatory changes, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and impending regulations, changes in banking, securities and tax laws and regulations and their application by our regulators and changes in the scope and cost of Federal Deposit Insurance Corporation (“FDIC”) insurance and other coverages;

● ·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 (the “Federal Reserve”);

● ·inflation, interest rate, market and monetary fluctuations;

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

● ·the effect of and our compliance with the terms of the Agreement by and between our wholly owned subsidiary, Sun National Bank (the “Bank”) and the Office of the Comptroller of the Currency (the “OCC”) dated April 15, 2010 (the “OCC Agreement”) as well as compliance with the individual minimum capital ratios established for the Bank by the OCC;

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

● ·our ability to control operating costs and expenses;

● ·our ability to manage delinquency rates;

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

● ·the costs of litigation, including settlements and judgments;

● ·the increased competitive pressures among financial services companies;

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

● ·technological changes;

● ·acquisitions;

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

● ·adverse changes in securities markets;

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

● ·changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board;

● ·war or terrorist activities;

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

● ·our success at managing the risks involved in the foregoing.

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Some of these and other factors are discussed in the Company’s December 31, 2010 Annual Report on Form 10-K Item 1A. Risk Factors section as such may be amended or supplemented herein or in other filings pursuant to the Securities Exchange Act of 1934, as amended. The development of any or all of these factors could have an adverse impact on our financial position and results of operations.

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

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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 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 expenses. 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. The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio as of the balance sheet date. The determination of the allowance for loan losses requires management to make significant estimates with respect to the amounts and timing of losses and market and economic conditions. The allowance for loan losses is maintained at a level that management considers adequate to provide for estimated losses and impairment based upon an evaluation of known and inherent risk in the loan portfolio. Loan impairment is evaluated based on the fair value of collateral or estimated net realizable value. A provision for loan losses is charged to operations based on management’s evaluation of the estimated losses that have been incurred in the Company’s loan portfolio. It is the policy of management to provide for losses on unidentified loans in its portfolio in addition to classified loans.

Management monitors its allowance for loan losses on a monthly basis and makes adjustments to the allowance through the provision for loan losses as economic conditions and other pertinent factors 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 modifications

●   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

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

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

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 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 provision for loan losses will not be required in future periods. Accordingly, the current state of the national economy and the local economies of the areas in which the loans are concentrated and their slow recovery from a severe recession could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss reserves 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 Financial Accounting Standards Board, (“FASB”) Accounting Standards CodificationTM (the “Codification” or “ASC”) 740, Income Taxes. ("FASB ASC 740"). FASB ASC 740 requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the unaudited condensed consolidated statements of operations. Assessment of uncertain tax positions under FASB ASC 740 requires careful consideration of the technical merits of a position based on management's analysis of tax regulations and interpretations. Significant judgment may be involved in applying the requirements of FASB ASC 740.

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

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

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

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

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

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

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 The Company measures financial assets and liabilities at fair value in accordance with FASB ASC 820. 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.

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, SBA servicing assets, restricted equity investments and loans or bank properties transferred in other real estate owned at fair value on a non-recurring basis.

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

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

Market Overview

The economic recovery has been slower than anticipated. The debt crisis in Europe has caused further economic concerns and weakness in global markets.  Interest rates have remained near historical lows. The housing sector continues to be depressed and is expected to remain weak as the number of foreclosed properties available for sale continues to increase. The unemployment rate in the U.S. decreased slightly to 9.1% in September 2011 from 9.2% in June 2011. According to recently released estimates, the U.S. gross domestic product for the third quarter of 2011 increased at an annual rate of 2.5% as compared to 1.3% growth in the second quarter of 2011. This increase was primarily driven by personal consumption expenditures.

At the state level, according to the latest South Jersey Business Survey produced by the Federal Reserve Bank of Philadelphia, there has been a modest increase in business activity. Employment among the firms in the region continues to improve slightly.

At its latest meeting in September 2011, the Federal Reserve decided to keep the Federal Funds target rate unchanged in a continued effort to help stimulate economic growth. Since December 2008, the Federal Reserve has kept the Federal Funds rate, a key indicator of short-term rates such as credit card rates and HELOC rates, at a range of 0.00%-0.25% with the intent of encouraging consumers and businesses to borrow and spend to help jump start the economy. However, Federal Reserve policymakers are increasingly focused on when and how to start boosting rates once the recovery is firmly entrenched. The Federal Reserve is also cautiously considering what to do with its vast holdings of mortgage-backed securities. The Federal Reserve policymakers continue to consider providing additional monetary policy accommodations to support the economic recovery.

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 The housing market continues to languish with indicators of housing activity such as New Home Sales Housing Starts and Existing Home Sales stabilizing but at levels significantly below their peaks in 2005 and 2006. However, the supply of homes is still believed to be in excess of one year in parts of New Jersey, according to the New Jersey Real Estate Report.

The continued uncertainty with the economy, together with the challenging regulatory environment, will continue to affect the Company and the markets in which it does business, and may adversely impact the Company’s results in the future. The following discussion provides further detail on the financial condition and results of operations of the Company at and for the three and nine months ended September 30, 2011.

 Common Stock Offering and Private Placements

On March 22, 2011, the Company completed a public offering of 28,750,000 shares of common stock at a public offering price of $3.00 per share, which included the full exercise of the over-allotment option granted to the underwriters to purchase an additional 3,750,000 shares of common stock. After deducting the underwriting discount and offering expenses payable by the Company, the net proceeds were $81.4 million.

The Company’s three largest shareholders, WL Ross, Siguler Guff, and the Brown family, along with certain officers and directors, purchased an aggregate of 10,193,224 shares in the offering. WL Ross and Siguler Guff maintained their percentage interest in the Company in the offering. Pursuant to the terms of the securities purchase agreements entered into between WL Ross, Siguler Guff, and the Brown family and the Company in connection with the private placement of Company securities in the fall of 2010, each of these investors was entitled to purchase shares in the offering at $2.85 per share which represented the public offering price less the underwriting discount of $0.15 per share paid to the underwriters on the other shares sold.

On April 11, 2011, the Company issued and sold in a private placement transaction an additional 3,802,131 shares at $2.85 per share totaling $10.8 million in additional stock proceeds pursuant to the exercise of gross-up rights contained in the previously executed security purchase agreements with the three investors noted above. The gross-up rights were triggered by the underwriters’ exercise of the over-allotment option in the public offering. On August 8, 2011, the Company issued approximately 2,378,232 additional shares at $2.85 per share totaling $6.8 million in stock proceeds pursuant to the exercise of gross-up rights. The transactions were triggered pursuant to the gross-up rights issued to Anchorage Capital Group, LLC, in connection with its purchase of shares in the public offering.

