UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended March 31, 2007.

 

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:  0-21815

 

FIRST MARINER BANCORP

(Exact name of registrant as specified in its charter)

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to file such report, and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  o

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

Large accelerated filer   o         Accelerated filer   x         Non-accelerated filer   o

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

The number of shares of common stock outstanding as of May 4, 2007 is 6,429,969 shares.

FIRST MARINER BANCORP AND SUBSIDIARIES
CONTENTS

PART I— FINANCIAL INFORMATION
Item 1—		Financial Statements
		Consolidated Statements of Financial Condition at March 31, 2007 (unaudited) and at December 31, 2006
		Consolidated Statements of Operations (unaudited) for the Three months Ended March 31, 2007 and 2006
		Consolidated Statements of Cash Flows (unaudited) for the Three months Ended March 31, 2007 and 2006
		Notes to Consolidated Financial Statements (unaudited)
Item 2—		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3—		Quantitative and Qualitative Disclosures About Market Risk
Item 4—		Controls and Procedures
PART II—OTHER INFORMATION
Item 1—		Legal Proceedings
Item 1a—		Risk Factors
Item 2—		Unregistered Sales of Equity Securities and Use of Proceeds
Item 3—		Defaults Upon Senior Securities
Item 4—		Submission of Matters to a Vote of Security Holders
Item 5—		Other Information
Item 6—		Exhibits
Signatures

 

2

PART I — FINANCIAL INFORMATION

Item 1 — Financial Statements

First Mariner Bancorp and Subsidiaries
Consolidated Statements of Financial Condition
(dollars in thousands, except per share data)

		March 31,			December 31,
		2007			2006
		(unaudited)
ASSETS
Cash and due from banks		$	32,404		$	36,734
Federal funds sold and interest-bearing deposits		104,343			6,235
Trading securities, at fair value		40,901			—
Securities available for sale, at fair value		55,336			147,290
Loans held for sale		57,273			94,371
Loans receivable		857,051			866,459
Allowance for loan losses		(11,886		)	(12,399		)
Loans, net		845,165			854,060
Other real estate owned		5,991			2,440
Restricted stock investments		5,983			6,449
Premises and equipment, net		50,836			49,062
Accrued interest receivable		8,577			10,579
Deferred income taxes		7,468			6,806
Bank-owned life insurance		33,827			33,492
Prepaid expenses and other assets		13,719			15,772
Total assets		$	1,261,823		$	1,263,290
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits:
Noninterest-bearing		$	166,826		$	186,720
Interest-bearing		747,445			738,218
Total deposits		914,271			924,938
Short-term borrowings		42,477			40,884
Long-term borrowings, at fair value		62,099			—
Long-term borrowings		81,519			132,557
Junior subordinated deferrable interest debentures		73,724			73,724
Accrued expenses and other liabilities		10,335			12,558
Total liabilities		1,184,425			1,184,661
Stockholders’ equity:
Common stock, $.05 par value; 20,000,000 shares authorized; 6,428,469 and 6,427,725 shares issued and outstanding, respectively		321			321
Additional paid-in capital		57,110			57,123
Retained earnings		19,965			22,109
Accumulated other comprehensive income (loss)		2			(924		)
Total stockholders’ equity		77,398			78,629
Total liabilities and stockholders’ equity		$	1,261,823		$	1,263,290

 

See accompanying notes to the consolidated financial statements

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First Mariner Bancorp and Subsidiaries
Consolidated Statements of Operations
(dollars in thousands except per share data)

		Three Months Ended
		March 31,
		2007			2006
		(unaudited)
Interest income:
Loans		$	19,735		$	19,028
Investments and other earning assets		2,244			3,287
Total interest income		21,979			22,315
Interest expense:
Deposits		6,929			5,047
Short-term borrowings		315			1,997
Long-term borrowings		3,528			3,029
Total interest expense		10,772			10,073
Net interest income		11,207			12,242
Provision for loan losses		537			422
Net interest income after provision for loan losses		10,670			11,820
Noninterest income:
Gain on sale of mortgage loans		1,593			1,443
Other mortgage-banking revenue		730			625
ATM fees		716			785
Service fees on deposits		1,471			1,679
Trading loss on securities and long-term borrowings		(111		)	—
Gain on sale of investment securities, net		887			—
Commissions on sales of nondeposit investment products		307			94
Income from bank-owned life insurance		335			252
Commissions on sales of other insurance products		587			561
Other		434			559
Total noninterest income		6,949			5,998
Noninterest expense:
Salaries and employee benefits		9,357			8,432
Occupancy		2,240			1,703
Furniture, fixtures and equipment		863			800
Professional services		350			202
Advertising		511			466
Data processing		429			449
ATM servicing expenses		230			283
Secondary marketing valuation		33			—
Service and maintenance		744			538
Other		2,890			2,645
Total noninterest expense		17,647			15,518
Net (loss) income before income taxes		(28		)	2,300
Income tax (benefit) expense		(128		)	640
Net income		$	100		$	1,660
Net income per share:
Basic		$	0.02		$	0.26
Diluted		$	0.02		$	0.25

 

See accompanying notes to the consolidated financial statements.

