First Priority Financial 10Q 2008 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

For the quarterly period ended September 30, 2008


o		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 333-147950

First Priority Financial Corp.

(Exact name of registrant as specified in its charter)


Pennsylvania		20-8420347

(State or other jurisdiction		(I.R.S. Employer
of incorporation or		Identification No.)
organization)

2 West Liberty Boulevard, Suite 104
Malvern, Pennsylvania 19355

(Address, including zip code, of registrant’s principal executive offices)

(610) 280-7100

(Registrant’s telephone number, including area code)

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. Yesþ Noo

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. (Check one):


Large accelerated filero		Accelerated filero		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting companyþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,122,929 shares of Common Stock, $1.00 par value, outstanding on November 12, 2008.

FIRST PRIORITY FINANCIAL CORP.

INDEX TO FORM 10-Q REPORT


	Page
	No.
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets — September 30, 2008 (unaudited) and December 31, 2007		3
Consolidated Statements of Income — For the three months and nine months ended September 30, 2008 and 2007 (unaudited)		4
Consolidated Statements of Shareholders’ Equity — For the nine months ended September 30, 2008 and 2007 (unaudited)		5
Consolidated Statements of Cash Flows — For the nine months ended September 30, 2008 and 2007 (unaudited)		6
Notes to Unaudited Consolidated Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3. Quantitative and Qualitative Disclosures About Market Risk		53
Item 4T. Controls and Procedures		53
Part II. OTHER INFORMATION
Item 1. Legal Proceedings		54
Item 1A. Risk Factors		54
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		54
Item 3. Defaults Upon Senior Securities		54
Item 4. Submission of Matters to a Vote of Security Holders		54
Item 5. Other Information		54
Item 6. Exhibits		55

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

First Priority Financial Corp.

Consolidated Balance Sheets

(In thousands, except per share data)


	September 30,			December 31,
	2008			2007
	(Unaudited)
Assets
Cash and due from banks	$	1,651		$	943
Federal funds sold and securities purchased under agreements to resell		19			—
Interest bearing deposits in banks		348			—

Total cash and cash equivalents		2,018			943

Securities available for sale (amortized cost: $29,926 and $45,015, respectively)		29,748			45,026

Loans receivable		163,691			105,207
Less: allowance for loan losses		1,709			1,055

Net Loans		161,982			104,152

Restricted investments in bank stocks		1,145			50
Premises and equipment, net		1,366			574
Accrued interest receivable		901			545
Goodwill		1,194			—
Other assets		334			321


Total Assets	$	198,688		$	151,611

Liabilities and Shareholders’ Equity
Liabilities
Deposits:
Non-interest bearing	$	8,758		$	6,846
Interest-bearing		150,700			109,459

Total Deposits		159,458			116,305

Short-term borrowings		2,201			18,097
Long-term debt		8,000			390
Accrued interest payable		1,094			858
Other liabilities		7,663			641


Total Liabilities		178,416			136,291

Shareholders’ Equity
Preferred stock, $100 par value; authorized 10,000 shares; no shares issued or outstanding		—			—
Common stock, $1 par value; authorized 10,000 shares; 3,123 and 2,108 shares issued and outstanding, respectively		3,123			2,108
Surplus		25,831			18,982
Accumulated deficit		(8,504	)		(5,781	)
Accumulated other comprehensive income (loss)		(178	)		11

Total Shareholders’ Equity		20,272			15,320


Total Liabilities and Shareholders’ Equity	$	198,688		$	151,611

See notes to unaudited consolidated financial statements.

First Priority Financial Corp.

Consolidated Statements of Income

Unaudited (In thousands, except per share data)


	For the three months						For the nine months
	ended September 30,						ended September 30,
	2008			2007			2008			2007
Interest Income
Loans receivable, including fees	$	2,293		$	1,517		$	6,044		$	3,809
Securities — taxable		243			98			497			415
Interest bearing deposits and other		2			—			4			2
Federal funds sold and securities purchased under agreements to resell		6			347			232			811

Total Interest Income		2,544			1,962			6,777			5,037


Interest Expense
Deposits		1,381			1,220			3,801			3,012
Short-term borrowings		16			2			30			11
Other		78			5			122			5

Total Interest Expense		1,475			1,227			3,953			3,028


Net Interest Income		1,069			735			2,824			2,009

Provision for Loan Losses		127			87			520			324


Net Interest Income after Provision for Loan Losses		942			648			2,304			1,685


Non-Interest Income
Wealth management fee income		47			54			136			160
Other		39			11			100			38

Total Non-Interest Income		86			65			236			198


Non-Interest Expenses
Salaries and employee benefits		1,217			808			3,543			2,394
Occupancy and equipment		200			99			505			314
Data processing equipment and operations		90			59			254			171
Professional fees		86			90			275			321
Marketing, advertising, and business development		61			43			156			118
FDIC insurance assessments		30			14			83			45
Capital stock tax expense		23			12			67			35
Merger integration costs		—			—			72			—
Other		115			86			308			251

Total Non-Interest Expenses		1,822			1,211			5,263			3,649


Net Loss	$	(794	)	$	(498	)	$	(2,723	)	$	(1,766	)

Loss per share
Basic and diluted	$	(0.25	)	$	(0.24	)	$	(0.95	)	$	(0.84	)

Weighted average shares outstanding
Basic and diluted		3,110			2,108			2,879			2,108

See notes to unaudited consolidated financial statements.

First Priority Financial Corp.

Consolidated Statements of Shareholders’ Equity

For the Nine Months Ended September 30, 2008 and 2007

Unaudited (Dollars in thousands)


								Accumulated
								Other
	Common				Accumulated			Comprehensive
	Stock		Surplus		Deficit			Income (Loss)			Total
Balance — December 31, 2006	$	2,108	$	18,934	$	(3,405	)	$	1		$	17,638

Comprehensive loss:
Net loss		—		—		(1,766	)		—			(1,766	)
Net unrealized holding gain on available for sale securities		—		—		—			4			4


Total Comprehensive Loss												(1,762	)


Stock options expense		—		33		—			—			33


Balance — September 30, 2007	$	2,108	$	18,967	$	(5,171	)	$	5		$	15,909


Balance — December 31, 2007	$	2,108	$	18,982	$	(5,781	)	$	11		$	15,320

Issuance of common stock for acquisition of Prestige Community Bank (976,137 shares)		976		6,415		—			—			7,391
Issuance of common stock for conversion of subordinated debentures (39,292 shares)		39		364		—			—			403

Comprehensive loss:
Net loss		—		—		(2,723	)		—			(2,723	)
Net unrealized holding loss on available for sale securities		—		—		—			(189	)		(189	)


Total Comprehensive Loss												(2,912	)


Stock options expense		—		70		—			—			70


Balance — September 30, 2008	$	3,123	$	25,831	$	(8,504	)	$	(178	)	$	20,272

See notes to unaudited consolidated financial statements.

First Priority Financial Corp.

Consolidated Statements of Cash Flows

Unaudited (Dollars in thousands)


	For the nine months ended
	September 30,
	2008			2007
Cash Flows from Operating Activities

Net loss	$	(2,723	)	$	(1,766	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Provision for loan losses		520			324
Depreciation and amortization		163			89
Net accretion and amortization of securities discounts and premiums		(2	)		(140	)
Stock based compensation expense		70			33
Increase in accrued interest receivable		(356	)		(232	)
(Increase) decrease in other assets		38			(80	)
Increase in accrued interest payable		215			533
Increase (decrease) in other liabilities		(813	)		1,995


Net Cash Provided by (Used in) Operating Activities		(2,888	)		756


Cash Flows from Investing Activities

Net increase in loans		(52,654	)		(38,590	)
Purchases of securities available for sale		(62,032	)		(108,866	)
Purchase of restricted stock		(1,095	)		—
Proceeds from maturities of securities available for sale		84,122			154,000
Purchases of premises and equipment		(148	)		(271	)
Net cash received from acquisition		21,844			—


Net Cash Provided by (Used in) Investing Activities		(9,963	)		6,273


Cash Flows from Financing Activities

Net increase in deposits		22,305			41,814
Net decrease in short-term borrowings		(16,379	)		(22,811	)
Proceeds from the issuance of long-term debt		8,000			380


Net Cash Provided by Financing Activities		13,926			19,383


Net Increase in Cash and Cash Equivalents		1,075			26,412

Cash and Cash Equivalents — Beginning		943			1,984


Cash and Cash Equivalents — Ending	$	2,018		$	28,396


Supplementary Disclosures of Cash Flows Information

Noncash activity:
Trade date accounting for investment securities purchases	$	7,000		$	—
Conversion of subordinated debentures to common stock	$	403		$	—

Cash paid during year for interest on deposits and borrowings	$	4,052		$	2,495

See notes to unaudited consolidated financial statements.

Notes to Unaudited Consolidated Financial Statements

Note 1 — Summary of Significant Accounting Policies

Organization and Nature of Operations

First Priority Financial Corp.

First Priority Financial Corp. (referred to herein as the “Company” or “First Priority”) was formed on May 11, 2007. On February 20, 2007, First Priority Bank’s Board of Directors approved an agreement of reorganization and merger, dated as of February 20, 2007 which was subsequently approved by regulators and the shareholders of the First Priority Bank (the “Bank”) at the Bank’s annual meeting on April 17, 2007. The reorganization agreement provided that the Bank become a wholly-owned subsidiary of the Company, a Pennsylvania corporation formed by the Bank for the purpose of becoming a holding company for the Bank, and as such, the Company is subject to the rules and regulations of the Federal Reserve Board. Accordingly, the financial information relating to the periods prior to May 11, 2007 are reported under the name of First Priority Financial Corp.

Under the reorganization agreement, each outstanding share of the Bank’s common stock and warrant to acquire the Bank’s common stock was converted into one share of the Company’s common stock and one warrant to acquire the Company’s common stock. The former holders of the Bank’s common stock and warrants became the holders of all of the outstanding shares and warrants of the Company. Following the reorganization, the Bank continued its operations at the same location, with the same management, and was subject to all the rights, obligations and liabilities of the Bank existing immediately prior to the reorganization. The Company’s assets consist principally of its investment in the Bank and the primary activities are conducted through the Bank.

The Company’s revenue is dependent primarily on net interest income, which is the difference between the interest income earned on loans, investments, and other interest earning assets and the interest paid on deposits and other interest bearing liabilities. Total revenue is also affected by non-interest income which is primarily derived from asset management related fees, service charges and other fees.

The Company’s operations are significantly affected by prevailing economic conditions, competition, and the monetary, fiscal, and regulatory policies of governmental agencies. Lending activities are influenced by a number of factors, including the general credit needs of individuals and small and medium-sized businesses in the Company’s market area, competition, the level of interest rates, and the availability of funds. Deposit flows and cost of funds are influenced by prevailing market rates of interest, competition, account maturities, and the level of personal income and savings in the market area.

Note 1 — Summary of Significant Accounting Policies (continued)

First Priority Bank

The Bank was incorporated on May 25, 2005 under the laws of the Commonwealth of Pennsylvania and is a Pennsylvania chartered, FDIC insured bank. The Bank commenced operations on November 14, 2005 and is a full service commercial bank providing personal and business lending, deposit products and wealth management services. As a state chartered bank, the Bank is subject to regulation of the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation. The Bank is located in, and serves customers in, southeastern Pennsylvania.

In March 2007, the Bank opened its second market-service office which is located in Wyomissing, Pennsylvania and serves customers in the Berks County market.

Effective February 29, 2008, the Bank completed its acquisition of Prestige Community Bank (“Prestige”), a de novo bank headquartered in Newtown, Bucks County, Pennsylvania, with offices in Newtown and Pipersville, Pennsylvania. The acquisition has been accounted for using the purchase method of accounting which requires that the financial statements include activity of Prestige beginning March 1, 2008. See Note 2 for more information on the acquisition.

Basis of Presentation

The accompanying unaudited consolidated financial statements were prepared in accordance with the instructions to Form 10-Q, and therefore, do not include all the information or footnotes necessary for a complete presentation of financial condition, results of operations, changes in equity and comprehensive income, and cash flows in conformity with accounting principles generally accepted in the United States of America. However, all normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the consolidated financial statements have been included. These financial statements should be read in conjunction with the audited consolidated financial statements of the Company and the accompanying notes thereto for the year ended December 31, 2007, as set forth in First Priority’s 2007 Annual Report to Shareholders, a paper copy of which is available from the Securities and Exchange Commission (“SEC”). The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The results for the three months and nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2008, or any other period.

