Sun Bancorp (SNBC) 10-Q 2012 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, 2012

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 – 86,074,931, Shares Outstanding at November 5, 2012

TABLE OF CONTENTS

	Page Number
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Statements of Financial Condition at September  30, 2012 and December 31, 2011		3
Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2012 and 2011		4
Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2012 and 2011		5
Unaudited Condensed Consolidated Statements of Shareholders’ Equity for the Nine Months Ended September 30, 2012 and 2011		6
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September  30, 2012 and 2011		7
Notes to Unaudited Condensed Consolidated Financial Statements		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		36
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. Mine Safety Disclosures		51
Item 5. Other Information		51
Item 6. Exhibits		52
Signatures		53
Certifications
Exhibit 31(a) Section 302 Certification of CEO
Exhibit 31(b) Section 302 Certification of Chief Accounting Officer
Exhibit 32 Section 906 Certifications
Exhibit 101.INS XBRL Instance Document
Exhibit 101.SCH XBRL Taxonomy Extension Schema Document
Exhibit 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
Exhibit 101.LAB XBRL Taxonomy Extension Label Linkbase Document
Exhibit 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
Exhibit 101.DEF XBRL Taxonomy Definition Linkbase Document

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands, except par value amounts)

	September 30, 2012			December 31, 2011
ASSETS
Cash and due from banks	$	75,555		$	68,773
Interest-earning bank balances		8,299			51,049
Cash and cash equivalents		83,854			119,822
Investment securities available for sale (amortized cost of $503,432 and $514,488 at September 30, 2012 and December 31, 2011, respectively)		508,173			515,545
Investment securities held to maturity (estimated fair value of $884 and $1,413 at September 30, 2012 and December 31, 2011, respectively)		821			1,344
Loans receivable (net of allowance for loan losses of $49,016 and $41,667 at September 30, 2012 and December 31, 2011, respectively)		2,261,980			2,249,455
Loans held-for-sale, at cost		—			23,192
Loans held-for-sale, at fair value		60,676			—
Restricted equity investments, at cost		18,040			15,826
Bank properties and equipment, net		51,630			54,756
Real estate owned		5,513			5,020
Accrued interest receivable		8,183			8,912
Goodwill		38,188			38,188
Intangible assets, net		4,183			6,947
Bank owned life insurance (BOLI)		76,369			74,871
Other assets		62,653			70,038
Total assets	$	3,180,263		$	3,183,916
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits	$	2,646,807		$	2,667,977
Federal funds purchased		30,000			—
Securities sold under agreements to repurchase – customers		3,587			5,668
Advances from the Federal Home Loan Bank of New York (FHLBNY)		16,749			2,733
Securities sold under agreements to repurchase – FHLBNY		20,000			15,000
Obligations under capital lease		7,675			7,868
Junior subordinated debentures		92,786			92,786
Deferred taxes, net		1,937			432
Other liabilities		73,242			82,369
Total liabilities		2,892,783			2,874,833
Commitments and contingencies (see Note 10)
Shareholders’ equity:
Preferred stock, $1 par value, 1,000,000 shares authorized; none issued		—			—
Common stock, $1 par value, 200,000,000 shares authorized; 88,143,024 shares issued and 86,036,301 shares outstanding at September 30, 2012; 87,825,038 shares issued and 85,718,315 shares outstanding at December 31, 2011		88,171			87,825
Additional paid-in capital		505,954			504,508
Retained deficit		(283,055	)		(257,520	)
Accumulated other comprehensive income		2,804			625
Deferred compensation plan trust		(232	)		(193	)
Treasury stock at cost, 2,106,723 shares at September 30, 2012 and December 31, 2011		(26,162	)		(26,162	)
Total shareholders’ equity		287,480			309,083
Total liabilities and shareholders’ equity	$	3,180,263		$	3,183,916

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,
	2012			2011			2012			2011
INTEREST INCOME
Interest and fees on loans	$	25,631		$	28,149		$	78,037		$	85,115
Interest on taxable investment securities		2,221			2,603			7,278			8,086
Interest on non-taxable investment securities		393			542			1,228			1,984
Dividends on restricted equity investments		224			216			735			679
Total interest income		28,469			31,510			87,278			95,864
INTEREST EXPENSE
Interest on deposits		3,279			4,298			10,410			14,696
Interest on funds borrowed		259			356			978			1,067
Interest on junior subordinated debentures		597			675			2,023			2,302
Total interest expense		4,135			5,329			13,411			18,065
Net interest income		24,334			26,181			73,867			77,799
PROVISION FOR LOAN LOSSES		1,868			2,321			33,061			67,440
Net Interest income after provision for loan losses		22,466			23,860			40,806			10,359
NON-INTEREST INCOME
Service charges on deposit accounts		2,848			2,838			8,246			8,090
Other service charges		69			85			222			259
Gain on sale of loans		4,204			708			6,785			2,341
Net impairment losses on available for sale securities
Total impairment	$	—		$	—		$	—		$	250
Portion of loss (gain) recognized in other comprehensive income (before taxes)		—			—			—			—
Net impairment losses recognized in operations		—			—			—			(250	)
Gain on sale of investment securities		—			—			430			1,408
Investment products income		510			562			1,690			2,460
BOLI income		489			549			1,498			1,655
Derivative credit valuation adjustment		(198	)		(309	)		(525	)		(12,324	)
Other		1,666			1,337			4,289			3,025
Total non-interest income		9,588			5,770			22,635			6,664
NON-INTEREST EXPENSE
Salaries and employee benefits		16,128			13,619			46,655			39,490
Occupancy expense		3,275			3,021			9,595			9,730
Equipment expense		1,866			1,899			5,394			5,484
Data processing expense		1,084			1,058			3,246			3,234
Amortization of intangible assets		922			922			2,764			2,764
Insurance expense		1,375			1,479			4,318			4,753
Professional fees		578			879			1,814			2,859
Advertising expense		464			395			1,769			2,282
Problem loan expense		2,154			1,506			4,905			6,476
Real estate owned expense, net		779			448			1,350			1,078
Office supplies expense		302			315			949			984
Other		1,933			1,432			6,251			3,865
Total non-interest expense		30,860			26,973			89,010			82,999
INCOME (LOSS) BEFORE INCOME TAXES		1,194			2,657			(25,569	)		(65,976	)
INCOME TAX (BENEFIT) EXPENSE		(34	)		(23	)		(34	)		10
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS	$	1,228		$	2,680		$	(25,535	)	$	(65,986	)
Basic earnings (loss) per share	$	0.01		$	0.03		$	(0.30	)	$	(0.90	)
Diluted earnings (loss) per share	$	0.01		$	0.03		$	(0.30	)	$	(0.90	)
Weighted average shares - basic		86,001,929			84,429,644			85,888,236			73,643,303
Weighted average shares - diluted		86,047,655			84,538,449			85,888,236			73,643,303

See Notes to Unaudited Condensed Consolidated Financial Statements.

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SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands)

	For the Three Months Ended September 30,					For the Nine Months Ended September 30,
	2012		2011			2012			2011
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS	$	1,228	$	2,680		$	(25,535	)		(65,986	)
Other Comprehensive Income, net of tax
Unrealized gains (losses) on securities:
Unrealized holding (losses) gains arising during period	$	953	$	(381	)	$	2,384		$	5,928
Less: reclassification adjustment for gains (losses) included in net income		54		—			(205	)		(834	)
Reclassification adjustment for net impairment loss recognized in earnings		—		—			—			148
Reclassification adjustment for portion of impairment loss recognized in other comprehensive loss		—		(308	)		—			(308	)
Other comprehensive income (loss)		1,007		(689	)		2,179			4,934
COMPREHENSIVE INCOME (LOSS)	$	2,235	$	1,991		$	(23,356	)	$	(61,052	)

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 Income			Deferred Compensation			Treasury Stock			Total
BALANCE, JANUARY 1, 2011	$	—	$	52,464	$	438,335	$	(190,015	)	$	(6,146	)	$	(234	)	$	(26,162	)	$	268,242
Net loss		—		—		—		(65,986	)		—			—			—			(65,986	)
Other comprehensive income		—		—				—			4,934			—			—			4,934
Issuance of common stock		—		35,144		64,544		—			—			83			—			99,771
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
BALANCE, JANUARY 1, 2012	$	—	$	87,825	$	504,508	$	(257,520	)	$	625		$	(193	)	$	(26,162	)	$	309,083
Net loss		—		—		—		(25,535	)		—			—			—			(25,535	)
Other comprehensive income		—		—		—		—			2,179			—			—			2,179
Issuance of common stock		—		277		512		—			—			(39	)		—			750
Stock-based compensation		—		69		934		—			—			—			—			1,003
BALANCE, September 30, 2012	$	—	$	88,171	$	505,954	$	(283,055	)	$	2,804		$	(232	)	$	(26,162	)	$	287,480

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,
	2012			2011
OPERATING ACTIVITIES
Net loss	$	(25,535	)	$	(65,986	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for loan losses		33,061			67,440
Reserve for unfunded commitments		24			(1,142	)
Depreciation, amortization and accretion		9,436			5,101
Write down of book value of bank properties and equipment and real estate owned		986			1,298
Other-than-temporary impairment on investment securities		—			250
Net gain on sale of investment securities available-for-sale		(347	)		(1,408	)
Mark-to-market on trading securities		—			(168	)
Net loss on sale of real estate owned		150			76
Increase in fair value of interest rate lock commitments		(630	)		—
Gain on sale of mortgage loans		(5,237	)		(2,341	)
Mark-to-market adjustment on loans held-for-sale		(1,548	)		—
Derivative credit valuation adjustments		51			12,324
Increase in cash surrender value of BOLI		(1,498	)		(1,655	)
Stock-based compensation		1,003			1,094
Shares contributed to employee benefit plans		750			744
Mortgage loans originated for sale		(275,609	)		(93,562	)
Proceeds from the sale of mortgage loans		244,910			94,059
Change in assets and liabilities which provided (used) cash:
Accrued interest receivable		729			1,312
Other assets		2,935			4,223
Other liabilities		(3,463	)		(11,835	)
Purchases of trading securities		—			(41,371	)
Proceeds from sale of trading securities		—			36,396
Net cash (used in) provided by operating activities		(19,832	)		4,849
INVESTING ACTIVITIES
Purchases of available-for-sale securities		(117,022	)		(202,560	)
Net (purchases) redemption of restricted equity securities		(2,214	)		1,830
Proceeds from maturities, prepayments or calls of investment securities available for sale		98,131			104,697
Proceeds from maturities, prepayments or calls of investment securities held to maturity		1,020			1,323
Proceeds from sale of investment securities		27,447			42,136
Proceeds from death benefit from BOLI		—			1,559
Proceeds from sale of loans		—			99,162
Net (increase) decrease in loans		(49,121	)		14,150
Purchases of bank properties and equipment		(2,862	)		(7,078	)
Proceeds from sale of real estate owned		2,914			1,202
Net cash (used in) provided by investing activities		(41,707	)		56,421
FINANCING ACTIVITIES
Net decrease in deposits		(21,170	)		(212,432	)
Net repayments of securities sold under agreements to repurchase - customer		(2,081	)		(281	)
Issuances of federal funds purchased		30,000			—
Issuances (repayments) of advances from FHLBNY		14,016			(945	)
Net issuances of securities sold under agreements to repurchase -FHLBNY		5,000			—
Repayment of obligations under capital leases		(193	)		(181	)
Proceeds from issuance of common stock		—			99,552
Net cash provided by (used in) financing activities		25,572			(114,287	)
NET DECREASE IN CASH AND CASH EQUIVALENTS		(35,968	)		(53,017	)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		119,822			187,226
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	83,854		$	134,209
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid	$	21,583		$	19,913
Income taxes paid		—			154
SUPPLEMENTAL DISCLOSURE OF NON-CASH ITEMS
Transfer of loans to held-for-sale	$	—		$	5,096
Transfer of loans and bank property to real estate owned		4,142			2,925

See Notes to Unaudited Condensed Consolidated Financial Statements.

