Alarion Financial Services 10-Q 2009 Q1 Quarterly report

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2009

OR

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

For the transition period from             to             

Commission file number 000-51843

ALARION FINANCIAL SERVICES, INC.

(Exact Name of Small Business Issuer as Specified in Its Charter)

Florida	20-3851373
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

One Northeast First Avenue, Ocala, Florida	34470
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s Telephone Number, Including Area Code (352) 237-4500

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report.

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:    Yes  x    No  ¨

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

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

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	x

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common stock, par value $.01 per share 2,653,208 shares outstanding at May 13, 2009

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

INDEX

			Page
Part I. FINANCIAL INFORMATION
	Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets - at March 31, 2009 (Unaudited) and at December 31, 2008		2
	Condensed Consolidated Statements of Operations (Unaudited) - Three Months ended March 31, 2009 and 2008		3
	Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) - Three Months ended March 31, 2009 and 2008		4-5
	Condensed Consolidated Statements of Cash Flows (Unaudited) - Three Months ended March 31, 2009 and 2008		6
	Notes to Condensed Consolidated Financial Statements (Unaudited)		7-11
	Review by Independent Registered Public Accounting Firm		12
	Report of Independent Registered Public Accounting Firm		13
	Item 2.	Management’s Discussion and Analysis	14-19
	Item 4T.	Controls and Procedures	20
Part II. OTHER INFORMATION
	Item 1.	Legal Proceedings	20
	Item 1.A.	Risk Factors	20
	Item 2.	Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities	20
	Item 3.	Defaults upon Senior Securities	20
	Item 4.	Submission of Matters to a Vote of Security Holders	20
	Item 5.	Other Information	20
	Item 6.	Exhibits	21
SIGNATURES			22

1

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets

($ in thousands, except per share amounts)

	At March 31, 2009			At December 31, 2008
	(unaudited)
Assets
Cash and due from banks	$	2,899		1,666
Interest-earning time deposits in banks		599		2,097
Interest-earning deposits and federal funds sold		8,955		5,708
Cash and cash equivalents		12,453		9,471
Interest-earning time deposits in banks		21,194		12,410
Securities available for sale		18,720		13,123
Loans, net of allowance for loan losses of $2,457 and $2,714		212,285		205,307
Accrued interest receivable		712		731
Premises and equipment, net		13,561		13,604
Other real estate owned		929		651
Federal Home Loan Bank stock, at cost		1,454		1,356
Deferred income taxes		1,120		1,103
Other assets		974		883
Total assets	$	283,402		258,639
Liabilities and Stockholders’ Equity
Liabilities:
Noninterest-bearing demand deposits		19,136		15,161
NOW, money-market and savings deposits		56,041		43,109
Time deposits < $100,000		98,757		94,547
Time deposits > = $100,000		50,070		50,097
Total deposits		224,004		202,914
Federal Home Loan Bank advances		21,000		22,000
Other borrowings		5,781		7,584
Accrued interest payable		1,082		1,118
Accrued expenses and other liabilities		490		387
Total liabilities		252,357		234,003
Stockholders’ equity:
Preferred stock, $.01 par value; 1,000,000 shares authorized
Preferred stock, series A, $.01 par value; $1,000 liquidation value; 6,514 shares outstanding in 2009		—		—
Preferred stock, series B, $.01 par value; $1,000 liquidation value; 326 shares outstanding in 2009		—		—
Additional paid-in capital, preferred		6,840		—
Preferred stock discount		(313	)	—
Common stock, $.01 par value; 4,000,000 shares authorized, 2,653,208 shares issued and outstanding in 2009 and 2008		27		27
Additional paid-in capital, common		26,647		26,613
Accumulated deficit		(2,289	)	(2,142	)
Accumulated other comprehensive income		133		138
Total stockholders’ equity		31,045		24,636
Total liabilities and stockholders’ equity	$	283,402		258,639

See accompanying Notes to Condensed Consolidated Financial Statements.