These consolidated statements consist of the Bank’s financial statements prior to the formation of the Company on May 11, 2007. The consolidated balance sheets and related income statements of the Company are substantially the same as the balance sheets and income statements of the Bank. The consolidated results of operations and financial condition presented for those periods after the merger date, May 11, 2007, include consolidated financial results for the Company which includes the Bank. All significant inter-company accounts and transactions have been eliminated in consolidation.

Note 1 — Summary of Significant Accounting Policies (continued)

These statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

Goodwill

Goodwill represents the excess of the cost of an acquired entity over the fair value of the identifiable net assets acquired in accordance with the purchase method of accounting. Goodwill is not amortized but is reviewed for potential impairment on an annual basis, or more often if events or circumstances indicate that there may be impairment, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Goodwill is tested for impairment at the reporting unit level and an impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Company employs general industry practices in evaluating the fair value of its goodwill. Any impairment loss related to goodwill and other intangible assets is reflected as other non-interest expense in the statement of income in the period in which the impairment is determined. No assurance can be given that future impairment tests will not result in a charge to earnings.

The balance of goodwill at September 30, 2008 is $1.19 million, all of which resulted from the acquisition of Prestige effective February 29, 2008, as described in Note 2 below.

Recent Accounting Pronouncements

FASB Statement No. 141(R)

In December 2007, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 141 (R) “Business Combinations.” This Statement establishes principles and requirements as to how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The Statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines the information to be disclosed that will enable users of the financial statements to evaluate the nature and financial effects of the business combination. The guidance will become effective as of the beginning of a company’s fiscal year beginning after December 15, 2008. This new pronouncement will impact the Company’s accounting for business combinations completed beginning January 1, 2009.

FASB Statement No. 159

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115.” This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.

Note 1 — Summary of Significant Accounting Policies (continued)

This Statement is expected to expand the use of fair value measurement, which is consistent with the FASB’s long-term measurement objectives for accounting for financial instruments. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.

The Company has not elected the fair value option for any financial assets or liabilities at September 30, 2008.

FASB Statement No. 162

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This Statement identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements. This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements.

FSP FAS 140-3

In February 2008, the FASB issued a FASB Staff Position (FSP) FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.” This FSP addresses the issue of whether or not these transactions should be viewed as two separate transactions or as one “linked” transaction. The FSP includes a “rebuttable presumption” that presumes linkage of the two transactions unless the presumption can be overcome by meeting certain criteria. The FSP will be effective for fiscal years beginning after November 15, 2008 and will apply only to original transfers made after that date; early adoption is not allowed. The Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements.

FASB Staff Position (FSP) 157-3

In October 2008, the FASB issued FSP SFAS No. 157-3,"Determining the Fair Value of a Financial Asset When The Market for That Asset Is Not Active” (FSP 157-3), to clarify the application of the provisions of SFAS No. 157 (SFAS 157), “Fair Value Measurements,” in an inactive market and how an entity would determine fair value in an inactive market. FSP 157-3 is effective immediately and applies to our September 30, 2008 financial statements. The application of the provisions of FSP 157-3 did not materially affect our results of operations or financial condition as of and for the periods ended September 30, 2008.

Note 1 — Summary of Significant Accounting Policies (continued)

FSP APB 14-1

In May 2008, the FASB issued FASB Staff Position (FSP) APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” which clarifies the accounting for convertible debt instruments that may be settled in cash (including partial cash settlement) upon conversion. The FSP requires issuers to account separately for the liability and equity components of certain convertible debt instruments in a manner that reflects the issuer’s nonconvertible debt borrowing rate when interest cost is recognized. The FSP requires bifurcation of a component of the debt, classification of that component in equity and the accretion of the resulting discount on the debt to be recognized as part of interest expense. The FSP requires retrospective application to the terms of instruments as they existed for all periods presented. The FSP is effective for fiscal years beginning after December 15, 2008, and interim periods within those years. Early adoption is not permitted. The Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements.

SAB 109

Staff Accounting Bulletin No. 109 (SAB 109), “Written Loan Commitments Recorded at Fair Value Through Earnings” expresses the views of the staff of the Securities and Exchange Commission (“SEC”) regarding written loan commitments that are accounted for at fair value through earnings under generally accepted accounting principles. To make the staff’s views consistent with current authoritative accounting guidance, SAB 109 revises and rescinds portions of SAB No. 105, “Application of Accounting Principles to Loan Commitments.” Specifically, SAB 109 revises the SEC staff’s views on incorporating expected net future cash flows related to loan servicing activities in the fair value measurement of a written loan commitment. SAB 109 retains the staff’s views on incorporating expected net future cash flows related to internally-developed intangible assets in the fair value measurement of a written loan commitment. The staff expects registrants to apply the views in Question 1 of SAB 109 on a prospective basis to derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The implementation of SAB 109 did not have any impact on the Company’s consolidated financial statements.

SAB 110

Staff Accounting Bulletin No. 110 (SAB 110) amends and replaces Question 6 of Section D.2 of Topic 14, “Share-Based Payment,” of the Staff Accounting Bulletin series. Question 6 of Section D.2 of Topic 14 expresses the views of the staff of the SEC regarding the use of the “simplified” method in developing an estimate of expected term of “plain vanilla” share options and allows usage of the “simplified” method for share option grants prior to December 31, 2007. SAB 110 allows public companies which do not have historically sufficient experience to provide a reasonable estimate to continue use of the “simplified” method for estimating the expected term of “plain vanilla” share option grants after December 31, 2007. SAB 110 is effective January 1, 2008. The Company has used the “simplified” method to determine the expected life of options issued as part of determining the fair value of option grants.

Note 2 — Acquisition of Prestige Community Bank

Effective at the close of business on February 29, 2008, First Priority completed its acquisition of Prestige, a de novo bank headquartered in Newtown, Bucks County, Pennsylvania. Prestige, with $28.9 million in total assets, $5.8 million in loans and $20.8 million in deposits as of February 29, 2008, merged into the Bank. The acquisition expands the Bank’s branch network into Bucks County, Pennsylvania, with offices in Newtown and Pipersville, and increases the number of offices of the Bank to four, serving customers in Chester, Berks, and Bucks Counties in Southeastern Pennsylvania.

In connection with the merger, four directors of Prestige were appointed to the First Priority Board of Directors. The former Prestige directors will be compensated on the same or similar terms under which current non-management directors are compensated for their services. The former Prestige directors have loans and other extensions of credit with the Bank which are on substantially the same terms (including interest rate and collateral), as the terms prevailing at the time for comparable banking transactions with other persons who are not affiliates and who are not subject to Regulation O.

The acquisition was consummated pursuant to the Agreement and Plan of Merger, dated as of October 19, 2007, by and among First Priority, First Priority Bank, and Prestige. Under the Purchase Agreement, the Company acquired 100% of the outstanding shares of Prestige which was merged with and into the Bank, the wholly owned subsidiary of the Company. Prestige shareholders received one share of common stock and one warrant to acquire a share of First Priority for each share of common stock and each warrant to acquire a share of Prestige outstandng immediately prior to the closing of the transaction. In the merger transaction, First Priority issued 976,137 shares of common stock, and warrants to purchase 195,227 shares of its common stock at a price of $12.50 per share, which expire in October of 2012.

The acquisition has been accounted for using the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations,” which requires that the Company’s financial statements include Prestige’s results of operation beginning March 1, 2008. The following table summarizes the fair values of Prestige’s assets acquired and liabilities assumed at the date of acquisition.

Note 2 — Acquisition of Prestige Community Bank (continued)


	Balance Sheet Acquired
	February 29, 2008
	(Dollars in thousands)
Assets
Cash and cash equivalents	$	22,184

Loans receivable		5,830
Less: allowance for loan losses		150

Net Loans		5,680

Other assets		1,071


Total Assets		28,935


Liabilities
Non-interest bearing deposits		1,379
Interest-bearing deposits		19,470
Short-term borrowings		483
Other liabilities		212


Total Liabilities		21,544


Net Assets Acquired	$	7,391

The following pro forma combined results of operations for the nine months ended September 30, 2008, give effect to the acquisition as if the merger had been completed on January 1, 2008. The pro forma results show the combination of Prestige’s results into First Priority’s consolidated statement of income. While adjustments have been made for the estimated effect of purchase accounting, the pro forma results do not reflect the actual results that the combined company would have achieved had the combination occurred at the beginning of the period. Since Prestige did not open for business until October, 2007, there are no pro forma results presented for the three and nine months ended September 30, 2007.


	Pro Forma Nine months ended
	September 30, 2008
	(Dollars in thousands)
Total revenue	$	3,051
Net loss		(3,319	)
Basic and diluted loss per share		(1.07	)

Note 2 — Acquisition of Prestige Community Bank (continued)

In accordance with SFAS No. 141, “Business Combinations,” the consideration paid in an acquisition should be determined by either determining: (1) the value of the actual consideration paid, i.e., the value of the Company’s common stock, or (2) the value of what was received, i.e., the fair value of the net assets of Prestige. The determination of which methodology to use is based upon which is more clearly evident, and thus, provides a value that is considered more reliable.

Management has determined that the most appropriate methodology to determine the consideration paid in this transaction is to determine the fair value of the net assets acquired for the following reasons: (1) the common stock of the Company is closely held and at the time of the acquisition, was not traded on any open market and, therefore, a value for the stock was not readily determinable or considered reliable, and (2) as a de novo and relatively new organization, the net assets of Prestige were recently acquired and it was relatively simple to determine a fair value at the instrument level.

Goodwill of $1.19 million was recorded in connection with the acquisition of Prestige. The Company currently has one reporting segment, banking, which will be used to evaluate potential impairment of goodwill in the future.

Goodwill related to the merger with Prestige is not deductible for tax purposes. Due to the net operating losses previously incurred by the Company, deferred tax assets are reduced by a valuation allowance until such time as, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will be realized. Therefore, no deferred tax component has been recorded related to this transaction.

Prestige has a net operating loss (“NOL”) for tax purposes which will carry forward for the benefit of First Priority in future years. As of February 29, 2008, the NOL for Prestige was $2.0 million. As it becomes evident that the Company will be able to utilize the NOL for Prestige, it would be recognized going forward. Section 382 of the Internal Revenue Code applies a limitation as to how much of the carryforward NOL can be used in any one year and must be utilized within a specified period (20 years). As the Company is able to utilize the NOL of Prestige in future periods, the impact of this reduction in the Company’s tax liability would be recorded as a reduction of goodwill.

Note 2 — Acquisition of Prestige Community Bank (continued)

The following table provides the calculation of the goodwill.


	(Dollars in thousands)
Purchase Price:
Net assets acquired	$	7,391
Transaction costs		320

Total purchase price		7,711


Net Assets Acquired:
Seller shareholders’ equity		7,524
Estimated adjustments to reflect assets acquired at fair value:
Loans (2.5 years weighted average life)		28
Estimated amount allocated to liabilities assumed at fair value:
Time deposits (0.4 year weighted average life)		(161	)

Fair value of net assets acquired		7,391


Estimated adjustment for contract termination costs and other purchase accounting adjustments		874


Goodwill Resulting from Acquisition	$	1,194

The fair value of certain assets (fixed rate loans) and certain liabilities (fixed rate time deposits) was determined using a discounted cash flow analysis and applying a discount rate which uses assumptions that marketplace participants would use in estimating fair values. In other instances, the Company assumed that the historical book value of certain assets and liabilities represented a reasonable proxy of fair value. Since Prestige was a de novo banking operation which, at time of merger, was open for only 4.5 months, it was assumed that there was no core deposit intangible related to the acquisition due to the limited time of existence and the limited “stability” of the deposit base of Prestige. The Company determined that there were no other categories of identifiable intangible assets arising from the Prestige acquisition. The Company also determined that there were no material purchase accounting adjustments needed with respect to SOP 03-03, “Accounting for Certain Loans and Debt Securities Acquired in a Transfer.”