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For the quarterly period ended September 30, 2012

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, 2011. The results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012 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. 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, the Company has one reportable operating segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent upon the ability of the Company to fund itself with deposits and other borrowings and manage interest rate and credit risk. Accordingly, all significant operating decisions are based upon analysis of the Company as one segment or unit.

Loans Held-for-sale. Loans held-for-sale totaled $60.7 million and $23.2 million at September 30, 2012 and December 31, 2011, respectively. These loans represent residential mortgages originated with the intent to sell. At September 30, 2012, these loans were carried at fair value. Effective July 1, 2012, the Company elected the fair value option under FASB ASC 825,The Fair Value Option for Financial Instruments, (“FASB ASC 825”), on its loans held-for-sale portfolio. For all loans held-for-sale originated on July 1, 2012 or later, this election resulted in a $1.5 million market value adjustment which was recognized in gain on sale of loans on the unaudited condensed consolidated statement of operations for the three and nine months ended September 30, 2012. At December 31, 2011, loans held-for-sale were carried at the lower of cost or estimated fair value, on an aggregate basis.

Accumulated Other Comprehensive Income. The Company classifies items of accumulated comprehensive income by their nature and displays the details of other comprehensive loss in the unaudited condensed consolidated statements of comprehensive income. Amounts categorized as comprehensive loss represent net unrealized gains or losses on investment securities available for sale, net of tax and the non-credit portion of any

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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 loss for the period .. These reclassifications for the nine months ended September 30, 2012 and 2011 were as follows:

	For the Nine Months Ended September 30,
	2012									2011
	Pre-tax			Tax			After-tax			Pre-tax			Tax			After-tax
Unrealized holding gain on securities available for sale during the period	$	4,030		$	(1,646	)	$	2,384		$	10,020		$	(4,092	)	$	5,928
Reclassification adjustment for net gains included in net income(1)		(346	)		141			(205	)		(1,408	)		574			(834	)
Reclassification adjustment for net impairment loss recognized in earnings(1)		—			—			—			250			(102	)		148
Reclassification adjustment for portion of impairment loss recognized in other comprehensive income		—			—			—			(520	)		212			(308	)
Net unrealized gain on securities available for sale	$	3,684		$	(1,505	)	$	2,179		$	8,342		$	(3,408	)	$	4,934

(1) All amounts are included in non-interest income in the unaudited condensed consolidated statements of operations.

Recent Accounting Principles.

In September 2011, the FASB issued 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; retroactive application of this guidance is permitted. The Company does not intend to apply this guidance, allowing the Company to make a qualitative evaluation about the likelihood of goodwill impairment, but will continue to apply the two-step goodwill impairment test annually.

In December 2011, the FASB issued Accounting Standards Update (“ASU”) 2011-11,Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.This amendment results in common offsetting requirements and disclosure requirements in GAAP and IFRS. This guidance is not intended to change, but enhance, the application requirements in Topic 210. This guidance is effective for public entities during interim and annual periods beginning after January 1, 2013. This guidance amends only the disclosure requirements and not the application of the accounting standard. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial statements.

In July 2012, the FASB issued Accounting Standards Update (“ASU”) 2012-02,Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This amendment provides an entity with the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. This amendment is effective for public entities for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial statements.

(2) Stock-Based Compensation

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

9

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, 2012 was as follows:

Summary of Stock Option Activity

	Number of Options		Weighted Average Exercise Price		Number of Options Exercisable
January 1, 2012		2,828,077	$	7.94		2,037,549
Granted		283,322		2.91		—
Exercised		—		—		—
Forfeited		74,776		3.76		—
Expired		1,169,706		8.08		—
September 30, 2012		1,866,917	$	7.26		1,200,984
Stock options vested or expected to vest(1)		1,647,880	$	7.32		—

(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 7.0 years for options outstanding and 6.2 years for options exercisable as of September 30, 2012.

At September 30, 2012, the aggregate intrinsic value was $121 thousand for options outstanding and $0 for options exercisable.

During the nine months ended September 30, 2012 and 2011, the Company granted 283,322 options and 242,500 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 a stock option is estimated using historical exercise behavior of employees at a particular level of management who were granted options with a comparable term. The stock options have historically been granted with a 10 year term. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected volatility is based on the historical volatility of the Company’s stock price.

Significant weighted average assumptions used to calculate the fair value of the options for the nine months ended September 30, 2012 and 2011 are as follows:

	For the Nine Months  Ended September 30,
	2012			2011
Weighted average fair value of options granted	$	1.51		$	2.11
Weighted average risk-free rate of return		0.94	%		2.72	%
Weighted average expected option life in months		60			78
Weighted average expected volatility		62	%		47	%
Expected dividends(1)	$	—		$	—

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

10

A summary of the Company’s nonvested stock award activity during the nine months ended September 30, 2012 is presented in the following table:

Summary of Nonvested Stock Award Activity

	Number of Shares			Weighted Average Grant Date Fair Value
Nonvested stock awards outstanding, January 1, 2012		178,819		$	6.05
Issued		49,623			1.20
Vested		(95,790	)		5.75
Forfeited		(21,675	)		3.45
Nonvested stock awards outstanding, September 30, 2012		110,977		$	4.65

There were 49,623 shares of nonvested stock awards issued during the nine months ended September 30, 2012. During the nine months ended September 30, 2011, there were no shares of nonvested stock awards issued. The value of these shares is based upon the closing price of the common stock on the date of grant. Compensation expense is recognized on a straight-line basis over the service period for all of the nonvested stock awards issued.

Total compensation expense recognized related to options and nonvested stock awards, including that for non-employee directors, during the three and nine months ended September 30, 2012 was $264 thousand and $1.1 million, respectively, as compared to $318 thousand and $1.1 million for the three and nine months ended September 30, 2011, respectively. As of September 30, 2012 there was approximately $1.2 million and $288 thousand 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 2.7 years and 0.9 years, respectively.

(3) Investment Securities

The amortized cost of investment securities and the approximate fair value at September 30, 2012 and December 31, 2011 were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
September 30, 2012
Available for sale:
U.S. Treasury securities	$	11,998	$	31	$	—		$	12,029
U.S. Government agency securities		4,965		16		—			4,981
U.S. Government agency mortgage-backed securities		411,090		8,057		(1,000	)		418,147
Other mortgage-backed securities		289		—		(5	)		284
State and municipal securities		36,996		3,699		—			40,695
Trust preferred securities		12,622		—		(7,021	)		5,601
Corporate bonds		24,399		964		—			25,363
Other securities		1,073		—		—			1,073
Total available for sale		503,432		12,767		(8,026	)		508,173
Held to maturity:
U.S. Government agency mortgage-backed securities		821		63		—			884
Total held to maturity		821		63		—			884
Total investment securities	$	504,253	$	12,830	$	(8,026	)	$	509,057
December 31, 2011
Available for sale:
U.S. Treasury securities	$	11,999	$	80	$	—		$	12,079
U.S. Government agency mortgage-backed securities		423,269		6,264		(629	)		428,904
Other mortgage-backed securities		323		—		(27	)		296
State and municipal obligations		45,424		3,373		(12	)		48,785
Trust preferred securities		12,619		—		(7,711	)		4,908
Corporate bonds		19,689		57		(338	)		19,408
Other securities		1,165		—		—			1,165
Total available for sale		514,488		9,774		(8,717	)		515,545
Held to maturity:
U.S. Government agency mortgage-backed securities		1,344		69		—			1,413
Other mortgage-backed securities		—		—		—			—
Total held to maturity		1,344		69		—			1,413
Total investment securities	$	515,832	$	9,843	$	(8,717	)	$	516,958

11

During the nine months ended September 30, 2012, the Company had one trust preferred security and five state and municipal securities called prior to maturity at an aggregate par value of $5.0 million and $2.0 million, respectively, resulting in gross realized losses and gains of $95 thousand and $10 thousand, respectively. During the same period, three securities were sold prior to maturity for gross proceeds of $22.5 million, which resulted in gross realized gains and losses of $475 thousand and $46 thousand, respectively, and one debt security and five state and municipal securities matured which had an aggregate value of $500 thousand and $6.5 million, respectively. 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, 2012 and December 31, 2011:

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, 2012
U.S. Government agency mortgage-backed securities	$	65,231	$	(835	)	$	11,052	$	(165	)	$	76,283	$	(1,000	)
Other mortgage-backed securities		—		—			284		(5	)		284		(5	)
Trust preferred securities		—		—			5,601		(7,021	)		5,601		(7,021	)
Total	$	65,231	$	(835	)	$	16,937	$	(7,191	)	$	82,168	$	(8,026	)
December 31, 2011
U.S. Government agency mortgage-backed securities	$	79,221	$	(627	)	$	7,224	$	(2	)	$	86,445	$	(629	)
Other mortgage-backed securities		—		—			296		(27	)		296		(27	)
State and municipal securities		—		—			233		(12	)		233		(12	)
Corporate Bonds		14,231		(338	)		—		—			14,231		(338	)
Trust preferred securities		—		—			4,908		(7,711	)		4,908		(7,771	)
Total	$	93,452	$	(965	)	$	12,661	$	(7,752	)	$	106,113	$	(8,717	)

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.

12

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 OTTI charges of $0 and $250 thousand during the nine months ended September 30, 2012 and 2011, respectively.