2

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations (Unaudited)

($ in thousands, except per share amounts)

	Three Months Ended March 31,
	2009			2008
Interest income:
Loans	$	3,040		2,880
Securities		133		235
Other		139		88
Total interest income		3,312		3,203
Interest expense:
Deposits		1,635		1,726
Borrowings		203		150
Total interest expense		1,838		1,876
Net interest income		1,474		1,327
Provision for loan losses		94		185
Net interest income after provision for loan losses		1,380		1,142
Noninterest income:
Deposit account fees		91		71
Loan brokerage fees		197		216
Other		15		12
Total noninterest income		303		299
Noninterest expense:
Salaries and employee benefits		931		806
Occupancy and equipment		262		184
Data processing		136		104
Professional services		81		40
Advertising and promotion		34		44
Office supplies and printing		30		34
Other		289		228
Total noninterest expense		1,763		1,440
(Loss) earnings before income tax (benefit) expense		(80	)	1
Income tax (benefit) expense		(14	)	8
Net loss		(66	)	(7	)
Preferred stock dividend requirements and accretion of preferred stock to par		81		—
Net loss available to common shareholders	$	(147	)	(7	)
Loss per common share – basic	$	(0.06	)	—
Loss per common share – diluted	$	(0.06	)	—
Weighted-average number of common shares outstanding, basic		2,653,208		2,504,726
Weighted-average number of common shares outstanding, diluted		2,653,208		2,504,726
Dividends per share	$	—		—

See accompanying Notes to Condensed Consolidated Financial Statements.

3

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

Three Months Ended March 31, 2009 and 2008

($ in thousands)

	Preferred Stock								Common Stock				Accumulated Deficit		Accumulated Other Comprehensive Income	Total Stockholders’ Equity
	Series A			Series B			Additional Paid-in Capital	Discount	Shares	Amount		Additional Paid-In Capital
	Shares	Amount		Shares	Amount
Balance at December 31, 2007	—	$	—	—	$	—	—	—	2,183,485	$	22	21,856	(1,657	)	30	20,251
Comprehensive income:
Net loss (unaudited)	—		—	—		—	—	—	—		—	—	(7	)	—	(7	)
Net change in unrealized gain on securities available for sale, net of taxes of $25 (unaudited)	—		—	—		—	—	—	—		—	—	—		42	42
Comprehensive income (unaudited)																35
Common stock options exercised (unaudited)	—		—	—		—	—	—	17,486		—	175	—		—	175
Common stock warrants exercised (unaudited)	—		—	—		—	—	—	452,237		5	4,522	—		—	4,527
Balance at March 31, 2008 (unaudited)	—	$	—	—	$	—	—	—	2,653,208	$	27	26,553	(1,664	)	72	24,988

(continued)

4

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited), Continued

Three Months Ended March 31, 2009 and 2008

($ in thousands)

	Preferred Stock									Common Stock				Accumulated Deficit		Accumulated Other Comprehensive Income		Total Stockholders’ Equity
	Series A			Series B			Additional Paid-in Capital	Discount		Shares	Amount		Additional Paid-In Capital
	Shares	Amount		Shares	Amount
Balance at December 31, 2008	—	$	—	—	$	—	—	—		2,653,208	$	27	26,613	(2,142	)	138		24,636
Comprehensive loss:
Net loss (unaudited)	—		—	—		—	—	—		—		—	—	(66	)	—		(66	)
Net change in unrealized gain on securities available for sale, net of taxes of $(3) (unaudited)	—		—	—		—	—	—		—		—	—	—		(5	)	(5	)
Comprehensive loss (unaudited)																		(71	)
Share-based compensation (unaudited)	—		—	—		—	—	—		—		—	34	—		—		34
Proceeds from issuance of 6,514 shares of Series A preferred stock to U.S. Treasury (unaudited)	6,514		—	—		—	6,514	—		—		—	—	—		—		6,514
Preferred stock warrants exercised by U.S. Treasury (unaudited)	—		—	326		—	326	(326	)	—		—	—	—		—		—
Preferred stock dividend requirements and Series B preferred stock accretion (unaudited)	—		—	—		—	—	13		—		—	—	(81	)	—		(68	)
Balance at March 31, 2009 (unaudited)	6,514	$	—	326	$	—	6,840	(313	)	2,653,208	$	27	26,647	(2,289	)	133		31,045

See accompanying Notes to Condensed Consolidated Financial Statements.

