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ACCESS NATIONAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 11, 2014

The following discussion and analysis should be read in conjunction with Access National Corporation's ("Corporation", "we", "us") consolidated financial statements, and notes thereto, included in the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 2013. Operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results for the year ending December 31, 2014 or any future period.



CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements. For this purpose, any statements contained herein, including documents incorporated by reference, that are not statements of historical fact may be deemed to be forward-looking statements. Examples of forward-looking statements include discussions as to our expectations, beliefs, plans, goals, objectives and future financial or other performance or assumptions concerning matters discussed in this document. Forward-looking statements often use words such as "believes," "expects," "plans," "may," "will," "should," "projects," "contemplates," " anticipates," "forecasts," "intends" or other words of similar meaning. Forward-looking statements in this Quarterly Report on Form 10-Q include, without limitation, statements regarding the Corporation's beliefs regarding the future strength of the economy and labor markets and anticipated interest rates and the effect of such rates on the Corporation's performance and net interest margin and the volume of future mortgage refinancing, as well as the Corporation's expectations concerning operating losses and the profitability of its mortgage segment after the closure of the Mortgage Production Branch. You can also identify them by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Corporation include, but are not limited to, changes in: collateral values, especially in the real estate market; continued challenging economic conditions or deterioration in general business and economic conditions and in the financial markets; the impact of any laws, regulations, policies or programs implemented pursuant to the Dodd-Frank Act, the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009; branch expansion plans; interest rates; monetary and fiscal policies of the U.S. Government, including policies of the Office of the Comptroller of the Currency ("Comptroller"), the U.S. Department of the Treasury and the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of Richmond; the economy of Northern Virginia, including governmental spending and commercial and residential real estate markets; the quality or composition of the loan or investment portfolios; demand for loan products; deposit flows; competition; the liquidity of the Corporation; the impact that the closure of the Mortgage Production Branch has on the Corporation's operating losses and profitability; and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made.



For additional discussion of risk factors that may cause our actual future results to differ materially from the results indicated within forward looking statements, please see "Item 1A - Risk Factors" of the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

CRITICAL ACCOUNTING POLICIES The Corporation's consolidated financial statements have been prepared in accordance with GAAP. In preparing the Corporation's financial statements management makes estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. Management believes that the most significant subjective judgments that it makes include the following: 34 Allowance for Loan Losses The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) FASB ASC 450-10, which requires that losses be accrued when they are probable of occurring and can be estimated, and (ii) FASB ASC 310-10, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. An allowance for loan losses is established through a provision for loan losses based upon industry standards, known risk characteristics, management's evaluation of the risk inherent in the loan portfolio, and changes in the nature and volume of loan activity. Such evaluation considers, among other factors, the estimated market value of the underlying collateral and current economic conditions. For further information about our practices with respect to allowance for loan losses, please see Note 4 to the consolidated financial statements.



Other Than Temporary Impairment of Securities

Securities in the Corporation's securities portfolio are classified as either available-for-sale or held-to-maturity. At June 30, 2014, there were no non-agency mortgage backed securities or trust preferred securities in the portfolio. The estimated fair value of the portfolio fluctuates due to changes in market interest rates and other factors. Changes in estimated fair value are recorded in shareholders' equity as a component of other comprehensive income. Securities are monitored to determine whether a decline in their value is other than temporary. Management evaluates the securities portfolio on a quarterly basis to determine the collectability of amounts due per the contractual terms of each security. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to net income is recognized. At June 30, 2014, there were no securities with other than temporary impairment. Income Taxes The Corporation uses the liability method of accounting for income taxes. This method results in the recognition of deferred tax assets and liabilities that are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The deferred provision for income taxes is the result of the net change in the deferred tax asset and deferred tax liability balances during the year. This amount combined with the current taxes payable or refundable results in the income tax expense for the current year. The Corporation's evaluation of the deductibility or taxability of items included in the Corporation's tax returns has not resulted in the identification of any material, uncertain tax positions. Fair Value Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on and off-balance sheet financial instruments do not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments. For additional information about our financial assets carried at fair value, please see Note 9 to the consolidated financial statements. 35 FINANCIAL CONDITION Executive Summary