Note 3 — Stock Option Plan

In 2005, the Company adopted the 2005 Stock Option Plan. The Plan allows equity benefits to be awarded in the form of Incentive Stock Options, Compensatory Stock Options or Restricted Stock. The Plan authorizes the Board of Directors to grant options up to an aggregate of 20% of the common stock outstanding to a maximum of 658,000 shares to officers, other employees and directors of the Company. Only employees of the Company are eligible to receive Incentive Stock Options and such grants are subject to the limitations under Section 422 of the Internal Revenue Code.

Note 3 — Stock Option Plan (continued)

All options granted under the Plan vest in four years and terminate ten years from the date of the grant. The exercise price of the options granted is the fair market value of a share of common stock at the time of the grant, but not less than $10 per share. Restricted Stock grants will be subject to five year vesting requirements.

Effective February 29, 2008, in connection with the completion of the merger with Prestige, the Company issued 47,022 options to those officers, employees, and directors of Prestige who held options to purchase Prestige common stock prior to the merger. The Prestige options became fully vested on October 18, 2007 upon execution of the merger agreement due to change in control provisions. Upon completion of the merger, comparable fully vested options were issued by the Company effective October 18, 2007, the original issue date of the options, at an exercise price of $10 per share and an expiration date of October 18, 2017. These options became part of the Company’s 2005 Stock Option Plan.

In addition, 100,000 options issued by Prestige to its organizers were exchanged for the same number of options of the Company at the merger date. These options also are fully vested, are exercisable at a price of $10 per share, and expire on October 18, 2017.

A summary of the option activity under the Company’s stock option plan as of September 30, 2008 and for the nine months ended September 30, 2008 is presented below:


				Weighted
				Average
				Exercise
	Shares			Price
Outstanding at December 31, 2007		421,000		$	10.00

Granted during 2008		52,950			10.25
Options exchanged — Prestige acquisition		147,022			10.00
Forfeited/cancelled during period		(81,222	)		10.00


Outstanding at September 30, 2008		539,750		$	10.02


Exercisable at September 30, 2008		117,000		$	10.00

The weighted average remaining contractual life of the outstanding stock options at September 30, 2008 is 7.94 years. The aggregate intrinsic value of options outstanding was $0 as of September 30, 2008. Intrinsic value is measured using the fair value of the Company’s stock less the applicable exercise price.

Note 3 — Stock Option Plan (continued)

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The fair value of options granted in 2008 was determined using the following weighted average assumptions:


	Granted in
	2008
Dividend yield		0.0	%
Expected life	7 years
Expected volatility		25	%
Risk-free interest rate		2.93	%
Weighted average fair value	$	3.46

The dividend yield assumption is based on the Company’s history and expectation of dividend payouts which are restricted under regulation. Due to the Company’s lack of sufficient historical exercise data and the limited period of time for which shares have been issued, the “simplified” method is used to determine the expected life of options, calculated as the average of the sum of the vesting term and original contractual term for all periods presented. The expected volatility percentage is based on the average expected volatility of similar public financial institutions in the Company’s market area. The risk-free interest rates for periods within the contractual life of the awards are based on the U.S. Treasury yield curve in effect at the time of the grant.

Compensation expense related to stock options granted is included in salaries and employee benefits in the accompanying consolidated statements of income. For the quarters ended September 30, 2008 and 2007, compensation expense related to options was $26 thousand and $10 thousand, respectively, and for the nine months ended September 30, 2008 and 2007 compensation expense was $70 thousand and $33 thousand, respectively. There was no tax benefit recognized related to this stock-based compensation.

As of September 30, 2008, there was $286 thousand of unrecognized compensation cost related to nonvested stock options granted after January 1, 2006, which is expected to be recognized over a weighted average period of 2.9 years.

Note 4—Earnings Per Share

The calculations of basic earnings per share and diluted earnings per share are presented below. All weighted average shares, actual shares and per share information in the financial statements have been adjusted retroactively for the effect of stock dividends and splits, if applicable.

Options to purchase 539,750 and 421,000 shares of common stock outstanding at September 30, 2008 and 2007, respectively, and warrants to purchase common stock were not included in dilutive earnings per share since their exercise price exceeded the fair value of the related common stock and due to the net loss incurred.

Note 4—Earnings Per Share (continued)


	For the three months						For the nine months
	ended September 30,						ended September 30,
	2008			2007			2008			2007
	(In thousands, except per share information)
Basic and diluted loss per share
Net loss	$	(794	)	$	(498	)	$	(2,723	)	$	(1,766	)
Weighted average common shares outstanding		3,110			2,108			2,879			2,108
Basic and diluted loss per share	$	(0.25	)	$	(0.24	)	$	(0.95	)	$	(0.84	)

Note 5 — Financial Instruments with Off-Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk incurred in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. Such financial instruments are recorded in the financial statements when they become payable. Those commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet.

The Company’s exposure to credit loss in the event of nonperformance by the counter party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

At September 30, 2008 and December 31, 2007, outstanding commitments to extend credit consisting of total unfunded commitments under lines of credit were $38.3 million and $26.1 million, respectively.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies, but may include personal or commercial real estate, accounts receivable, inventory and equipment.

Note 6 — Short-Term Borrowings

At September 30, 2008 and December 31, 2007, the Company had total short-term borrowings of $2.2 million and $18.1 million, respectively. The Company’s short-term borrowings generally consist of Federal funds purchased, securities sold under repurchase agreements and other secured borrowings from correspondent banks. These borrowings generally represent overnight borrowings.

Note 6 — Short-Term Borrowings (continued)

As of September 30, 2008 and December 31, 2007, the Company had a borrowing facility with a correspondent bank totaling $10 million, of which $2 million is available unsecured. The remaining $8 million is a secured line of credit with security provided by a pledge of Company investment assets. As of December 31, 2007, the Company also had a borrowing facility for $20 million which would be secured by a pledge of Company investment assets. All secured facilities are available for short-term limited purpose usage.

In addition, at September 30, 2008, the Bank had excess secured borrowing capacity at the Federal Home Loan Bank of Pittsburgh (“FHLB”). As a de novo bank, the Bank is required to deliver collateral to support borrowings. Based on margin requirements and the current level of available qualifying collateral, primarily qualifying investments and loans secured by 1-4 family residential mortgages, the Bank’s excess borrowing capacity exceeded $50 million at September 30, 2008.

Short-term borrowings outstanding as of September 30, 2008 consisted of $2.2 million outstanding under customer repurchase agreements. Investment securities pledged as collateral to secure these borrowings totaled $2.5 million. At December 31, 2007, short-term borrowings consisted of $2.0 million of unsecured borrowings and $16.0 million of secured borrowings under lines of credit with correspondent banks, secured by collateral pledged of $16.3 million, and $0.1 million outstanding under customer repurchase agreements.

Note 7 — Long-Term Debt

Long-term debt, consisting of FHLB advances, totaled $8.0 million at September 30, 2008 with a weighted average interest rate of 4.08%. First Priority Bank became a member of FHLB in March 2008. The advances are collateralized by FHLB stock and certain residential mortgage loans and mortgage backed securities. Advances are made pursuant to several different credit programs offered from time to time by the FHLB.

As of December 31, 2007, long-term debt of $390 thousand consisted of convertible subordinated debentures (“Debentures”) issued in June and July 2007. The Company issued the 5.30% debentures due June 21, 2012, to provide operating capital within the bank holding company. The Company’s directors and management were the purchasers of the Debentures.

The Notes provided that the Debentures would automatically convert into shares of the Company’s common stock, $1.00 par value per share (“Common Stock”), immediately prior to the consummation of a Qualified Offering, as defined by the Debenture. In addition, both payee and maker of the Debenture had the right to convert the Debentures into Common Stock after one year from issuance at an initial conversion price of $10.25 per share, which First Priority exercised effective August 1, 2008.

Effective August 1, 2008, the Company elected to convert the $403 thousand outstanding balance of Debentures, including accrued interest to date, into 39,292 shares of the Company’s Common Stock, based on the conversion price of $10.25 per share.

Note 8 — Fair Value of Financial Instruments

Effective January 1, 2008, the Company adopted SFAS 157. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, but does not expand the use of fair value in any new circumstances. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows:

Level 1 inputs — Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

Level 2 inputs — Inputs are other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly, through corroboration with observable market data. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs — Unobservable inputs for the assets or liabilities that reflect an entity’s own assumptions about the factors that market participants would use in pricing the assets or liabilities developed based on the best information available.

The following is a description of valuation methodologies used for assets recorded at fair value. Securities classified as available for sale are reported at fair value generally utilizing Level 1 or Level 2 inputs. Level 1 securities are readily marketable and have prices quoted in active markets which the Bank has the ability to access. The fair value measurement for Level 2 securities is provided by independent pricing sources. The fair value measurements 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 information and the bond’s terms and conditions, among other things.

Available for sale securities is the only balance sheet category that the Company is required by GAAP to account for at fair value. In developing these fair values, the valuation services and brokers use estimates of cash flows based on historical performance of similar instruments in similar rate environments. The following table presents information about the Company’s assets measured at fair value on a recurring basis as of September 30, 2008, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

Note 8 — Fair Value of Financial Instruments (continued)

Fair Value Measurements

At September 30, 2008, Using

Quoted Prices in

Active

Markets for

Other

Significant

Fair Value

Identical

Observable

Unobservable

September

Assets

Inputs

30, 2008

(Level 1)

(Level 2)

(Level 3)

(Dollars in thousands)

Available for Sale Securities

29,748

—

29,748

—

Total Assets Measured at Fair Value

29,748

—

29,748

—

Note 9 — Subsequent Event

On November 7, 2008, First Priority Bank signed an operating lease to rent 2,575 square feet at 10 Sentry Parkway, Suite 100, Blue Bell, Pennsylvania. The Bank intends to open its fifth market-service office at this location during the first quarter of 2009, serving customers in Montgomery County, Pennsylvania. The initial lease term is 127 months, with total operating lease payments of approximately $758 thousand during this initial term, and includes two successive five year renewal options.

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

Following is management’s discussion and analysis of the significant changes in the results of operations presented in its accompanying consolidated financial statements for First Priority and its wholly owned subsidiary, First Priority Bank. First Priority’s consolidated financial condition and results of operations consist almost entirely of First Priority Bank’s financial condition and results of operations. Current performance does not guarantee, and may not be indicative of, similar performance in the future.

Forward-Looking Statements

This document and the documents incorporated by reference into this document contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Statements containing the words “believes,” “expects,” “anticipates,” “estimates,” “plans,” “projects,” “predicts,” “intends,” “seeks,” “will,” “may,” “should,” “would,” “continues,” “hope” and similar expressions, or the negative of these terms, constitute forward-looking statements that involve risks and uncertainties. Such statements are based on current expectations and are subject to risks, uncertainties and changes in condition, significance, value, and effect. Such risks, uncertainties and changes in condition, significance, value and effect could cause First Priority’s actual results to differ materially from those anticipated events.

Although the Company believes its plans, intentions, and expectations as reflected in or suggested by these forward-looking statements are reasonable, it can give no assurance that its plans, intentions, or expectations will be achieved. Accordingly, you should not place undue reliance on them. Listed below, and discussed elsewhere, are some important risks, uncertainties, and contingencies that could cause actual results, performances, or achievements to be materially different from the forward-looking statements made in this document. These factors, risks, uncertainties, and contingencies include, but are not limited to, the following:

	•		the strength of the United States economy in general and the strength of the regional and local economies in which First Priority conducts operations;

	•		the effects of changing economic conditions in First Priority’s market areas and nationally;

	•		the effects of, and changes in, trade, monetary, and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;

	•		changes in federal and state banking, insurance, and investment laws and regulations which could impact First Priority’s operations;

	•		inflation, interest rate, market, and monetary fluctuations;

	•		First Priority’s timely development of competitive new products and services in a changing environment and the acceptance of such products and services by customers;

	•		the impact of changes in financial services policies, laws, and regulations, including laws, regulations, policies, and practices concerning taxes, banking, capital, liquidity, proper accounting treatment, securities, and insurance, and the application thereof by regulatory bodies and the impact of changes in and interpretations of generally accepted accounting principles;

	•		the occurrence of adverse changes in the securities markets;

	•		the effects of changes in technology or in consumer spending and savings habits;

	•		terrorist attacks in the United States or upon United States interests abroad, or armed conflicts involving the United States military;

	•		regulatory or judicial proceedings;

	•		changes in asset quality; and

	•		First Priority’s success in managing the risks involved in the foregoing.