5

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

	Three Months Ended March 31,
	2009			2008
Cash flows from operating activities:
Net loss	$	(66	)	(7	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for loan losses		94		185
Share-based compensation		34		—
Depreciation and amortization		156		92
Deferred income tax (benefit) expense		(14	)	8
Net amortization of deferred loan fees and costs		8		42
Net (decrease) increase in accrued interest payable		(36	)	86
Net decrease in accrued interest receivable		19		179
Net increase in other assets		(91	)	(69	)
Net increase in accrued expenses and other liabilities		103		92
Net cash provided by operating activities		207		608
Cash flows from investing activities:
Proceeds from principal repayments and maturities on securities available for sale		3,706		7,272
Purchase of securities available for sale		(9,311	)	(1,995	)
Net increase in time deposits		(8,784	)	(2,968	)
Loan disbursements, net of repayments		(7,409	)	(16,855	)
Purchase of premises and equipment		(113	)	(1,266	)
Proceeds from sale of other real estate owned		51		—
Purchase of Federal Home Loan Bank stock		(98	)	(385	)
Net cash used in investing activities		(21,958	)	(16,197	)
Cash flows from financing activities:
Net increase in deposits		21,090		9,366
Net decrease in other borrowings		(1,803	)	(988	)
Net (decrease) increase in advances from Federal Home Loan Bank		(1,000	)	6,000
Proceeds from common stock options and warrants exercised		—		4,702
Proceeds from preferred stock issued		6,514		—
Preferred stock dividend requirements and series B stock accretion		(68	)	—
Net cash provided by financing activities		24,733		19,080
Net increase in cash and cash equivalents		2,982		3,491
Cash and cash equivalents at beginning of period		9,471		3,638
Cash and cash equivalents at end of period	$	12,453		7,129
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest, net of capitalized interest of $0 and $48	$	1,874		1,838
Income taxes	$	—		—
Noncash transactions:
Accumulated other comprehensive income, net change in unrealized gain on securities available for sale, net of taxes	$	(5	)	42
Transfer of loans to other real estate owned	$	329

See accompanying Notes to Condensed Consolidated Financial Statements.

6

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Basis of Presentation. In the opinion of the management of Alarion Financial Services, Inc. (the “Holding Company”), the accompanying condensed consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position at March 31, 2009 and the results of operations and cash flows for the three-month periods ended March 31, 2009 and 2008. The results of operations for the three-month period ended March 31, 2009, are not necessarily indicative of results that may be expected for the year ending December 31, 2009.

The Holding Company owns 100% of the common stock of Alarion Bank (the “Bank”) and North Central Florida Developers Corporation (“NCFDC”) (together the “Company”). The Holding Company’s primary activity is the operation of the Bank and NCFDC. The Bank is a state (Florida)-chartered commercial bank. The Bank offers a variety of banking and financial services to individual and corporate customers through its six banking offices located in Ocala and Gainesville, Florida. The deposit accounts of the Bank are insured up to the applicable limits by the Federal Deposit Insurance Corporation. NCFDC holds loans or assets that might require a longer term hold to realize full economic value.

2. Loans. The components of loans are summarized as follows (in thousands):

	At March 31, 2009			At December 31, 2008
Commercial real estate	$	109,024		102,788
Residential real estate and home equity		38,638		36,801
Construction		44,984		45,569
Commercial		18,857		19,635
Consumer		2,928		2,928
Total loans		214,431		207,721
Add/Deduct:    Allowance for loan losses		(2,457	)	(2,714	)
Deferred loan costs, net		311		300
Loans, net	$	212,285		205,307

(continued)

7

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

3. Loan Impairment and Loan Losses.An analysis of the change in the allowance for loan losses follows (in thousands):

	Three Months Ended March 31,
	2009			2008
Balance at January 1	$	2,714		2,046
Provision for loan losses		94		185
Charge-offs		(351	)	—
Balance at March 31	$	2,457		2,231