The following is a roll-forward for the three and nine months ended September 30, 2012 and 2011 of OTTI charges recognized in earnings as a result of credit losses on investments:

	For the Three Months Ended September 30,
	2012		2011
Cumulative OTTI, beginning of period	$	10,203	$	10,203
Additional increase as a result of net impairment losses recognized on investments		—		—
Decrease as a result of the sale of an investment with net impairment losses		—		—
Cumulative OTTI, end of period	$	10,203	$	10,203
	For the Nine Months Ended September 30,
	2012		2011
Cumulative OTTI, beginning of period	$	10,203	$	10,683
Additional increase as a result of net impairment losses recognized on investments		—		250
Decrease as a result of the sale of an investment with net impairment losses		—		(730	)
Cumulative OTTI, end of period	$	10,203	$	10,203

U.S. Government Agency Mortgage-Backed Securities. At September 30, 2012, the gross unrealized loss in the category of less than 12 months of $835 thousand consisted of six mortgage-backed securities with an estimated fair value of $65.2 million issued and guaranteed by a U.S. Government sponsored agency. The gross unrealized loss in the category of 12 months or longer of $165 thousand consists of two mortgage-backed securities with an estimated fair value of $11.1 million issued and guaranteed by a U.S. Government sponsored agency. The Company monitors key credit metrics such as delinquencies, defaults, cumulative losses and credit support levels to determine if an OTTI exists. As of September 30, 2012, management concluded that an OTTI did not exist on any of the aforementioned securities based upon its assessment. Management also concluded that it does not intend nor will it be required to sell the securities, before their recovery, which may be maturity, and management expects to recover the entire amortized cost basis of these securities.

Other Mortgage-Backed Securities.At September 30, 2012, the gross unrealized loss in the category 12 months or longer of $5 thousand consisted of one non-agency mortgage-backed security with an estimated fair value of $285 thousand. 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, 2012, management concluded that an OTTI did not exist on this security and believes the unrealized loss is 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.

13

Trust Preferred Securities.At September 30, 2012, the gross unrealized loss in the category of 12 months or longer of $7.0 million consisted of two trust preferred securities. These securities consisted of one non-investment grade rated pooled security with an amortized cost of $8.8 million and estimated fair value of $3.9 million and one non-rated single issuer security with an amortized cost of $3.8 million and an estimated fair value of $1.7 million.

For the pooled security, the Company monitors each issuer in the collateral pool with respect to financial performance using data from the issuer’s most recent regulatory reports as well as information on issuer deferrals and defaults. Also the security structure is monitored with respect to collateral coverage and current levels of subordination. Expected future cash flows are projected assuming additional defaults and deferrals based on the performance of the collateral pool. The non-investment grade pooled security is in a senior position in the capital structure. The security had a 1.75 times principal coverage. As of the most recent reporting date interest has been paid in accordance with the terms of the security. The Company reviews projected cash flow analysis for adverse changes in the present value of projected future cash flows that may result in an other-than-temporary credit impairment to be recognized through earnings. The most recent valuations assumed no recovery on any defaulted collateral, no recovery on any deferring collateral and additional 3.6% of defaults or deferrals’ every 3 years with no recovery rate. As of September 30, 2012, management concluded that an OTTI did not exist on the aforementioned security based upon its assessment. Management also concluded that it does not intend to sell the security, and that it is not more likely than not it will be required to sell the security, before their recovery, which may be maturity, and management expects to recover the entire amortized cost basis of this security.

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

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

During the nine months ended September 30, 2012, the Company did not record an OTTI credit-related charge related to this deferring single issuer trust preferred security. However, the Company had previously recorded a credit-related charge of $250 thousand during the nine months ended September 30, 2011. Based on the Company’s most recent evaluation, the Company does not expect the issuer to default on the security based primarily on the issuer’s subsidiary bank reporting that it meets the minimum regulatory requirements to be considered a “well capitalized” institution. The total cumulative credit related OTTI on this security is $1.2 million as of September 30, 2012.

The amortized cost and estimated fair value of the investment securities, by contractual maturity, at September 30, 2012 and December 31, 2011 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.

	Available for Sale				Held to Maturity
	Amortized Cost		Estimated  Fair Value		Amortized Cost		Estimated  Fair Value
September 30, 2012
Due in one year or less	$	13,198	$	13,231	$	—	$	—
Due after one year through five years		24,647		25,610		—		—
Due after five years through ten years		12,616		13,458		—		—
Due after ten years		41,592		37,443		—		—
Total investment securities, excluding mortgage-backed securities		92,053		89,742		—		—
U.S. Government agency mortgage-backed securities		411,090		418,147		821		884
Other mortgage-backed securities		289		284		—		—
Total investment securities	$	503,432	$	508,173	$	821	$	884
December 31, 2011
Due in one year or less	$	9,789	$	9,820	$	—	$	—
Due after one year through five years		29,903		29,693		—		—
Due after five years through ten years		3,817		4,204		—		—
Due after ten years		47,387		42,628		—		—
Total investment securities, excluding mortgage-backed securities		90,896		86,346		—		—
U.S. Government agency mortgage-backed securities		423,269		428,904		1,344		1,413
Other mortgage-backed securities		323		296		—		—
Total investment securities	$	514,488	$	515,545	$	1,344	$	1,413

14

At September 30, 2012, the Company had $137.4 million, amortized cost, and $142.9 million, estimated fair value, of investment securities pledged to secure public deposits. As of September 30, 2012, the Company had $207.0 million, amortized cost, and $211.0 million, estimated fair value, of investment securities pledged as collateral on secured borrowings.

(4) Loans

The components of loans as of September 30, 2012 and December 31, 2011 were as follows:

Loan Components

	September 30, 2012			December 31, 2011
Commercial:
Commercial and industrial	$	559,211		$	551,396
CRE owner occupied		541,146			604,361
CRE non-owner occupied		628,848			626,795
Land and development		72,856			95,474
Consumer:
Home equity lines of credit		212,911			224,517
Home equity term loans		32,610			41,470
Residential real estate		224,346			100,438
Other		39,068			46,671
Total gross loans held-for-investment		2,310,996			2,291,122
Allowance for loan losses		(49,016	)		(41,667	)
Net loans held-for-investment	$	2,261,980		$	2,249,455
Loans past due 90 days and accruing	$	—		$	154

Loans on Non-Accrual Status

	September 30, 2012		December 31, 2011
Commercial:
Commercial & industrial	$	19,761	$	6,501
CRE owner occupied		18,120		32,579
CRE non-owner occupied		21,304		9,873
Land and development		25,673		32,088
Consumer:
Home equity lines of credit		2,846		3,620
Home equity term loans		972		1,246
Residential real estate		5,440		2,522
Other		1,267		1,227
Total non-accrual loans held-for-investment	$	95,383	$	89,656
Loans held-for-sale, non-accrual	$	—	$	—
Troubled debt restructuring, non-accrual		25,463		17,875

15

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, cash flow 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, 2012, the Company had $18.3 million outstanding on 14 residential construction, commercial construction and land development relationships which agreements included interest reserves. As of December 31, 2011, the Company had $31.4 million outstanding on 18 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 $1.3 million and $956 thousand at September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012, the Company had four residential construction relationships with interest reserves of $2.3 million in the aggregate on non-accrual status and two commercial construction relationships with interest reserves of $446 thousand on non-accrual status. As of December 31, 2011, the Company had six residential construction relationships with interest reserves of $2.4 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 completed. 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 third quarter of 2012, the Company did not enter into any new TDR agreements. During the nine months ended September 30, 2012, the Company entered into one TDR agreement as an interest rate concession was granted. At September 30, 2012, the carrying amount of that TDR was $571 thousand. That TDR is currently on non-accrual status.

(5) Allowance for Loan Losses

Changes in the allowance for loan losses were as follows:

Allowance for Loan Losses and Recorded Investment in Financing Receivables

	For the Nine Months Ended September 30, 2012
	Commercial  and Industrial			Home Equity(1)			Residential Real  Estate			Other(2)			Total
Allowance for loan losses:
Beginning balance	$	34,227		$	2,566		$	903		$	3,971		$	41,667
Charge-offs		(25,474	)		(1,353	)		(207	)		(603	)		(27,637	)
Recoveries		1,507			259			12			148			1,926
Net charge-offs		(23,967	)		(1,094	)		(195	)		(455	)		(25,711	)
Provision for loan losses		31,267			925			1,628			(760	)		33,060
Ending balance	$	41,527		$	2,397		$	2,336		$	2,756		$	49,016
Ending balance: individually evaluated for impairment	$	3,248		$	—		$	13		$	—		$	3,261
Ending balance: collectively evaluated for impairment	$	38,279		$	2,397		$	2,323		$	2,756		$	45,755
Financing Receivables:
Ending balance	$	1,802,060		$	245,521		$	224,246		$	39,069		$	2,310,996
Ending balance: individually evaluated for impairment	$	110,191		$	3,591		$	4,798		$	226		$	118,806
Ending balance: collectively evaluated for impairment	$	1,691,869		$	241,930		$	219,548		$	38,843		$	2,192,190

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

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

16

	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.

The allowance for loan losses was $49.0 million and $41.7 million at September 30, 2012 and December 31, 2011, respectively. The ratio of allowance for loan losses to gross loans receivable was 2.12% at September 30, 2012 and 1.82% at December 31, 2011.

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

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

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

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Accrued Interest Income Recognized		Cash Interest Income Recognized
For the Nine Months Ended September 30, 2012
With no related allowance:
Commercial:
Commercial & industrial	$	21,884	$	23,120	$	—	$	14,588	$	—	$	—
CRE owner occupied		36,108		67,087		—		39,668		23		23
CRE non-owner occupied		21,290		24,226		—		20,071		24		24
Land and development		25,338		34,692		—		29,867		22		22
Consumer:
Home equity lines of credit		2,696		3,623		—		2,928		8		8
Home equity term loans		895		994		—		1,018		3		3
Residential real estate		4,761		5,158		—		4,144		—		—
Other		226		261		—		192		—
With an allowance recorded:
Commercial:
Commercial & industrial	$	2,169	$	3,284	$	1,963	$	1,993	$	—	$	—
CRE owner occupied		2,491		3,100		848		4,402		—		—
Land and development		907		915		436		433		—		—
Consumer:
Residential Real Estate		37		41		13		45		—		—
Other		—		—		—		5		—		—
Total commercial	$	110,187	$	156,424	$	3,247	$	111,022	$	69	$	69
Total consumer	$	8,615	$	10,077	$	13	$	8,331	$	11	$	11
For the Year Ended December 31, 2011
With no related allowance:
Commercial:
Commercial & industrial	$	9,401	$	12,778	$	—	$	9,180	$	67	$	67
CRE owner occupied		32,202		55,982		—		36,266		357		357
CRE non-owner occupied		7,308		8,584		—		15,299		36		36
Land and development		25,925		26,148		—		29,932		57		57
Consumer:
Residential real estate		2,433		2,758		—		470		—		—
Home Equity Lines of Credit		3,398		4,402		—		637		—		—
Home Equity Term Loans		1,197		1,306		—		228		—		—
Other		50		50		—		2		—		—
With an allowance recorded:
Commercial:
Commercial & industrial	$	4,955	$	6,110	$	262	$	13,368	$	337	$	337
CRE owner occupied		9,706		14,449		2,448		18,929		212		201
CRE non-owner occupied		2,565		3,468		229		6,211		438		438
Land and development		6,854		7,063		2,490		7,937		—		—
Consumer:
Residential Real Estate		89		164		14		45		—		—
Other		47		47		47		19		—		—
Total commercial	$	98,916	$	134,582	$	5,429	$	136,582	$	1,504	$	1,493
Total consumer	$	7,214	$	8,726	$	61	$	1,354	$	—	$	—

The unaudited condensed consolidated statements of operations for the nine months ended September 30, 2012 included $80 thousand of recognized interest income (on the accrual and cash basis) on average impaired loans of $119.4 million.