Financial Condition

Total assets were $3.24 billion at September 30, 2011 as compared to $3.42 billion at December 31, 2010. Loans receivable, net of allowance for loan losses, decreased by $188.5 million, or 7.7%, primarily due to the sale of commercial loans. Loans held-for-sale increased $7.0 million, or 51.0%. Total investments increased $63.9 million, or 12.9%. Total liabilities decreased $221.1 million, or 7.0%, to $2.93 billion at September 30, 2011 compared to $3.15 billion at December 31, 2010 primarily due to a decrease in deposits of $212.8 million, or 7.2%, and other liabilities of $6.9 million, or 8.4%. Stockholders’ equity was $308.1 million at September 30, 2011 as compared to $268.2 million at December 31, 2010 primarily as a result of the $99.0 million of capital generated from the common stock offering and private placements offset by the Company’s year to date net loss of $66.0 million.

Loans receivable, net of allowance for loan losses, decreased $188.5 million to $2.25 billion at September 30, 2011 as compared to $2.44 billion at December 31, 2010. This decrease was driven primarily by the sale of commercial real estate loans in 2011.

Total non-performing loans decreased $37.8 million to $135.9 million at September 30, 2011 from December 31, 2010, primarily as a result of the sale of $110.8 million of non-performing commercial real estate loans, offset by the movement of a performing troubled debt restructuring (“TDR”) to non-accrual status and the migration of $45.1 million due to three commercial relationships moving to non-accrual status. Total non-accruing TDRs at September 30, 2011 were $22.4 million. Non-performing loans at September 30, 2011 includes one $5.2 million commercial real estate loan held-for-sale.

As of September 30, 2011, the Company had $38.5 million outstanding on 18 residential construction, commercial construction and land development relationships which agreements included interest reserves. As of December 31, 2010, the Company had $81.1 million outstanding on 25 residential construction, commercial construction and land development relationships which agreements included interest reserves. The total amount available in those reserves to fund interest payments was $1.4 million and $2.4 million at September 30, 2011 and December 31, 2010, respectively. As of September 30, 2011, the Company had six residential construction relationships with aggregate interest reserves of $2.4 million on non-accrual status and one commercial construction relationship with an interest reserve of $140,000 on non-accrual status. As of December 31, 2010, the Company had six residential construction relationships with interest reserves of $3.4 million on non-accrual status. As these relationships are in technical default, no additional fundings of interest will be made. Construction projects are monitored throughout their lives by professional inspectors engaged by the Company. The budgets for loan advances and borrower equity injections are developed at underwriting time in conjunction with the review of the plans and specifications for the project being financed.  Advances of the Company’s funds are based on the prepared budgets and will not be made unless the project has been inspected by the Company’s professional inspector who must certify that the work related to the advance is in place and properly complete. As it relates to construction project financing, the Company does not extend, renew or restructure terms unless its borrower posts cash collateral in an interest reserve.

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 Included in the Company’s loan portfolio are modified commercial loans. Per FASB ASC 310-40, Troubled Debt Restructuring, (“FASB ASC 310-40”), a modification is one in which the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider, such as providing for a below market interest rate and/or forgiving principal or previously accrued interest; this modification may stem from an agreement or be imposed by law or a court, and may involve a multiple note structure. Generally, prior to the modification, the loans which are modified as a troubled debt restructuring (“TDR”) are already classified as non-performing. These loans may only be returned to performing (i.e. accrual status) after considering the borrower’s sustained repayment performance for a reasonable amount of time, generally six months; this sustained repayment performance may include the period of time just prior to the restructuring. During the first quarter of 2011, the Company entered into a TDR agreement with one commercial relationship. At September 30, 2011, the carrying value of the TDR was $708,000. The Company granted a concession by deferring interest on the borrowing and extending the term. The TDR is currently on non-accrual status. During the second quarter of 2011, the Company returned a TDR that was on accrual status back to non-accrual for lack of repayment performance. At September 30, 2011, the total carrying value of loans in TDR status is $22.4 million, all of which are on non-accrual status.

Table 1 provides detail regarding the Company’s non-performing assets and TDRs at September 30, 2011 and December 31, 2010.

Table 1: Summary of Non-performing Assets and TDRs

	September 30, 2011		December 31, 2010
Non-performing assets:
Non-accrual loans	$	107,665	$	159,426
Non-accrual loans held-for-sale		5,186		-
Troubled debt restructuring, non-accruing		22,353		11,796
Loans past due 90 days and accruing		744		2,554
Real estate owned, net		4,893		3,913
Total non-performing assets		140,841		177,689
Troubled debt restructuring, accruing	$	-	$	20,341

The Company’s allowance for losses on loans decreased to $55.2 million, or 2.39% of gross loans receivable, at September 30, 2011 from $81.7 million, or 3.24% of gross loans receivable, at December 31, 2010. The provision for loan losses was $2.3 million for the three months ended September 30, 2011 compared to $42.4 million for the same period in 2010. The decline in reserve balances is due primarily to the sale of commercial real estate loans during 2011.  Across the commercial and consumer loan portfolio, the Company continues to closely monitor areas of weakness and take expedient and appropriate action as necessary to ensure adequate reserves are in place. Net charge-offs for the three months ended September 30, 2011 were $5.8 million, or 0.3% of average loans outstanding. Net charge-offs for the nine months ended September 30, 2011 were $94.3 million, which included $69.4 million related to the loan sale and $13.0 million related to four commercial relationships.

Real estate owned increased $980,000 to $4.9 million at September 30, 2011 as compared to $3.9 million at December 31, 2010. During the nine months ended September 30, 2011, the Company transferred one commercial property in the amount of $390,000 and nine residential properties totaling $2.5 million from loans into real estate owned. During the three months ended September 30, 2011, the Company recorded $188,000 of write-downs of real estate owned relating to five bank properties.  During the nine months ended September 30, 2011, the Company’s write-downs totaled $667,000, including $260,000 on the carrying value of two commercial properties and $407,000 on the carrying value of five bank properties. There were three residential properties with a total carrying amount of $1.1 million sold resulting in a loss of $147,000, two commercial properties with a total carrying amount of $33,000 sold resulting in a net gain of $81,000, and one bank property with a carrying amount of $189,000 sold resulting in a loss of $10,000 during the nine months ended September 30, 2011. At September 30, 2011, the Company had 17 properties in the real estate owned portfolio, five of which are former bank branches.  

The net deferred tax asset decreased $3.4 million from $4.2 million at December 31, 2010 to $837,000 at September 30, 2011 due to a decrease in the unrealized losses on investment securities. The Company maintains a valuation allowance of $90.1 million against the remaining portion of the gross deferred tax asset as the Company is a three-year cumulative loss company and it is more likely than not that the full deferred tax asset will not be realized.