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First Mariner Bancorp and Subsidiaries
Consolidated Statements of Cash Flows
(dollars in thousands)

		Three Months Ended March 31,
		2007			2006
		(unaudited)
Cash flows from operating activities:
Net income		$	100		$	1,660
Adjustments to reconcile net income to net cash from operating activities:
Stock-based compensation		16			—
Depreciation and amortization		1,206			970
Amortization of unearned loan fees and costs, net		(200		)	(306		)
Amortization of premiums and discounts on loans, net		(271		)	(150		)
Amortization of premiums and discounts on mortgage-backed securities, net		5			59
Loss on trading securities		50			—
Loss on long-term debt accounted for at fair value		61			—
Gain on sale of securities available for sale		(887		)	—
Gain on sale of mortgage loans		(1,593		)	(1,443		)
Decrease in accrued interest receivable		2,002			188
Provision for loan losses		537			422
Valuation allowance on other real estate owned		439			—
Loss on sale of other real estate owned		21			—
Valuation allowance for loans held for sale		33			—
Increase in cash surrender value of bank-owned life insurance		(335		)	(252		)
Originations of mortgage loans held for sale		(211,112		)	(288,454		)
Proceeds from mortgage loans held for sale		248,802			281,716
Net decrease in accrued expenses and other liabilities		(2,280		)	(2,638		)
Net decrease (increase) in prepaids and other assets		2,054			(792		)
Net cash provided by (used in) operating activities		38,648			(9,020		)
Cash flows from investing activities:
Loan repayments, net of principal (disbursements)		4,842			(190		)
Purchases of premises and equipment		(2,980		)	(1,633		)
Redemptions of restricted stock investments		466			1,281
Activity in securities available for sale:
Sales of securities available for sale		1,301			—
Maturities/calls/repayments of securities available for sale		51,665			5,965
Purchase of securities available for sale		(999		)	—
Proceeds from sales of other real estate owned		977			866
Net cash provided by investing activities		55,272			6,289
Cash flows from financing activities:
Net (decrease) increase in deposits		(10,667		)	11,781
Net increase (decrease) in other borrowed funds		10,555			(17,343		)
Proceeds from stock issuance		109			174
Repurchase of common stock, net of costs		(139		)	—
Net cash used in financing activities		(142		)	(5,388		)
Increase (decrease) in cash and cash equivalents		93,778			(8,119		)
Cash and cash equivalents at beginning of period		42,969			45,835
Cash and cash equivalents at end of period		$	136,747		$	37,716
Supplemental information:
Interest paid on deposits and borrowed funds		$	5,354		$	9,902
Income taxes paid		$	610		$	247
Real estate acquired in satisfaction of loans		$	4,988		$	—
Transfer of loans held for sale to loan portfolio		$	1,001		$	—

 

See accompanying notes to the consolidated financial statements.

5

First Mariner Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
(Information as of and for the three months
ended March 31, 2007 and 2006 is unaudited)

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis Of Presentation

The accompanying consolidated financial statements for First Mariner Bancorp (the “Company”) have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and notes necessary for a full presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements should be read in conjunction with the audited financial statements included in our 2006 Annual Report on Form 10-K.

The consolidated financial statements include the accounts of the Company’s subsidiaries, First Mariner Bank (the “Bank”), Finance Maryland LLC (“Finance Maryland”), and FM Appraisals, LLC (“FM Appraisals”).  All significant intercompany balances and transactions have been eliminated.

The consolidated financial statements as of March 31, 2007 and for the three months ended March 31, 2007 and 2006 are unaudited but include all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of financial position and results of operations for those periods. The results of operations for the three months ended March 31, 2007 are not necessarily indicative of the results that will be achieved for the entire year.

The preparation of the financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for credit losses (the “allowance”), other than temporary impairment of investment securities, accounting for gain on sale of mortgage loans, determination of changes in fair value for the derivative loan commitments, use of derivatives to manage interest rate risk, and deferred tax assets.

Certain reclassifications have been made to amounts previously reported to conform to the classifications made in 2007.

Investment Securities

We designate securities into one of the three categories at the time of purchase. Debt securities that we have the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost. Debt and equity securities are classified as trading securities if bought and held principally for the purpose of selling them in the near term. Trading securities are reported at estimated fair value, with unrealized gains and losses included in earnings. Debt securities not classified as held to maturity and debt and equity securities not classified as trading securities are considered available for sale and are reported at estimated fair value, with unrealized gains and losses reported as a separate component of stockholders’ equity, net of tax effects, in accumulated other comprehensive income.  Effective January 1, 2007, we adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115, and designated $42.000 million in securities as trading securities which were previously designated as available for sale.  In accordance with SFAS No. 159, we recorded a cumulative effect of accounting change reduction to retained earnings related to the investments in the amount of $993,000 (net of deferred tax impact) as of January 1, 2007.

Borrowings

In conjunction with our adoption of SFAS No. 159 as of January 1, 2007, we began recording certain of our long-term borrowings at fair value, with corresponding changes in fair values recorded in income.  On January 1, 2007, we recorded a cumulative effect of accounting change reduction to retained earnings in the amount of $1.251 million (net of deferred tax impact) related to $60.000 million in borrowings that we began recording at fair value.

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NOTE 2 — COMPREHENSIVE INCOME

The following table shows the Company’s comprehensive income for the three months ended March 31, 2007 and 2006:

		Three Months Ended
		March 31,
(dollars in thousands)		2007			2006
Net income		$	100		$	1,660
Other comprehensive income items:
Cumulative effect of accounting change for certain investments, net of tax expense of $625 and $0, respectively		993			—
Unrealized holding gains (losses) arising during the period (net of tax expense (benefit) of $300 and $(746), respectively)		477			(1,185		)
Less: reclassification adjustment for gains (net of taxes of $343 and $0, respectively) included in net income		(544		)	—
Total other comprehensive income (loss)		926			(1,185		)
Total comprehensive income		$	1,026		$	475

 

NOTE 3 — PER SHARE DATA

Basic earnings per share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding.  Diluted earnings per share is computed after adjusting the denominator of the basic earnings per share computation for the effects of all dilutive potential common shares outstanding during the period. The dilutive effects of options, warrants and their equivalents are computed using the “treasury stock” method.  For the three month period ended March 31, 2007 and 2006, there were 310,638 and 0 shares, respectively, which were antidilutive and excluded from the computation.