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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, 2012 were five TDRs, three of which were fully collateralized and two of which had specific reserves totaling $122 thousand. In addition, one of the TDRs at September 30, 2012 included a line of credit of $6.5 million, of which $4.6 million was utilized and $1.9 million was available. One TDR included a commitment to lend additional funds of $244 thousand at September 30, 2012.

	Troubled Debt Restructurings
	As of September 30, 2012
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial and industrial		2		8,718		4,310
CRE Owner occupied		10		31,950		20,582
Land and development		1		371		571
	Troubled Debt Restructurings
	As of December 31, 2011
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial and industrial		3	$	8,760	$	7,855
CRE Owner occupied		7		22,995		9,329
Land and development		1		1,745		691

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, 2012 and December 31, 2011:

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, 2012
Grade:
Pass	$	511,515	$	458,390	$	573,324	$	42,025	$	205,913	$	31,554	$	216,358	$	37,265
Special Mention		11,724		22,929		18,788		—		—		—		—		—
Substandard		35,972		59,827		36,736		30,831		6,998		1,056		7,988		1,803
Total	$	559,211	$	541,146	$	628,848	$	72,856	$	212,911	$	32,610	$	224,346	$	39,068
As of December 31, 2011
Grade:
Pass	$	501,605	$	515,555	$	567,295	$	42,268	$	218,066	$	40,138	$	94,681	$	44,821
Special Mention		26,062		24,483		30,013		5,799		—		—		—		—
Substandard		23,729		64,323		29,487		47,407		6,451		1,332		5,757		1,850
Total	$	551,396	$	604,361	$	626,795	$	95,474	$	224,517	$	41,470	$	100,438	$	46,671

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”).

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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.

Aging of Receivables

	30-59 Days Past Due		60-89 Days Past Due		90 Days Past Due		Total Past Due		Current		Total Financing Receivables		Loans 90 Days Past Due and Accruing
As of September 30, 2012
Commercial:
Commercial & industrial	$	927	$	659	$	5,709	$	7,295	$	551,916	$	559,211	$	—
CRE owner occupied		2,455		—		21,620		24,075		517,071		541,146		—
CRE non-owner occupied				—		7,054		9,866		618,982		628,848		—
Land and development		—		1,926		19,030		19,030		53,826		72,856		—
Consumer:
Home equity lines of credit		2,830		583		1,949		5,362		207,549		212,911		—
Home equity term loans		1,009		444		933		2,386		30,224		32,610		—
Residential real estate		2,839		464		4,623		7,926		216,420		224,346		—
Other		837		155		894		1,886		37,182		39,068		—
Total	$	11,783	$	4,231	$	61,812	$	77,826	$	2,233,170	$	2,310,996	$	—
As of December 31, 2011
Commercial:
Commercial & industrial	$	1,024	$	4,600	$	6,407	$	12,031	$	539,365	$	551,396	$	—
CRE owner occupied		6,408		1,176		35,003		42,587		561,774		604,361		—
CRE non-owner occupied		2,187		4,981		8,398		15,566		611,229		626,795		—
Land and development		371		—		32,088		32,459		63,015		95,474		—
Consumer:
Home equity lines of credit		2,001		1,016		3,182		6,199		218,318		224,517		138
Home equity term loans		687		145		1,200		2,032		39,438		41,470		—
Residential real estate		3 ,324		565		2,307		6,196		94,242		100,438		—
Other		891		227		902		2,020		44,651		46,671		16
Total	$	16,893	$	12,710	$	89,487	$	119,090	$	2,172,032	$	2,291,122	$	154

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(6) Real Estate Owned

Real estate owned at September 30, 2012 and December 31, 2011 was as follows:

	September 30, 2012		December 31, 2011
Commercial properties	$	2,625	$	1,777
Residential properties		808		1,683
Bank properties		2,080		1,560
Total	$	5,513	$	5,020

Summary of Real Estate Owned Activity

	Commercial Properties			Residential Properties			Bank Properties			Total
Beginning balance, January 1, 2012	$	1,777		$	1,683		$	1,560		$	5,020
Transfers from loans		2,462			315			—			2,777
Transfers from fixed assets		—			—			1,365			1,365
Sale of real estate owned		(1,182	)		(1,085	)		(797	)		(3,064	)
Write down of real estate owned		(432	)		(105	)		(48	)		(585	)
Ending balance, September 30, 2012	$	2,625		$	808		$	2,080		$	5,513

(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, 2012 and December 31, 2011.

The following tables provide information pertaining to interest rate swaps designated as fair value hedges under FASB ASC 815 at September 30, 2012 and December 31, 2011:

Summary of Interest Rate Swaps Designated As Fair Value Hedges

	September 30, 2012					December 31, 2011
Balance Sheet Location	Notional		Fair Value			Notional		Fair Value
Other liabilities	$	31,002	$	(3,833	)	$	33,663	$	(4,489	)

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Summary of Interest Rate Swap Components

	September 30, 2012			December 31, 2011
Weighted average pay rate		6.85	%		6.83	%
Weighted average receive rate		2.23	%		2.27	%
Weighted average maturity in years		2.8			3.4

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 $51 thousand and $12.3 million in fair value adjustment charges during the nine months ended September 30, 2012 and 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.

	September 30, 2012					December 31, 2011
Balance Sheet Location	Notional		Fair Value			Notional		Fair Value
Other assets	$	370,766	$	45,383		$	400,311	$	50,355
Other liabilities		370,766		(45,541	)		400,311		(50,462	)

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 $16.1 million and $16.6 million at September 30, 2012 and December 31, 2011, respectively.

Interest rate lock commitments on residential mortgages.As a part of its normal residential mortgage operations, the Company will enter into an interest rate lock commitment with a potential borrower. The Company enters into a corresponding commitment to an investor to sell that loan at a specific price shortly after origination. In accordance with FASB ASC 820, adjustments are recorded through earnings to account for the net change in fair value of these transactions. The Company recognized $630 thousand and $0 in fair value adjustments during the nine months ended September 30, 2012 and 2011, respectively, which were included in the unaudited condensed consolidated statements of operations as an increase to other income. The interest rate lock commitment had a notional amount of $192.7 million as of September 30, 2012.

(8) Deposits

Deposits consist of the following major classifications:

	September 30, 2012		December 31, 2011
Interest-bearing demand deposits	$	1,229,746	$	1,244,590
Non-interest-bearing demand deposits		498,439		527,796
Savings deposits		265,152		262,044
Time certificates under $100,000		331,595		376,369
Time certificates $100,000 or more		247,423		177,747
Brokered time deposits		74,452		79,431
Total	$	2,646,807	$	2,667,977

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(9) Earnings (Loss) Per Share

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

Earnings (Loss) Per Share Computation

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2012		2011		2012			2011
Net income (loss)	$	1,228	$	2,680	$	(25,535	)	$	(65,986	)
Average common shares outstanding		86,001,929		84,429,644		85,888,236			73,643,303
Net effect of dilutive common stock equivalents		45,726		108,805		—			—
Adjusted average shares outstanding - dilutive		86,047,655		84,538,449		85,888,236			73,643,303
Basic earnings (loss) per share	$	0.01	$	0.03	$	(0.30	)	$	(0.90	)
Diluted earnings (loss) per share	$	0.01	$	0.03	$	(0.30	)	$	(0.90	)

(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 $38.7 million and $51.9 million at September 30, 2012 and December 31, 2011, respectively) which are not reflected in the accompanying unaudited condensed consolidated financial statements. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In the judgment of management, the financial condition of the Company will not be affected materially by the final outcome of any letters of credit.

Reserve for Unfunded Commitments

The Company maintains a reserve for unfunded loan commitments and letters of credit which is reported in other liabilities in the unaudited condensed consolidated statements of financial condition consistent with FASB ASC 825,Financial Instruments. As of September 30, 2012, 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, 2012 and December 31, 2011 was $405 thousand and $381 thousand, respectively. Management believes this reserve level is sufficient to absorb estimated probable losses related to these commitments.

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(11) Fair Value of Financial Instruments

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

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

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

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

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

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

			Category Used for Fair Value Measurement
September 30, 2012	Total		Level 1		Level 2		Level 3
Assets:
Investment securities available for sale:
U.S. Treasury securities	$	12,029	$	12,029	$	—	$	—
U.S. Government agency securities		4,981		—		4,981		—
U.S. Government agency mortgage-backed securities		418,147		—		418,147		—
Other mortgage-backed securities		284		—		284		—
State and municipal securities		40,695		—		40,695		—
Trust preferred securities		5,601		—		—		5,601
Corporate bonds		25,363		—		25,363		—
Other securities		1,073		1,073		—		—
Loans held-for-sale		60,676		—		60,676		—
Interest rate lock commitments on residential mortgages		630		—		—		630
Interest rate swaps		45,383		—		45,383		—
Interest rate floor		313		—		313		—
Liabilities:
Fair value interest rate swaps		3,833		—		3,833		—
Interest rate swaps		45,541		—		45,541		—
Interest rate floor		313		—		313		—
December 31, 2011
Assets:
Investment securities available for sale:
U.S. Treasury securities	$	12,079	$	12,079	$	—	$	—
U.S. Government agency mortgage-backed securities		428,904		—		428,904		—
Other mortgage-backed securities		296		—		296		—
State and municipal obligations		48,785		—		48,785		—
Trust preferred securities		4,908		—		—		4,908
Corporate bonds		19,408		—		19,408		—
Other securities		1,165		665		500		—
Interest rate swaps		50,355		—		50,355		—
Interest rate floor		360		—		360		—
Liabilities:
Fair value interest rate swaps		4,489		—		4,489		—
Interest rate swaps		50,462		—		50,462		—
Interest rate floor		360		—		360		—

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Level 1 Valuation Techniques and Inputs

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

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

Level 2 Valuation Techniques and Inputs

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

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

U.S. Government agency securities. The Company’s U.S. agency securities consist of a fixed rate agency callable security.