The following is a summary of information regarding nonaccrual and impaired loans (in thousands):

	At March 31, 2009			At December 31, 2008
Nonaccrual loans	$	878		1,497
Accruing loans past due ninety days or more	$	—		—
Gross impaired loans with no related allowance for losses		545		644
Gross impaired loans with related allowance for losses		1,353		2,964
Less: Allowance on these loans		(586	)	(588	)
Net investment in impaired loans	$	1,312		3,020
	Three Months Ended March 31,
	2009			2008
Interest income recognized on impaired loans	$	—		—
Interest income received on impaired loans	$	—		—
Average net recorded investment in impaired loans	$	1,656		526

4. Loss Per Share.Basic loss per share has been computed on the basis of the weighted-average number of shares of common stock outstanding during the periods, which was 2,653,208 shares and 2,504,726 shares during the three-month periods ended March 31, 2009 and 2008, respectively. All outstanding warrants and stock options are not dilutive due to the net losses of the Company.

(continued)

8

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5. Share Based Compensation. The Company follows the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (R),Share-Based Payment (“SFAS 123 (R)”), using the modified-prospective-transition method. Under the transition method, compensation cost recognized includes: (a) compensation cost for all share-base payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value calculated in accordance with the original provisions of SFAS 123, and (b) compensation cost for all share-based payments granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123 (R). Prior to December 31, 2005, the Company was not considered a public company as defined in SFAS 123 and used the minimum value method to determine stock based compensation. Therefore, the stock options granted in 2005 that vested subsequent to December 31, 2005 are not required to be expensed by the Company upon implementation of SFAS 123(R). The Company recognizes stock-based compensation for all subsequent options granted in salaries and employee benefits in the accompanying consolidated statements of operations on a straight-line basis over the vesting period.

The Company adopted a stock option plan for its employees and directors (the “Plan”). Fifteen percent of the total amount of common shares outstanding, up to 450,000 shares (currently 397,981 shares), have been reserved under the Plan. Stock options are granted at an exercise price equal to or greater than the fair market value of the common stock on the date of grant. Options granted to directors vest immediately and for employees, the options primarily vest over two years starting with the date of grant and ending on the second anniversary thereof. At March 31, 2009, there were 88,128 options available for future grants under the Plan. A summary of stock option transactions under the Plan for the three-month period ended March 31, 2009, follows:

	Number of Options		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term	Aggregate Intrinsic Value
Options outstanding at December 31, 2008	261,970		$	10.14
Options forfeited	(233	)		10.50
Options granted	24,600			10.00
Options outstanding at March 31, 2009	286,337		$	10.14	7.44 years	$	—
Options exercisable at March 31, 2009	232,069		$	10.11	7.28 years	$	—

(continued)

9

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5. Share Based Compensation, Continued. The fair value of each option granted for the three-month period ended March 31, 2009 and 2008 are estimated on the date of the grant using the Black-Scholes option-pricing model with the following assumptions:

	Three Months Ended March 31,
	2009			2008
Risk-free interest rate		1.46	%	4.04	%
Dividend yield		—	%	—	%
Expected stock volatility		10.00	%	6.92	%
Expected life in years		5.50		5.50
Per share grant-date fair value of options issued during the period	$	1.29		2.02

The Company has examined its historical pattern of option exercises in an effort to determine if there were any patterns based on certain employee populations. From this analysis, the Company could not identify any patterns in the exercise of options. As such, the Company used the guidance in Staff Accounting Bulletin No. 107 issued by the Securities and Exchange Commission to determine the estimated life of options. Expected volatility is based on historical volatility of similar size financial institutions. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield assumption is based on the Company’s history and expectation of dividend payments.