Investment securities available for sale increased $61.9 million, or 13.1%, from $472.9 million at December 31, 2010 to $534.8 million at September 30, 2011 as the Company utilized its excess liquidity to purchase securities. Investment securities held to maturity decreased $1.3 million, or 43.6%, from $3.0 million at December 31, 2010 to $1.7 million at September 30, 2011. The overall decrease in the held-to-maturity portfolio was due to security pay downs. The Company is maintaining its strategy of prudently investing any excess liquidity and maintaining its slight asset sensitive risk profile in light of anticipated rate increases.

Other assets decreased $6.5 million, or 7.4%, to $81.8 million at September 30, 2011 from $88.3 million at December 31, 2010. This decrease was primarily the result of $3.6 million in fair value adjustments on swap transactions recorded during the nine months ended September 30, 2011 and a $3.7 million reduction in prepaid FDIC insurance assessments. For more information on the Company’s financial derivative instruments, see Note 7 of the notes to unaudited condensed consolidated financial statements.

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 Total deposits at September 30, 2011 were $2.73 billion, a decrease of $212.8 million, or 7.2%, from $2.94 billion at December 31, 2010. This decrease is due primarily to a decrease of $178.2 million in certificates of deposit, including those placed through brokers. Core deposits, which exclude all certificates of deposit, decreased $34.6 million to $2.11 billion, or 77.3% of total deposits at September 30, 2011, as compared to $2.14 billion, or 72.8% of total deposits at December 31, 2010.

Total borrowings, excluding debentures held by trusts, totaled $32.0 million and $33.4 million at September 30, 2011 and December 31, 2010, respectively.

Other liabilities decreased $6.9 million, or 8.4%, to $75.7 million at September 30, 2011 from $82.6 million at December 31, 2010. This decrease was primarily related to a decrease in the Company’s interest rate swap liabilities due to the termination of 19 swap agreements.

Stockholders’ equity increased $39.8 million, or 14.8%, to $308.1 million at September 30, 2011 from $268.2 million at December 31, 2010. There was an increase of $99.0 million in stockholders’ equity as a result of the Company's common stock offering during the nine months ended September 30, 2011. Retained deficit increased $66.0 million as a result of losses the Company experienced during the nine months ended September 30, 2011.

Comparison of Operating Results for the Three Months Ended September 30, 2011 and 2010

Overview. The Company recognized net income available to shareholders for the three months ended September 30, 2011 of $2.7 million, or $0.03 per common share, compared to a net loss of $75.3 million, or a loss of $3.14 per common share, for the same period in 2010. During the three months ended September 30, 2010, the Company established a valuation allowance of $49.9 million against the entire net deferred tax asset after concluding that it was more likely than not that the full deferred tax asset would not be realized.

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

 Net interest income, on a tax-equivalent basis, decreased $1.8 million to $26.5 million for the three months ended September 30, 2011, from $28.3 million for the same period in 2010.

 Tax equivalent interest income decreased $5.2 million, or 14.0%, from $37.0 million for the three months ended September 30, 2010, to $31.8 million for the three months ended September 30, 2011. This decrease was primarily volume driven as average interest-earning loans decreased $425.1 million as compared to the quarter ended September 30, 2010. In addition, the yield on investment securities decreased 97 basis points to 2.88% for the three months ended September 30, 2011 from 3.85% for the comparable prior year period due to changes in the interest rate environment.

Interest expense decreased $3.4 million, or 38.6%, for the three months ended September 30, 2011, as compared to the same period in 2010. Average interest-bearing deposit accounts decreased $350.2 million, or 13.8% from September 30, 2010 and the cost of interest-bearing deposits decreased 35 basis points. These decreases occurred as the Company aggressively lowered interest rates on deposits in 2010.

The interest rate spread and net interest margin for the three months ended September 30, 2011 were 3.41% and 3.61%, respectively, compared to 3.24% and 3.47%, respectively, for the same period in 2010.

Table 2 provides detail regarding the Company’s average daily balances with corresponding interest income (on a tax-equivalent basis) and interest expense as well as yield and cost information for the three months ended September 30, 2011 and 2010. Average balances are derived from daily balances.

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Table 2: Quarterly Statements of Average Balances, Income or Expense, Yield or Cost

SUN BANCORP, INC. AND SUBSIDIARIES
AVERAGE BALANCE SHEETS (Unaudited)
(Dollars in thousands)
	For the Three Months Ended September 30,
	2011							2010
	Average		Income/		Yield/			Average		Income/		Yield/
	Balance		Expense		Cost			Balance		Expense		Cost
Interest-earning assets:
Loans receivable (1),(2):
Commercial and industrial	$	1,901,394	$	23,028		4.84	%	$	2,292,274	$	26,620		4.65	%
Home equity		232,458		2,418		4.16			250,033		2,921		4.67
Second mortgage		47,844		698		5.84			60,729		932		6.14
Residential real estate		89,010		1,161		5.22			82,094		1,160		5.65
Other		49,361		844		6.84			59,998		1,031		6.87
Total loans receivable		2,320,067		28,149		4.85			2,745,128		32,664		4.76
Investment securities(3)		498,329		3,582		2.88			443,203		4,261		3.85
Interest-earning bank balances		118,350		71		0.24			75,059		46		0.25
Total interest-earning assets		2,936,746		31,802		4.33			3,263,390		36,971		4.53
Non-interest earning assets:
Cash and due from banks		72,744							51,660
Bank properties and equipment, net		55,461							52,962
Goodwill and intangible assets, net		46,511							50,324
Other assets		123,089							159,960
Total non-interest-earning assets		297,805							314,906
Total assets	$	3,234,551						$	3,578,296
Interest-bearing liabilities:
Interest-bearing deposit accounts:
Interest-bearing demand deposits	$	1,286,426	$	1,589		0.49	%	$	1,325,084	$	2,706		0.82	%
Savings deposits		270,196		321		0.48			293,744		550		0.75
Time deposits		631,415		2,388		1.51			919,404		4,004		1.74
Total interest-bearing deposit accounts		2,188,037		4,298		0.79			2,538,232		7,260		1.14
Short-term borrowings:
Federal funds purchased		-		-		-			6,288		5		0.32
Securities sold under agreements to repurchase - customers		6,952		1		0.06			19,003		9		0.19
Long-term borrowings:
FHLBNY advances (4)		18,162		223		4.91			19,412		222		4.57
Obligations under capital lease		7,959		132		6.63			8,194		136		6.64
Junior subordinated debentures		92,786		675		2.91			92,786		1,054		4.54
Total borrowings		125,859		1,031		3.28			145,683		1,426		3.92
Total interest-bearing liabilities		2,313,896		5,329		0.92			2,683,915		8,686		1.29
Non-interest bearing liabilities:
Non-interest-bearing demand deposits		528,505							505,036
Other liabilities		84,215							101,448
Total non-interest bearing liabilities		612,630							606,484
Total liabilities		2,926,526							3,290,399
Shareholders' equity		308,025							287,897
Total liabilities and shareholders' equity	$	3,234,551						$	3,578,296
Net interest income			$	26,473						$	28,285
Interest rate spread (5)						3.41	%						3.24	%
Net interest margin (6)						3.61	%						3.47	%
Ratio of average interest-earning assets to average interest-bearing liabilities						126.92	%						121.59	%
(1)  Average balances include non-accrual loans and loans held-for-sale.
(2)  Loan fees are included in interest income and the amount is not material for this analysis.
(3)  Interest earned on non-taxable investment securities is shown on a tax-equivalent basis assuming a 35% marginal federal tax rate for all periods. The fully taxable equivalent adjustments for the three months ended September 30, 2011 and 2010 were $292,000 and $399,000, 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 3: Quarterly Rate-Volume Variance Analysis(1)