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.

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.

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Loans held-for-sale. Effective July 1, 2012, the Company’s residential mortgage loans held-for-sale were recorded at fair value utilizing Level 2 measurements. This fair value measurement is determined based upon third party quotes obtained on similar loans. The Company adopted the fair value option on these loans which allows the Company to record the mortgage loans held-for-sale portfolio at fair market value as opposed to the lower of cost or market. The Company economically hedges its residential loans held for sale portfolio with forward sale agreements which are reported at fair value. A lower of cost or market accounting treatment would not allow the Company to record the excess of the fair market value over book value but would require the Company to record the corresponding reduction in value on the hedges. Both the loans and related hedges are carried at fair value which reduces earnings volatility as the amounts more closely offset, particularly in environments when interest rates are declining. For loans held-for-sale for which the fair value option has been elected, the aggregate fair value exceeded the aggregate principal balance by $1.5 million, as of September 30, 2012 of the loans held for sale for which the fair value option has been elected, no loans are 90 days or more past due or in nonaccrual status as of September 30, 2012.

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

Level 3 Valuation Techniques and Inputs

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

The cash flow model for the pooled issue owned by the Company at September 30, 2012 assumes no recovery on defaulted collateral, no recovery on securities in deferral and an additional 3.6% future default rate assumption on the remaining performing collateral every three years with no recovery rate.

For trust preferred securities, projected cash flows are discounted at a rate based on a trading group of similar securities quoted on the New York Stock Exchange (“NYSE”) or over-the-counter markets which is reviewed for market data points such as credit rating, maturity, price and liquidity. The Company indexes the securities to a comparable maturity interest rate swap to determine the market spread, which is then used as the discount rate in the cash flow models. As of the reporting date, the market spreads were 6.0% and 11.0%, respectively, for the two trust preferred securities. The 11.0% discount rate is reflective of the single issuer that is currently deferring interest payments.

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,
	2012		2011			2012		2011
Balance, beginning of period	$	5,231	$	6,427		$	4,908	$	5,642
Total gains, realized/unrealized:
Included in earnings(1)		—		—			—		(250	)
Included in accumulated other comprehensive income		370		(1,869	)		693		(834	)
Purchases		—		—			—		—
Maturities		—		—			—		—
Prepayments		—		—			—		—
Calls		—		—			—		—
Transfers into Level 3		—		—			—		—
Balance, end of period	$	5,601	$	4,558		$	5,601	$	4,558

(1) Amount included in net impairment losses on available for sale securities of the unaudited condensed consolidated statements of operations.

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Interest rate lock commitments on residential mortgages.The determination of the fair value of interest rate lock commitments is based on agreed upon pricing with the respective investor on each loan and includes a pull through percentage. The pull through percentage represents an estimate of loans in the pipeline to be delivered to an investor versus the total loans committed for delivery. Significant changes in this input could result in a significantly higher or lower fair value measurement. As the pull through percentage is a significant unobservable input, this is deemed a Level 3 valuation input. The pull through percentage, which is based upon historical experience, was 70% at September 30, 2012.

The fair value of interest rate lock commitments was $630 thousand at September 30, 2012.

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, 2012 and 2011, these assets were valued in accordance with GAAP and, except for impaired loans and real estate owned included in the following table, did not require fair value disclosure under the provisions of FASB ASC 820.

			Category Used for Fair Value Measurement						Total Losses Or Changes in Net Assets
	Total		Level 1		Level 2		Level 3
September 30, 2012
Assets:
Impaired loans	$	103,185	$	—	$	—	$	103,185	$	(25,153	)
Real estate owned		1,311		—		—		1,311		(585	)
September 30, 2011
Assets:
Impaired loans	$	76,019	$	—	$	—	$	76,019	$	(39,007	)
Real estate owned		2,272		—		—		2,272		(667	)

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 20% 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. Increases to the discount assumption could potentially have a significant impact on the fair value of the impaired loans.

The following table summarizes the Company’s appraisal approach based upon loan category.

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

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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 determination of the value of the collateral under review. 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 determination of the value of the collateral under review. 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 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. This typically occurs when a loan is delinquent 90 days, but can be sooner depending upon any other circumstances known to the Bank which would suggest that performance issues exist. 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 and appraisal discount.

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 $5.6 million and $63.9 million at September 30, 2012 and 2011, respectively. The collateral underlying these loans had a fair value of $2.3 million and $43.5 million, including a specific reserve in the allowance for loan losses of $3.3 million and $20.5 million at September 30, 2012 and 2011, respectively. There were charge-offs of $475 thousand and $6.6 million for impaired loans with specific reserves during the nine months ended September 30, 2012 and 2011, respectively. No specific reserve was calculated for impaired loans with an aggregate carrying amount of $100.8 million and $32.5 million at September 30, 2012 and 2011, respectively, as the underlying collateral was not below the carrying amount; however, these loans did include charge-offs of $21.4 million and $12.0 million during the nine months ended September 30, 2012 and 2011, 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, 2012, the Company recorded a decrease in fair value of $432 thousand on five commercial properties, $105 thousand on three residential properties, and $48 thousand on three bank properties. These adjustments were based upon unobservable inputs, and therefore categorized as Level 3 measurements.

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There were no transfers between the three categories of the fair value hierarchy during the nine months ended September 30, 2012 or 2011. The Company evaluates its hierarchy on a quarterly basis to ensure proper classification.

Carrying Amounts and Estimated Fair Values of Financial Assets and Liabilities

	September 30, 2012				December 31, 2011
	Carrying Amount		Estimated  Fair Value		Carrying Amount		Estimated Fair  Value
Assets:
Cash and due from banks	$	75,555	$	75,555	$	68,773	$	68,773
Interest-earning bank balances		8,299		8,299		51,049		51,049
Investment securities available for sale		508,173		508,173		515,545		515,545
Investment securities held to maturity		821		884		1,344		1,413
Loans receivable, net		2,230,979		2,111,772		2,215,785		2,031,013
Loans held-for-sale		60,676		60,676		23,192		23,287
Hedged commercial loans(1)		31,001		34,830		33,670		38,148
Restricted equity investments		18,040		18,040		15,826		15,826
Interest rate lock commitments on residential mortgages		630		630		—		—
Interest rate swaps		45,383		45,383		50,355		50,355
Interest rate floor		313		313		360		360
Liabilities:
Demand deposits		1,728,185		1,752,179		1,772,386		1,797,554
Savings deposits		265,152		267,642		262,044		264,469
Time deposits		653,470		651,026		633,547		638,036
Securities sold under agreements to repurchase – customers		3,587		3,587		5,668		5,668
Advances from FHLBNY		16,749		17,629		2,733		3,017
Securities sold under agreements to repurchase – FHLBNY		20,000		20,003		15,000		15,382
Junior subordinated debentures		92,786		56,905		92,786		46,973
Fair value interest rate swaps		3,833		3,833		4,489		4,489
Interest rate swaps		45,541		45,541		50,462		50,462
Interest rate floor		313		313		360		360

(1) Includes positive market value adjustment of $3.8 million and $4.5 million at September 30, 2012 and December 31, 2011, respectively, which is equal to the change in value of related interest rate swaps designated as fair value hedges of these hedged loans in accordance with FASB ASC 815.

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

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

Loans receivable.The fair value of loans receivable is estimated using discounted cash flow analysis. Projected future cash flows are calculated using loan characteristics, and assumptions of voluntary and involuntary prepayment speeds. For performing loans, Level 2 inputs are utilized as the cash flow analysis is performed using available market data on the performance of similar loans. For non-performing loans, the cash flow assumptions are considered Level 3 inputs as market data is not readily available. 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. At September 30, 2012, these loans were recorded at fair value as the Company elected the fair value option under FASB ASC 825, effective July 1, 2012. At December 31, 2011, loans held-for-sale were recorded at the lower of amortized cost or fair value. The fair value of loans held-for-sale is valued using the quoted market price of such loans, which is a Level 2 input.

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

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

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

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

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

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

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

The fair value estimates presented herein are based on pertinent information available to management as of September 30, 2012 and December 31, 2011. 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, 2012. 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, 2012 and December 31, 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

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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. Effective October 18, 2012, the OCC approved an increase of this limit to 6.0%. As of September 30, 2012, the Bank’s brokered deposits represented 2.6% 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.

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, 2012
Total capital (to risk-weighted assets):
Sun Bancorp, Inc.	$	363,689		14.58	%	$	199,586		8.00	%			N/A
Sun National Bank		345,590		13.88			199,249		8.00		$	249,056		10.00	%
Tier I capital (to risk-weighted assets):
Sun Bancorp, Inc.		324,441		13.00			99,793		4.00				N/A
Sun National Bank		314,223		12.62			99,622		4.00			149,434		6.00
Leverage ratio:
Sun Bancorp, Inc.		324,441		10.44			124,291		4.00				N/A
Sun National Bank		314,223		10.11			124,291		4.00			155,364		5.00
December 31, 2011
Total capital (to risk-weighted assets):
Sun Bancorp, Inc.	$	385,034		15.22	%	$	202,415		8.00	%			N/A
Sun National Bank		338,240		13.39			202,120		8.00		$	252,650		10.00	%
Tier I capital (to risk-weighted assets):
Sun Bancorp, Inc.		353,283		13.96			101,208		4.00				N/A
Sun National Bank		306,534		12.13			101,060		4.00			151,590		6.00
Leverage ratio:
Sun Bancorp, Inc.		353,283		11.09			127,381		4.00				N/A
Sun National Bank		306,534		9.64			127,240		4.00			159,050		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 thousand.

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

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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, 2012, the Company’s prepaid assessment balance was $3.6 million, with $2.9 million being recognized in expense during the nine months ended September 30, 2012.

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 Bank would not be able to pay a dividend to the Company at September 30, 2012. Moreover, 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.

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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;

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• 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 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.

Some of these and other factors are discussed in the Company’s December 31, 2011 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.