There were no options exercised during the three month period ended March 31, 2009. There were 17,486 options exercised during the three month period ended March 31, 2008. There was no intrinsic value or tax benefit related to these options exercised. At March 31, 2009, there was approximately $53,000 of total unrecognized compensation expense related to the nonvested share-based compensation arrangement granted under the plan. The cost is expected to be recognized over a weighted-average period of twenty months. The total fair value of shares vesting and recognized as compensation was approximately $34,000 for the three month period ended March 31, 2009. There was no compensation expense recognized related to share based compensation during the three month period ended March 31, 2008.

(continued)

10

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

6. Fair Value Measurements. Our listing of financial assets subject to fair value measurements on a recurring basis are as follows (in thousands):

			Fair Value Measurements at Reporting Date Using
	Fair Value as of March 31, 2009		Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Available for sale securities	$	18,720	—	18,720	—

Assets measured at fair value on a nonrecurring basis are summarized below (in thousands):

	Net Carrying Value at March 31, 2009					Total Losses	Total Losses Recorded In Operations For the Period Ended March 31, 2009
	Total		Level 1	Level 2	Level 3
Impaired loans	$	767	—	—	767	586	438
Other real estate owned	$	929	—	—	929	—	—

Loans with a carrying value of $545,000 at March 31, 2009 were measured for impairment using Level 3 inputs and had a fair value in excess of carrying value.

7. Subsequent Event. On May 1, 2009, the Office of the Comptroller of Currency closed Silverton Bank, N.A. The FDIC was appointed as the receiver and the bank is now operating as Silverton Bridge Bank, National Association. The Company had previously purchased a total of 200 shares of common stock of Silverton Financial Services, Inc., for a total investment of $625,296. The total investment will be written off during the second quarter of 2009, less any residual value that may be determined.

11

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Review by Independent Registered Public Accounting Firm

Hacker, Johnson & Smith PA, the Company’s independent registered public accounting firm, has made a limited review of the financial data as of March 31, 2009 and for the three-month periods ended March 31, 2009 and 2008 presented in this document, in accordance with standards established by the Public Company Accounting Oversight Board (United States).

Their report furnished pursuant to Article 10 of Regulation S-X is included herein.

12

Report of Independent Registered Public Accounting Firm

Alarion Financial Services, Inc.

Ocala, Florida:

We have reviewed the accompanying condensed consolidated balance sheet of Alarion Financial Services, Inc. and Subsidiaries (the “Company”) as of March 31, 2009, and the related condensed consolidated statements of operations, changes in stockholders’ equity and cash flows for the three-month periods ended March 31, 2009 and 2008. These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2008, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the year then ended (not presented herein); and in our report dated March 23, 2009, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2008, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Hacker, Johnson & Smith PA

HACKER, JOHNSON & SMITH PA

Tampa, Florida

May 13, 2009

13

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

General

Alarion Financial Services, Inc. (the “Holding Company”) owns 100% of the common stock of Alarion Bank (the “Bank”) and North Central Florida Developers Corporation (collectively the “Company”). The Holding Company’s primary activity is the operation of the Bank and North Central Florida Developers Corporation. The Bank is a state (Florida)-chartered commercial bank. The Company offers a variety of banking and financial services to individual and corporate customers through its six banking offices located in Ocala and Gainesville, Florida. North Central Florida Developers Corporation holds loans or assets that might require a longer term hold to realize full economic value.

The Bank’s deposits are insured by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”) up to applicable limits. The Holding Company’s operations are subject to supervision and regulation of the Federal Reserve Board. The operations of the Bank are subject to the supervision and regulation of the FDIC and the Florida Office of Financial Regulation.

The Bank provides a variety of consumer and commercial banking services to individuals, businesses and industries. The basic services offered by the Bank include: demand interest-bearing and noninterest-bearing accounts, money market deposit accounts, NOW accounts, time deposits, credit cards, cash management, direct deposits, notary services, money orders, night depository, travelers’ checks, cashier’s checks, domestic collections, savings bonds, bank drafts, automated teller services, drive-in tellers, and banking by mail. In addition, the Bank makes secured and unsecured commercial, consumer, and real estate loans and issues stand-by letters of credit. The Bank provides automated teller machine (ATM) cards and is a member of the Star ATM network, thereby permitting customers to utilize the convenience of larger ATM networks. In addition to the foregoing services, the offices of the Company provide customers with extended banking hours. The Company does not have trust powers and, accordingly, no trust services are provided.