The effects of these factors are difficult to predict. New factors emerge from time to time and we cannot assess the impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. Any forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q, even if subsequently made available by First Priority on its website or otherwise. First Priority undertakes no obligation to update or revise these statements to reflect events of circumstances occurring after the date of this Quarterly Report on Form 10-Q.

Overview

First Priority was formed May 11, 2007, as the holding company for the Bank pursuant to a reorganization and merger agreement. As part of the reorganization and merger, each outstanding share of the Bank’s common stock and each outstanding warrant to acquire a share of the Bank’s common stock was converted into one share of First Priority common stock and one warrant to acquire one share of First Priority common stock and, as a result, the Bank became a wholly-owned subsidiary of First Priority.

Accordingly, descriptions of balance sheet and income statement items prior to May 11, 2007 represent those of the Bank, and descriptions of balance sheet and income statement items after May 11, 2007 represent the consolidated results of First Priority. The consolidated results of operations and financial condition presented for those periods after the merger date, May 11, 2007, include consolidated results for First Priority and the Bank.

The consolidated balance sheets and related income statements of First Priority are substantially the same as the balance sheets and income statements of the Bank except for the issuance of convertible debentures by First Priority totaling $380 thousand in June and July 2007. Effective August 1, 2008, the Company elected to convert the $403 thousand outstanding balance of debentures, including accrued interest to date, into 39,292 shares of the Company’s common stock, based on the conversion price of $10.25 per share, as described in the “long-term debt” section below.

First Priority issued 976,137 shares of common stock and 195,227 warrants to purchase 195,227 shares of its common stock at a price of $12.50 per share, expiring in October 2012, in the merger transaction which resulted in incremental capital to First Priority of $7.4 million. The acquisition has been accounted for using the purchase method of accounting which requires that the Company’s financial statements include Prestige’s results of operations beginning March 1, 2008.

Like most financial institutions, First Priority derives the majority of its income from interest it receives on its interest-earning assets, such as loans and investments. First Priority’s primary source of funds for making these loans and investments is its deposits, on which First Priority pays interest. Consequently, one of the key measures of First Priority’s success is its amount of net interest income, or the difference between the income on its interest-earning assets and the expense on its interest-bearing liabilities, such as deposits and borrowings, which is called the net interest income. Another key measure is the spread between the yield First Priority earns on these interest-earning assets and the rate paid on its interest-bearing liabilities, which is called its net interest spread.

There are risks inherent in all loans, and First Priority maintains an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. First Priority maintains this allowance by charging a provision for loan losses against its operating earnings. First Priority has included a detailed discussion of this process, as well as several tables describing its allowance for loan losses.

In addition to earning interest on its loans and investments, First Priority earns income through other sources, such as fees and other charges to its customers and income from wealth management services. First Priority describes the various components of this non-interest income, as well as its non-interest expense, in the following discussion.

Critical Accounting Policies

First Priority has adopted various accounting policies that govern the application of accounting principles generally accepted in the United States of America and that are consistent with general practices within the banking industry in the preparation of its consolidated financial statements. First Priority’s significant accounting policies are described in Note 1 of the Notes to the Consolidated Financial Statements as of December 31, 2007, as set forth in First Priority’s 2007 Annual Report to Shareholders, a paper copy of which is available from the SEC.

Certain accounting policies involve significant judgments and assumptions by First Priority that have a material impact on the carrying value of certain assets and liabilities. First Priority considers these accounting policies to be critical accounting policies. The judgment and assumptions First Priority uses are based on historical experience and other factors, which First Priority believes to be reasonable under the circumstances. Because of the nature of the judgments and assumptions First Priority makes, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of its assets and liabilities and its results of operations.

The following is a summary of the policies First Priority recognizes as involving critical accounting estimates: Allowance for Loan Losses, Stock-Based Compensation, Unrealized Gains and Losses on Securities Available for Sale, Goodwill and Deferred Income Taxes.

Allowance for Loan Losses: First Priority maintains an allowance for loan losses at a level management believes is sufficient to absorb estimated probable credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires significant estimates by management. Consideration is given to a variety of factors in establishing these estimates including historical losses, current and anticipated economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ perceived financial and management strengths, the adequacy of underlying collateral, the dependence on collateral, the strength of the present value of future cash flows and other relevant factors. These factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required which may adversely affect First Priority’s results of operations in the future.

Stock-Based Compensation: First Priority recognizes compensation expense for stock options in accordance with SFAS No. 123 (revised 2004, “Share-Based Payment” (SFAS No. 123(R)) adopted at January 1, 2006 under the prospective application method of transition. As a result, options granted prior to January 1, 2006 will generally not be subject to expense. The expense related to options granted after January 1, 2006 is generally measured based on the fair value of the option at the grant date, with compensation expense recognized over the service period, which is usually the vesting period. First Priority utilizes the Black-Scholes option-pricing model (as used under SFAS No. 123(R)) to estimate the fair value of each option on the date of grant. The Black-Scholes model takes into consideration the exercise price and expected life of the option, the current price of the underlying stock and its expected volatility, the expected dividends on the stock and the current risk-free interest rate for the expected life of the option. First Priority’s estimate of the fair value of a stock option is based on expectations

derived from historical experience and may not necessarily equate to its market value when fully vested.

Unrealized Gains and Losses on Securities Available for Sale: First Priority receives estimated fair values of debt securities from independent valuation services and brokers. In developing these fair values, the valuation services and brokers use estimates of cash flows based on historical performance of similar instruments in similar rate environments. Debt securities available for sale are comprised of U.S. government agency securities, federal agency mortgage-backed securities, and other debt securities. First Priority uses various indicators in determining whether a security is other than temporarily impaired, including for equity securities, if the market value is below its cost for an extended period of time with low expectation of recovery or, for debt securities, when it is probable that the contractual interest and principal will not be collected. The debt securities are monitored for changes in credit ratings because adverse changes in credit ratings could indicate a change in the estimated cash flows of the underlying collateral or issuer. As of September 30, 2008, the unrealized losses associated with securities that management has the ability and intent to hold until maturity or market recovery were not considered to be other than temporary, because the unrealized losses were related to changes in interest rates and did not affect the expected cash flows of the underlying collateral or issuer. As of December 31, 2007, there were no unrealized losses associated with securities.

Goodwill: First Priority recognizes goodwill in accordance with the purchase method of accounting. Goodwill represents the excess of the cost of an acquired entity over the fair value of the identifiable net assets acquired. Goodwill is not amortized but is reviewed for potential impairment on an annual basis, or more often if events or circumstances indicate that there may be impairment, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Goodwill is tested for impairment at the reporting unit level and an impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Company employs general industry practices in evaluating the fair value of its goodwill. Any impairment loss related to goodwill and other intangible assets is reflected as other non-interest expense in the statement of income in the period in which the impairment is determined.

Deferred Income Taxes: First Priority provides for deferred income taxes on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and net operating loss carryforwards and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

Recently Issued Accounting Standards

Refer to Note 1 of the Unaudited Consolidated Financial Statements for discussion of recently issued accounting standards.

Results of Operations

Income Statement Review

The Company’s net loss is affected by five major elements: (1) net interest income, or the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowed funds; (2) the provision for loan losses, or the amount added to the allowance for loan losses to provide reserves for inherent losses on loans; (3) non-interest income, primarily income from wealth management services and also fees and other charges to banking customers; (4) non-interest expense, which consists primarily of salaries, employee benefits and other operating expenses, including merger transaction costs; and (5) income taxes, when applicable. Each of these major elements is reviewed in more detail in the following discussion.

Summary

The net loss recorded for the three months ended September 30, 2008 was $794 thousand, or $0.25 per basic and diluted share, compared to a net loss of $498 thousand, or $0.24 per basic and diluted share, for the three months ended September 30, 2007. For the nine months ended September 30, 2008, First Priority reported a net loss of $2.72 million, or $0.95 per basic and diluted share, compared to a net loss of $1.77 million, or $0.84 per basic and diluted share for the same period in 2007.

Total revenue for the third quarter of 2008 was $1.16 million, compared to $800 thousand in the third quarter, 2007, as net interest income in the current quarter was $1.07 million while non-interest income was $86 thousand. Net interest margin averaged 2.35% during the third quarter, 2008 compared to 2.52% a year ago. Total revenue for the first nine months of 2008 was $3.06 million which increased $853 thousand, or 38.6%, from $2.21 million for the same period in 2007 primarily due to increased net interest income resulting from growth in earning assets. Net interest margin for the nine months ended September 30, 2008 averaged 2.36% compared to 2.71% for the same period a year ago.

The provision for loan losses was $127 thousand in the current quarter compared to $87 thousand in the third quarter of 2007. The provision for loan losses for the nine months ended September 30, 2008 was $520 thousand compared to $324 thousand for the same period in 2007, an increase of $196 thousand which resulted from additional loan volume as well as an additional provision for non-accrual loans provided for in the first quarter of 2008.

Non-interest expenses were $1.82 million in the third quarter of 2008 compared to $1.21 million in the same quarter last year. Included in the current quarter are incremental direct operating expenses totaling $349 thousand related to the addition of Prestige, the financial results of which are included in First Priority’s results of operations effective March 1, 2008. For the nine months ended September 30, 2008, non-interest expenses were $5.26 million compared to $3.65 million for the same period in 2007. The increase is related to incremental operating expenses from the Prestige acquisition of $807 thousand as well as increases in business development staff and supporting infrastructure necessary to support loan and deposit growth since the prior year.

Net Interest Income

First Priority’s primary source of revenue is net interest income. Net interest income is determined by the balances of interest-earning assets and interest-bearing liabilities and the interest rates earned and paid on these balances. The amount of net interest income recorded by the Company is affected by the rate and amount of growth of interest-earning assets and interest-bearing liabilities, the amount of interest-earning assets as compared to the amount of interest-bearing liabilities, and by changes in interest rates earned and interest rates paid on these assets and liabilities.

First Priority’s net interest income increased $334 thousand to $1.07 million for the three months ended September 30, 2008 from $735 thousand for the same period in 2007. The increase in net interest income was primarily due to the growth in interest earning assets, as reflected by an increase in average earning assets of 56.8% from $115.7 million to $181.4 million. Average loans outstanding for the three months ended September 30, 2008 were $155.6 million, an increase of 90.9% or $74.1 million from the same period a year ago. Average interest bearing liabilities increased 63.9% from $95.3 million to $156.2 million for the three months ended September 30, 2008 and 2007, respectively, primarily due to increases in time deposits of $61.3 million and borrowed funds of $10.4 million, partially offset by a decline in money market deposit accounts of $11.1 million.

The following table sets forth, for the three months ended September 30, 2008 and 2007 information related to First Priority’s average balances, yields on average assets, and costs of average liabilities. Average balances are derived from the daily balances throughout the periods indicated and yields are derived by dividing annualized income or expense by the average balance of the corresponding assets or liabilities. Average loans are stated net of deferred costs and include non-accrual loans.