At June 30, 2014, the Corporation's assets totaled $999.2 million, compared to $847.2 million at December 31, 2013, an increase of $152.0 million. The increase in assets was primarily due to a growth in loans held for investment of $53.1 million, an increase in interest-bearing balances of $20.8 million, an increase in investment securities of $33.8 million, an increase in loans held for sale of $26.6 million, and the purchase of bank-owned life insurance (BOLI) in the amount of $15 million. The increase in loans held for investment at June 30, 2014 in comparison with December 31, 2013 is primarily attributable to a $29.5 million or 16.2% growth in commercial loans and a $20.3 million or 22.4% increase in commercial real estate - non-owner occupied loans. At June 30, 2014, loans secured by real estate collateral comprised 70.4% of our total loan portfolio, with loans secured by commercial real estate contributing 40.8% of our total loan portfolio, loans secured by residential real estate contributing 24.2% and real estate construction loans contributing 5.4%. Loans held for sale totaled $51.0 million at June 30, 2014, compared to $24.4 million at December 31, 2013. Loans held for sale fluctuates with the volume of loans originated during any given month and the length of time the loans are held prior to selling them in the secondary market. Deposits totaled $791.8 million at June 30, 2014, compared to $573.0 million at December 31, 2013, an increase of $218.8 million. Noninterest-bearing deposits increased $81.3 million from $189.9 million at December 31, 2013 to $271.2 million at June 30, 2014. Savings and interest-bearing deposits increased from $200.2 million at December 31, 2013 to $235.7 million at June 30, 2014, an increase of $35.5 million. The largest increase in our deposits came in time deposits, growing from $182.9 million at December 31, 2013 to $284.8 million at June 30, 2014. This increase of $101.9 million increase was due in part to management's decision to utilize the Certificate of Deposit Account Registry Service (CDARS) to partially offset the increase in securities as well as the increase in loans held for sale from December 31, 2013 and reduce short-term borrowings. Net income for the second quarter of 2014 totaled $3.1 million compared to $3.5 million for the same period in 2013. Earnings per diluted share were $0.29 for the second quarter of 2014, compared to $0.34 per diluted share in the same period of 2013. The banking segment continued to show positive growth in pretax income of $477 thousand when comparing the periods ended June 30, 2014 to June 30, 2013,due to an increase in net interest income of $576 thousand, while the mortgage segment reflected declines in the mortgage loan origination volume for the same comparison period of $62.2 million. This decreased volume as well as a reduction in the secondary market pricing led to the $3.3 million decrease in the mortgage segment's gain on sale of loans when comparing the three month period ending June 2014 to the same period ending June 2013. Net income for the six months ended June 30, 2014 totaled $5.5 million compared to $7.2 million for the same period in 2013. Earnings per diluted share were $0.52 for the first six months of 2014, compared to $0.69 per diluted share in the same period of 2013. For the six month period ended June 30, 2014, the banking segment saw an increase in pretax income of $860 thousand when compared to the six months ended June 30, 2013 due to an increase in net interest income of $656 thousand as well as a $225 thousand reduction in the provision for loan losses. The mortgage segment saw a reduction of $209.3 million in loan origination volume for the six month period ended June 30, 2014 in comparison with the same period in 2013. This decreased volume as well as a reduction in the secondary market pricing led to the $9.5 million decrease in gain on sale of loans when comparing the six month period ending June 2014 to the same period ending June 2013. Non-performing assets ("NPA") totaled $1.9 million, or 0.19%, of total assets at June 30, 2014, down from $2.5 million, or 0.30%, of total assets at December 31, 2013. NPA are comprised solely of non-accrual loans at June 30, 2014. 36 The U.S. Bureau of Labor Statistics reported an increase in labor productivity of 2.5% annually in the nonfarm business sector for the second quarter of 2014, an increase of 1.2% when compared to the second quarter of 2013. The unemployment rate for Fairfax County, Virginia rose slightly from 4.1% in March 2014 to 4.4% in June 2014, still remaining below the 5.3% for the state of Virginia at the end of June 2014 and 6.2% for the nation at the end of June 2014. Information reviewed at the Federal Open Market Committee's (FOMC) July 2014 meeting showed growth in economic activity rebounded during the second quarter of 2014 while labor market indicators suggested significant underutilization of labor resources remain. Fiscal policy continues to restrain economic growth; however, the extent of the restraint is deemed to be diminishing as the FOMC "sees the risks to the outlook for economic activity and the labor market as nearly balanced…". The historically low interest rate environment continues to negatively impact yields of variable loans and the securities portfolio. The Corporation's net interest margin for the six months ended June 30, 2014 decreased to 3.79% from the June 30, 2013 percentage of 3.81% due mainly to the declining yield on the loans held for investment portfolio. While there is no certainty to the magnitude of any impact, the continued extended period of low short-term interest rates, as presently forecasted by the Federal Reserve, will continue to have an adverse effect