14

ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

The revenues of the Bank are primarily derived from interest on, and fees received in connection with, real estate and other loans, and from interest and dividends from investment and mortgage-backed securities, and short-term investments. The principal sources of funds for the Bank’s lending activities are its deposits and borrowings, repayment of loans, and the sale and maturity of investment securities. The principal expenses of the Bank are the interest paid on deposits, and operating and general administrative expenses.

As is the case with banking institutions generally, the Company’s operations are materially and significantly influenced by general economic conditions and by related monetary and fiscal policies of financial institution regulatory agencies, including the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the FDIC. Deposit flows and costs of funds are influenced by interest rates on competing investments and general market rates of interest. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn is affected by the interest rates at which such financing may be offered and other factors affecting local demand and availability of funds. The Company faces strong competition in the attraction of deposits (its primary source of lendable funds) and in the origination of loans.

Capital Resources, Commitments and Capital Requirements

The Bank’s principal sources of funds are those generated by the Bank, including net increases in deposits and borrowings, principal and interest payments on loans, and proceeds from maturities of investment securities.

The Bank uses its capital resources principally to fund existing and continuing loan commitments and to purchase investment securities. Off-balance-sheet commitments to extend credit represent legally binding agreements to lend to customers with fixed expiration dates or other termination clauses. Since many commitments are expected to expire without being funded, committed amounts do not necessarily represent future cash requirements.

The following table summarizes the Bank’s contractual obligations, including certain on-balance sheet and off-balance sheet obligations, at March 31, 2009 (in thousands):

	Total
Contractual Obligations
Time deposit maturities	$	148,827
Advances from Federal Home Loan Bank		21,000
Other borrowings		5,781
Commitments to extend credit		6,068
Unused lines of credit		29,173
Standby letters of credit		632
Total	$	211,481

Management believes that the Bank has adequate resources to fund all its commitments, that a majority of all of its existing commitments will be funded within 12 months and, if so desired, that the Bank can adjust the rates and terms on time deposits and other deposit accounts to retain or obtain new deposits in a changing interest rate environment.

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ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Regulatory Capital Requirements

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. 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 consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and percentages of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. If such minimum amounts and percentages are met, the Bank is considered “adequately capitalized.” If the actual amounts exceed the requirements of “adequately capitalized,” and meet even more stringent minimum standards, they are considered “well capitalized.” Management believes as of March 31, 2009, the Bank meets the capital requirements for a “well capitalized” financial institution.

The table below shows the total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios of the Bank at March 31, 2009 and December 31, 2008, and the minimum required amounts and percentages ($ in thousands).

		Actual				For Capital Adequacy Purposes				For Well Capitalized Purposes
		Amount		Percent		Amount		Percent		Amount		Percent
As of March 31, 2009:	��
Total capital (to Risk-Weighted Assets)		$	27,581	11.95	%	$	18,464	8.00	%	$	23,080	10.00	%
Tier I Capital (to Risk-Weighted Assets)			25,124	10.89			9,228	4.00			13,842	6.00
Tier I Capital (to Average Assets)			25,124	9.37			10,725	4.00			13,407	5.00
As of December 31, 2008:
Total capital (to Risk-Weighted Assets)			23,852	10.74			17,767	8.00			22,209	10.00
Tier I Capital (to Risk-Weighted Assets)			21,138	9.52			8,882	4.00			13,322	6.00
Tier I Capital (to Average Assets)			21,138	8.37			10,102	4.00			12,627	5.00

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ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Results of Operations

The following table shows selected ratios for the periods ended or at the dates indicated:

	Three Months Ended March 31, 2009		Year Ended December 31, 2008		Three Months Ended March 31, 2008
Average equity as a percentage of average assets	10.89	%	10.49	%	10.39	%
Total equity to total assets at end of period	10.95	%	9.53	%	11.22	%
Return on average assets (1)	(.10	)%	(.21	)%	(.01	)%
Return on average equity (1)	(.91	)%	(1.99	)%	(.13	)%
Noninterest expense to average assets (1)	2.66	%	2.71	%	2.70	%
Nonperforming loans to total loans at end of period (2)	.41	%	.72	%	.41	%

(1) Annualized for the three months ended March 31, 2009 and 2008.