Average Balances, Income and Expenses, and Rates


	For the Three Months Ended September 30,
	2008							2007
			Interest							Interest
	Average		Income/		Yield/			Average		Income/		Yield/
	Balance		Expense		Rate			Balance		Expense		Rate
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	155,566	$	2,293		5.86	%	$	81,476	$	1,517		7.39	%
Securities available for sale		24,469		243		3.95	%		7,251		98		5.35	%
Federal funds sold		1,364		6		1.94	%		26,996		347		5.11	%
Deposits with banks and other		42		2		—			5		—		6.73	%

Total interest earning assets		181,441		2,544		5.58	%		115,728		1,962		6.73	%

Non-interest-earning assets		4,544							1,390


TOTAL ASSETS	$	185,985						$	117,118


Interest-bearing liabilities:
Demand, interest-bearing	$	1,150		4		1.43	%	$	871		6		2.58	%
Money market and savings		34,411		252		2.92	%		45,474		566		4.94	%
Time deposits		109,749		1,125		4.08	%		48,466		648		5.31	%
Borrowed funds		10,888		94		3.40	%		517		7		5.26	%

Total interest-bearing liabilities		156,198		1,475		3.76	%		95,328		1,227		5.11	%

Non interest-bearing liabilities:
Demand, non-interest bearing deposits		7,377							4,412
Other liabilities		1,775							1,230

Shareholders’ equity		20,635							16,148


TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	185,985						$	117,118


Net interest income/rate spread			$	1,069		1.82	%			$	735		1.62	%


Net interest margin						2.35	%						2.52	%

Net interest margin declined 17 basis points from 2.52% for the third quarter, 2007 to 2.35% for the same period in 2008. This decline in net interest margin is attributable to overall growth achieved in earning assets, primarily loans, which was generally funded by higher costing deposit products, thereby changing the relative mix of funding sources. Also, as the Company’s balance sheet continues to grow, the positive impact on net interest margin of free funds related to equity and other non-interest bearing funds becomes relatively smaller. In addition, the Bank, as well as the banking industry in general, continues to experience increased competition and market pressures in regards to rates paid on deposits.

The yield on earning assets decreased 115 basis points from 6.73% in the third quarter, 2007 to 5.58% in the third quarter, 2008 which is related to a decline in the prime lending rate. The average overnight targeted federal funds rate declined 318 basis points from 5.18% during the third quarter, 2007 to an average of 2.00% during the third quarter of 2008. The cost related to interest-bearing liabilities decreased from 5.11% in the third quarter, 2007 to 3.76% for the three months ended September 30, 2008. Net interest spread increased from 1.62% in the third quarter 2007 to 1.82% in the third quarter of 2008 due to a favorable shift in the mix of earning assets.

For the nine months ended September 30, 2008, the Company’s net interest income increased $815 thousand to $2.82 million from $2.01 million for the same period in 2007. Average interest earning assets grew $60.8 million to $160.0 million compared to $99.3 million for the first nine months of 2007, primarily related to loans outstanding. Average interest bearing liabilities increased $56.0 million from $79.2 million to $135.3 million when comparing these same periods, primarily due to increases in time deposits of $50.2 million and borrowed funds of $5.6 million.

The following table sets forth, for the nine months ended September 30, 2008 and 2007 information related to First Priority’s average balances, yields on average assets, and costs of average liabilities. Average balances are derived from the daily balances throughout the periods indicated and yields are derived by dividing annualized income or expense by the average balance of the corresponding assets or liabilities. Average loans are stated net of deferred costs and include non-accrual loans.

Average Balances, Income and Expenses, and Rates


	For the Nine months Ended September 30,
	2008							2007
			Interest							Interest
	Average		Income/		Yield/			Average		Income/		Yield/
	Balance		Expense		Rate			Balance		Expense		Rate
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	132,399	$	6,044		6.10	%	$	68,018	$	3,809		7.49	%
Securities available for sale		16,495		497		4.03	%		10,329		415		5.37	%
Federal funds sold		11,107		232		2.80	%		20,880		811		5.20	%
Deposits with banks and other		41		4		—			35		2		—

Total interest earning assets		160,042		6,777		5.66	%		99,262		5,037		6.79	%

Non-interest-earning assets		3,389							1,301


TOTAL ASSETS	$	163,431						$	100,563


Interest-bearing liabilities:
Demand, interest-bearing	$	1,130		13		1.56	%	$	840		14		2.19	%
Money market and savings		38,361		850		2.96	%		38,395		1,428		4.97	%
Time deposits		89,826		2,938		4.37	%		39,607		1,570		5.30	%
Borrowed funds		5,948		152		3.41	%		390		16		5.53	%

Total interest-bearing liabilities		135,265		3,953		3.90	%		79,232		3,028		5.11	%

Non interest-bearing liabilities:
Demand, non-interest bearing deposits		6,515							3,674
Other liabilities		1,860							887

Shareholders’ equity		19,791							16,770


TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	163,431						$	100,563


Net interest income/rate spread			$	2,824		1.76	%			$	2,009		1.68	%


Net interest margin						2.36	%						2.71	%

Net interest margin declined 35 basis points from 2.71% for the first nine months of 2007 to 2.36% for the same period in 2008. This decline in net interest margin is primarily due to a shift in the mix of funding sources as the increase in loans outstanding was funded by higher costing deposit products. In addition, the relative impact of free funds on net interest margin becomes smaller as the overall balance sheet grows. The yield on earning assets decreased 113 basis points from 6.79% for the first nine months of 2007 to 5.66% for the same period in 2008. During this same time, the cost of interest-bearing liabilities decreased from 5.11% for the first nine months of 2007 to 3.90% for the same period of 2008 while net interest spread increased from 1.68% to 1.76% due to a higher level of non-interest bearing funds.

Analysis of Changes in Net Interest Income

Net interest income also can be analyzed in terms of the impact of changing interest rates and changing volume. As noted in the Changes in Net Interest Income Table below, the increased volume of earning assets provided an additional $1.11 million in interest income, primarily related to loan growth, while the increase in interest bearing deposits, primarily deposits, to fund that growth resulted in higher interest expense of $630 thousand when comparing the three months ending September 30, 2008 to the same period in 2007. Changes in rate structure had a negative impact on net interest income of approximately $150 thousand for these same periods.

For the nine months ended September 30, 2008, the impact of higher average levels of earning assets and the required funding to support the asset growth resulted in an overall increase of $1.13 million in net interest income while the impact of lower average rates had a negative impact on net interest income of $315 thousand when comparing these same periods.

The following table sets forth the effect which varying levels of interest-earning assets, interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.


	Changes in Net Interest Income
	Three months ended September									Nine months ended September 30,
	30, 2008 vs. September 30, 2007									2008 vs. September 30, 2007

	Increase (Decrease)									Increase (Decrease)
	Due to Change In									Due to Change In
							Net									Net
	Volume			Rate			Change			Volume			Rate			Change
	(in thousands)									(in thousands)
Interest income:
Loans receivable	$	1,142		$	(366	)	$	776		$	3,052		$	(817	)	$	2,235
Securities available for sale		177			(32	)		145			204			(122	)		82
Federal funds sold		(206	)		(135	)		(341	)		(291	)		(288	)		(579	)
Deposits with banks and other		1			1			2			—			2			2

Total interest earning assets		1,114			(532	)		582			2,965			(1,225	)		1,740


Interest expense:
Demand, interest-bearing		1			(3	)		(2	)		4			(5	)		(1	)
Money market and savings		(117	)		(197	)		(314	)		(1	)		(577	)		(578	)
Time deposits		656			(179	)		477			1,687			(319	)		1,368
Borrowed funds		90			(3	)		87			145			(9	)		136

Total interest bearing liabilities		630			(382	)		248			1,835			(910	)		925


Change in net interest income	$	484		$	(150	)	$	334		$	1,130		$	(315	)	$	815

Provision for Loan Losses

The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses will be maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management’s periodic evaluation of the adequacy of the allowance is based on known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revisions as more information becomes available.

At the end of each quarter or more often, if necessary, First Priority analyzes the collectibility of its loans and accordingly adjusts the loan loss allowance to an appropriate level. The allowance for loan losses covers estimated credit losses on individually evaluated loans that are determined to be impaired, as well as estimated credit losses inherent in the remainder of the loan portfolio. For a description of the process for determining the adequacy of the allowance for loan losses, see the “Allowance for Loan Losses” section below.

The provision for loan losses was $127 thousand and $87 thousand for the three months ended September 30, 2008 and 2007, respectively. One loan relationship remains on non-accrual at September 30, 2008 with an outstanding balance of $709 thousand, a slight decline during the current quarter. For the nine months ended September 30, 2008, the provision for loan losses was $520 thousand compared to $324 thousand for the same period in 2007, an increase of $196 thousand due to additional loan volume between the periods and an additional provision in 2008 related to the aforementioned loan relationship on non-accrual.

During the second half of 2007, First Priority implemented a quantitative and qualitative method to allocating its allowance to the various loan categories based on specific criteria and employed a similar methodology in determining the provision. This methodology resulted in a risk-based calculation of the provision for loan losses in regards to the type of loans booked. Of the $58.5 million net increase in loans during the first nine months of 2008, 73% of this increase was secured primarily by real estate, including residential mortgages, home equity loans and commercial real estate, none of which would be considered sub-prime loans. Net loan growth during the first nine months of 2007 was $38.8 million. Management continues to review and evaluate the allowance for loan losses based on the performance of the loan portfolio.

Non-Interest Income

Non-interest income totaled $86 thousand for the three months ended September 30, 2008 compared to $65 thousand in the third quarter, 2007, and was $236 thousand for the nine months ended September 30, 2008 compared to $198 thousand for the first nine months of 2007. The following table sets forth information related to the various components of non-interest income for each respective period.


	For the three months				For the nine months
	ended September 30,				ended September 30,
	2008		2007		2008		2007
	(in thousands)				(in thousands)
Non-Interest Income
Wealth management fee income	$	47	$	54	$	136	$	160
Service charges on deposits		11		3		23		9
Other branch fees		7		3		21		9
Loan related fees		20		4		50		12
Other		1		1		6		8

Total Non-Interest Income	$	86	$	65	$	236	$	198

Non-interest income is comprised of wealth management fees which are typically non-recurring commissions and fees related to the sale of insurance products and annuities, service charges on deposit accounts, and other fees from its banking customers. A loan referral fee totaling $11 thousand was recorded in the first quarter of 2008.

Non-Interest Expenses

Non-interest expenses were $1.82 million in the third quarter of 2008 compared to $1.21 million in the same quarter last year, an increase of $611 thousand, or 50.5%. For the nine months ended September 30, 2008, non-interest expenses were $5.26 million compared to $3.65 million for the same period in 2007, an increase of $1.61 million, or 44.2%.

The following table sets forth information related to the various components of non-interest expenses for each respective period.


	For the three months				For the nine months
	ended September 30,				ended September 30,
	2008		2007		2008		2007
	(in thousands)				(in thousands)
Non-Interest Expenses
Salaries and employee benefits	$	1,217	$	808	$	3,543	$	2,394
Occupancy and equipment		200		99		505		314
Data processing equipment and operations		90		59		254		171
Professional fees		86		90		275		321
Marketing, advertising and business development		61		43		156		118
FDIC deposit insurance assessments		30		14		83		45
Capital stock tax expense		23		12		67		35
Merger integration costs		—		—		72		—
Other		115		86		308		251

Total Non-Interest Expenses	$	1,822	$	1,211	$	5,263	$	3,649

First Priority’s financial results include the impact of Prestige beginning March 1, 2008. Included in the third quarter of 2008 are incremental direct operating expenses related to Prestige totaling $349 thousand and for the first nine months of 2008, there were $807 thousand of incremental operating expenses due to the acquisition. Conversely, $72 thousand of one-time merger integration costs were recorded as expense in the first half of 2008. Both the current quarter and the nine month period ended September 30, 2008, when compared with the prior year, include additional personnel costs related to incremental business development staff and increased supporting infrastructure costs necessary to support the continued growth of the organization, which occurred throughout the last six months of 2007 and the first half of 2008.

Salaries and employee benefits totaled $1.22 million for the third quarter of 2008 compared to $808 thousand for the same period in 2007, an increase of $409 thousand, or 50.6%, and increased $1.15 million, or 48.0%, for the first nine months of 2008 from $2.39 million to $3.54 million when compared to the same period in 2007. The incremental salaries and benefits related to the addition of Prestige was $227 thousand for the third quarter and $549 thousand for the first nine months of 2008. In addition, both the current quarter and the first nine months of 2008 include additional costs of staff additions and related benefits required to support asset growth, developing geographic and customer reach, and market expansion through the opening of the Wyomissing office in March 2007 and the addition of Prestige in March 2008.

Occupancy and equipment expenses were $200 thousand in the third quarter, 2008 compared to $99 thousand for the same period in the prior year, an increase of $101 thousand, or 102.0%. For the first nine months of 2008, occupancy and equipment expenses increased $191 thousand or 60.8% from $314 thousand to $505 thousand from the prior year. The incremental expense related to Prestige was $94 thousand for the third quarter and $196 thousand for the first nine months of 2008.