on the net interest margin. While we continue to see price appreciation in the local residential real estate market, there is no guarantee that these positive trends will continue, and contrasting the real estate market price appreciation are mixed results in the labor markets. As such, we remain cautious as to the macro-economic risks, many openly identified by the Federal Open Market Committee, including persistently high rates of unemployment and underemployment. As a consequence, we have generally retained more cautious loan underwriting criteria established during the financial crisis period of 2007 - 2009. In spite of these challenges, we are proactive in seeking new client relationships driven by our target market profile: business-to-business and business-to-government companies with annual revenue of $1 million to $100 million and the various banking services needed by the business and the professionals associated with the businesses. Although we believe that the credit quality of our primary business and professional customers has stabilized and has begun to improve, we will continue to focus on improving the credit quality of our loan portfolio and reducing non-performing assets. The Corporation is optimistic with a strong capital base and being positioned for continued growth. Securities The Corporation's securities portfolio is comprised of U.S. government agency securities, mortgage backed securities, corporate bonds, a CRA mutual fund, and other asset backed securities as well as municipal bonds. The portfolio does not have any non-agency mortgage backed securities or trust preferred securities. At June 30, 2014 the fair value of the securities portfolio totaled $126.5 million, compared to $92.2 million at December 31, 2013. Included in the fair value totals are held-to-maturity securities with an amortized cost of $12.4 million (fair value of $12.3 million) and $16.3 million (fair value of $15.7 million) at June 30, 2014 and December 31, 2013, respectively. Securities classified as available-for-sale are accounted for at fair market value with unrealized gains and losses recorded directly to a separate component of shareholders' equity, net of associated tax effect while held-to-maturity securities are carried at amortized cost. Investment securities are used to provide liquidity, to generate income, and to temporarily supplement loan growth as needed. Restricted Stock Restricted stock consists of FHLB stock and FRB stock. These stocks are classified as restricted stocks because their ownership is restricted to certain types of entities and they lack a market. Restricted stock is carried at cost on the Corporation's financial statements. Dividends are paid semiannually on FRB stock and quarterly on FHLB stock. 37 Loans

The loan portfolio constitutes the largest component of earning assets and is comprised of commercial real estate - owner occupied, commercial real estate - non-owner occupied, residential real estate, commercial, real estate construction, and consumer loans. All lending activities of the Bank and its subsidiaries are subject to the regulations and supervision of the Comptroller. The loan portfolio does not have any pay option adjustable rate mortgages, loans with teaser rates or subprime loans or any other loans considered "high risk loans". Loans totaled $740.1 million at June 30, 2014 compared to $687.1 million at December 31, 2013, an increase of $53.0 million or 7.7%. Comprising the majority of the growth, commercial loans increased $29.5 million and commercial real estate - non-owner occupied increased $20.3 million. The overall increase in loans reflects results from our marketing outreach as well as continued improvement in loan demand by local businesses. Please see Note 4 to the consolidated financial statements for a table that summarizes the composition of the Corporation's loan portfolio. The following is a summary of the loan portfolio at June 30, 2014. Commercial Real Estate Loans - Owner Occupied:This category of loans represented the second largest segment of the loan portfolio and was comprised of owner occupied loans secured by the commercial property, totaling $190.9 million, representing 25.79% of the loan portfolio at June 30, 2014. Commercial real estate loans are secured by the subject property and underwritten to policy standards. Policy standards approved by the Board of Directors from time to time set forth, among other considerations, loan-to-value limits, cash flow coverage ratios, and the general creditworthiness of the obligors.



Commercial Real Estate Loans - Non-Owner Occupied: This category of loans represented the fourth largest segment of the loan portfolio and was comprised of loans secured by income producing commercial property, totaling $111.0 million and representing 14.99% of the loan portfolio at June 30, 2014. Commercial real estate loans are secured by the subject property and underwritten to policy standards as listed above.

Residential Real Estate Loans: This category represented the third largest segment of the loan portfolio and included loans secured by first or second mortgages on one to four family residential properties. This segment totaled $179.0 million and comprised 24.19% of the loan portfolio as of June 30, 2014. Of this amount, the following sub-categories existed as a percentage of the whole residential real estate loan portfolio as of June 30, 2014: home equity lines of credit, 17.3%; first trust mortgage loans, 75.3%; and junior trust loans, 7.4%. Home equity lines of credit are extended to borrowers in our target market. Real estate equity is often the largest component of consumer wealth in our marketplace. Once approved, this consumer finance tool allows the borrowers to access the equity in their homes or investment properties and use the proceeds for virtually any purpose. Home equity lines of credit are most frequently secured by a second lien on residential property. The proceeds of first trust mortgage loans are used to acquire or refinance the primary financing on owner occupied and residential investment properties. Junior trust loans are loans to consumers wherein the proceeds have been used for a stated consumer purpose. Examples of consumer purposes are education, refinancing debt, or purchasing consumer goods. The loans are generally extended in a single disbursement and repaid over a specified period of time. Loans in the residential real estate portfolio are underwritten to standards within a traditional consumer framework that is periodically reviewed and updated by management and the Board of Directors and takes into consideration repayment source and capacity, value of the underlying property, credit history, savings pattern, and stability. Commercial Loans: Commercial Loans represented the largest segment of the loan portfolio, totaling $211.7 million and representing 28.61% of the loan portfolio as of June 30, 2014. These loans are made to businesses or individuals within our target market for business purposes. Typically the loan proceeds are used to support working capital and the acquisition of fixed assets of an operating business. We underwrite these loans based upon our assessment of the obligor(s)' ability to generate operating cash flows in the future necessary to repay the loan. To address the risks associated with the uncertainties of future cash flows, these loans are generally well secured by assets owned by the business or its principal shareholders/owners and the principal shareholders/owners are typically required to guarantee the loan. 38