NON-GAAP FINANCIAL MEASURES

This Quarterly Report on Form 10-Q of the Company contains financial information by methods other than in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”). Management uses these “non-GAAP” measures in their analysis of the Company’s performance. Management believes that these non-GAAP financial measures provide a greater understanding of ongoing operations and enhance comparability of results with prior periods as well as demonstrate the effects of significant gains and charges in the current period. The

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Company believes that a meaningful analysis of its financial performance requires an understanding of the factors underlying that performance. These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Management uses these measures to evaluate the underlying performance and efficiency of operations. Management believes these measures reflect core trends of the business. This Quarterly Report on Form 10-Q references tax-equivalent interest income. Tax-equivalent interest income is a non-GAAP financial measure. Tax-equivalent interest income assumes a 35% marginal federal tax rate for all periods. The fully taxable equivalent adjustments for the three months ended September 30, 2012 and September 30, 2011 were $212 thousand and $292 thousand, respectively. The fully taxable equivalent adjustments for the nine months ended September 30, 2012 and September 30, 2011 were $661 thousand and $1.1 million, respectively.

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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 the allowance for loan losses, goodwill, intangible assets, income taxes, stock-based compensation and the fair value of financial instruments. Management bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances. These form the basis for making judgments on the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Allowance for Loan Losses. Through 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 provisions for loan losses will not be required in future periods. Accordingly, the current state of the national economy and local economies of the areas in which the loans are concentrated and their slow recovery from a severe recession could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss allowances in future periods. In addition, the Company’s determination as to the amount of its allowance for loan losses is subject to review by the Bank’s primary regulator, the 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 Codification^TM (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 an entity to disclose inputs and valuation techniques, and changes therein, used to measure fair value. FASB ASC 820 addresses the valuation techniques used to measure fair value. These valuation techniques include the market approach, income approach and cost approach. The market approach uses price or relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach involves converting future amounts to a single present value. The measurement is valued based on current market expectations about those future amounts. The cost approach is based on the amount that currently would be required to replace the service capacity of the asset.

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

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

• Level 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 the value of which are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

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

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

Derivative financial instruments. The Company’s derivative financial instruments are not exchange-traded and therefore are valued utilizing models that use as their basis readily observable market parameters, specifically the 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 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 does not intend to perform the step zero impairment assessment option as described in FASB ASU 2011-08, but will continue to use the two-step goodwill impairment test annually at December 31, unless circumstances indicate that a test is required at an earlier date.

Recent Accounting Principles.

In September 2011, the FASB issued 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; retroactive application of this guidance is permitted. The Company does not intend to apply this guidance allowing the Company to make a qualitative evaluation about the likelihood of goodwill impairment, but will continue to apply the two-step goodwill impairment test annually.

In December 2011, the FASB issued Accounting Standards Update (“ASU”) 2011-11,Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.This amendment results in common offsetting requirements and disclosure requirements in GAAP and IFRS. This guidance is not intended to change, but enhance, the application requirements in Topic 210. This guidance is effective for public entities during interim and annual periods beginning after January 1, 2013. This guidance amends only the disclosure requirements and not the application of the accounting standard. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial condition.

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In July 2012, the FASB issued Accounting Standards Update (“ASU”) 2012-02,Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This amendment provides an entity with the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. This amendment is effective for public entities for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial condition.

Market Overview

The economic recovery continued at a moderate pace into the third quarter of 2012. Interest rates remain near historical lows. While employment growth has been slow, the unemployment rate in the U.S. decreased to 7.9% in October 2012 from 8.5% in December 2011. According to recently released estimates, the U.S. gross domestic product for the third quarter of 2012 increased at an annual rate of 2.0% as compared to 1.5% growth in the second quarter of 2012. This growth was the result of increased consumer and government spending as well as improved spending on homebuilding and renovations. The housing sector has displayed some signs of improvement and inflation is expected to remain at or below 2%. Despite the recent signs of improvement, several downside risk factors exist for the economic environment, such as the debt crisis in Europe and the slowing growth in China as well as possible tax increases and government spending cuts coincident with the looming U.S. federal budget deadline.

At the state level, according to the latest South Jersey Business Survey produced by the Federal Reserve Bank of Philadelphia, steady business activity was reported, while little growth exists. Some pickup is anticipated in employment and companies are optimistic about growth opportunities over the next six months, but significant uncertainty still remains. In Northern New Jersey, business activity Is expected to continue to increase at a slow pace. Overall, New Jersey’s unemployment rate remains one of the highest in the U.S at 9.8% as of September 2012.

In September, the Federal Reserve announced its next round of quantitative easing (QE3) through which they would purchase $40 billion per month of additional agency mortgage-backed securities. There was no specified end date for this action. The Fed will also continue to extend the average maturity of its holdings of treasuries through the end of 2012. These actions should ensure that interest rates remain at record lows for the near future. At its latest meeting in October 2012, 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. Based upon low rates of resource utilization and a subdued outlook for inflation, the Open Market Committee expects to maintain the exceptionally low levels of its current target range through at least mid-2015.

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 six months ended September 30, 2012.

Impact of Hurricane Sandy

In late October 2012, many parts of New Jersey were devastated by the impact of Hurricane Sandy. The Company is currently evaluating the impact on its own customers and its business operations. Due to the recent occurrence of this event, the Company is unable to establish reasonably accurate estimates of damages and/or uninsured losses associated with the hurricane and it may take significant time to establish these estimates.

Financial Condition

Total assets were $3.18 billion at September 30, 2012 as and December 31, 2011. Loans receivable, net of allowance for loan losses, increased $12.5 million to $2.26 billion at September 30, 2012 as compared to $2.25 billion at December 31, 2011. Loans held-for-sale increased $37.5 million, or 161.6%. Total investments decreased $5.7 million, or 1.1%. Cash and cash equivalents decreased by $36.0 million, or 30.0% as excess cash balances were utilized to fund loan originations.

Total liabilities increased $18.2 million, or 0.6%, to $2.89 billion at September 30, 2012 compared to $2.87 billion at December 31, 2011. Stockholders’ equity was $287.5 million at September 30, 2012 as compared to $309.1 million at December 31, 2011, with the decrease primarily as a result of the net loss of $25.5 million for the nine months ended September 30, 2012.

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Loans receivable, net of allowance for loan losses, increased $12.5 million to $2.26 billion at September 30, 2012 as compared to $2.25 billion at December 31, 2011. This increase was primarily the result of growth in the residential mortgage portfolio as of September 30, 2012.

Total non-performing loans increased $13.6 million to $120.8 million at September 30, 2012 from December 31, 2011, This increase was primarily due to the transfer of two credit relationships in the aggregate amount of $24 million into non-performing status at September 30, 2012; partially offset by $6.9 million in net paydowns out of the category. Total non-accruing troubled debt restructurings (“TDRs”) at September 30, 2012 were $25.5 million.

As of September 30, 2012, the Company had $18.3 million outstanding on 14 residential construction, commercial construction and land development relationships which agreements included interest reserves. As of December 31, 2011, the Company had $31.4 million outstanding on 18 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 $1.3 million and $956 thousand at September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012, the Company had four residential construction relationships with aggregate interest reserves of $2.3 million on non-accrual status and two commercial construction relationships with interest reserves of $446 thousand on non-accrual status. As of December 31, 2011, the Company had six residential construction relationships with interest reserves of $2.4 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 the time the loan is underwritten 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 completed. As it relates to construction project financing, the Company does not extend, renew or restructure terms unless its borrower posts cash collateral in an interest reserve.

Table 1 provides detail regarding the Company’s non-performing assets and TDRs at September 30, 2012 and December 31, 2011.

Table 1: Summary of Non-performing Assets and TDRs

	September 30, 2012		December 31, 2011
Non-performing assets:
Non-accrual loans	$	95,383	$	89,656
Troubled debt restructuring, non-accruing		25,463		17,875
Loans past due 90 days and accruing		21		154
Real estate owned		5,513		5,020
Total non-performing assets		126,371		112,705

The Company’s allowance for losses on loans increased to $49.0 million, or 2.12% of gross loans receivable, at September 30, 2012 from $41.7 million, or 1.82% of gross loans receivable, at December 31, 2011. The provision for loan losses was $33.1 million for the nine months ended September 30, 2012 compared to $67.4 million for the same period in 2011. The increase in reserve balances is due primarily to deterioration in appraisal values of certain commercial land loans in the first quarter as well as the extension of the credit resolution process as compared to previous expectations. 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 nine months ended September 30, 2012 were $25.7 million, or 1.11% of average loans outstanding.

Real estate owned increased $493 thousand to $5.5 million at September 30, 2012 as compared to $5.0 million at December 31, 2011. During the nine months ended September 30, 2012, the Company transferred ten commercial properties in the aggregate amount of $2.5 million and four residential properties totaling $315 thousand from loans into real estate owned. During the nine months ended September 30, 2012, the Company recorded $432 thousand of write-downs of real estate owned related to five commercial properties. There were five commercial properties with a total carrying amount of $1.2 million sold for a net loss of $221 thousand, five residential properties with a total carrying amount of $1.1 million sold resulting in a net loss of $51 thousand and two bank properties with a total carrying amount of $797 thousand sold for a gain of $122 thousand during the nine months ended September 30, 2012. At September 30, 2012, the Company had 23 properties in the real estate owned portfolio, six of which are former bank branches.

The net deferred tax liability increased $1.5 million from $432 thousand at December 31, 2011 to $1.9 million at September 30, 2012 due to an increase in the unrealized gains on investment securities. The Company maintains a valuation allowance of $102.9 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.

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Investment securities available for sale decreased $7.4 million, or 1.4%, from $515.5 million at December 31, 2011 to $508.1 million at September 30, 2012 due primarily to sales and maturities during the nine month period. Investment securities held to maturity decreased $523 thousand, or 38.9%, from $1.3 million at December 31, 2011 to $821 thousand at September 30, 2012. 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 slightly asset sensitive risk profile with a bias towards an increasing rate environment.

Other assets decreased $7.4 million, or 10.5%, to $62.7 million at September 30, 2012 from $70.0 million at December 31, 2011. This decrease was primarily the result of $4.9 million in downward market value adjustments on swap transactions recorded during the nine months ended September 30, 2012 and a $2.9 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. These decreases were partially offset by an increase of $630 thousand in interest rate lock commitment derivatives on residential mortgages.

Total borrowings, excluding debentures held by the trusts totaled $78.0 million and $31.3 million at September 30, 2012 and December 31, 2011, respectively. This increase of $46.8 million was due primarily to a $30.0 million increase in federal funds purchased and a $14.0 million increase in FHLB advances. The Company increased its borrowings in order to fund the loan growth experienced during the year.

Other liabilities decreased $9.1 million, or 11.1%, to $73.2 million at September 30, 2012 from $82.4 million at December 31, 2011. This decrease was primarily due to a reduction of $6.5 million relating to normal cash settlements with the Federal Reserve as well as a decrease of $5.6 million in market value adjustments on swap transactions from December 31, 2011. These decreases were partially offset by a $1.4 million increase in compensation accruals due to significantly increased mortgage production and a $1.6 million increase in general accruals due to the timing of payments over the same period.