Information relating to the calculation of earnings per common share is summarized as follows:

		Three Months Ended
		March 31,
(dollars in thousands, except for per share data)		2007			2006
Net income - basic and diluted		$	100		$	1,660
Weighted-average share outstanding - basic		6,420,811			6,264,833
Dilutive securities - options and warrants		210,319			331,828
Adjusted weighted-average shares outstanding - dilutive		6,631,130			6,596,661
Earnings per share - basic		$	0.02		$	0.26
Earnings per share - diluted		$	0.02		$	0.25

 

NOTE 4 — STOCK BASED COMPENSATION

We have stock option award arrangements, which provide for the granting of options to acquire common stock to our directors and key employees. Option prices are equal to or greater than the estimated fair market value of the common stock at the date of the grant. As of March 31, 2007, all outstanding options are fully vested and expire ten years after the date of grant. There have been no modifications to the existing plan.  We recognized compensation cost of $16,000 and $0 for the three months ended March 31, 2007 and 2006, respectively.

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Information with respect to stock options is as follows for the three months ended March 31, 2007:

 

The weighted average fair value of our option grants for the three months ended March 31, 2007 was $6.35 on the dates of grants.  We did not grant any options for the three months ended March 31, 2006. The fair value of our options granted was calculated using the Black-Scholes-Merton option-pricing model with the following weighted average assumptions for the three months ended March 31, 2007:

 

The total intrinsic value of options exercised for the three months ended March 31, 2007 and 2006, amounted to $5,685 and $32,195, respectively.  The related tax benefit during the three months ended March 31, 2007 and 2006 amounted to $0 and $12,434, respectively, and proceeds from exercises of stock options amounted to $11,065 and $76,174, respectively for the three months ended March 31, 2007 and 2006.

While our employee stock purchase plan provides for a 10% discount from market value at issuance, we do not recognize compensation expense on the discount as:  substantially all employees that meet limited employment qualifications may participate in the plan on an equitable basis; the plan incorporates no option features, the purchase price is based solely on the market price of the shares at the date of purchase, and employees are permitted to cancel participation before the purchase date and obtain a refund of amounts previously paid and;  the discount from the market price does not exceed the per-share amount of share issuance costs that would have been incurred to raise a significant amount of capital by a public offering.

NOTE 5 — COMMITMENTS AND CONTINGENT LIABILITIES

We are party to financial instruments with off-balance-sheet risk in the normal course of business in order to meet the financing needs of customers.  These financial instruments include commitments to extend credit, available lines of credit and standby letters of credit.  Our exposure to credit risk is represented by the contractual amounts of those financial instruments.  We apply the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.  A summary of the financial instruments at March 31, 2007 whose contract amounts represent potential credit risk is as follows:

		March 31,			December 31,
(dollars in thousands)		2007			2006
Commitments to extend credit (includes unused lines of credit)		$	256,787		$	294,227
Standby letters of credit		4,538			4,677

 

NOTE 6 — SEGMENT INFORMATION

We are in the business of providing financial services, and we operate in three business segments—commercial and consumer banking, consumer finance and mortgage-banking.  Commercial and consumer banking is conducted through the Bank and involves delivering a broad range of financial services, including lending and deposit taking, to individuals and commercial enterprises.  This segment also includes our treasury and administrative functions.  Consumer finance is conducted through Finance Maryland, and involves originating small direct consumer loans, mortgage loans, and the purchase of retail installment sales contracts.  Mortgage-banking is conducted through First Mariner Mortgage, a division of the Bank, and involves originating first- and second-lien residential mortgages for sale in the secondary market and to the Bank.  The results of our subsidiary, FM Appraisals, are included in the mortgage-banking segment.

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The following table presents certain information regarding our business segments:

For the three month period ended March 31, 2007:

		Commercial and			Consumer			Mortgage-
(dollars in thousands)		Consumer Banking			Finance			Banking			Total
Interest income		$	16,665		$	3,930		$	1,384		$	21,979
Interest expense		8,879			962			931			10,772
Net interest income		7,786			2,968			453			11,207
Provision for loan losses		250			287			—			537
Net interest income after provision for loan losses		7,536			2,681			453			10,670
Noninterest income		4,110			729			2,110			6,949
Noninterest expense		12,390			2,628			2,629			17,647
Net intersegment income		21			—			(21		)	—
Net income before income taxes		$	(723	)	$	782		$	(87	)	$	(28	)
Total assets		$	1,137,015		$	67,535		$	57,273		$	1,261,823

 

For the three month period ended March 31, 2006:

		Commercial and			Consumer			Mortgage-
(dollars in thousands)		Consumer Banking			Finance			Banking			Total
Interest income		$	17,579		$	3,250		$	1,486		$	22,315
Interest expense		8,413			682			978			10,073
Net interest income		9,166			2,568			508			12,242
Provision for loan losses		—			422			—			422
Net interest income after provision for loan losses		9,166			2,146			508			11,820
Noninterest income		3,356			695			1,947			5,998
Noninterest expense		10,573			2,273			2,672			15,518
Net intersegment income		(9		)	—			9			—
Net income before income taxes		$	1,940		$	568		$	(208	)	$	2,300
Total assets		$	1,202,193		$	52,195		$	100,532		$	1,354,920

 

 NOTE 7 — RECENT ACCOUNTING PRONOUNCEMENTS

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140.  This statement amends SFAS No. 133 and SFAS No. 140 by: permitting fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifying which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; establishing a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifying that concentrations of credit risk in the form of subordination are not embedded derivatives and; amending SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.  The statement is effective for fiscal years beginning after September 15, 2006.  The adoption of this standard did not have a material impact on our financial condition, results of operations or liquidity.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets — an amendment of FASB Statement No. 140.  This statement amends SFAS No. 140 with respect to the accounting for separately recognized servicing assets and servicing liabilities.  It requires an entity to recognize a servicing asset or servicing liability each time an obligation is undertaken to service a financial asset by entering into a servicing contract in certain situations and requires all separately recognized servicing assets and liabilities to be initially measured at fair value, if practicable.  The statement permits the choice between the “amortization method” and the “fair value measurement method” for the subsequent measurement of the servicing assets or liabilities and allows for a one-time reclassification of available-for-sale securities to trading securities at initial adoption.   The statement also requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities.   The statement is effective for fiscal years beginning after September 15, 2006.  The adoption of this standard did not have a material impact on our financial condition, results of operations or liquidity.