Real Estate Construction Loans: Real estate construction loans, also known as construction and land development loans represented the fifth largest segment of the loan portfolio and totaled $40.5 million and represented 5.47% of the loan portfolio as of June 30, 2014. These loans generally fall into one of three categories: first, loans to individuals that are ultimately used to acquire property and construct an owner occupied residence; second, loans to builders for the purpose of acquiring property and constructing homes for sale to consumers; and third, loans to developers for the purpose of acquiring land that is developed into finished lots for the ultimate construction of residential or commercial buildings. Loans of these types are generally secured by the subject property within limits established by the Board of Directors based upon an assessment of market conditions and updated from time to time. The loans typically carry recourse to principal owners. In addition to the repayment risk associated with loans to individuals and businesses, loans in this category carry construction completion risk. To address this additional risk, loans of this type are subject to additional administration procedures designed to verify and ensure progress of the project in accordance with allocated funding, project specifications and time frames. Consumer Loans: Consumer loans, which were the smallest segment of the loan portfolio, totaled $7.0 million and represented 0.95% of the loan portfolio as of June 30, 2014. Most loans in this category are well secured with assets other than real estate, such as marketable securities or automobiles. Very few consumer loans are unsecured. As a matter of operation, management discourages unsecured lending. Loans in this category are underwritten to standards within a traditional consumer framework that is periodically reviewed and updated by management and the Board of Directors and takes into consideration repayment capacity, collateral value, savings pattern, credit history, and stability.



Loans Held for Sale ("LHFS")

LHFS are residential mortgage loans originated by the mortgage division of the Bank to consumers and underwritten in accordance with standards set forth by an institutional investor to whom we expect to sell the loans for a profit. Loan proceeds are used for the purchase or refinance of the property securing the loan. Loans are sold with the servicing released to the investor. At June 30, 2014, LHFS at fair value totaled $51.0 million compared to $24.4 million at December 31, 2013. The LHFS loans are closed by the Bank and held on average fifteen to thirty days pending their sale to government sponsored entities as well as mortgage banking subsidiaries of large financial institutions. During the second quarter of 2014 we originated $109.3 million of loans processed in this manner, compared to $70.6 million in the first quarter of 2014 and $171.4 million for the second quarter of 2013. Loans are sold without recourse and subject to industry standard representations and warranties that may require the repurchase by the Bank of loans previously sold. The repurchase risks associated with this activity center around early payment defaults and borrower fraud. Allowance for Loan Losses The allowance for loan losses totaled $13.2 million at June 30, 2014 compared to $13.1 million at December 31, 2013. The allowance for loan losses was equivalent to 1.78% and 1.91% of total loans held for investment at June 30, 2014 and December 31, 2013, respectively. Adequacy of the allowance is assessed and increased by provisions for loan losses charged to expense no less than quarterly. Charge-offs are taken when a loan is identified as uncollectible. For additional information about the allowance for loan losses, please see Note 4 to the consolidated financial statements. Non-performing Assets



At June 30, 2014 and December 31, 2013, the Bank had non-performing assets totaling $1.9 million and $2.5 million, respectively. Non-performing assets consist of non-accrual and restructured loans. All non-performing loans are carried at the expected liquidation value of the underlying collateral.

39 The following table is a summary of our non-performing assets at June 30, 2014 and December 31, 2013. June 30, 2014December 31, 2013 (Dollars In Thousands) Non-accrual loans :

Commercial real estate - owner occupied $ - $ - Commercial real estate - non-owner occupied -

- Residential real estate 129 871 Commercial 1,743 1,664 Real estate construction - - Consumer - - Total non-accrual loans $ 1,872 $ 2,535

Other real estate owned ("OREO") -

- Total non-performing assets $ 1,872 $ 2,535

Restructured loans included above in non-accrual loans $ 714 $ 931 Ratio of non-performing assets to: Total loans plus OREO 0.25 % 0.37 % Total Assets 0.19 % 0.30 % Accruing Past due loans: 90 or more days past due $ - $ -



At June 30, 2014 and December 31, 2013, the Bank had no loans past due 90 days or more and still accruing interest.