Data processing expenses increased by $31 thousand, or 52.5%, for the three months ended September 30, 2008 to $90 thousand compared to $59 thousand for the same period in 2007, and increased $83 thousand, or 48.5%, from $171 thousand to $254 thousand when comparing the first nine months of 2008 to the same period in the prior year. These increases are primarily related to the increased cost of outsourced processing resulting from increased customer activity of the Bank.

Professional fees decreased $4 thousand, or 4.4%, to $86 thousand for the third quarter of 2008 from $90 thousand in the third quarter, 2007. This decrease relates to costs for human resource consulting and search fees of $28 thousand to expand the business development staff incurred during the third quarter of 2007, partially offset by increased auditing and compliance fees totaling $26 thousand. For the first nine months of 2008, professional fees were $275 thousand compared to $321 thousand for the same period in 2007, a decrease of $46 thousand or 14.3%. The first nine months of 2007 included human resource consulting and search fees of $55 thousand, legal fees related to the formation of the bank holding company of $65 thousand, and a higher level of marketing consulting expenses of $19 thousand. The first half of 2008 includes incremental audit and accounting fees of $79 thousand, partially due to additional filing and reporting requirements of becoming a public company.

Marketing, advertising and business development costs increased $18 thousand, from $43 thousand to $61 thousand, when comparing the three months ended September 30, 2008 and 2007, respectively, and increased $38 thousand, or 32.2%, for the first nine months of 2008 compared to the prior year, from $118 thousand to $156 thousand. These increases reflect additional advertising costs related to promoting deposit products as well as business promotion expense to develop the First Priority name within the Bucks County market.

FDIC insurance assessment expense increased $16 thousand, or 114.3%, from $14 thousand to $30 thousand when comparing the third quarter of 2008 to the same period in the prior year and increased $38 thousand or 84.4% from $45 thousand to $83 thousand for the first nine months of 2008 and 2007, respectively. This assessment is calculated based on the amount and type of deposits an institution maintains. The increase in cost is attributed to First Priority’s growth in its deposit base.

Capital stock tax expense was $23 thousand for the third quarter of 2008 compared to $12 thousand in the same quarter last year and was $67 thousand for the first nine months of 2008 compared to $35 thousand for the same period in 2007.

Merger integration costs, totaling $72 thousand, were recorded in the first six months of 2008 primarily related to system conversion costs to integrate Prestige onto First Priority’s core banking system.

All other expenses increased $29 thousand to $115 thousand for the three months ended September 30, 2008 from $86 thousand for the same period in 2007 and were $308 thousand for the first nine months of 2008, an increase of $57 thousand, or 22.7% from $251 thousand for same period in 2007. Contributing to this increase are additional expenses related to filing requirements of the Securities and Exchange Commission as well as increased loan origination expenses, correspondent bank charges and other administrative expenses.

Management continues to recognize the importance of expense awareness and controlling operating expenses to improve profitability; however, management continues to be committed to retaining key asset generation and operational staff, exploring and implementing a professional marketing program, and maintaining excellent customer service. Proper implementation and management of these items will assist in achieving the goal of continued asset growth, maintaining credit quality, and efficient operations.

Provision for Income Taxes

There is no provision for income taxes for the three and nine months ended September 30, 2008 or 2007 due to the net operating losses incurred. Deferred income taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Because First Priority has not yet achieved profitability, management has recorded a valuation allowance in the full amount of its deferred tax asset. To satisfy the “more likely than not” criteria required to reduce the valuation allowance, First Priority would need to become profitable and demonstrate that a consistent positive trend of profitability is sustainable.

Financial Condition

Balance Sheet Review

Overview

As of September 30, 2008, First Priority had total assets of $198.7 million, an increase of 31.1% over total assets of $151.6 million on December 31, 2007. Total assets at September 30, 2008, consisted primarily of loans outstanding of $163.7 million and investment securities available for sale of $29.7 million. At December 31, 2007, total assets consisted principally of loans outstanding of $105.2 million and investment securities available for sale of $45.0 million. The Company maintained a restricted investment in bank stock of $1.15 million at September 30, 2008, consisting primarily of stock of the Federal Home Loan Bank of Pittsburgh (“FHLB”) in proportion to the Bank’s outstanding debt to the FHLB. Premises and equipment were $1.37 million, an increase of $792 thousand during the first nine months of 2008, principally resulting from the addition of the two Prestige branches. Goodwill of $1.19 million was also recorded in connection with the acquisition during the first quarter of 2008. See Note 2 “Acquisition of Prestige Community Bank.”

Total deposits at September 30, 2008, were $159.5 million compared to $116.3 million at December 31, 2007. Deposits consisted principally of money market accounts and certificates of deposit, which at September 30, 2008 were $33.3 million and $116.5 million, respectively, compared to $45.4 million and $62.6 million at December 31, 2007, respectively. Short-term borrowings were $2.2 million at September 30, 2008 compared to $18.1 million at December 31, 2007 while long-term debt was $8.0 million at the end of the current quarter compared to $390 thousand at December 31, 2007.

Other liabilities were $7.7 million as of September 30, 2008 compared to $641 thousand at December 31, 2007. The increase of $7.0 million was due to investment securities purchased with a trade date prior to September 30, 2008 which did not settle until October 2008.

Investments

On September 30, 2008 and December 31, 2007, First Priority’s investment securities portfolio of $29.7 million, and $45.0 million, respectively, represented approximately 15.3% and 30.0%, respectively, of total interest-earning assets. As of September 30, 2008, First Priority was invested in U.S. Government agency securities, federal agency mortgage-backed securities and corporate bonds, all of which were rated AAA, were highly marketable, and were classified as available for sale with an amortized cost of $29.9 million for an unrealized loss of $178 thousand. As of December 31, 2007, all investments were in U.S. Government agency securities and federal agency mortgage-backed securities, were rated AAA, were highly marketable, and were classified as available for sale with an amortized cost of $45.0 million for an unrealized gain of $11 thousand. At December 31, 2007, First Priority increased its investment portfolio by $18.1 million as part of a tax planning program instituted to lower the impact of the Pennsylvania Bank Shares tax. These investments were funded by incremental short-term borrowings.

The following tables set forth information about the maturities and weighted average yields on First Priority’s investment securities as of September 30, 2008 and December 31, 2007.


	As of September 30, 2008
						After one but					After five but
	Within 1 year					within five years					within ten years					Over ten years					Total
	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
	(Dollars in thousands)
U.S. Government agency securities	$	4,984		2.69	%	$	13,005		3.64	%	$	—		—		$	—		—		$	17,989		3.37	%
Mortgage-backed securities		—		—			—		—			936		4.75	%		9,896		5.07	%		10,832		5.04	%

Other securities		—		—			927		4.00	%		—		—			—		—			927		4.00	%

Total investments available for sale	$	4,984		2.69	%	$	13,932		3.66	%	$	936		4.75	%	$	9,896		5.07	%	$	29,748		4.00	%


	As of December 31, 2007
						After one but					After five but
	Within 1 year					within five years					within ten years				Over ten years					Total
	Amount		Yield			Amount		Yield			Amount		Yield		Amount		Yield			Amount		Yield
	(Dollars in thousands)
U.S. Government agency securities	$	38,995		3.54	%	$	2,003		5.13	%	$	—		—	$	—		—		$	40,998		3.62	%
Mortgage-backed securities		—		—			—		—			—		—		4,028		5.26	%		4,028		5.26	%

Total investments available for sale	$	38,995		3.54	%	$	2,003		5.13	%	$	—		—	$	4,028		5.26	%	$	45,026		3.76	%

The amortized cost and fair value of First Priority’s investments (all available for sale) as of September 30, 2008 and December 31, 2007 are shown in the following table:


	September 30, 2008				December 31, 2007
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
	(Dollars in thousands)
U.S. Government agency securities	$	18,000	$	17,989	$	40,995	$	40,998
Mortgage-backed securities		10,926		10,832		4,020		4,028

Other securities		1,000		927		—		—


Total Investments	$	29,926	$	29,748	$	45,015	$	45,026

Restricted investments in bank stocks

As of September 30, 2008 and December 31, 2007, the Bank had an investment of $50 thousand in restricted bank stock of Atlantic Central Bankers Bank, Camp Hill, Pennsylvania, representing a required investment in the common stock of the correspondent bank which is carried at cost.

In addition, the Bank is also required to maintain an investment in the stock of the FHLB according to a predetermined formula as set forth in the FHLB’s Capital Plan. This required investment in FHLB stock fluctuates in proportion to the Bank’s outstanding debt to the FHLB and is carried at cost. As debt is repaid, stock held in excess of the minimum requirement is periodically adjusted and refunded. At September 30, 2008, the investment in FHLB stock totaled $1.10 million.

Loans

First Priority’s loan portfolio is the primary component of its assets. At September 30, 2008, total loans were $163.7 million, an increase of $58.5 million, or 55.6%, from $105.2 million at December 31, 2007. Included in the loan balances at December 31, 2007 was a short-term commercial loan made to Prestige which was used for a year-end tax planning program. This loan was paid off in early January, 2008. The overall growth in the loan portfolio for the first nine months of 2008 is partially due to the acquisition of Prestige, which had $5.8 million in loans at February 29, 2008, the effective date of the acquisition.

The following table sets forth the classification of First Priority’s loan portfolio at September 30, 2008 and December 31, 2007.


	September 30, 2008					December 31, 2007
			Percent					Percent
	Amount		of total			Amount		of total
	(Dollars in thousands)
Commercial	$	45,887		28	%	$	33,506		32	%
Commercial Real Estate		46,548		28	%		24,590		23	%
Residential Real Estate		37,105		23	%		23,708		23	%
Consumer		34,117		21	%		23,310		22	%


Total Loans		163,657		100	%		105,114		100	%

Net deferred loan costs		34		—			93		—


Total	$	163,691		100	%	$	105,207		100	%

Commercial loans are made for the purpose of providing working capital, financing the purchase of equipment or inventory, and for other business purposes. Real estate loans consist of loans secured by commercial or residential real property and loans for the construction of commercial or residential property. Consumer loans are made for the purpose of financing the purchase of consumer goods, home improvements, and other personal needs, and are generally secured by the personal property.

Due to the length of time First Priority’s portfolio has existed, the current mix of the loan portfolio may not be indicative of the ongoing portfolio mix. First Priority does not generally originate traditional long-term residential mortgages. Generally, First Priority limits the loan-to-value ratio on loans it makes to 80% and attempts to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral.

Commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. The payment experience of such loans is typically dependent upon the successful operation of the real estate project. These risks can be significantly affected by supply and demand conditions in the market for office and retail space and for apartments and, as such may be subject, to a greater extent, to adverse conditions in the economy. In dealing with these risk factors, First Priority generally limits itself to a real estate market or to borrowers with which First Priority has experience. First Priority generally concentrates on originating commercial real estate loans secured by properties located within its market area. In addition, many of First Priority’s commercial real estate loans are secured by owner-occupied property with personal guarantees for the debt.

The information in the following tables is based on the contractual maturities of individual loans, including loans that may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon their maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.

The following tables summarize the loan maturity distribution by type and related interest rate characteristics as of September 30, 2008 and December 31, 2007.


	At September 30, 2008
	Maturities of Outstanding Loans
				After 1 But
	Within 1			Within 5			After 5
	Year			Years			Years			Total Loans
	(Dollars in thousands)
Commercial	$	30,840		$	12,453		$	2,594		$	45,887
Commercial Real Estate		9,434			24,912			12,202			46,548
Residential Real Estate		626			11,300			25,179			37,105
Consumer		11,965			5,975			16,177			34,117


Total Loans	$	52,865		$	54,640		$	56,152		$	163,657


Percentage composition of maturity		32	%		34	%		34	%		100	%

Loans with fixed predetermined interest rates	$	6,986		$	39,763		$	8,720		$	55,469
Loans with variable or floating interest rates		45,879			14,877			47,432			108,188


Total Loans	$	52,865		$	54,640		$	56,152		$	163,657


	At December 31, 2007
	Maturities of Outstanding Loans
				After 1 But
	Within 1			Within 5			After 5
	Year			Years			Years			Total Loans
	(Dollars in thousands)
Commercial	$	21,387		$	12,069		$	50		$	33,506
Commercial Real Estate		3,371			14,306			6,913			24,590
Residential Real Estate		832			10,751			12,125			23,708
Consumer		8,478			3,614			11,218			23,310


Total Loans	$	34,068		$	40,740		$	30,306		$	105,114


Percentage composition of maturity		32	%		39	%		29	%		100	%

Loans with fixed predetermined interest rates	$	2,330		$	35,678		$	5,602		$	43,610
Loans with variable or floating interest rates		31,738			5,062			24,704			61,504


Total Loans	$	34,068		$	40,740		$	30,306		$	105,114

Credit Quality

First Priority Bank’s written lending policies require specified underwriting, loan documentation and credit analysis standards to be met prior to funding, with independent credit department approval for the majority of new loan balances. The Credit Policy Committee is comprised of senior members of management who oversee the loan approval process to monitor that proper standards are maintained.