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In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.  The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes.  The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition.  The interpretation is effective for fiscal years beginning after December 15, 2006.  The adoption of this standard did not have a material impact on our financial condition, results of operations or liquidity.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.  This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.  The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007.  We adopted this standard effective January 1, 2007, with no material impact on our financial condition, results of operations or liquidity.

In September 2006, the FASB ratified the consensus reached by the EITF on Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.  EITF 06-4 requires the recognition of a liability and related compensation costs for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods as defined in SFAS No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions.  The EITF reached a consensus that Bank Owned Life Insurance policies purchased for this purpose do not effectively settle the entity’s obligation to the employee in this regard and, thus, the entity must record compensation costs and a related liability.  Entities should recognize the effects of applying this Issue through either, (a) a change in accounting principle through a cumulative-effective adjustment to retained earnings or to other components of equity or net assets in the balance sheet as of the beginning of the year of adoption, or (b) a change in accounting principle through retrospective application to all prior periods.  This Issue is effective for fiscal years beginning after December 15, 2007.  The adoption of this interpretation is not anticipated to have a material impact on our financial condition, results of operations or liquidity.

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, which generally permits the measurement of selected eligible financial instruments, including investment securities, at fair value as of specified election dates and the reporting of unrealized gains or losses on those instruments in earnings at each subsequent reporting date. Generally, the fair value option may be applied on an instrument by instrument basis but, once applied, the election is irrevocable and is applied to the entire instrument.  The statement is effective for fiscal years beginning after November 15, 2007, with early adoption permitted as of the beginning of a fiscal year that begins on or before November 15, 2007.

We adopted SFAS No. 159 on January 1, 2007.  The effect of adopting this statement on existing eligible items at the time of adoption is recorded as a cumulative effect of accounting change through retained earnings in the financial statements and is detailed as follows:

								Balance Sheet
		Balance Sheet						January 1, 2007
		January 1, 2007			Net Gain/(Loss)			After Adoption
(dollars in thousands)		Prior to Adoption			Upon Adoption			of Fair Value Option
Investment trading securities		$	42,569		$	(1,618	)	$	40,951
Long-term debt		60,000			(2,038		)	62,038
Pre-tax cumulative effect of adoption of the fair value option					(3,656		)
Increase in deferred tax assets					1,412
Cumulative effect of adoption of the fair value option (charge to retained earnings)					$	(2,244	)

 

Management believes the adoption was appropriate in order to more closely align the impact of interest rate movements within stockholders’ equity.  Prior to adoption, the securities were marked to market through the Company’s stockholders’ equity, with no offsetting impact of any borrowings or other interest-bearing liabilities, which may act as a natural interest rate risk hedge.  By treating certain assets and liabilities with similar characteristics as fair value instruments, both positions will be subject to fair value adjustments through earnings and ultimately stockholders’ equity.  Management believes the adoption will minimize the volatility in reported stockholders’ equity as the borrowing position will also be subject to fair value treatment.

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As a result of our early adoption of SFAS No. 159, we elected to transfer $42.000 million of investment securities previously held as available for sale to trading securities.  These securities were selected based upon their yield (under 5%) and quality of available pricing data.  The average life of the bonds selected was 5.22 years.  In addition, we elected to record $60.000 million of our long-term borrowings at fair value.  The borrowings selected were fixed rate (6.07%) with an average remaining life of 3.24 years and have a consistent and reliable pricing source.  Retained earnings as of January 1, 2007 was reduced by $2.244 million, net of tax, as a result of the election. This is a permanent adjustment to retained earnings; however, there is no impact to total stockholders’ equity from the investment reclassification because the market value adjustment of the available for sale securities was already recorded in accumulated other comprehensive loss. This one-time charge will not be recognized in current earnings based upon application of SFAS No. 159. In addition, a pre-tax loss of approximately $111,000 was recognized in the first quarter of 2007 due to a net decrease in the fair value of these financial instruments since January 1, 2007.

Interest income on trading securities and interest expense on long-term borrowings at fair value is accrued at the contractual rate based on the principal outstanding.  Premiums and discounts related to trading securities are expensed at time of purchase.  The interest from trading securities is included in the Statements of Operations in “Interest income from investments and other earning assets” and the interest on borrowings at fair value is included in the Statements of Operations in “Interest expense from long-term borrowings.”

The following table shows details of the financial instruments as of March 31, 2007 for which we elected to apply the fair value option:

								Significant
								Other						Total Changes
		Carrying			Quoted			Observable			Trading			In Fair Values
		Value			Prices			Inputs			Gains and			Included In
(dollars in thousands)		(Fair Value)			(Level 1)			(Level 2)			Losses			Period Earnings
Trading securities		$	40,901		$	40,901		$	—		$	(50	)	$	(50	)
Long-term debt at fair value		62,099			—			62,099			(61		)	(61		)

 

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

The following discussion should be read and reviewed in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in our Annual Report on Form 10-K for the year ended December 31, 2006.

Forward-Looking Statements

This quarterly report on Form 10-Q may contain forward-looking language within the meaning of The Private Securities Litigation Reform Act of 1995.  Statements may include expressions about our confidence, policies and strategies, provisions and allowance for loan losses, adequacy of capital levels, and liquidity.  All statements included or incorporated by reference in this Quarterly Report on Form 10-Q, other than statements that are purely historical, are forward-looking statements. Statements that include the use of terminology such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “estimates” and similar expressions also identify forward-looking statements. The forward-looking statements are based on our current intent, belief and expectations. Forward-looking statements in this Quarterly Report on Form 10-Q include, but are not limited to, statements of our plans, strategies, objectives, intentions, including, among other statements, statements involving our projected loan and deposit growth, loan collateral values, collectibility of loans, anticipated changes in other operating income, payroll and branching expenses, branch, office and product expansion of the Company and its subsidiaries, and liquidity and capital levels.  Such forward-looking statements involve certain risks and uncertainties, including general economic conditions, competition in the geographic and business areas in which we operate, inflation, fluctuations in interest rates, legislation and government regulation.  These statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. For a more complete discussion of risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements, see “Risk Factors” filed as Item 1A of Part I in our Form 10-K for the year ended December 31, 2006.  Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.