Stockholders’ equity decreased $21.6 million, or 7.0%, to $287.5 million at September 30, 2012 from $309.1 million at December 31, 2011. This decrease was primarily a result of $25.5 million of losses the Company experienced during the nine months ended September 30, 2012.

Comparison of Operating Results for the Three Months Ended September 30, 2012 and 2011

Overview. The Company’s net income available to shareholders for the three months ended September 30, 2012 was $1.2 million, or $0.01 per common share, compared to net income of $2.7 million, or $0.03 per common share, for the same period in 2011.

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 $1.9 million to $24.5 million for the three months ended September 30, 2012, from $26.5 million for the same period in 2011.

Tax equivalent interest income decreased $3.1 million, or 9.8%, from $31.8 million for the three months ended September 30, 2011, to $28.7 million for the three months ended September 30, 2012. This decrease was primarily rate driven as the yield on loans decreased by 43 basis points to 4.42% for the quarter ended September 30, 2012 as compared to 4.85% in the comparable prior year period. In addition, the yield on investment securities decreased 61 basis points to 2.27% for the three months ended September 30, 2012 from 2.88% for the comparable prior year period due to changes in the interest rate environment.

Interest expense decreased $1.2 million, or 22.4%, for the three months ended September 30, 2012, as compared to the same period in 2011. Average interest-bearing deposit accounts decreased $50.9 million, or 2.3% from the quarter ended September 30, 2011 and the cost of interest-bearing deposits decreased 18 basis points. These decreases occurred as the Company aggressively lowered interest rates on deposits in 2011 and into early 2012.

The interest rate margin and net interest spread for the three months ended September 30, 2012 were 3.41% and 3.26%, respectively, compared to 3.61% and 3.41%, respectively, for the same period in 2011.

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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, 2012 and 2011. Average balances are derived from daily balances.

Table 2: Average Balance Sheets

SUN BANCORP, INC. AND SUBSIDIARIES

AVERAGE BALANCE SHEETS (Unaudited)

(Dollars in thousands)

	For the Three Months Ended September 30,
	2012							2011
	Average		Income/		Yield/			Average		Income/		Yield/
	Balance		Expense		Cost			Balance		Expense		Cost
Interest-earning assets:
Loans receivable(1),(2):
Commercial and industrial	$	1,805,623	$	20,139		4.46	%	$	1,901,394	$	23,028		4.84	%
Home equity		215,542		2,141		3.97			232,458		2,418		4.16
Second mortgage		35,816		518		5.79			47,844		698		5.84
Residential real estate		230,259		2,257		3.92			89,010		1,161		5.22
Other		33,658		576		6.85			49,361		844		6.84
Total loans receivable		2,320,898		25,631		4.42			2,320,067		28,149		4.85
Investment securities(3)		534,842		3,038		2.27			498,329		3,582		2.88
Interest-earning bank balances		21,004		12		0.23			118,350		71		0.24
Total interest-earning assets		2,876,744		28,681		3.99			2,936,746		31,802		4.33
Non-interest earning assets:
Cash and due from banks		75,627							72,744
Bank properties and equipment, net		52,127							55,461
Goodwill and intangible assets, net		42,826							46,511
Other assets		106,344							123,089
Total non-interest-earning assets		276,924							297,805
Total assets	$	3,153,668						$	3,234,551
Interest-bearing liabilities:
Interest-bearing deposit accounts:
Interest-bearing demand deposits	$	1,218,338	$	1,195		0.39	%	$	1,286,426	$	1,589		0.49	%
Savings deposits		264,112		225		0.34			270,196		321		0.48
Time deposits		654,662		1,859		1.14			631,415		2,388		1.51
Total interest-bearing deposit accounts		2,137,112		3,279		0.61			2,188,037		4,298		0.79
Short-term borrowings:
Federal funds purchased		6,467		4		0.25			—		—		—
FHLBNY advances		20,000		22		0.44			—		—		—
Securities sold under agreements to repurchase - customers		4,925		2		0.16			6,952		1		0.06
Long-term borrowings:
FHLBNY advances(4)		10,181		103		4.71			18,162		223		4.91
Obligations under capital lease		7,706		128		6.64			8,019		132		6.63
Junior subordinated debentures		92,786		597		2.57			92,786		675		2.91
Total borrowings		142,065		856		2.46			125,859		1,031		3.28
Total interest-bearing liabilities		2,279,177		4,135		0.73			2,313,896		5,329		0.92
Non-interest bearing liabilities:
Non-interest-bearing demand deposits		504,936							528,505
Other liabilities		80,426							84,125
Total non-interest bearing liabilities		585,362							612,630
Total liabilities		2,864,539							2.926,526
Shareholders’ equity		289,129							308,025
Total liabilities and shareholders’ equity	$	3,153,668						$	3,234,551
Net interest income			$	24,546						$	26,473
Interest rate spread(5)						3.26	%						3.41	%
Net interest margin(6)						3.41	%						3.61	%
Ratio of average interest-earning assets to average interest-bearing liabilities						126.22	%						126.92	%

(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, 2012 and 2011 were $212 thousand and $292 thousand, respectively.

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

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

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

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Table 3: Rate/Volume⁽¹⁾

	For the Three Months Ended September 30, 2012 vs.  2011
	Increase (Decrease) Due To
	Volume			Rate			Net
Interest income:
Loans receivable:
Commercial and industrial	$	(1,129	)	$	(1,760	)	$	(2,889	)
Home equity lines of credit		(170	)		(107	)		(277	)
Home equity term loan		(174	)		(6	)		(180	)
Residential real estate		1,450			(354	)		1,096
Other		(270	)		1			(269	)
Total loans receivable		(293	)		(2,226	)		(2,519	)
Investment securities		253			(797	)		(544	)
Interest-earning deposits with banks		(56	)		(3	)		(59	)
Total interest-earning assets		(96	)		(3,026	)		(3,122	)
Interest expense:
Interest-bearing deposit accounts:
Interest-bearing demand deposits		(81	)		(313	)		(394	)
Savings deposits		(7	)		(89	)		(96	)
Time deposits		84			(613	)		(529	)
Total interest-bearing deposit accounts		(4	)		(1,015	)		(1,019	)
Short-term borrowings:
Federal funds purchased		4-			—			4-
FHLBNY advances		22-			—			22
Securities sold under agreements to repurchase - customers		1-			—			1-
Long-term borrowings:
FHLBNY advances(2)		(4	)		(116	)		(120	)
Obligations under capital lease		(5	)		(73	)		(78	)
Junior subordinated debentures		(4	)		(1	)		(5	)
Total borrowings		(14	)		(190	)		(176	)
Total interest-bearing liabilities		10			(1,205	)		(1,195	)
Net change in net interest income	$	(106	)	$	(1,821	)	$	(1,927	)

(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 $1.9 million during the three months ended September 30, 2012, as compared to $2.3 million for the same period in 2011. The Company’s total loans receivable before allowance for loan losses, or gross loans receivable, increased $19.9 million, or 0.87%, to $2.31 billion at September 30, 2012 as compared to $2.29 billion at December 31, 2011. In addition, total non-performing loans increased $13.7 million from $107.7 million at December 31, 2011 to $120.8 million at September 30, 2012. The ratio of allowance for loan losses to gross loans receivable was 2.12% at September 30, 2012 as compared to 1.82% at December 31, 2011. Net charge-offs for the three months ended September 30, 2012 were $4.2 million as compared to $5.8 million during the same period in 2011.

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

43

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 $3.8 million to $9.6 million for the three months ended September 30, 2012, as compared to $5.8 million for the same period in 2011. This increase was primarily attributable to an increase of $3.5 million in gain on the sale of loans due to significant growth in the Company’s mortgage operations from the prior year. Of this amount, $1.5 million was due to a mark-to-market adjustment on residential loans held-for-sale.

Non-Interest Expense. Non-interest expense increased $3.9 million to $30.9 million for the three months ended September 30, 2012 as compared to $27.0 million for the same period in 2011. Compared to the prior year period, salaries and employee benefits increased by $2.5 million due to the growth of the mortgage operations and problem loan costs increased by $648 thousand due to protective advances made on one credit relationship.

Comparison of Operating Results for the Nine Months Ended September 30, 2012 and 2011

Overview. The Company recognized a net loss available to shareholders for the nine months ended September 30, 2012 of $25.5 million, or $0.30 per common share, compared to a net loss of $66.0 million, or a loss of $0.90 per common share, for the same period in 2011. During the nine months ended September 30, 2012 and 2011, the Company recorded $33.1 million and $67.4 million of loan loss provisions, respectively.

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

Net interest income, on a tax-equivalent basis, decreased $4.3 million to $74.5 million for the nine months ended September 30, 2012, from $78.9 million for the same period in 2011.

Tax equivalent interest income decreased $9.0 million, or 9.3%, from $96.9 million for the nine months ended September 30, 2011, to $87.9 million for the nine months ended September 30, 2012. This decrease was both volume and rate driven as average interest-earning loans decreased $99.9 million and the yield on loans declined 20 basis points as compared to the quarter ended September 30, 2011. In addition, the yield on investment securities decreased 74 basis points to 2.40% for the nine months ended September 30, 2012 from 3.14% for the comparable prior year period due to changes in the interest rate environment.

Interest expense decreased $4.7 million, or 25.8%, for the nine months ended September 30, 2012, as compared to the same period in 2011. Average interest-bearing deposit accounts decreased $169.9 million, or 7.4% from September 30, 2011 and the cost of interest-bearing deposits decreased 20 basis points. These decreases occurred as the Company aggressively lowered interest rates on deposits in 2011 and into early 2012.

The interest rate spread and net interest margin for the nine months ended September 30, 2012 were 3.31% and 3.47%, respectively, compared to 3.29% and 3.49%, respectively, for the same period in 2011.

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 nine months ended September 30, 2012 and 2011. Average balances are derived from daily balances.