Deposits

Deposits are the primary sources of funding loan growth. At June 30, 2014, deposits totaled $791.8 million compared to $573.0 million on December 31, 2013, an increase of $218.8 million or 38.18%. Noninterest-bearing deposits increased $81.3 million from $189.9 million at December 31, 2013 to $271.2 million at June 30, 2014. Savings and interest-bearing deposits increased to $235.7 million at June 30, 2014 from $200.2 million at December 31, 2013, an increase of $35.5 million, or 17.73%. The largest increase in our deposits came in the time deposits, growing from $182.9 million at December 31, 2013 to $284.8 million, an increase of $101.9 million, or 55.71%. This increase was due in part to management's decision to utilize the Certificate of Deposit Account Registry Service (CDARS) to partially offset the increase in securities as well as the increase in loans held for sale from December 31, 2013 and reduce short-term borrowings. The growth in noninterest-bearing accounts is attributable to new accounts opened during the first six months of 2014 as a result of our outreach to operating businesses and positive balance fluctuations of existing commercial accounts. Shareholders' Equity Shareholders' equity totaled $96.1 million at June 30, 2014 compared to $91.1 million at December 31, 2013. The increase in shareholders' equity is due mainly to retained earnings net of dividends paid. Banking regulators have defined minimum regulatory capital ratios that the Corporation and the Bank are required to maintain. These risk based capital guidelines take into consideration risk factors, as defined by the banking regulators, associated with various categories of assets, both on and off the balance sheet. Both the Corporation and Bank are classified as well capitalized, which is the highest rating. 40



The following table outlines the regulatory components of the Corporation's capital and risk based capital ratios.

June 30, December 31, 2014 2013 (In Thousands) Tier 1 Capital: Common stock $ 8,703$ 8,659 Capital surplus 17,994 17,320 Retained earnings 70,205 67,121

Less: Net unrealized loss on equity securities (42 ) (58 ) Less: Disallowed goodwill (1,491 )



-

Less: Dissallowed servicing assets (228 )

(255 ) Total Tier 1 capital 95,141 92,787 Allowance for loan losses 10,655 9,680 Total risk based capital $ 105,796$ 102,467 Risk weighted assets $ 849,188$ 770,276 Quarterly average assets $ 943,886$ 848,886 Regulatory Capital Ratios: Minimum Tier 1 risk based capital ratio 11.20 % 12.05 % 4.00 % Total risk based capital ratio 12.46 % 13.30 % 8.00 % Leverage ratio 10.08 % 10.93 % 4.00 % RESULTS OF OPERATIONS Summary Net income for the second quarter of 2014 totaled $3.1 million or $0.29 diluted earnings per share. This compares with $3.5 million or $0.34 diluted earnings per share for the same quarter in 2013. The decrease in net income for the three months ended June 30, 2014 as compared to the same period in 2013 is attributable to the decreased earnings from the mortgage banking segment and was mitigated by favorable increases in net interest income and a decrease in provision for loan loss. Net income for the six months ended June 30, 2014 totaled $5.5 million or $0.52 diluted earnings per share compared to $7.2 million or $0.69 diluted earnings per share for the same period in 2013. The decrease in earnings for the six months ended June 30, 2014 is attributable to the decreased earnings from the mortgage banking segment. The decrease in mortgage activity was mitigated by favorable increases in net interest income as well as a decrease in provision for loan loss. 41 Net Interest Income Net interest income, the principal source of earnings, is the amount of income generated by earning assets (primarily loans and investment securities) less the interest expense incurred on interest-bearing liabilities (primarily deposits) used to fund earning assets. Net interest income before the provision for loan losses totaled $8.7 million for the three months ended June 30, 2014 compared to $8.1 million for the same period in 2013. The increase in net interest income is primarily due to lower funding costs and changes in the composition of earning assets. The annualized yield on earning assets was 4.16% for the quarter ended June 30, 2014 when compared to 4.39% for the quarter ended June 30, 2013. The increase in the second quarter income on earning assets of $416 thousand is attributable to increased yields in securities and loans held for sale as well as increased volume in loans held for investment and securities. The cost of interest-bearing deposits and borrowings decreased from 0.74% for the quarter ended June 30, 2013 to 0.56% for the quarter ended June 30, 2014. Net interest margin was 3.80% for the quarter ended June 30, 2014 compared to 3.89% for

the same period in 2013. Net interest income before the provision for loan losses totaled $16.8 million for the first six months of 2014 compared to $16.1 million for the same period in 2013. The annualized yield on earning assets for the first six months of 2014 was 4.16% compared to 4.31% for the same period in 2013. The cost of interest-bearing deposits and borrowings for the first six months of 2014 was 0.56% compared to 0.72% for the same period in 2013. Net interest margin was 3.79% for the first six months of 2014 compared to 3.81% for the same period in 2013. Volume and Rate Analysis



The following tables present the dollar amount of changes in interest income and interest expense for each category of interest earning assets and interest-bearing liabilities.