The Company

The Company is a financial holding company incorporated under the laws of Maryland and registered under the federal Bank Holding Company Act of 1956, as amended.  The Company was organized in 1994 and changed its name to First Mariner Bancorp in May 1995. Since 1995, the Company’s strategy has involved building a network of banking branches, ATMs and other financial services outlets to capture market share and build a community franchise for stockholders, customers and employees.  The Company is currently focused on growing assets and earnings by capitalizing on the broad network of bank branches, mortgage offices, consumer finance offices, and ATMs established during its infrastructure expansion phase.

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The Company’s business is conducted primarily through its wholly owned subsidiaries, First Mariner Bank (the “Bank”), Finance Maryland LLC (“Finance Maryland”), and FM Appraisals, LLC (“FM Appraisals”).  The Bank is the largest operating subsidiary of the Company with assets exceeding $1.1 billion as of March 31, 2007. The Bank was formed in 1995 through the merger of several small financial institutions. The Bank’s primary market area for its core banking operations, which consist of traditional commercial and consumer lending, as well as retail and commercial deposit operations, is central Maryland as well as portions of Maryland’s eastern shore.   The Bank opened its first branch in Pennsylvania during the first quarter of 2007.  The Bank is an independent community bank, and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”).

The Bank is engaged in the general commercial banking business, with particular attention and emphasis on the needs of individuals and small to mid-sized businesses, and delivers a wide range of financial products and services that are offered by many larger competitors. Products and services include traditional deposit products, a variety of consumer and commercial loans, residential and commercial mortgage and construction loans, wire transfer services, non-deposit investment products, and internet banking and similar services.  Most importantly, the Bank provides customers with access to local Bank officers who are empowered to act with flexibility to meet customers’ needs in an effort to foster and develop long-term loan and deposit relationships.

First Mariner Mortgage, a division of the Bank, engages in mortgage-banking activities, providing mortgages and associated products to customers and selling most of those mortgages on the secondary market.  During the first quarter of 2006, First Mariner Mortgage expanded its secondary marketing activities significantly and began hedging the interest rate risk associated with mortgage-banking activities.  During 2007, such activity decreased significantly due to decreased loan demand resulting in a decline in originations.  In addition, we reduced the types of products that we offer and tightened our underwriting standards.

Finance Maryland engages in traditional consumer finance activities, making small direct loans to individuals, mortgage loans, the purchase of installment loan sales contracts from local merchants and retail dealers of consumer goods, and loans to individuals via direct mail solicitations. Finance Maryland currently operates 18 branches, including a central approval office, in Maryland and four branches in Delaware, which operate under the trade name “Finance Delaware.” Finance Maryland had total assets of $67.5 million as of March 31, 2007.

FM Appraisals is a residential real estate appraisal preparation and management company that is headquartered in Baltimore City. FM Appraisals offers appraisal services for residential real estate lenders, including appraisal preparation, the compliance oversight of sub-contracted appraisers, appraisal ordering and administration, and appraisal review services. FM Appraisals provides these services to First Mariner Mortgage.

Critical Accounting Policies

The Company’s financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States of America and follow general practices within the industry in which it operates.  Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. When applying accounting policies in such areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets and liabilities.   Below is a discussion of our critical accounting policies.

Allowance for loan losses

A variety of estimates impact the carrying value of the loan portfolio including the calculation of the allowance for loan losses, valuation of underlying collateral and the timing of loan charge-offs.

The allowance is established and maintained at a level that management believes is adequate to cover losses resulting from the inability of borrowers to make required payments on loans.  Estimates for loan losses are arrived at by analyzing risks associated with specific loans and the loan portfolio.  Current trends in delinquencies and charge-offs, the views of the Bank’s regulators, changes in the size and composition of the loan portfolio and peer comparisons are also factors.  The analysis also requires consideration of the economic climate and direction and change in the interest rate environment, which may impact a borrower’s ability to pay, legislation impacting the banking industry and environmental and economic conditions specific to the Bank’s service areas.  Because the calculation of the allowance for loan losses relies on estimates and judgments relating to inherently uncertain events, results may differ from our estimates.

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Investment securities

Securities are evaluated periodically to determine whether a decline in their value is other than temporary. The term “other than temporary” is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Management reviews criteria such as the magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

Deferred income taxes

Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. Deferred tax assets are subject to management’s judgment based upon available evidence that future realization is more likely than not.

Loan income recognition

Interest income on loans is accrued at the contractual rate based on the principal outstanding. Loan origination fees and certain direct loan origination costs are deferred and amortized as a yield adjustment over the contractual loan terms. Accrual of interest is discontinued when its receipt is in doubt, which typically occurs when a loan becomes 90 days past due as to principal or interest. Any interest accrued to income in the year when interest accruals are discontinued is reversed. Management may elect to continue the accrual of interest when a loan is in the process of collection and the estimated fair value of the collateral is sufficient to satisfy the principal balance and accrued interest. Loans are returned to accrual status once the doubt concerning collectibility has been removed and the borrower has demonstrated the ability to pay and remain current. Payments on nonaccrual loans are generally applied to principal.

Derivative Loan Commitments and Hedging Activities

In connection with our mortgage-banking activities, we enter into commitments to fund residential mortgage loans at specified times in the future. We enter into these commitments through retail and broker channels and also purchase loan commitments from correspondent lenders. A mortgage loan commitment binds the Company to lend funds to a potential borrower at a specified interest rate and within a specified period of time, generally up to 90 days after inception of the rate lock commitment. Such a commitment is referred to as a derivative loan commitment if the loan that will result from exercise of the commitment will be held for sale upon funding under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. As such, loan commitments that are derivatives must be recognized at fair value on the consolidated balance sheets with changes in their fair values recorded as part of income from mortgage-banking operations. For accounting purposes, we value this commitment to zero at inception. Subsequent to inception, we estimate the fair value of the commitment, taking into consideration the probability of funding of the loan, and compare it to the fair value calculated at inception to measure the change in value, which is recorded through current period earnings with a corresponding asset for an increase in value or a liability for a decrease in value.