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Table 4: Average Balance Sheets

SUN BANCORP, INC. AND SUBSIDIARIES

AVERAGE BALANCE SHEETS (Unaudited)

(Dollars in thousands)

	For the Nine Months Ended September 30,
	2012							2011
	Average Balance		Income/ Expense		Yield/ Cost			Average Balance		Income/ Expense		Yield/ Cost
Interest-earning assets:
Loans receivable(1),(2):
Commercial and industrial	$	1,823,449	$	62,537		4.57	%	$	1,969,551	$	69,565		4.71	%
Home equity		218,278		6,683		4.08			234,278		7,426		4.23
Second mortgage		38,559		1,658		5.73			50,481		2,207		5.83
Residential real estate		169,989		5,241		4.11			79,885		3,209		5.36
Other		36,707		1,918		6.97			52,656		2,708		6.86
Total loans receivable		2,286,982		78,037		4.55			2,386,851		85,115		4.75
Investment securities(3)		547,968		9,858		2.40			490,397		11,565		3.14
Interest-earning bank balances		25,296		44		0.23			139,297		253		0.24
Total interest-earning assets		2,860,246		87,939		4.10			3,016,545		96,933		4.28
Non-interest earning assets:
Cash and due from banks		73,292							71,980
Bank properties and equipment, net		53,206							54,362
Goodwill and intangible assets, net		43,743							47,424
Other assets		111,242							114,496
Total non-interest-earning assets		281,483							288,262
Total assets	$	3,141,729						$	3,304,807
Interest-bearing liabilities:
Interest-bearing deposit accounts:
Interest-bearing demand deposits	$	1,226,064	$	3,600		0.39	%	$	1,333,259	$	5,589		0.56	%
Savings deposits		263,091		671		0.34			274,280		1,127		0.55
Time deposits		638,259		6,139		1.28			689,738		7,980		1.54
Total interest-bearing deposit accounts		2,127,414		10,410		0.65			2,297,277		14,696		0.85
Short-term borrowings:
Federal funds purchased		7,263		19		0.35			—		—		—
FHLBNY advances		6,715		41		0.81
Securities sold under agreements to repurchase - customers		5,797		6		0.14			6,942		6		0.12
Long-term borrowings:
FHLBNY advances(4)		20,421		526		3.43			18,476		665		4.80
Obligations under capital lease		7,770		386		6.62			8,019		396		6.58
Junior subordinated debentures		92,786		2,023		2.91			92,786		2,302		3.31
Total borrowings		140,752		3,001		2.84			126,223		3,369		3.56
Total interest-bearing liabilities		2,268,166		13,411		0.79			2,423,500		18,065		0.99
Non-interest bearing liabilities:
Non-interest-bearing demand deposits		495,279							500,620
Other liabilities		82,615							85,489
Total non-interest bearing liabilities		577,894							586,109
Total liabilities		2,846,060							3,009,609
Shareholders’ equity		295,669							295,198
Total liabilities and shareholders’ equity	$	3,141,729						$	3,304,807
Net interest income			$	74,528						$	78,868
Interest rate spread(5)						3.31	%						3.29	%
Net interest margin(6)						3.47	%						3.49	%
Ratio of average interest-earning assets to average interest-bearing liabilities						126.10	%						124.47	%

(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, 2012 and 2011 were $661 thousand and $1.1 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: Rate/Volume⁽¹⁾

	For the Nine Months Ended September 30, 2012 vs.  2011
	Increase (Decrease) Due To
	Volume			Rate			Net
Interest income:
Loans receivable:
Commercial and industrial	$	(5,017	)	$	(2,011	)	$	(7,028	)
Home equity lines of credit		(489	)		(254	)		(743	)
Home equity term loan		(512	)		(37	)		(549	)
Residential real estate		2,923			(891	)		2,032
Other		(833	)		43			(790	)
Total loans receivable		(3,928	)		(3,150	)		(7,078	)
Investment securities		1,239			(2,946	)		(1,707	)
Interest-earning deposits with banks		(199	)		(10	)		(209	)
Total interest-earning assets		(2,888	)		(6,106	)		(8,994	)
Interest expense:
Interest-bearing deposit accounts:
Interest-bearing demand deposits		(416	)		(1,573	)		(1,989	)
Savings deposits		(44	)		(412	)		(456	)
Time deposits		(564	)		(1,277	)		(1,841	)
Total interest-bearing deposit accounts		(1,024	)		(3,262	)		(4,286	)
Short-term borrowings:
Federal funds purchased		19			—			19
FHLBNY advances		41			—			41
Securities sold under agreements to repurchase - customers		(1	)		1			—
Long-term borrowings:
FHLBNY advances(2)		65			(204	)		(139	)
Obligations under capital lease		(12	)		2			(10	)
Junior subordinated debentures		1			(280	)		(279	)
Total borrowings		113			(481	)		(368	)
Total interest-bearing liabilities		(911	)		(3,743	)		(4,654	)
Net change in net interest income	$	(1,977	)	$	(2,363	)	$	(4,340	)

(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 $33.1 million during the nine months ended September 30, 2012, as compared to $67.4 million for the same period in 2011. Net charge-offs for the nine months ended September 30, 2012 were $25.7 million as compared to $94.3 million during the same period in 2011.

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 $16.0 million to $22.6 million for the nine months ended September 30, 2012, as compared to $6.7 million for the same period in 2011. The 2011 period had included $12.3 million of downward derivative credit valuation adjustments as compared to $525 thousand in the current period due to the loan sale which occurred in the prior year. Also, gain on sale of loans increased by $4.4 million over the same period due to significant mortgage growth. Of this amount, $1.5 million was due to a mark-to-market adjustment on loans held-for-sale.

Non-Interest Expense. Non-interest expense increased $6.0 million to $89.0 million for the nine months ended September 30, 2012 as compared to $83.0 million for the same period in 2011. There were several offsetting fluctuations that comprised this change. Compared to the prior year period, salaries and employee benefits increased by $7.2 million due primarily to significantly increased mortgage production. Partially offsetting this increase was a reduction of $1.6 million in problem loan costs during the same period.

46

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 attractiveness 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 2011 and into 2012. As a result, the Company continued to experience a decline in core deposits through the first nine months of 2012. Core deposits, which exclude all certificates of deposit, decreased $41.1 million to $1.99 billion, or 75.3% of total deposits at September 30, 2012, as compared to $2.03 billion, or 76.3% of total deposits at December 31, 2011. The Company has additional secured borrowing capacity with the Federal Reserve Bank of approximately $222.8 million, of which none was utilized, and the FHLBNY of approximately $212.8 million, of which $66.7 million was utilized. In addition to secured borrowings, the Company also has unsecured borrowing capacity through lines of credit with other financial institutions of $55.0 million, of which none were utilized as of September 30, 2012. 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, 2012, the Company had a par value of $383.8 million and $197.3 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, 2013 total $455.9 million, or approximately 69.8% 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.

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. Effective October 18, 2012, the OCC approved an increase of this limit to 6.0%. At September 30, 2012, the Bank’s brokered deposits represented 2.6% 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 2012, the Bank met all of the three capital ratios established by the OCC as its Leverage ratio was 10.11%, Tier 1 Capital ratio was 12.62%, and Total Capital ratio was 13.88%.

47

The following table provides both the Company’s and the Bank’s regulatory capital ratios as of September 30, 2012:

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, 2012
Total capital (to risk-weighted assets):
Sun Bancorp, Inc.	$	363,689		14.58	%	$	199,586		8.00	%				N/A
Sun National Bank		345,590		13.88			199,249		8.00		$	249,056			10.00	%
Tier I capital (to risk-weighted assets):
Sun Bancorp, Inc.		324,441		13.00			99,793		4.00					N/A
Sun National Bank		314,223		12.62			99,622		4.00			149,434			6.00
Leverage ratio:
Sun Bancorp, Inc.		324,441		10.44			124,291		4.00					N/A
Sun National Bank		314,223		10.11			124,291		4.00			155,364			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.

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, 2012, $82.1million of a total of $90.0 million in capital securities qualified as Tier 1 with $7.8 million qualifying as Tier 2.

The ability of the Bank to pay dividends to the Company is governed by certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock. In addition, a national bank may not pay any dividends in an amount greater than its undivided profits and a national bank may not declare any dividends if such declaration would leave the bank inadequately capitalized. Therefore, the ability of the Bank to declare dividends will depend on its future net income and capital requirements. Also, banking regulators have indicated that national banks should generally pay dividends only out of current operating earnings. Following this guidance, the Bank would not be able to pay a dividend to the Company at September 30, 2012. Moreover, 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

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September 30, 2012 was $38.7 million and the portion of the exposure not covered by collateral was approximately $579 thousand. We believe that the utilization rate of these letters of credit will continue to be substantially less than the amount of these commitments, as has been our experience to date.

The Company maintains a reserve for unfunded loan commitments and letters of credit, which is reported in other liabilities in the unaudited condensed consolidated statements of financial condition, consistent with FASB ASC 825. As of the balance sheet date, the Company records estimated losses inherent with unfunded loan commitments in accordance with FASB ASC 450,Contingencies,and estimated future obligations under letters of credit in accordance with FASB ASC 460,Guarantees.The methodology used to determine the adequacy of this reserve is integrated in the Company’s process for establishing the allowance for loan losses and considers the probability of future losses and obligations that may be incurred under these off-balance sheet agreements. The reserve for unfunded loan commitments and letters of credit at September 30, 2012 and December 31, 2011 was $405 thousand and $381 thousand, respectively. Management believes this reserve level is sufficient to absorb estimated probable losses related to these commitments.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Asset and Liability Management

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

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

At September 30, 2012, 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 $321.6 million representing a positive one-year gap ratio of 10.11%. All amounts are categorized by their actual maturity or anticipated call or re-pricing date with the exception of interest-bearing demand deposits and savings deposits. Though the rates on interest-bearing demand and savings deposits generally trend with open market rates, they often do not fully adjust to open market rates and frequently adjust with a time lag. As a result of prior experience during periods of rate volatility and management’s estimate of future rate sensitivities, the Company allocates the interest-bearing demand deposits and savings deposits based on an estimated decay rate for those deposits.

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

Net interest income simulation analysis at September 30, 2012 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 5 provides the Company’s estimated earnings sensitivity profile versus the most likely rate forecast as of September 30, 2012. The Company anticipates that strong deposit pricing competition will continue to limit deposit pricing flexibility in an increasing and a decreasing rate environment.

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Table 7: Sensitivity Profile

Change in Interest Rates (Basis Points)	Percentage Change in Net Interest Income Year 1
+200		1.2	%
+100		0.3	%
-100		(1.4	)%
-200		(2.6	)%

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

Item 4. Controls and Procedures

(a)Evaluation of disclosure controls and procedures. Based on their evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)), the Company’s principal executive officer and principal accounting officer have concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q, such disclosure controls and procedures 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, 2012. 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, 2011, previously filed with the Securities and Exchange Commission.
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
	Not applicable
Item 3.	Defaults Upon Senior Securities
	Not applicable
Item 4.	Mine Safety Disclosures.
	Not applicable
Item 5.	Other Information
	Not Applicable

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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 Accounting Officer Pursuant to §302 of the Sarbanes-Oxley Act of 2002.
	Exhibit 32 Certifications of Chief Executive Officer and Chief Accounting 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 8, 2012	/s/ Thomas X. Geisel
	Thomas X. Geisel
	President and Chief Executive Officer
Date: November 8, 2012	/s/ Neil Kalani
	Neil Kalani
	Senior Vice President and
	Chief Accounting Officer

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