	For the Three Months Ended September 30, 2011 vs. 2010
	Increase (Decrease) Due To
	Volume			Rate			Net
Interest income:
Loans receivable:
Commercial and industrial	$	(4,626	)	$	1,034		$	(3,592	)
Home equity lines of credit		(197	)		(306	)		(503	)
Home equity term loan		(190	)		(44	)		(234	)
Residential real estate		92			(91	)		1
Other		(183	)		(4	)		(187	)
Total loans receivable		(5,104	)		589			(4,515	)
Investment securities		474			(1,153	)		(679	)
Interest-earning deposits with banks		27			(2	)		25
Total interest-earning assets		(4,603	)		(566	)		(5,169	)
Interest expense:
Interest-bearing deposit accounts:
Interest-bearing demand deposits		(76	)		(1,041	)		(1,117	)
Savings deposits		133			(362	)		(229	)
Time deposits		(798	)		(818	)		(1,616	)
Total interest-bearing deposit accounts		(741	)		(2,221	)		(2,962	)
Short-term borrowings:
Federal funds purchased		(2	)		(3	)		(5	)
Securities sold under agreements to repurchase - customers		(4	)		(4	)		(8	)
Long-term borrowings:
FHLBNY advances(2)		-			1			1
Obligations under capital lease		139			(143	)		(4	)
Junior subordinated debentures		(497	)		118			(379	)
Total borrowings		(364	)		(31	)		(395	)
Total interest-bearing liabilities		(1,105	)		(2,252	)		(3,357	)
Net change in net interest income	$	(3,498	)	$	1,686		$	(1,812	)
(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. The Company recorded a provision for loan losses of $2.3 million during the three months ended September 30, 2011, as compared to $42.4 million for the same period in 2010. The Company’s total loans receivable before allowance for loan losses, or gross loans receivable, decreased $214.9 million, or 8.5%, to $2.31 billion at September 30, 2011 as compared to $2.52 billion at December 31, 2010. In addition, total non-performing assets decreased $36.8 million from $177.7 million at December 31, 2010 to $140.8 million at September 30, 2011. The ratio of allowance for loan losses to gross loans receivable was 2.39% at September 30, 2011 as compared to 3.24% at December 31, 2010. Net charge-offs for the three months ended September 30, 2011 were $5.8 million as compared to $41.6 million during the same period in 2010. Net charge-offs for the three months ended September 30, 2011 included $2.3 million related to three commercial relationships.

The provision recorded is the amount necessary to bring the allowance for loan losses to a level deemed appropriate by management based on the current risk profile of the portfolio. At least monthly, management performs an analysis to identify the inherent risk of loss in the Company’s loan portfolio. This analysis includes a qualitative evaluation of 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. Additionally, management updates the migration analysis and historic loss experience on a quarterly basis.

Non-Interest Income. Non-interest income increased $8.1 million to $5.8 million for the three months ended September 30, 2011, as compared to a loss of $2.4 million for the same period in 2010. This increase was primarily attributable to $7.5 million of derivative credit valuation adjustments on the Company’s derivative portfolio recorded in the prior year as compared to $309,000 in the current period.  Also, the prior year period included an other-than-temporary impairment charge of $950,000.

Non-Interest Expense. Non-interest expense decreased $2.4 million to $27.0 million for the three months ended September 30, 2011 as compared to $29.3 million for the same period in 2010. The decrease in non-interest expense was primarily attributable to a reduction of $1.4 million in salaries and employee benefits and a decrease of $626,000 in insurance expense resulting from reduced FDIC insurance assessments.

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 Income Tax Provision. The income tax provision decreased $28.7 million, to a benefit of $23,000 for the three months ended September 30, 2011 as compared to income tax expense of $28.8 million for the same period in 2010. In the third quarter of 2010, the Company established a valuation allowance against its entire net deferred tax asset, in excess of unrealized losses on available-for-sale securities after concluding that it was more likely than not that the future benefits of the deferred tax asset would not be realized. The resulting charge was recorded through the income tax provision.  As the Company remains in a cumulative loss position, no income tax expense was recorded for the current period. The Company is currently under IRS audit for tax years 2008 through 2010.  It is not anticipated that these audits will result in any material adjustments to the financial statements.

Comparison of Operating Results for the Nine months Ended September 30, 2011 and 2010

Overview. The Company recognized a net loss available to shareholders for the nine months ended September 30, 2011 of $66.0 million, or a loss of $0.90 per common share, compared to a net loss of $157.2 million, or a loss of $6.66 per common share, for the same period in 2010. During the nine months ended September 30, 2011 and 2010, the Company recorded $67.4 million and $66.0 million of loan loss provisions, respectively. In May 2011, the Company completed the sale of $174.3 million of loans, having a recorded investment of $159.8 million, to a third-party investor for gross proceeds of $99.2 million. The loan sale was the primary factor in the loss for the nine months ended September 30, 2011. The results for the nine months ended September 30, 2010 included a goodwill impairment charge of $89.7 million and a valuation allowance of $49.9 million established against the deferred tax asset after concluding that it was more likely than not that the full deferred tax asset would not be realized.

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 $6.2 million to $78.9 million for the nine months ended September 30, 2011, from $85.1 million for the same period in 2010.