Three Months Ended June 30, 2014 compared to 2013 Change Due To: Increase / (Decrease) Volume Rate (In Thousands) Interest Earning Assets: Investments $ 174$ 142$ 32 Loans held for sale (133 ) (223 ) 90 Loans 376 911 (535 ) Interest-bearing deposits (1 ) 3 (4 )

Total increase (decrease) in interest income 416



833 (417 )

Interest-Bearing Liabilities:

Interest-bearing demand deposits 37



24 13

Money market deposit accounts (15 )

(4 ) (11 ) Savings accounts 2 1 1 Time deposits (203 ) (128 ) (75 )

Total interest-bearing deposits (179 )



(107 ) (72 )

FHLB Advances 36



37 (1 )

Securities sold under agreements to repurchase 1



(1 ) 2

Other short-term borrowings -

- - Long-term borrowings - - - FDIC term note - - - Subordinated debentures (53 ) (26 ) (27 )

Total increase (decrease) in interest expense (195 )



(97 ) (98 )

Increase (decrease) in net interest income $ 611$ 930$ (319 ) 42 Six Months Ended June 30, 2014 compared to 2013 Change Due To: Increase / (Decrease) Volume Rate (In Thousands)



Interest Earning Assets:

Investments $ 107$ 128$ (21 ) Loans held for sale (545 ) (785 ) 240 Loans 652 1,787 (1,135 )

Interest-bearing deposits (9 ) (9



) -

Total increase (decrease) in interest income 205 1,121



(916 )

Interest-Bearing Liabilities:

Interest-bearing demand deposits 53 36



17

Money market deposit accounts (47 ) (8

) (39 ) Savings accounts 3 1 2 Time deposits (461 ) (519 ) 58

Total interest-bearing deposits (452 ) (490



) 38

FHLB Advances 102 104



(2 )

Securities sold under agreements to repurchase (2 ) (3



) 1

Other short-term borrowings - -

- Long-term borrowings - - - FDIC term note - - - Subordinated debentures (106 ) (53 ) (53 )

Total increase (decrease) in interest expense (458 ) (442



) (16 )

Increase (decrease) in net interest income $ 663$ 1,563

$ (900 ) 43



Average Balances, Net Interest Income, Yields Earned and Rates Paid

The following tables present for the periods indicated the total dollar amount of interest income from average interest earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed in dollars and rates. Yield on



Average Earning Assets and Rates on Average Interest-Bearing Liabilities

Three Months Ended June 30, 2014 June 30, 2013 Average Income / Yield / Average Income / Yield / Balance Expense Rate Balance Expense Rate (Dollars In Thousands) Assets: Interest earning assets: Securities $ 122,698$ 621 2.02 % $ 94,358$ 447 1.90 % Loans held for sale 27,502 297 4.32 % 49,814 430 3.45 % Loans(1) 720,634 8,557 4.75 % 645,654 8,181 5.07 %

Interest-bearing balances and federal funds sold 42,055 27 0.26 % 38,310 28 0.29 % Total interest earning assets 912,889 9,502 4.16 % 828,136 9,086 4.39 % Noninterest earning assets: Cash and due from banks 9,223 11,922 Premises, land and equipment 8,383 8,501 Other assets 27,139 14,576 Less: allowance for loan losses (13,183 ) (12,936 ) Total noninterest earning assets 31,562 22,063 Total Assets $ 944,452$ 850,200 Liabilities and Shareholders' Equity: Interest-bearing deposits: Interest-bearing demand deposits $ 109,602 $

62 0.23 % $ 62,215 $ 25 0.16 % Money market deposit accounts 115,355 58 0.20 % 122,468 73 0.24 % Savings accounts 3,353 3 0.36 % 2,499 1 0.18 % Time deposits 271,125 664 0.98 % 321,558 867 1.08 %

Total interest-bearing deposits 499,435

787 0.63 % 508,740 966 0.76 % Borrowings: FHLB Advances 76,978 47 0.24 % 17,011 11 0.26 % Securities sold under agreements to repurchase and federal funds purchased 20,082 5 0.10 % 23,265 4 0.08 % Subordinated Debentures - - 0.00 % 6,186 53 3.43 % Total borrowings 97,060 52 0.21 % 46,462 68 0.59 %

Total interest-bearing deposits and borrowings 596,495 839 0.56 % 555,202 1,034 0.74 % Noninterest-bearing liabilities: Demand deposits 243,602 191,009 Other liabilities 9,555 9,254 Total liabilities 849,652 755,465 Shareholders' Equity 94,800 94,735

Total Liabilities and Shareholders' Equity: $ 944,452

$ 850,200 Interest Spread(2) 3.60 % 3.64 % Net Interest Margin(3) $ 8,663 3.80 % $ 8,052 3.89 %



(1) Loans placed on nonaccrual status are included in loan balances

(2) Interest spread is the average yield earned on earning assets, less the average rate incurred on interest-bearing liabilities.