The accrual of interest on loans is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on non-accrual loans is generally either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

The following table summarizes loan delinquency and other non-performing assets at the dates indicated.


	September 30,			December 31,			September 30,
	2008			2007			2007
	(Dollars in thousands)
Loans past due 90 days or more and still accruing interest	$	—		$	—		$	—
Non-accrual loans		709			—			—

Total non-performing loans (1)		709			—			—
Other real estate owned		—			—			—


Total non-performing assets (2)	$	709		$	—		$	—


Non-performing loans as a percentage of total loans		0.43	%		—			—
Non-performing assets as a percentage of total assets		0.36	%		—			—
Ratio of allowance to non-performing loans at end of period		241	%		—			—
Ratio of allowance to non-performing assets at end of period		241	%		—			—
Allowance for loan losses as a percentage of total loans		1.04	%		1.00	%		1.07	%


(1)		Non-performing loans are comprised of (i) loans that are on a non-accrual basis; (ii) accruing loans that are 90 days or more past due and (iii) restructured loans.

(2)		Non-performing assets are comprised of non-performing loans and other real estate owned (assets acquired in foreclosure).

Asset quality remains acceptable compared to the industry’s averages. Non-accrual loans totaled $709 thousand at September 30, 2008 which represents 0.43% of total loans outstanding. The balance of non-accrual loans is the result of a single loan relationship which was categorized as impaired during the first quarter of 2008. The Bank’s management continues to monitor and explore potential options and remedial actions to recover the Bank’s investment in these loans. According to policy, the Bank is required to maintain a specific reserve for impaired loans. See the Allowance for Loan Losses section below for further information.

As of September 30, 2008, the Bank had one potential problem loan relationship with balances outstanding of $4.1 million, including one residential real estate loan, one loan fully-secured by a certificate of deposit and four commercial notes, with payments past due. Subsequently, these loans have been paid in full or have been brought current as to all payments due and have a current balance outstanding of $3.1 million.

Allowance for Loan Losses

The allowance for loan losses represents an amount that First Priority believes will be adequate to absorb estimated probable credit losses on existing loans that may become impaired. The allowance is established through charges to earnings in the form of a provision for loan losses. While First Priority applies the methodology discussed below in connection with the establishment of the allowance for loan losses, the allowance is subject to critical judgments on the part of management. Loan losses are charged directly to the allowance when they occur and any recovery is credited to the allowance.

Risks within the loan portfolio are analyzed on a continuous basis by the Bank, by an external independent loan review function, and by the Audit Committee of the Board of Directors. A risk system, consisting of multiple grading categories, is utilized as an analytical tool to assess risk and appropriate allowances. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management believes deserve recognition in establishing an appropriate allowance. These estimates are reviewed at least quarterly by the Bank’s Credit Policy Committee and by the Audit Committee of the Board of Directors, and, as adjustments become necessary, they are realized in the periods in which they become known.

During 2007, First Priority implemented a quantitative and qualitative method to allocating its allowance to the various loan categories. An unallocated component, which is maintained to cover uncertainties that could affect management’s estimate of probable losses, reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Since the Bank is a relatively new banking organization with limited operating history and relatively new credits, a relatively larger portion of the allowance is unallocated to specific loans or loan categories compared to more seasoned financial institutions.

Additions to the allowance are generally made by provisions charged to expense and the allowance is reduced by net charge-offs, which are loans judged to be impaired, less any recoveries on loans previously charged off. During the first quarter of 2008, the allowance was also increased due to the acquired allowance for loan losses related to the business combination with Prestige totaling $150 thousand. In regard to the acquisition, the Company determined that there were no material purchase accounting adjustments needed with respect to SOP 03-03, “Accounting for Certain Loans and Debt Securities Acquired in a Transfer.”

Management considers the allowance for loan losses to be adequate as of September 30, 2008 based on current information available; however, future additions to the allowance may be required due to the growth of the loan portfolio, changes in asset quality, changes in market conditions and other factors. Additionally, various regulatory agencies periodically review the allowance for loan losses. These agencies may require additional provisions based upon their judgment about information available to them at the time of their examination. Although management uses what it believes to be the best information available, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and short term change.

The following table sets forth the changes in the allowance for loan losses for the periods indicated:


	For the three months						For the nine months
	ended September 30,						ended September 30,
	2008			2007			2008			2007
	(Dollars in thousands)						(Dollars in thousands)
Balance at the beginning of period	$	1,582		$	871		$	1,055		$	634


Charge-offs:
Commercial		—			—			1			—
Commercial real estate		—			—			15			—

Net loans charged off		—			—			16			—

Acquired reserve in business combination		—			—			150			—
Provision charged to operations		127			87			520			324

Balance at end of period	$	1,709		$	958		$	1,709		$	958


Average loans (1)	$	155,566		$	81,476		$	132,399		$	68,018


Ratio of net charge-offs during period to average loans outstanding during period (annualized) (1)		—			—			0.02	%		—
Allowance for loan losses as a percentage of total loans		1.04	%		1.07	%		1.04	%		1.07	%


(1)		Includes non-accrual loans

Total charge-offs recorded during the nine months ended September 30, 2008 were $16 thousand related to unpaid interest accrued in prior years for loans placed into a non-accrual status during the current year.

The following table sets forth the allocation of the allowance for loan losses by loan category.


	September 30, 2008					December 31, 2007					September 30, 2007
			Percent of					Percent of					Percent of
			loans in					loans in					loans in
			each					each					each
			category to					category to					category to
	Amount		total loans			Amount		total loans			Amount		total loans
	(Dollars in thousands)
Commercial	$	588		28	%	$	94		32	%	$	71		28	%
Commercial Real Estate		243		28	%		81		23	%		65		22	%
Residential Real Estate		165		23	%		43		23	%		42		26	%
Consumer		56		21	%		39		22	%		36		24	%


Total Allocated		1,052		100	%		257		100	%		214		100	%

Unallocated		657					798					744


Total	$	1,709				$	1,055				$	958

The specific allocations of the allowance for loan losses in any particular category may be reallocated in the future to reflect then current conditions. Accordingly, management considers the entire allowance to be available to absorb losses in any category.

Loan Concentrations

First Priority’s loans consist of credits to borrowers spread over a broad range of industrial classifications. First Priority’s largest concentration of loans is to lessors of residential buildings and dwellings. These loans totaled $22.6 million at September 30, 2008, or 13.8% of the total loans outstanding at September 30, 2008. These credits were subject to First Priority’s normal underwriting standards and did not present more than the normal amount of risk assumed by First Priority’s other lending activities. Management believes this concentration does not pose abnormal risk when compared to the risk it assumes in other types of lending. First Priority has no other concentration of loans which exceeds 10% of total loans.

Deposits

First Priority’s primary source of funds for loans and investments is its deposits. At September 30, 2008, total deposits were $159.5 million, an increase of $43.2 million, or 37.1%, from $116.3 million at December 31, 2007. First Priority attracts deposits by offering competitive interest rates on deposit products and supplements deposits raised in the local market with brokered certificates of deposit. At September 30, 2008 and December 31, 2007, First Priority had $26.1 million and $9.1 million, respectively, in brokered certificates of deposits. The guidelines governing First Priority’s participation in brokered CD programs are included in its Asset Liability Management Policy, which is reviewed, revised and approved annually by the Asset Liability Management Committee and the Board of Directors.

The following table summarizes First Priority’s deposit classification at the dates indicated.


	September 30,		December 31,
	2008		2007
	(in thousands)
Demand, non-interest bearing	$	8,758	$	6,846

Demand, interest bearing		863		1,486
Money market and savings deposits		33,320		45,403
Time		116,517		62,570

Total interest bearing deposits		150,700		109,459


Total deposits	$	159,458	$	116,305

Core deposits, which exclude time deposits of $100,000 or more, provide a relatively stable funding source for First Priority’s loan portfolio and other interest-earning assets. First Priority’s core deposits were $127.9 million and $94.7 million as of September 30, 2008, and December 31, 2007, respectively. The maturity distribution of its time deposits of $100,000 or more as of September 30, 2008, is as follows:


	September 30,
	2008
	(In thousands)
Three Months or Less	$	7,897
Over Three Through Nine months		5,810
Over Six Through Twelve Months		8,371
Over Twelve Months		9,495

Total time deposits of $100,000 or more	$	31,573

Other Interest-Bearing Liabilities

Short-Term Borrowed Funds

First Priority Bank had short-term borrowed funds outstanding as of December 31, 2007 as part of a tax-planning strategy to reduce the Pennsylvania Bank Shares tax. Proceeds from these borrowings are invested in short-term U.S. government securities.

In addition, at September 30, 2008, the Bank had secured borrowing capacity at the FHLB. As a de novo bank, the Bank is required to deliver collateral to support borrowings. Based on the available qualifying collateral and margin requirements, the Bank’s unused borrowing capacity exceeded $50 million at September 30, 2008. Collateral would consist primarily of qualifying investments and loans secured by 1-4 family residential mortgages.

Short-term borrowings outstanding as of September 30, 2008 totaled $2.2 million and consisted of overnight borrowings under customer repurchase agreements. Investment securities pledged as collateral to secure these borrowings totaled $2.5 million. At December 31, 2007, short-term borrowings totaled $18.1 million, consisting of $2.0 million of unsecured borrowings and $16.0 million of secured borrowings under lines of credit with correspondent banks, secured by collateral pledged of $16.3 million, and $0.1 million outstanding under customer repurchase agreements.

Long-Term Debt

FHLB advances at September 30, 2008 totaled $8 million with a weighted average interest rate of 4.08%. The advances are collateralized by FHLB stock and certain first mortgage loans and mortgage backed securities. First Priority Bank became a member of FHLB in March 2008. Advances are made pursuant to several different credit programs offered from time to time by the FHLB.

The Notes provided that the Debentures would automatically convert into shares of the Company’s common stock, $1.00 par value per share (“Common Stock”), immediately prior to the consummation of a Qualified Offering consisting of either a public offering or a private offering pursuant to Regulation D, promulgated under the Securities Act of 1933, of Common Stock resulting in aggregate net proceeds of at least $4 million.

In addition, both payee and maker of the Debenture had the right to convert the Debentures into Common Stock after one year from issuance at an initial conversion price of $10.25 per share, which First Priority exercised effective August 1, 2008. The numbers of shares of Common Stock would be determined based on the offer price at time of offering.

Capital Resources

The Pennsylvania Department of Banking, in issuing its charter to First Priority Bank, required an allocation of its initial capital to an expense fund in the amount of $750 thousand to defray anticipated initial losses. Accordingly, $750 thousand of First Priority Bank’s surplus is reserved for this purpose until First Priority Bank becomes profitable.

Total shareholders’ equity amounted to $20.3 million and $15.3 million on September 30, 2008 and December 31, 2007, respectively. The increase of $5.0 million resulted from incremental equity related to the Prestige acquisition of $7.4 million and the issuance of common stock in regards to the convertible debentures of $403 thousand, which the Company elected to convert effective August 1, 2008 as described in the“Long-Term Debt”section above. The incremental equity was reduced by the net loss recorded of $2.7 million during the first nine months of 2008. The net unrealized gain (loss) on securities available for sale, recorded to reflect the aggregate net change in the fair value of available for sale securities was an unrealized loss of $178 thousand at September 30, 2008 and an unrealized gain of $11 thousand at December 31, 2007.