 Tax equivalent interest income decreased $14.7 million, or 13.2%, from $111.7 million for the nine months ended September 30, 2010 to $96.9 million for the nine months ended September 30, 2011. This decrease was primarily volume driven as average interest-earning loans decreased $336.5 million from September 30, 2010. In addition, the yield on loans decreased five basis points to 4.75% for the nine months ended September 30, 2011 from 4.80% for the comparable prior year period. Investment yields decreased by 100 basis points to 3.14% for the nine months ended September 30, 2011 from 4.14% for the comparable prior year period. This decrease was partially offset by an increase in average investment securities of $51.3 million, or 11.7% over the same period.

 Interest expense decreased $8.5 million, or 32.0%, for the nine months ended September 30, 2011, as compared to the same period in 2010. This decrease was primarily interest rate driven as the cost of average interest-bearing deposits decreased 33 basis points. This decrease occurred as the Company aggressively lowered interest rates on deposits in 2011. In addition, average interest-bearing deposit balances declined by $204.2 million, or 8.2%, from the nine months ended September 30, 2010 to the same current year period.

The interest rate spread and net interest margin for the nine months ended September 30, 2011 were 3.29% and 3.49%, respectively, compared to 3.32% and 3.55%, respectively, for the same period in 2010.

Table 4 provides detail regarding the Company’s average daily balances with corresponding interest income (on a tax-equivalent basis) and interest expense as well as yield and cost information for the nine months ended September 30, 2011 and 2010. Average balances are derived from daily balances.

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Table 4: Quarterly Statements of Average Balances, Income or Expense, Yield or Cost

SUN BANCORP, INC. AND SUBSIDIARIES
AVERAGE BALANCE SHEETS (Unaudited)
(Dollars in thousands)
	For the Nine Months Ended September 30,
	2011								2010
	Average			Income/		Yield/			Average		Income/		Yield/
	Balance			Expense		Cost			Balance		Expense		Cost
Interest-earning assets:
Loans receivable (1),(2):
Commercial and industrial	$	1,969,551		$	69,565		4.71	%	$	2,265,644	$	79,555		4.68	%
Home equity		234,278			7,426		4.23			254,999		8,969		4.69
Second mortgage		50,481			2,207		5.83			64,047		3,020		6.29
Residential real estate		79,885			3,209		5.36			76,650		3,236		5.63
Other		52,656			2,708		6.86			62,003		3,196		6.87
Total loans receivable		2,386,851			85,115		4.75			2,723,343		97,976		4.80
Investment securities (3)		490,397			11,565		3.14			439,147		13,629		4.14
Interest-earning bank balances		139,297			253		0.24			37,242		62		0.22
Total interest-earning assets		3,016,545			96,933		4.28			3,199,732		111,667		4.65
Non-interest earning assets:
Cash and due from banks		71,980								47,359
Bank properties and equipment, net		54,362								52,919
Goodwill and intangible assets, net		47,424								110,380
Other assets		114,496								152,088
Total non-interest-earning assets		288,262								362,746
Total assets	$	3,304,807							$	3,562,478
Interest-bearing liabilities:
Interest-bearing deposit accounts:
Interest-bearing demand deposits	$	1,333,259		$	5,589		0.56	%	$	1,287,747	$	8,112		0.84	%
Savings deposits		274,280			1,127		0.55			299,745		1,772		0.79
Time deposits		689,738			7,980		1.54			913,988		12,239		1.79
Total interest-bearing deposit accounts		2,297,277			14,696		0.85			2,501,480		22,123		1.18
Short-term borrowings:
Federal funds purchased		-			-		-			22,604		89		0.52
Securities sold under agreements to repurchase - customers		6,942			6		0.12			16,612		22		0.18
Long-term borrowings:
FHLBNY advances (4)		18,476			665		4.80			23,926		829		4.62
Obligations under capital lease		8,019			396		6.58			8,238		412		6.67
Junior subordinated debentures		92,786	��		2,302		3.31			92,786		3,085		4.43
Total borrowings		126,223			3,369		3.56			164,166		4,437		3.60
Total interest-bearing liabilities		2,423,500			18,065		0.99			2,665,646		26,560		1.33
Non-interest bearing liabilities:
Non-interest-bearing demand deposits		500,620								472,545
Other liabilities		85,489								88,996
Total non-interest bearing liabilities		586,109								561,541
Total liabilities		3,009,609								3,227,187
Shareholders' equity		295,198								335,291
Total liabilities and shareholders' equity	$	3,304,807							$	3,562,478
Net interest income				$	78,868						$	85,107
Interest rate spread (5)							3.29	%						3.32	%
Net interest margin (6)							3.49	%						3.55	%
Ratio of average interest-earning assets to average interest-bearing liabilities							124.47	%						120.04	%
(1)  Average balances include non-accrual loans and loans held-for-sale.
(2)  Loan fees are included in interest income and the amount is not material for this analysis.
(3)  Interest earned on non-taxable investment securities is shown on a tax-equivalent basis assuming a 35% marginal federal tax rate for all periods. The fully taxable equivalent adjustments for the nine months ended September 30, 2011 and 2010 were $1.1 million and $1.4 million, 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 5: Quarterly Rate-Volume Variance Analysis(1)

	For the Nine Months Ended September 30, 2011 vs. 2010
	Increase (Decrease) Due To
		Volume			Rate			Net
Interest income:
Loans receivable:
Commercial and industrial		$	(10,646	)	$	656		$	(9,990	)
Home equity lines of credit			(708	)		(835	)		(1,543	)
Home equity term loan			(611	)		(202	)		(813	)
Residential real estate			129			(156	)		(27	)
Other			(492	)		5			(487	)
Total loans receivable			(12,328	)		(532	)		(12,860	)
Investment securities			1,450			(3,515	)		(2,065	)
Interest-earning deposits with banks			185			6			191
Total interest-earning assets			(10,693	)		(4,041	)		(14,734	)
Interest expense:
Interest-bearing deposit accounts:
Interest-bearing demand deposits			274			(2,797	)		(2,523	)
Savings deposits			354			(999	)		(645	)
Time deposits			(2,140	)		(2,119	)		(4,259	)
Total interest-bearing deposit accounts			(1,512	)		(5,915	)		(7,427	)
Short-term borrowings:
Federal funds purchased			(44	)		(45	)		(89	)
Securities sold under agreements to repurchase - customers			(8	)		(8	)		(16	)
Long-term borrowings:
FHLBNY advances(2)			(69	)		(95	)		(164	)
Obligations under capital lease			377			(393	)		(16	)
Junior subordinated debentures			(1,173	)		390			(783	)
Total borrowings			(917	)		(151	)		(1,068	)
Total interest-bearing liabilities			(2,429	)		(6,066	)		(8,495	)
Net change in net interest income		$	(8,264	)	$	2,025		$	(6,239	)
(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. The Company recorded a provision for loan losses of $67.4 million during the nine months ended September 30, 2011, as compared to $66.0 million for the same period in 2010. The provision for the nine months ended September 30, 2011 was driven primarily by charge-offs related to the sale of a portfolio of primarily commercial real estate loans to a third party investor.