(2) Nonperforming loans consist of nonaccrual loans and accruing loans contractually past due ninety days or more.

Changes in Financial Condition

Total assets increased $24 million or 10%, from $259 million at December 31, 2008 to $283 million at March 31, 2009, primarily as a result of a $7 million increase in net loans, a $3 million increase in cash and cash equivalents, an $8 million increase in interest bearing time deposits in banks, and a $6 million increase in securities. Deposits increased $21 million from $203 million at December 31, 2008 to $224 million at March 31, 2009 and Federal Home Loan Bank advances decreased $1 million.

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ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Net Interest Margin and Interest Rate Spread

The following table sets forth, for the periods indicated, information regarding (i) the total dollar amount of interest and dividend income of the Company from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average costs; (iii) net interest/dividend income; (iv) interest-rate spread; and (v) net interest margin. Yields and costs were derived by dividing annualized income or expense by the average balance of assets or liabilities, respectively, for the periods shown. The yields and costs include certain fees which are considered to constitute adjustments to yields.

	Three Months Ended March 31,
	2009							2008
	Average Balance			Interest and Dividends		Average Yield/ Rate		Average Balance		Interest and Dividends			Average Yield/ Rate
	($ in thousands)
Interest-earning assets:
Loans	$	209,249			3,040	5.89	%	$	171,888		2,880		6.72	%
Securities		13,607			133	3.96			17,504		235		5.39
Other (1)		26,470			139	2.13			11,345		88		3.11
Total interest-earning assets		249,326			3,312	5.39			200,737		3,203		6.40
Noninterest-earning assets		19,876	��						12,474
Total assets	$	269,202						$	213,211
Interest-bearing liabilities:
Deposits		196,022			1,635	3.38			155,216		1,726		4.46
Federal Home Loan Bank advances and other borrowings		26,982			203	3.05			20,166		198		3.93
Total interest-bearing liabilities		223,004			1,838	3.34			175,382		1,924		4.40
Capitalized interest					—						(48	)
Net interest expense					1,838						1,876
Noninterest-bearing deposits		16,650							14,108
Noninterest-bearing liabilities		221							1,562
Stockholders’ equity		29,327							22,159
Total liabilities and stockholders’ equity	$	269,202						$	213,211
Net interest income				$	1,474					$	1,327
Interest-rate spread						2.04	%						2.00	%
Net interest margin (2)						2.40	%						2.65	%
Ratio of interest-earning assets to interest-bearing liabilities		1.12							1.14

(1) Includes interest-earning deposits, federal funds sold and Federal Home Loan Bank stock.

(2) Net interest margin is annualized net interest income divided by average interest-earning assets.

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ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Comparison of the Three-Month Periods Ended March 31, 2009 and 2008

General Operating Results.Net loss for the three-month period ended March 31, 2009 was $66,000, or $(.06) per basic and diluted common share, compared to a net loss of $7,000, or $(.00) per basic and diluted common share, for the comparable period in 2008. The $59,000 increase in net loss resulted primarily from a $323,000 increase in noninterest expense, partially offset by a $147,000 increase in net interest income, a $4,000 increase in noninterest income, and a $91,000 decrease in provision for loan losses.

Interest Income.Interest income increased $109,000 to $3.3 million for the three-month period ended March 31, 2009, when compared to the three-month period ended March 31, 2008. The increase was due to a $48.5 million increase in average interest-earning assets outstanding for the three months ended March 31, 2009 compared to the 2008 period, partially offset by a decrease in the average yield earned on interest-earning assets from 6.40% for the three months ended March 31, 2008 to 5.39% for the three months ended March 31, 2009.