First Priority uses securities available for sale to pledge as collateral to secure certain deposits and for other purposes required or permitted by law, including collateral for certain short-term borrowings. See the “Liquidity” section for a more detailed discussion on available liquidity sources. First Priority currently believes that it will have sufficient cash flow to fund ongoing operations.

First Priority Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet the minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on First Priority Bank’s financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, First Priority Bank must meet specific capital guidelines that involve quantitative measures of First Priority Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. First Priority Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors.

First Priority Bank exceeds the minimum capital requirements established by regulatory agencies. Under the capital adequacy guidelines, capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets plus trust preferred securities up to 25% of Tier 1 capital with the excess being treated as Tier 2 capital. Tier 2 capital also consists of the allowance for loan losses subject to certain limitations and qualifying subordinated debt. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed inherent in the type of asset.

Quantitative measures established by regulation to ensure capital adequacy require First Priority Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets and of Tier 1 capital to average assets which is known as the Tier 1 leverage ratio. In addition, The Federal Deposit Insurance Corporation requires that First Priority Bank maintain a ratio of Tier 1 leverage capital to total assets of at least 8% during the first three years of operation. Under the capital guidelines, First Priority Bank must maintain a minimum total risk-based capital of 8%, with at least 4% being Tier 1 capital. In addition, First Priority Bank must maintain a minimum Tier 1 leverage ratio of at least 8%. To be considered “well-capitalized,” First Priority Bank must maintain total risk-based capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 8%.

First Priority was formed May 11, 2007 under an agreement of reorganization and merger which provided that First Priority Bank become a wholly-owned subsidiary of First Priority. The following table sets forth the Bank’s capital ratios for September 30, 2008 and December 31, 2007. For all periods, First Priority Bank was considered “well-capitalized” and First Priority Bank met or exceeded its applicable regulatory requirements.


							To Be
	As of			As of			Considered
	September 30,			December 31,			“Well-
	2008			2007			Capitalized”
First Priority Bank:
Total risk-based capital ratio		13.56	%		16.01	%		10.00	%
Tier 1 risk-based capital ratio		12.43	%		14.98	%		6.00	%
Tier 1 leverage ratio		10.26	%		12.30	%		8.00	%

First Priority is exempt from the risk-based capital guidelines as it qualifies for an exemption under the provisions of the “Small Bank Holding Company Policy Statement” of the Board of Governors of the Federal Reserve System which exempts holding companies with total assets of less than $500 million that meet certain eligibility criteria from the risk-based capital requirements.

The change in First Priority Bank’s capital ratios from December 31, 2007 to September 30, 2008 is due to the incremental capital provided through the acquisition of Prestige, net of goodwill, totaling $6.2 million reduced by the net loss recorded of $2.7 million during the first nine months of 2008. For purposes of calculating risk-based capital ratios, the positive impact of the increase in capital is more than offset by the growth achieved in the balance sheet which results in an increase in both risk-weighted assets and average total assets for the period ended September 30, 2008. The incremental capital provided from the acquisition will be used for general corporate purposes of First Priority Bank, including, among other things, to provide additional capital to support asset growth and the expansion of market presence.

The Emergency Economic Stabilization Act of 2008, signed into law on October 3, 2008, provides authority to the United States Department of Treasury (“Treasury”) to, among other things, purchase up to $700 billion of mortgages, mortgage backed securities and certain other financial instruments from financial institutions. On October 14, 2008, the Treasury announced it will offer to qualifying U.S. banking institutions the opportunity to issue and sell preferred stock, along with warrants to purchase common stock, to the Treasury on what may be considered attractive terms under the Troubled Asset Relief Program Capital Purchase Program (the “Program”). Although First Priority’s capital ratios remain well above the minimum levels required for well capitalized status, it is currently evaluating the Program. In addition, the FDIC has initiated the Temporary Liquidity Guarantee Program that will provide a 100 percent guarantee for a limited period of time to newly issued senior unsecured debt and non-interest bearing transaction deposits. Coverage under the Temporary Liquidity Guarantee Program is available for 30 days without charge and thereafter at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for non-interest bearing transaction deposits. Management is currently evaluating the Temporary Liquidity Guarantee Program.

Since their inception, neither First Priority Bank nor First Priority has paid cash dividends on its common stock. First Priority’s ability to pay cash dividends is dependent on receiving cash in the form of dividends from First Priority Bank. However, certain restrictions exist regarding the ability of First Priority Bank to transfer funds to First Priority in the form of cash dividends. All dividends are currently subject to prior approval of the Pennsylvania Department of Banking and the FDIC and are payable only from the undivided profits of First Priority Bank. Because the Bank has not yet achieved profitability, at September 30, 2008, the Bank had no undivided profits.

Effect of Inflation and Changing Prices

The effect of relative purchasing power over time due to inflation has not been taken into effect in First Priority’s consolidated financial statements. Rather, the statements have been prepared on a historical cost basis in accordance with accounting principles generally accepted in the United States of America.

Unlike most industrial companies, the assets and liabilities of financial institutions, such as First Priority and First Priority Bank, are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on its performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. First Priority seeks to manage the relationships between interest-sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.

Off-Balance Sheet Arrangements

Through the operations of First Priority Bank, First Priority has made contractual commitments to extend credit in the ordinary course of its business activities to meet the financing needs of customers. Such commitments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the balance sheets. These commitments are legally binding agreements to lend money at predetermined interest rates for a specified period of time and generally have fixed expiration dates or other termination clauses. The same credit and collateral policies are used in making these commitments as for on-balance sheet instruments. Each customer’s creditworthiness is evaluated on a case-by-case basis and collateral is obtained, if necessary, based on the credit evaluation of the borrower.

As of September 30, 2008 and December 31, 2007, First Priority had issued commitments to extend credit of $38.3 million and $26.1 million, respectively, through various types of commercial and consumer lending arrangements, of which the majority are at variable rates of interest. First Priority believes that it has adequate sources of liquidity to fund commitments that may be drawn upon by borrowers.

First Priority is not involved in any other off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that could significantly impact earnings.

Liquidity

The objective of liquidity management is to assure that sufficient sources of funds are available as needed and at a reasonable cost to meet the ongoing and unexpected operational cash needs and commitments of First Priority and to take advantage of income producing opportunities as they arise. Sufficient liquidity must be available to meet the cash requirements of depositors wanting to withdraw funds and of borrowers wanting their credit needs met. Additionally, liquidity is needed to insure that First Priority has the ability to act at those times when profitable new lending and/or investment opportunities arise. While the desired level of liquidity may vary depending upon a variety of factors, it is a primary goal of First Priority to maintain strong liquidity in all economic environments through active balance sheet management.

Liquidity management is the ongoing process of monitoring and managing First Priority’s sources and uses of funds. The primary sources of funds are deposits, scheduled amortization of loan principal, maturities of investment securities and funds provided by operations. While scheduled loan payments and investment maturities are relatively predictable sources of funds, deposit flows and loan prepayments are far less predictable and are influenced by general interest rates, economic conditions and competition. First Priority measures and monitors its liquidity position on a frequent basis in order to better understand, predict and respond to balance sheet trends. The liquidity analysis encompasses a review of anticipated changes in loan balances, investments securities, core deposits and borrowed funds over a three month, six month and one year period.

As of September 30, 2008 and December 31, 2007, First Priority’s liquid assets, consisting of cash and due from banks, interest bearing deposits of other banks, Federal funds sold and unencumbered short-term Federal agency discount notes, totaled $2.0 million and $19.7 million, respectively, representing 1.0% and 13.1% of total assets. The decline in liquid assets was accompanied by an increase in the Bank’s borrowing capacity.

At September 30, 2008, the Bank had secured borrowing capacity at the FHLB. As a de novo bank, the Bank is required to deliver collateral to support any borrowings. Based on the available qualifying collateral and margin requirements, the Bank’s unused borrowing capacity exceeded $50 million at September 30, 2008. Collateral would consist primarily of qualifying investments and loans secured by 1-4 family residential mortgages.

In addition, First Priority maintains short term borrowing facilities that can be accessed for incremental funding. As of September 30, 2008 First Priority had available for borrowing: a $2 million unsecured Federal funds borrowing facility and an $8 million secured Federal funds borrowing facility, each facility provided by correspondent banks.

Contractual Obligations

The Bank utilizes a variety of deposit products and short-term borrowings to supplement its supply of lendable funds, to assist in meeting deposit withdrawal requirements, and to fund growth of interest-earning assets in excess of traditional deposit growth. Brokered certificates of deposit, unused borrowing capacity at the FHLB, correspondent bank lines of credit, and repurchase agreements serve as the primary sources of such funds.

Obligations under non-cancelable operating lease agreements are payable over multiple years and expire intermittently in the years 2016 through 2027. Management does not believe that any existing non-cancelable operating lease agreements are likely to materially impact the Company’s financial condition or results of operations in an adverse way.

The following table provides payments due by period for obligations under long-term borrowings and operating lease obligations as of September 30, 2008.


	Payments Due by Period
			Over 1		Over 2		Over 3
	Within 1		through 2		through 3		through 5		Over 5
	Year		Years		Years		Years		Years		Total
	(In thousands)
Time deposits	$	80,524	$	12,775	$	17,041	$	6,177	$	—	$	116,517
Operating lease obligations		459		459		459		918		2,832		5,127
Long-term debt		—		—		—		8,000		—		8,000
Short-term borrowings		2,201		—		—		—		—		2,201
Accrued interest payable		1,094		—		—		—		—		1,094


Total	$	84,278	$	13,234	$	17,500	$	15,095	$	2,832	$	132,939

Item 3. Quantitative and Qualitative Disclosures about Market Risk

As a smaller reporting company, the Company is not required to provide the information otherwise required by this item.

Item 4T. Controls and Procedures

Under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a — 15(e) and 15d — 15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that, as of the end of such period, these disclosure controls and procedures are effective.

There were no changes in First Priority’s internal control over financial reporting during the third quarter of 2008 that have materially affected, or are reasonably likely to materially affect, First Priority’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

None.

Item 1A. Risk Factors

As a smaller reporting company, the Company is not required to provide the information otherwise required by this Item.

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

The Company issued convertible subordinated debentures (“Debentures”), 5.30% in June and July 2007 due June 21, 2012, to provide operating capital within the bank holding company. The Company’s directors and management were the purchasers of the Notes. Effective August 1, 2008, the Company elected to convert the $403 thousand outstanding balance of Debentures, including accrued interest to date, into 39,292 shares of the Company’s Common Stock, based on the conversion price of $10.25 per share. Due to the conversion, no additional proceeds were provided from this transaction. The shares issued were not registered.

The Debentures provided for an automatic conversion into shares of the Company’s common stock, $1.00 par value per share (“Common Stock”), immediately prior to the consummation of a Qualified Offering consisting of either a public offering or a private offering pursuant to Regulation D, promulgated under the Securities Act of 1933, of Common Stock resulting in aggregate net proceeds of at least $4 million. In addition, both payee and maker of the Debenture had the right to convert the Debentures into Common Stock after one year from issuance at an initial conversion price of $10.25 per share, which First Priority exercised effective August 1, 2008.

Item 3. Defaults Upon Senior Securities.

None.

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

None.

Item 5. Other Information.

None.

Item 6. Exhibits.


Exhibit No.		Title
3.1		Articles of Incorporation of First Priority Financial Corp. (incorporated by reference to Exhibit 3.1 to the Company’s registration statement on Form S-4, SEC File No. 333-147950.)

3.2		Bylaws of First Priority Financial Corp. (incorporated by reference to Exhibit 3.2 to the Company’s registration statement on Form S-4, SEC File No. 333-147950.)

31.1		Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)

31.2		Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)

32.1		Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

32.2		Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

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.


	FIRST PRIORITY FINANCIAL CORP. (Registrant)
Date: November 13, 2008	By:	/s/ David E. Sparks
		David E. Sparks,
		Chairman, President and Chief Executive Officer



Date: November 13, 2008	By:	/s/ Lawrence E. Donato
		Lawrence E. Donato,
		Chief Financial Officer

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First Priority Financial Inactive 10-Q2008 Q3 Quarterly report

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