(3) Net interest margin is net interest income, expressed as a percentage of average earning assets. 44 Yield on



Average Earning Assets and Rates on Average Interest-Bearing Liabilities

Six Months Ended June 30, 2014 June 30, 2013 Average Income / Yield / Average Income / Yield / Balance Expense Rate Balance Expense Rate (Dollars In Thousands) Assets: Interest earning assets: Securities $ 113,789$ 1,089 1.91 % $ 100,493 $ 982 1.95 % Loans held for sale 23,129 499 4.31 % 62,222 1,044 3.36 % Loans(1) 709,593 16,814 4.74 % 636,129 16,162 5.08 %

Interest-bearing balances and federal funds sold 40,661 45 0.22 % 48,567 54 0.22 % Total interest earning assets 887,172 18,447 4.16 % 847,411 18,242 4.31 % Noninterest earning assets: Cash and due from banks 8,420 11,659 Premises, land and equipment 8,381 8,521 Other assets 21,604 14,466 Less: allowance for loan losses (13,182 ) (12,773 ) Total noninterest earning assets 25,223 21,873 Total Assets $ 912,396$ 869,285 Liabilities and Shareholders' Equity: Interest-bearing deposits: Interest-bearing demand deposits $ 107,719 $ 120 0.22 % $ 73,571 $ 67 0.18 % Money market deposit accounts 114,740

115 0.20 % 120,707 162 0.27 % Savings accounts 3,112 5 0.32 % 2,472 2 0.16 % Time deposits 245,184 1,275 1.04 % 345,328 1,736 1.01 %

Total interest-bearing deposits 470,755

1,515 0.64 % 542,078 1,967 0.73 % Borrowings: FHLB Advances 96,354 117 0.24 % 11,066 15 0.27 % Securities sold under agreements to repurchase and federal funds purchased 21,719 11 0.10 % 26,807 13 0.10 % Other short-term borrowings - - 0.00 % - - 0.00 % Subordinated Debentures -

- 0.00 % 6,186 106 3.43 % Total borrowings 118,073 128 0.22 % 44,059 134 0.61 %

Total interest-bearing deposits and borrowings 588,828 1,643 0.56 % 586,137 2,101 0.72 % Noninterest-bearing liabilities: Demand deposits 220,158 180,045 Other liabilities 9,707 9,562 Total liabilities 818,693 775,744 Shareholders' Equity 93,703 93,541

Total Liabilities and Shareholders' Equity: $ 912,396

$ 869,285 Interest Spread(2) 3.60 % 3.59 % Net Interest Margin(3) $ 16,804 3.79 % $ 16,141 3.81 %



(1) Loans placed on nonaccrual status are included in loan balances

(2) Interest spread is the average yield earned on earning assets, less the average rate incurred on interest-bearing liabilities.

(3) Net interest margin is net interest income, expressed as a percentage of average earning assets.

45 Noninterest Income Noninterest income consists of revenue generated from financial services and activities other than lending and investing. The mortgage segment provides the most significant contributions to noninterest income. Total noninterest income was $5.3 million for the second quarter of 2014 compared to $8.0 million for the same period in 2013. Gains on the sale of loans originated by the Banks's mortgage segment are the largest component of noninterest income. Gains on the sale of loans totaled $3.8 million for the three month period ended June 30, 2014, compared to $7.1 million for the same period of 2013. Gains on the sale of loans fluctuate with the volume of mortgage loans originated. During the three months ended June 30, 2014, the Bank's mortgage segment originated $109.3 million in mortgage and brokered loans, down from $171.4 million for the same period in 2013. For the three months ended June 30, 2014, other income reflected a gain of $1.3 million, up from $736 thousand for the three months ended June 30, 2013, due in part to the increased revenue generated by the Wealth Management segment of $302 thousand. Noninterest income was $8.6 million for the first six months of 2014 compared to $18.9 million for the same period in 2013. Gains on the sale of loans totaled $5.5 million for the six month period ended June 30, 2014, compared to $15.0 million for the same period of 2013. During the six months ended June 30, 2014, the Bank's mortgage segment originated $179.8 million in mortgage and brokered loans, down from $389.1 million for the same period in 2013. For the six months ended June 30, 2014, other income reflected a gain of $2.7 million, as compared to a $3.5 million gain for the six months ended June 30, 2013. The decline was due to a $4 million reduction in the realized gain on hedging activity in the Mortgage segment which was mitigated by a $2.7 million increase in the fair value adjustments on the mortgage loans held for sale as well as an increase in revenue generated by the Wealth Management segment of $592 thousand. Noninterest Expense Noninterest expense totaled $9.2 million for the three months ended June 30, 2014, compared to $10.5 million for the same period in 2013, a decrease of $1.3 million. Salaries and employee benefits totaled $6.0 million for the three months ended June 30, 2014, compared to $6.8 million for the same period last year. The decrease in salary and employee benefits is attributable in part to the reduction in the mortgage loan production. Other operating expenses totaled $2.6 million for the three months ended June 30, 2014, compared to $3.1 million for the same period in 2013.