Loan Repurchases

Our sales agreements with investors who buy our loans generally contain covenants which may require us to repurchase loans under certain provisions, including delinquencies, or return premiums paid by those investors should the loan be paid off early or be required to be repurchased.  These covenants are usual and customary within the mortgage-banking industry and generally apply for the first 90 days after the loan has been purchased by the investor.  We maintain a reserve (included in other liabilities) for potential losses relating to these sales covenants, including estimates for the devaluation of loans as a result of their delinquency status.

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Cumulative Effect of Accounting Change

We adopted SFAS No. 159 effective January 1, 2007.  The effect of adopting this statement on existing eligible items at the time of adoption is recorded as a cumulative effect of accounting change in the financial statements through retained earnings and is detailed as follows:

								Balance Sheet
		Balance Sheet						January 1, 2007
		January 1, 2007			Net Gain/(Loss)			After Adoption
(dollars in thousands)		Prior to Adoption			Upon Adoption			of Fair Value Option
Investment trading securities		$	42,569		$	(1,618	)	$	40,951
Long-term debt		60,000			(2,038		)	62,038
Pre-tax cumulative effect of adoption of the fair value option					(3,656		)
Increase in deferred tax assets					1,412
Cumulative effect of adoption of the fair value option (charge to retained earnings)					$	(2,244	)

 

See Note 7 to the Consolidated Financial Statements above for additional information about our adoption of SFAS No. 159.

Financial Condition

The Company’s total assets were $1.262 billion at March 31, 2007, compared to $1.263 billion at December 31, 2006, decreasing $1.467 million or 0.1% for the first three months of 2007.  Earning assets remained stable at $1.121 billion at both March 31, 2007 and December 31, 2006.  The decrease in assets was due to decreases in cash and due from banks (-$4.330 million),  investment securities (both trading and available for sale) (-$51.053 million), loans held for sale (-$37.098 million), and net loans outstanding (-$8.895 million), partially offset by increases in short-term investments (+$98.108 million).  We also experienced decreases in deposits (-$10.667 million), partially offset by increases in short-term (+$1.593 million) and long-term (+$11.061 million) borrowings.

Investment securities available for sale

We utilize the investment portfolio as part of our overall asset/liability management practices to enhance interest revenue while providing necessary liquidity for the funding of loan growth or deposit withdrawals.  Investment securities available for sale declined $91.954 million due to the transfer of securities available for sale to the trading securities portfolio, security sales of $1.301 million, normal principal payments on mortgage-backed securities and scheduled maturities of other investments ($51.665 million).  These decreases were offset by an increase in market values and additional purchases of securities of $999,000. At March 31, 2007, our unrealized gain on securities classified as available for sale totaled $7,000, compared to a loss of $1.505 million at December 31, 2006.  The improvement resulted from the transfer of certain securities to the trading portfolio and decreases in short-term and long-term interest rates from December 31, 2006 to March 31, 2007, which resulted in higher market valuation of our fixed income investments.

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The investment securities available for sale portfolio composition is as follows:

		March 31,					December 31,
		2007					2006
					Percent					Percent
(dollars in thousands)		Balance			of Total		Balance			of Total
Investment securities available for sale:
Mortgage-backed securities		$	19,267		34.8	%	$	62,281		42.3	%
Trust preferred securities		26,658			48.2	%	33,028			22.4	%
US government agency notes		—			—		39,894			27.1	%
US Treasury securities		1,004			1.8	%	998			0.7	%
Obligations of state and municipal subdivisions		2,962			5.3	%	2,965			2.0	%
Corporate obligations		1,979			3.6	%	1,988			1.3	%
Equity securities		720			1.3	%	1,395			1.0	%
Foreign government bonds		1,750			3.2	%	1,750			1.2	%
Other investment securities		996			1.8	%	2,991			2.0	%
Total investment securities available for sale		$	55,336		100.0	%	$	147,290		100.0	%

 

Loans

Total loans decreased $9.408 million during the first three months of 2007.  The majority of the decline occurred in our commercial real estate portfolio, which decreased by $17.637 million, and in our consumer residential construction portfolio, which decreased by $4.348 million.  These decreases reflect the softening demand for both residential and commercial real estate development loans.  These declines were partially offset by growth in our residential mortgage loan portfolio (+$7.462 million) (primarily due to repurchased loans), commercial construction portfolio (+$2.769 million), and consumer loan portfolio (+$4.772 million).  Our loans secured by deposits and other also increased by $387,000.  The total loan portfolio was comprised of the following:

		March 31,					December 31,
		2007					2006
					Percent					Percent
(dollars in thousands)		Balance			of Total		Balance			of Total
Loans secured by first mortgages on real estate:
Residential		$	64,186		7.5	%	$	56,724		6.5	%
Commercial		300,599			35.0	%	318,236			36.7	%
Consumer residential construction		93,658			10.9	%	98,006			11.3	%
Commercial / residential construction		140,538			16.4	%	137,769			15.9	%
		598,981			69.8	%	610,735			70.4	%
Commercial		77,616			9.1	%	79,001			9.1	%
Loans secured by second mortgages on real estate		100,657			11.7	%	102,367			11.8	%
Consumer loans		77,962			9.1	%	73,190			8.5	%
Loans secured by deposits and other		2,344			0.3	%	1,957			0.2	%
Total loans		857,560			100.0	%	867,250			100.0	%
Unamortized loan discounts		(163		)			(220		)
Unearned loan fees, net		(346		)			(571		)
		$	857,051				$	866,459

 

Credit Risk Management

We attempt to manage the risk characteristics of our loan portfolio through various control processes, such as credit evaluation of borrowers, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances. However, we seek to rely primarily on the cash flow of our borrowers as the principal source of repayment. Although credit policies are designed to minimize our risk, management recognizes that loan losses will occur and the amount of these losses will fluctuate depending on the risk characteristics of our loan portfolio, as well as general and regional economic conditions.