Interest Expense.Interest expense decreased $38,000 for the three-month period ended March 31, 2009 when compared to the comparable 2008 period. The decrease was primarily due to decrease in the average cost of interest-bearing liabilities from 4.40% for the three months ended March 31, 2008 to 3.34% for the comparable 2009 period, partially offset by a $47.6 million increase in average interest bearing liabilities. Average interest-bearing liabilities increased from $175.4 million outstanding during the three months ended March 31, 2008 to $223.0 million outstanding during the comparable period for 2009.

Provision for Loan Losses.The provision for loan losses is charged to operations to increase the total loan loss allowance to a level deemed appropriate by management. The provision is based upon the volume and type of lending conducted by the Company, industry standards, general economic conditions, particularly as they relate to the Company’s market area, and other factors related to the collectibility of the Company’s loan portfolio. The Company recorded provisions for loan losses for the three-month periods ended March 31, 2009 and 2008 of $94,000 and $185,000, respectively. Management believes that the allowance for loan losses, which was $2.5 million or 1.14% of gross loans at March 31, 2009 is adequate.

Noninterest Income.Noninterest income increased $4,000 during the 2009 period. The increase was primarily due to a $20,000 increase in deposit account fees when compared to the three-month period ended March 31, 2008.

Noninterest Expense.Noninterest expense increased by $323,000 from $1.4 million for the three-month period ended March 31, 2008 to $1.8 million for the three-month period ended March 31, 2009. The increase was primarily due to increases of $125,000 in salaries and employee benefits, $78,000 in occupancy and equipment expense, $32,000 in data processing expense, and $61,000 in other noninterest expense, all related to the overall growth of the Company.

Income Taxes.The income tax expense was $8,000 for the three-month period ended March 31, 2008. The income tax benefit was $14,000 for the corresponding period in 2009.

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ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Item 4T. Controls and Procedures

a. Evaluation of disclosure controls and procedures. The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures performed within 90 days of the filing date of this report, the Principal Executive and Principal Financial officers of the Company concluded that the Company’s disclosure controls and procedures were adequate.

b. Changes in internal controls. The Company made no significant changes in its internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation of those controls by the Principal Executive and Principal Financial officers.

Part II—OTHER INFORMATION

Item 1. Legal Proceedings

There are no material pending legal proceedings to which Alarion Financial Services, Inc. or its subsidiary is a party or to which any of their property is subject.

Item 1.A. Risk Factors

Not applicable

Item 2. Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities

Not applicable

Item 3. Defaults upon Senior Securities

Not applicable

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable

Item 5. Other Information

Not applicable

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ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Item 6. Exhibits

Exhibits marked with an (a) were filed in the Holding Company’s Annual Report on Form 10-KSB, filed with the Securities and Exchange Commission on March 15, 2006. The Exhibits marked with a (b) were filed in the Holding Company’s Form 10-Q, filed with the Securities and Exchange Commission on May 15, 2008. Exhibit (c) was filed in the Annual Report on Form 10-KSB/A filed with the Commission on July 17, 2006.

Exhibit No.		Description of Exhibit
3.1	(a)	Articles of Incorporation
3.2	(a)	Bylaws
4.1	(a)	Specimen Common Stock Certificate
4.3	(c)	2005 Stock Plan
10.1	(a)	Employment Agreement with Jon M. Kurtz
10.2	(a)	Lease for Main Office
10.3	(b)	Employment Agreement with Walter R. Czuryla
10.4	(b)	Employment Agreement with Robert L. Page
21.1	(a)	Schedule of Subsidiaries
31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - President and Principal Executive Officer
31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Principal Financial and Accounting Officer
32.1		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – President and Principal Executive Officer
32.2		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – Principal Financial and Accounting Officer

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ALARION FINANCIAL SERVICES, INC. AND SUBSIDIARIES

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 hereunto duly authorized.

Date: May 13, 2009

Alarion Financial Services, Inc.
By:	/s/ Jon M. Kurtz
Name:	Jon M. Kurtz, President and Principal Executive Officer
By:	/s/ Matthew Ivers
Name:	Matthew Ivers, Senior Vice President and Principal Financial and Accounting Officer

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