Noninterest expense totaled $16.9 million for the six months ended June 30, 2014, compared to $23.2 million for the same period in 2013, a decrease of $6.3 million. Salaries and employee benefits totaled $10.8 million for the six months ended June 30, 2014, compared to $14.9 million for the same period last year. The decrease in salary and employee benefits is attributable to the decrease in volume related compensation in the mortgage banking segment. Other operating expenses totaled $4.7 million for the six months ended June 30, 2014, compared to $7.0 million for the same period in 2013. This decrease is also primarily due to volume related expenses associated with a decrease in mortgage loan production. 46



The table below provides the composition of other operating expenses.

Six Months Ended June 30, 2014 2013 (In Thousands) Business and franchise tax $ 411$ 416 Advertising and promotional 364 915 Data processing 334 360 Accounting and auditing 306 306 Management fees 287 1,167 Director fees 270 180 FDIC insurance 211 225 Consulting fees 202 323 Office supplies-stationary print 185 138 Investor fees 179 530 Telephone 154 147 Publication and subscription 133 162 Disaster recovery 130 88 Legal fees 120 124 Stock option 118 104 Regulatory examinations 104 103 Credit report 102 186 SBA guarantee fee 92 111 Travel 67 87 D&O liability insurance 62 52 Business development and meals 58 64 Courier 55 69 FRB and bank analysis charges 54 47 Common stock 53 50 Dues and memberships 50 27 Verification fees 39 87 Education and training 26 64 Postage 25 24 Conventions and meetings 25 6 Provision for losses on mortgage loans sold - 388 Other 453 450 $ 4,669$ 7,000 Liquidity Management Liquidity is the ability of the Corporation to meet current and future cash flow requirements. The liquidity of a financial institution reflects its ability to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Corporation's ability to meet the daily cash flow requirements of both depositors and borrowers. Management monitors liquidity through a regular review of asset and liability maturities, funding sources, and loan

and deposit forecasts. 47

Asset and liability management functions not only serve to assure adequate liquidity in order to meet the needs of the Corporation's customers, but also to maintain an appropriate balance between interest sensitive assets and interest sensitive liabilities so that the Corporation can earn an appropriate return for its shareholders.

The asset portion of the balance sheet provides liquidity primarily through loan principal repayments and maturities of investment securities. Other short-term investments such as federal funds sold and interest-bearing deposits with other banks provide an additional source of liquidity funding. At June 30, 2014, overnight interest-bearing balances totaled $36.1 million and unpledged available-for-sale investment securities totaled approximately $41.8 million. The Bank proactively manages a portfolio of short-term time deposits issued to local municipalities and wholesale depositors in order to fund loans held for sale and short-term investments. As of June 30, 2014, the portfolio of CDARS and wholesale time deposits totaled $184.0 million compared to $76.6 million at December 31, 2013, respectively. The liability portion of the balance sheet provides liquidity through various interest-bearing and noninterest-bearing deposit accounts, federal funds purchased, securities sold under agreement to repurchase and other short-term borrowings. At June 30, 2014, the Bank had a line of credit with the FHLB totaling $277.9 million and had outstanding $80 million in short term loans at fixed rates between 0.19% and 0.23% leaving $197.9 million available on the line. In addition to the line of credit at the FHLB, the Bank issues repurchase agreements. As of June 30, 2014, outstanding repurchase agreements totaled $20.5 million. The interest rates on these instruments are variable and subject to change daily. The Bank also maintains federal funds lines of credit with its correspondent banks and, at June 30, 2014, these lines totaled $60.5 million and were available as an additional funding source.



The following table presents the composition of borrowings at June 30, 2014 and December 31, 2013 and for the periods indicated.

Borrowed Funds Distribution June 30, 2014 December 31, 2013 (Dollars In Thousands) Borrowings: FHLB advances $ 80,000 $ 145,000 Securities sold under agreements to repurchase and federal funds purchased 20,453 27,855 Total at period end $ 100,453 $ 172,855 June 30, 2014 December 31, 2013 (Dollars In Thousands) Borrowings: Average Balances FHLB advances $ 96,354 $ 43,077 Securities sold under agreements to repurchase and federal funds purchased 21,719 25,524 Subordinated debentures - 3,135 Total average balance $ 118,073 $ 71,736

Average rate paid on all borrowed funds 0.22

% 0.32 % 48

Management believes the Corporation is well positioned with liquid assets, the ability to generate liquidity through liability funding and the availability of borrowed funds, to meet the liquidity needs of depositors and customers' borrowing needs. The Corporation's ability to maintain sufficient liquidity may be affected by numerous factors, including economic conditions nationally and in our markets. Depending on the Corporation's liquidity levels, its capital position, conditions in the capital markets and other factors, the Corporation may from time to time consider the issuance of debt, equity or other securities, or other possible capital markets transactions, the proceeds of which could provide additional liquidity for its operations. Contractual Obligations

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.


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Source: Edgar Glimpses


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