 We provide for loan losses through the establishment of an allowance for loan losses (the “allowance”) by provisions charged against earnings. Our allowance for loan losses represents an estimated reserve for existing losses in the loan portfolio. We evaluate the adequacy of our allowance for loan losses continually based on a review of all significant loans, with a particular emphasis on nonaccruing, past due, and other loans that we believe require special attention.

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Based upon management’s evaluation, provisions are made to maintain the allowance as a best estimate of inherent losses within the portfolio. The provision for loan losses was $537,000 for the three months ended March 31, 2007 as compared to $422,000 for the same period in 2006. The provision for loan losses increased in an amount proportionate to the incremental inherent risk associated with the growth and decline in the various loan types as well as a deterioration in qualitative factors management uses in establishing the unallocated portion of the allowance for loan losses. We recorded net charge-offs of $1.050 million during the first three months of 2007 compared to net charge-offs of $296,000 for the same period in 2006.   This increase was primarily attributable to increases in net charge-offs of commercial, commercial mortgage and repurchased second mortgages.

The allowance consists of three elements: (1) specific reserves for individual credits; (2) general reserves for types or portfolios of loans based on historical loan loss experience, judgmentally adjusted for current conditions and credit risk concentrations; and (3) unallocated reserves. Combined specific reserves and general reserves by loan type are considered allocated reserves. All outstanding loans are considered in evaluating the adequacy of the allowance.

We deploy a systematic methodology for determining our allowance for loan losses that includes a quarterly review process and adjustment to our allowance. Our process includes updates on all loans that we have rated for risk. Our commercial loans are generally reviewed individually, in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, while large groups of homogeneous loans are reviewed as pools. Our methodology incorporates a variety of risk considerations, both qualitative and quantitative. Quantitative factors include our historical loss experience by loan type, collateral values, financial condition of borrowers, and other factors. Qualitative factors include judgments concerning general economic conditions that may affect credit quality, credit concentrations, the pace of portfolio growth, and delinquency levels; these qualitative factors are evaluated in connection with our unallocated portion of our allowance for loan losses. We periodically engage outside firms and experts to independently assess our methodology, and perform various loan review functions.

Our methodology employs management’s judgment as to the level of future losses on existing loans based on our internal review of the loan portfolio, including an analysis of the borrowers’ current financial position, the consideration of current and anticipated economic conditions and their potential effects on specific borrowers. In determining our ability to collect certain loans, we also consider the fair value of any underlying collateral. However, our determination of the appropriate allowance level is based upon a number of assumptions we make about future events, which we believe are reasonable, but which may or may not prove valid. Thus, there can be no assurance that our charge-offs in future periods will not exceed our allowance for loan losses or that we will not need to make additional increases in our allowance for loan losses.

The process of establishing the allowance with respect to our commercial and commercial real estate loan portfolios begins when a loan officer initially assigns each loan a risk grade, using established credit criteria. Risk grades are subject to review and validation annually by an independent consulting firm, as well as periodically by our internal credit review function. Management reviews, on a quarterly basis, current conditions that affect various lines of business and may warrant adjustments to reserves for a particular loan.  Management also evaluates credit risk concentrations, including trends in large dollar exposures to related borrowers, and industry and geographic concentrations. Economic and environmental factors are also considered.  All nonaccrual loans in the commercial and nonresidential real estate portfolios, as well as other loans in the portfolios identified as having the potential for further deterioration, are analyzed individually to confirm the appropriate risk grading and accrual status, and to determine the need for a specific reserve.

Consumer and residential mortgage loans are segregated into homogeneous pools with similar risk characteristics. Trends and current conditions in retail and residential mortgage pools are analyzed and historical loss experience is adjusted accordingly. Adjustment factors for the retail and residential mortgage portfolios are consistent with those for the commercial portfolios.

The unallocated portion of the allowance is intended to provide for losses that are not identified when establishing the specific and general portions of the allowance and is based upon management’s evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. Such conditions include general economic and business conditions affecting key lending areas, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, specific industry conditions within portfolio categories, recent loss experience in particular loan categories, duration of the current business cycle, bank regulatory examination results, findings of internal loan examiners, and management’s judgment with respect to various other conditions including loan administration and management and the quality of risk identification systems.  Executive management reviews these conditions quarterly.  We have risk management practices designed to ensure timely identification of changes in loan risk profiles; however, undetected losses may exist inherently within the loan portfolios. The judgmental aspects involved in applying the risk grading criteria, analyzing the quality of individual loans, and assessing collateral values can also contribute to undetected, but probable, losses.

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Valuation allowances established in relationship to repurchased loans originated for sale or transfer of loans from loans held for sale to the loan portfolio are in addition to and separate from the allowance for loan losses.  The valuation allowance was established for loans already repurchased and in the portfolio and the secondary marketing reserve is for loans that may be required to be repurchased in the future.  The valuation allowance ($1.027 million) and secondary marketing reserve ($2.471 million) are not part of our allowance for loan losses of $11.886 million, but are in addition to it.

In establishing the valuation allowance and secondary marketing reserve, management needed to make significant assumptions concerning the ultimate collectibility of loans currently delinquent, and those expected to be repurchased in the future.  Additionally, a portion of these reserves are based upon projected volume of repurchases.  While these projections were made with the most current data available to management, actual realized losses could differ due to the changes in the borrowers’ willingness or ability to resolve the delinquency status, changes in the actual volume of future repurchases, or changes in market values of those loans which are liquidated.  Management will update these assumptions continually as greater experience becomes available.

In response to the trends experienced in our secondary marketing business, management has taken steps to modify underwriting guidelines and strengthen borrower qualification terms.  Additionally, management has dramatically reduced its offering of second mortgage products through broker channels and has limited its mortgage lending to investor borrowers.