Net charge-offs for the nine months ended September 30, 2011 were $94.3 million as compared to $51.4 million during the same period in 2010. Net charge-offs for the nine months ended September 30, 2011 include $69.4 million related to sale of commercial real estate loans. In addition, the Company recorded $13.0 million in charge-offs on four commercial loan relationships. The Company provides provision levels based on the amount of criticized, classified, and non-accrual loans. As a result of the loan sales, and modest economic improvements, the level of these assets have declined dramatically since the prior year period, resulting in reduced provision levels excluding loan sale charges.

The provision recorded is the amount necessary to bring the allowance for loan losses to a level deemed appropriate by management based on the current risk profile of the portfolio. At least monthly, management performs an analysis to identify the inherent risk of loss in the Company’s loan portfolio. This analysis includes a qualitative evaluation of 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. Additionally, management updates the migration analysis and historic loss experience on a quarterly basis.

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 Non-Interest Income. Non-interest income decreased $1.1 million to $6.7 million for the nine months ended September 30, 2011, as compared $7.7 million for the same period in 2010. This decrease was primarily attributable to an increase of $2.8 million in fair value credit adjustments during the nine months ended September 30, 2011 on the Company’s derivative portfolio, resulting primarily from the transfer of certain loans to held-for-sale as well as credit deterioration of the Company’s counterparties. Also, service charges on deposit accounts declined by $767,000 over that same period.  These changes were partially offset by an increase of $1.3 million in gains on the sale of investment securities, a decrease of $700,000 in other- than-temporary impairment (“OTTI”) charges and an increase of $357,000 in investment products income during the nine months ended September 30, 2011 as compared to the comparable prior year period.

Non-Interest Expense. Non-interest expense decreased $90.1 million, or 52.1%, to $83.0 million for the nine months ended September 30, 2011 as compared to $173.1 million for the same period in 2010. The decrease in non-interest expense was due to the goodwill impairment charge recorded during the nine months ended September 30, 2010 of $89.7 million.

Income Tax Provision. The income tax provision decreased $9.2 million, to $10,000 for the nine months ended September 30, 2011 as compared to income tax expense of $9.2 million for the same period in 2010. In the third quarter of 2010, the Company established a valuation allowance against its entire net deferred tax asset, in excess of unrealized losses on available-for-sale securities after concluding that it was more likely than not that the future benefits of the deferred tax asset would not be realized. The resulting charge was recorded through the income tax provision. As the Company remains in a cumulative loss position, no income tax expense was recorded for the current period.

Liquidity and Capital Resources

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

The major source of the Company’s funding on a consolidated basis is deposits, which management believes will be sufficient to meet the Company’s daily and long-term operating liquidity needs. The ability of the Company to retain and attract new deposits is dependent upon the variety and effectiveness of its customer account products, customer service and convenience, and rates paid to customers. The Company also obtains funds from the repayment and maturities of loans, loan sales or participations and maturities or calls of investment securities. Additional liquidity can be obtained in a variety of wholesale funding sources as well, including, but not limited to, federal funds purchased, FHLBNY advances, securities sold under agreements to repurchase, and other securities and unsecured borrowings. Through the Bank, the Company also purchases brokered deposits for funding purposes; however, this funding source is currently limited to 3.5% of the Bank’s total liabilities in accordance with a written agreement between the Bank and the OCC (the “OCC Agreement”) as discussed later in this section. In a continued effort to balance deposit growth and net interest margin, especially in the current interest rate environment and with competitive local deposit pricing, the Company continually evaluates these other funding sources for funding cost efficiencies. Deposit rates continued to decrease through 2010 and into 2011. As a result, the Company continued to experience a decline in certificates of deposit and interest-bearing demand deposits through the first nine months of 2011. Core deposits, which exclude all certificates of deposit, decreased $34.6 million to $2.11 billion, or 77.3% of total deposits at September 30, 2011, as compared to $2.14 billion, or 72.8% of total deposits at December 31, 2010. The Company has additional secured borrowing capacity with the Federal Reserve Bank of approximately $217.9 million, of which none was utilized, and the FHLBNY of approximately $55.1 million, of which $18.1 million was utilized. In addition to secured borrowings, the Company also has unsecured borrowing capacity through lines of credit with other financial institutions of $45.0 million, of which none were utilized as of September 30, 2011. 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 September 30, 2011, the Company had a par value of $369.8 million and $42.5 million in loans and securities, respectively, pledged as collateral on secured borrowings with the Federal Reserve and FHLBNY.

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 September 30, 2012 total $493.3 million, or approximately 79.5% of total certificates of deposit. The Company continues to operate with a core deposit relationship strategy that values a long-term stable customer relationship. This strategy employs a pricing strategy that rewards customers that establish core accounts and maintain a certain minimum threshold account balance. Based on market conditions and other liquidity considerations, the Company may also avail itself to the secondary borrowings discussed above.

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

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 The Company is subject to regulatory capital requirements 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 the Bank’s capital amounts and classifications are also subject to qualitative judgments by the federal bank regulators about components, risk weightings and other factors. The Company’s and the Bank’s risk-based capital ratios have been computed in accordance with regulatory practices.  

On April 15, 2010, the Bank entered into the OCC Agreement which contained requirements to develop and implement a profitability and capital plan which will provide for the maintenance of adequate capital to support the Bank’s risk profile in the current economic environment.  The capital plan was required to contain a dividend policy allowing dividends only if the Bank is in compliance with the capital plan, and obtains prior approval from the OCC.

The Bank also agreed to: (A) implement a program to protect the Bank’s interest in criticized or classified assets, (b) review and revise the Bank’s loan review program; (c) implement a program for the maintenance of an adequate allowance for loan losses; and (d) revise the Bank’s credit administration policies. The Bank also agreed that its brokered deposits will not exceed 3.5% of its total liabilities unless approved by the OCC. Management does not expect this restriction will limit its access to liquidity as the Bank does not rely on brokered deposits as a major source of funding. At September 30, 2011, the Bank’s brokered deposits represented 2.3% of its total liabilities.

Management is taking all necessary actions to ensure the Bank becomes fully compliant with all requirements of the OCC Agreement.

The Bank is also subject to individual minimum capital ratios established by the OCC for the Bank requiring the Bank to continue to maintain a Leverage ratio at least equal to 8.50% of adjusted total assets, to continue to maintain a Tier 1 Capital ratio at least equal to 9.50% of risk-weighted assets and maintain a Total Capital ratio at least equal to 11.50% of risk-weighted assets. At September 30, 2011, the Bank met all of the three capital ratios established by the OCC as its Leverage ratio was 9.64%, Tier 1 Capital ratio was 11.81%, and Total Capital ratio was 13.07%.

The following table provides both the Company’s and the Bank’s regulatory capital ratios as of September 30, 2011:

Table 6: Regulatory Capital Levels

	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provision(1)
		Amount	Ratio				Amount	Ratio				Amount	Ratio
September 30, 2011
Total capital (to risk-weighted assets):
Sun Bancorp, Inc.	$	385,939		14.85	%	$	207,895		8.00	%		N/A
Sun National Bank		339,017		13.07			207,497		8.00		$	259,372		10.00	%
Tier I capital (to risk-weighted assets):
Sun Bancorp, Inc.		353,170		13.59			103,947		4.00			N/A
Sun National Bank		306,310		11.81			103,749		4.00			155,623		6.00
Leverage ratio:
Sun Bancorp, Inc.		353,170		11.08			127,535		4.00			N/A
Sun National Bank		306,310		9.64			127,121		4.00			158,902		5.00
(1) Not applicable for bank holding companies.

The Bank’s deposits are insured to applicable limits by the Federal Deposit Insurance Corporation (“FDIC”). As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) which was signed into law on July 21, 2010, the maximum deposit insurance limit was permanently increased to $250,000.

In addition, the Dodd-Frank Act amended the Federal Deposit Insurance Act to provide for full deposit insurance coverage for non interest-bearing transaction accounts for a two year period beginning December 31, 2010.  This applies to all insured depository institutions with no opt in or opt out requirements.

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 In November 2009, instead of imposing additional special assessments, the FDIC amended the assessment regulations to require all insured depository institutions to prepay their estimated risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012 on December 30, 2009. For purposes of estimating the future assessments, each institution’s base assessment rate in effect on September 30, 2009 was used, assuming a 5 percent annual growth rate in the assessment base and a 3 basis point increase in the assessment rate in 2011 and 2012. The prepaid assessment will be applied against actual quarterly assessments until exhausted. Any funds remaining after September 30, 2013 will be returned to the institution. If the prepayment would impair an institution’s liquidity or otherwise create significant hardship, it was able to apply for an exemption. Requiring this prepaid assessment does not preclude the FDIC from changing assessment rates or from further revising the risk-based assessment system. On December 31, 2009, the Company paid the FDIC prepaid assessment of $18.3 million.  At September 30, 2011, the Company’s prepaid assessment balance was $7.5 million, with $3.9 million being recognized in expense in the nine months ended September 30, 2011.   

The Company’s capital securities qualify as Tier 1 capital under federal regulatory guidelines. These instruments are subject to a 25% capital limitation under risk-based capital guidelines developed by the 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, 2010, and would have limited capital securities and other restricted core capital elements to 25 percent of all core capital elements, net of goodwill less any associated deferred tax liability. On March 16, 2010, the Federal Reserve Board extended for two years the ability for bank holding companies to include restricted core capital elements as Tier 1 capital up to 25 percent of all core capital elements, including goodwill. The portion that exceeds the 25 percent capital limitation qualifies as Tier 2, or supplementary capital of the Company. At September 30, 2011, all $90.0 million in capital securities qualified at Tier 1.

The ability of the Bank to pay dividends to the Company is governed by certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock. In addition, a national bank may not pay any dividends in an amount greater than its undivided profits and a national bank may not declare any dividends if such declaration would leave the bank inadequately capitalized. Therefore, the ability of the Bank to declare dividends will depend on its future net income and capital requirements. Also, banking regulators have indicated that national banks should generally pay dividends only out of current operating earnings. Following this guidance, the amount available for payment of dividends to the Company by the Bank totaled $0 at September 30, 2011. Per the OCC Agreement and the Board resolutions, a dividend may only be declared if it is in accordance with the approved capital plan, the Bank remains in compliance with the capital plan following the payment of the dividend and the dividend is approved by the OCC and the Federal Reserve.

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

Disclosures about Commitments

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The guarantees are primarily issued to support private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In the event of a draw by the beneficiary that complies with the terms of the letter of credit, the Company would be required to honor the commitment. The Company takes various forms of collateral, such as real estate assets and customer business assets, to secure the commitment. Additionally, all letters of credit are supported by indemnification agreements executed by the customer. The maximum undiscounted exposure related to these commitments at September 30, 2011 was $53.5 million and the portion of the exposure not covered by collateral was approximately $785,000. We believe that the utilization rate of these letters of credit will continue to be substantially less than the amount of these commitments, as has been our experience to date.

The Company maintains a reserve for unfunded loan commitments and letters of credit, which is reported in other liabilities in the unaudited condensed consolidated statements of financial condition, consistent with FASB ASC 825. As of the balance sheet date, the Company records estimated losses inherent with unfunded loan commitments in accordance with FASB ASC 450, Contingencies, and estimated future obligations under letters of credit in accordance with FASB ASC 460, Guarantees. The methodology used to determine the adequacy of this reserve is integrated in the Company’s process for establishing the allowance for loan losses and considers the probability of future losses and obligations that may be incurred under these off-balance sheet agreements. The reserve for unfunded loan commitments and letters of credit at September 30, 2011 and December 31, 2010 was $348,000 and $1.5 million, 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 the 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 named a 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. On May 28, 2010, Visa deposited an additional $500 million into the litigation escrow account previously established to satisfy specific settlement obligations. Visa funded the additional amount into the escrow account by reducing each Class B shareholders’ conversion ratio to Visa Class A shares from 0.5824 to 0.5550. Furthermore, on October 8, 2010, Visa deposited another $800 million into the litigation escrow account further reducing the conversion ratio from 0.5550 to 0.5102. The Company currently has 7,672 Class B shares, with a zero cost basis. The Company’s indemnification obligations based on its proportionate share of ownership in Visa USA, Inc. was not material at September 30, 2011 or December 31, 2010.

Recent Accounting Principles

In September 2011, the FASB issued Accounting Standards Update (“ASU”) 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This guidance allows an entity to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit. If, after assessing the totality of events or circumstances, an entity determines it is not more likely that not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step goodwill impairment test is unnecessary. This guidance is effective for public entities for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of this guidance is not expected to have any impact on the Company’s financial condition or results of operations.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This guidance eliminates the presentation option of presenting the component of other comprehensive income as part of the statement of changes in stockholders’ equity. In addition, the guidance requires the consecutive presentation of the statement of net income and other comprehensive income and requires the entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. These changes will apply to both annual and interim financial statements. This guidance is effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. As this guidance amends only presentation requirements, the adoption will not impact the Company’s financial condition or results of operations.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRSs”). This amendment results in common fair value measurement and disclosure requirements in GAAP and IFRSs. This guidance is not intended to change the application requirements in Topic 820. This guidance is effective for public entities during interim and annual periods beginning after December 15, 2011. As this guidance amends only the disclosure requirements and not the application of the accounting standard, the adoption will not impact the Company’s financial condition or results of operations.