The allowance at March 31, 2007 is considered by management to be sufficient to address the credit losses inherent in the current loan portfolio.   The changes in the allowance are presented in the following table:

		Three Months Ended
		March 31,
(dollars in thousands)		2007			2006
Allowance for loan losses, beginning of year		$	12,399		$	11,743
Loans charged off:
Commercial		(67		)	—
Residential construction - commercial		—			—
Commercial mortgages		(340		)	—
Residential construction - consumer		—			(9		)
Residential mortgages		—			—
Consumer		(795		)	(412		)
Total loans charged off		(1,202		)	(421		)
Recoveries:
Commercial		—			—
Residential construction - commercial		—			—
Commercial mortgages		—			—
Residential construction - consumer		—			23
Residential mortgages		29			—
Consumer		123			102
Total recoveries		152			125
Net charge-offs		(1,050		)	(296		)
Provision for loan losses		537			422
Allowance for loan losses, end of period		$	11,886		$	11,869
Loans (net of premiums and discounts):
Period-end balance		$	857,051		$	851,936
Average balance during period		859,389			847,794
Allowance as a percentage of period-end loan balance		1.39		%	1.39		%
Percent of average loans:
Provision for loan losses (annualized)		0.25		%	0.20		%
Net charge-offs (annualized)		0.50		%	0.14		%

 

During the first three months of 2007, annualized net charge-offs as compared to average loans outstanding increased to 0.50%, as compared to 0.14% during the same period of 2006, mostly due to a few large charge-offs in the commercial mortgage portfolio ($340,000) taken in the first quarter of 2007 and increased charge-offs in our consumer portfolio consistent with the increase in our consumer loan portfolio balances and charge offs of previously repurchased second mortgages.  Nonperforming assets, expressed as a percentage of total assets, totaled 1.73% at March 31, 2007, 0.52% at December 31, 2006 and 0.27% at March 31, 2006.  The increase as compared to March 31, 2006 reflects an increase in both residential real estate acquired by foreclosure and nonaccrual loans.  At March 31, 2007, there were a larger percentage of commercial and residential real estate loans classified as nonaccrual as compared to March 31, 2006, when a larger percentage consisted of commercial loans.  Loans past due 90 days or more and still accruing totaled $18.480 million as of March 31, 2007 compared to $27.274 million at December 31, 2006 and

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$1.649 million as of March 31, 2006.  Of the $18.480 million total, $4.057 million is for six commercial construction loans, $1.370 million is for two commercial mortgage loans, $88,000 is for one commercial loan, and $12.963 million is for first-lien position residential mortgages, all of which are well-collateralized and in the process of collection.  The remainder of the loans past due 90 days or more of $2,000 are consumer loans.

The following table summarizes our allocation of allowance by loan type:

		March 31, 2007							December 31, 2006
							Percent							Percent
							of Loans							of Loans
					Percent		to Total					Percent		to Total
(dollars in thousands)		Amount			of Total		Loans		Amount			of Total		Loans
Commercial		$	561		4.7	%	9.1	%	$	926		7.5	%	9.1	%
Residential construction -commercial		2,570			21.6	%	16.3	%	2,749			22.2	%	15.8	%
Commercial mortgages		2,375			20.0	%	35.1	%	3,073			24.8	%	36.7	%
Residential construction -consumer		729			6.1	%	10.9	%	1,068			8.6	%	11.3	%
Residential mortgages		202			1.7	%	7.5	%	28			0.2	%	6.5	%
Consumer		2,807			23.7	%	21.1	%	2,928			23.6	%	20.6	%
Unallocated		2,642			22.2	%	—		1,627			13.1	%	—
Total		$	11,886		100.0	%	100.0	%	$	12,399		100.0	%	100.0	%

 

Management applies SFAS No. 114 to determine accrual status for larger loans.  Under SFAS No. 114, when it is probable that we will be unable to collect all payments due, including interest, we place the loan on nonaccrual. Management may grant a waiver from nonaccrual status for a 90-day past-due loan that is both well secured and in the process of collection. A loan remains in nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to pay and remain current. As a result of our ongoing review of the loan portfolio, we may classify loans as nonaccrual even though the presence of collateral or the borrowers financial strength may be sufficient to provide for ultimate repayment. We recognize interest on nonaccrual loans only when it is received.

 The following table provides information concerning nonperforming assets and past-due loans:

		March 31,			December 31,			March 31,
(dollars in thousands)		2007			2006			2006
Nonaccrual loans		$	15,851		$	4,158		$	3,653
Real estate acquired by foreclosure		5,991			2,440			65
Total nonperforming assets		$	21,842		$	6,598		$	3,718
Loans past-due 90 days or more and accruing		$	18,480		$	27,274		$	1,649

 

A loan is determined to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan is not considered impaired during a period of delay in payment if we expect to collect all amounts due, including past-due interest. We generally consider a period of delay in payment to include delinquency up to 90 days.  Commercial loans are evaluated individually for impairment.  Pools of smaller-balance homogeneous loans such as consumer installment, residential first and second mortgage loans and credit card loans are collectively evaluated for impairment.  During the first quarter of 2007, management considered two large commercial construction loans ($9.9 million) to be impaired under this criteria and reclassified these loans as nonaccrual.

We consider impaired loans to be all commercial nonaccrual loans.  As of March 31, 2007, we had impaired loans of $12.393 million.  The valuation allowance for impaired loans was $1.400 million as of March 31, 2007.

At March 31, 2007, the allowance for loan losses represented 54.4% of nonperforming assets compared to 187.9% at December 31, 2006.  Management believes the allowance for loan losses is adequate as of March 31, 2007.

As of March 31, 2007, we maintained $19.783 million in delinquent loans that we have repurchased from investors in accordance with a covenant in our sales agreements.  We have established a valuation allowance for these loans in the amount of $1.027 million that is in addition to and separate from the allowance for loan losses.  The majority of the loans are 90 days past due.  Of the $19.783 million, $2.997 million have been placed on nonaccrual.

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