In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. This guidance removes from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. The update also eliminates the requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets. This guidance is effective for public entities for the first interim or annual period beginning on or after December 15, 2011. The Company is continuing to evaluate the impact of the new guidance, but does not expect the guidance will have a material impact on the Company’s financial condition or results of operations.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This guidance clarifies the guidance from ASU 2010-20, Receivables (Topic 310) on a creditor’s evaluation of whether a concession has been granted and whether a debtor is experiencing financial difficulties. This guidance also requires the disclosures related to troubled debt restructurings from Update 2010-20 as effective for public entities for the first interim or annual period beginning on or after June 15, 2011. This guidance was adopted by the Company and applied retroactively to January 1, 2011. 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 devises strategies and tactics to maintain the net interest income of the Company within acceptable ranges over a variety of interest rate scenarios. Should the Company’s risk modeling indicate an undesired exposure to changes in interest rates, there are a number of remedial options available including changing the investment portfolio characteristics, and changing loan and deposit pricing strategies. Two of the tools used in monitoring the Company’s sensitivity to interest rate changes are gap analysis and net interest income simulation.

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

At September 30, 2011, the Company’s gap analysis showed an asset sensitive position with total interest-earning assets maturing or re-pricing within one year exceeding interest-bearing liabilities maturing or re-pricing during the same time period by $266.1 million representing a positive one-year gap ratio of 8.22%. All amounts are categorized by their actual maturity or anticipated call or re-pricing date with the exception of interest-bearing demand deposits and savings deposits. Though the rates on interest-bearing demand and savings deposits generally trend with open market rates, they often do not fully adjust to open market rates and frequently adjust with a time lag. As a result of prior experience during periods of rate volatility and management's estimate of future rate sensitivities, the Company allocates the interest-bearing demand deposits and savings deposits based on an estimated decay rate for those deposits.

Net Interest Income Simulation. Due to the inherent limitations of gap analysis, the Company also uses simulation models to measure the impact of changing interest rates on its operations. The simulation model attempts to capture the cash flow and re-pricing characteristics of the current assets and liabilities on the Company’s balance sheet. Assumptions regarding such things as prepayments, 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 September 30, 2011 shows a position that is relatively neutral to interest rates with a more negative bias as rates decrease. The net income simulation results are impacted by an expected continuation of deposit pricing competition which may limit deposit pricing flexibility in both increasing and decreasing rate environments, floating-rate loan floors initially limiting loan rate increases and a relatively short liability maturity structure including retail certificates of deposit.

Actual results may differ from the simulated results due to such factors as the timing, magnitude and frequency of interest rate changes, changes in market conditions, management strategies and differences in actual versus forecasted balance sheet composition and activity. Table 7 provides the Company’s estimated earnings sensitivity profile versus the most likely rate forecast as of September 30, 2011. The Company anticipates that strong deposit pricing competition will continue to limit deposit pricing flexibility in an increasing and a decreasing rate environment.

Table 7: Sensitivity Profile

Change in Interest Rates	Percentage Change in Net Interest Income
(Basis Points)	Year 1
+200	1.1%
+100	0.0%
-100	-1.7%
-200	-3.7%

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

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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 September 30, 2011. In the ordinary course, the Company is from time to time party to legal proceedings incident to its business.  While the ultimate outcome of these proceedings cannot be predicted with certainty, management, after consultation with counsel representing the Company in these proceedings, does not expect that the resolution of these proceedings will have a material effect on the Company’s financial condition, results of operations or cash flows.
Item 1A.	Risk Factors
	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, 2010, previously filed with the Securities and Exchange Commission with the exception that the Risk Factor entitled “We do not currently pay cash dividends on our stock” is replaced with the following: We are subject to various restrictions on our ability to pay cash dividends. As a bank holding company, our ability to declare and pay dividends is dependent on certain federal regulatory considerations.  We have not historically paid a cash dividend on our common stock and are subject to various restrictions on our ability to pay cash dividends. In October 2011, our Board of Directors resolved, among other things, not to declare or pay any cash dividends or take any cash dividends from the Bank without the prior approval of the Federal Reserve. In addition, pursuant to the terms of the securities purchase agreements entered into by us in July 2010, we also agreed not to declare or pay any dividends on our capital stock through December 31, 2012. Further, pursuant to the terms of the OCC Agreement, the Bank may not pay any dividends if it is not in compliance with its approved capital plan or if the effect of the dividend would be to cause the Bank to not be in compliance and, in either event, not without prior OCC approval. Accordingly, there can be no assurance that we will pay dividends to our shareholders in the future. The following new Risk Factor is added: Our agreement not to take dividends from the Bank without prior regulatory approval could impact our liquidity and debt service capability. In October 2011, our Board of Directors resolved not to accept any dividends from the Bank without the prior approval of the Federal Reserve. Under the OCC Agreement, the Bank cannot pay a dividend without prior OCC approval. Dividends from the Bank have historically been our primary source of revenue.  While we maintain certain liquid assets at the Company level, we also have debt service obligations on the subordinated debentures we have issued.  While we believe we are capable of funding the interest obligation on our junior subordinated debentures through available cash balances, the absence of dividends from the Bank may restrict our ability to service our debt at the Company level.
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
	Not applicable
Item 3.	Defaults upon Senior Securities
	Not applicable
Item 4.	Reserved.
	Not applicable
Item 5.	Other Information
	Not Applicable

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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.
	Exhibit 101.INS XBRL Instance Document
	Exhibit 101.SCH XBRL Taxonomy Extension Schema Document
	Exhibit 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
	Exhibit 101.LAB XBRL Taxonomy Extension Label Linkbase Document
	Exhibit 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
	Exhibit 101.DEF XBRL Taxonomy Definition Linkbase Document

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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: November 9, 2011	/s/ Thomas X. Geisel
	Thomas X. Geisel
	President and Chief Executive Officer
Date: November 9, 2011	/s/ Robert B. Crowl
	Robert B. Crowl
	Executive Vice President and
	Chief Financial Officer
Date: November 9, 2011	/s/ Neil Kalani
	Neil Kalani
	Senior Vice President and
	Chief Accounting Officer and Controller

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