TOBC Tower Bancorp (MM)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2011,

or

 

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

Commission File Number: 001-34277

 

 

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania		25-1445946
(State or other jurisdiction of incorporation)		(IRS Employer Identification Number)
112 Market Street, Harrisburg, Pennsylvania		17101
(Address of principal executive office)		(Zip Code)

(717) 231-2700

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class		Name of exchange on which registered
Common Stock, No Par Value		The NASDAQ Stock Market, LLC

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

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

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

 

Large accelerated filed		¨		Accelerated filer		x
Non-accelerated filer		¨		Smaller reporting company		¨

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

 

 

 

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APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 12,007,187 as of October 31, 2011.

TABLE OF CONTENTS

 

		Description		Page
PART I
Item 1.		Financial Statements:
		Consolidated Balance Sheets			3
		Consolidated Statements of Operations			4
		Consolidated Statements of Equity and Comprehensive Income			5
		Consolidated Statements of Cash Flows			6
		Notes to Consolidated Financial Statements			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			36
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			58
Item 4.		Controls and Procedures			63
PART II
Item 1.		Legal Proceedings			64
Item 1A.		Risk Factors			64
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			65
Item 3.		Defaults Upon Senior Securities			65
Item 4.		Removed and Reserved			65
Item 5.		Other Information			65
Item 6.		Exhibits			66
		Signatures			67
		Exhibit Index			68

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PART I.

FINANCIAL INFORMATION

Item 1. Financial Statements

Tower Bancorp, Inc. and Subsidiaries

Con solidated Balance Sheets

September 30, 2011 and December 31, 2010

(Amounts in thousands, except share data)

 

		September 30, 2011				December 31, 2010
		(unaudited)
Assets
Cash and due from banks		$	116,418			$	219,741
Federal funds sold			14,547				28,738
Cash and cash equivalents			130,965				248,479
Securities available for sale			153,919				102,695
Restricted investments			12,629				14,696
Loans held for sale			30,095				147,281
Loans, net of allowance for loan losses of $11,925 and $14,053			2,051,931				2,058,191
Premises and equipment, net of accumulated depreciation of $10,820 and $6,188			52,808				56,388
Accrued interest receivable			6,956				7,856
Deferred tax asset, net			12,106				19,526
Bank owned life insurance			40,856				39,670
Goodwill			19,444				16,750
Other intangible assets, net of accumulated amortization of $2,348 and $1,188			6,333				7,493
Other real estate owned			4,293				4,647
Other assets			16,989				23,617
Total assets		$	2,539,324			$	2,747,289
Liabilities and equity
Liabilities
Deposits:
Non-interest bearing		$	292,619			$	301,210
Interest bearing			1,861,153				1,998,688
Total deposits			2,153,772				2,299,898
Securities sold under agreements to repurchase			10,555				6,605
Short-term borrowings			56				55,039
Long-term debt			87,887				87,800
Accrued interest payable			1,625				1,950
Other liabilities			23,805				38,111
Total liabilities			2,277,700				2,489,403
Equity
Common stock, no par value; 50,000,000 shares authorized; 12,110,545 issued and 12,007,187 outstanding at September 30, 2011, and 12,074,757 shares issued and 11,971,399 outstanding at December 31, 2010			—				—
Additional paid-in capital			272,368				271,350
Accumulated deficit			(9,311	)			(10,868	)
Accumulated other comprehensive income			2,595				251
Less: cost of treasury stock, 103,358 shares at September 30, 2011 and December 31, 2010			(4,093	)			(4,093	)
Total stockholders’ equity			261,559				256,640
Noncontrolling interests			65				1,246
Total equity			261,624				257,886
Total liabilities and equity		$	2,539,324			$	2,747,289

See Notes to the Consolidated Financial Statements

 

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Tower Bancorp, Inc. and Subsidiaries

Conso lidated Statements of Operations

Three and Nine Months Ended September 30, 2011 and 2010

(Amounts in thousands, except share and per share data)

 

		For three months ended September 30,								For nine months ended September 30,
		2011				2010				2011				2010
		(unaudited)				(unaudited)				(unaudited)				(unaudited)
Interest income
Loans, including fees		$	29,065			$	17,852			$	87,243			$	51,632
Securities			1,108				1,020				3,470				3,223
Federal funds sold and other			42				24				180				98
Total interest income			30,215				18,896				90,893				54,953
Interest expense
Deposits		$	4,959			$	4,492			$	14,275			$	13,645
Short-term borrowings			69				177				323				482
Long-term debt			1,288				856				3,658				2,503
Total interest expense			6,316				5,525				18,256				16,630
Net interest income			23,899				13,371				72,637				38,323
Provision for loan losses			1,300				1,600				4,450				4,950
Net interest income after provision for loan losses			22,599				11,771				68,187				33,373
Noninterest income
Service charges on deposit accounts			1,130				832				3,367				2,377
Fiduciary fees and brokerage commissions			905				87				2,868				225
Other service charges, commissions and fees			1,003				493				2,857				1,563
Gain on sale of mortgage loans originated for sale			1,076				656				3,672				1,250
Impairment losses on securities available for sale			—				(70	)			(63	)			(138	)
Increase in cash surrender value of bank owned life insurance			390				566				1,186				1,300
Other income			1,179				414				1,966				772
Total noninterest income			5,683				2,978				15,853				7,349
Noninterest expenses
Salaries and employee benefits			9,770				5,521				34,177				15,906
Occupancy and equipment			4,031				1,805				12,353				5,236
Amortization of intangible assets			343				160				1,093				496
FDIC insurance premiums			526				564				2,184				1,500
Advertising and promotion			508				231				1,770				740
Data processing			1,162				740				3,413				1,894
Communication			298				278				1,377				771
Professional service fees			700				385				2,862				1,197
Impairment of long-lived assets			—				—				—				920
Other operating expenses			2,068				1,149				8,157				3,501
Restructuring charges			61				—				1,635				—
Merger related expenses			(92	)			117				693				304
Total noninterest expense			19,375				10,950				69,714				32,465
Income before income taxes			8,907				3,799				14,326				8,257
Income tax expense			2,686				1,275				4,308				2,647
Net income including noncontrolling interest		$	6,221			$	2,524			$	10,018			$	5,610
Less: income from noncontrolling interest			2				22				71				26
Net income for Tower Bancorp, Inc.		$	6,219			$	2,502			$	9,947			$	5,584
Per share data
Net income per share
Basic		$	0.52			$	0.35			$	0.83			$	0.78
Diluted			0.52				0.35				0.83				0.78
Dividends declared			0.14				0.28				0.70				0.84
Weighted Average Common Shares Outstanding
Basic			12,007,187				7,144,685				11,993,204				7,134,611
Diluted			12,016,724				7,144,721				11,999,215				7,137,508

See Notes to the Consolidated Financial Statements

 

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Tower Bancorp, Inc. and Subsidiary

Consolidated Statement of Ch anges in Equity and Comprehensive Income

Nine months ended September 30, 2011 and 2010

(Amounts in thousands, except share and per share data)

 

		Shares Outstanding				Common Stock				Additional Paid-in Capital				Accu- mulated Deficit				Accumulated Other Compre- hensive Income (Loss)				Treasury Stock				Non- controlling Interest				Total
Balance—December 31, 2009			7,122,683			$	—			$	172,409			$	(4,025	)		$	(414	)		$	(4,093	)		$	16			$	163,893
Stock issued as investment in Dellinger, Dolan, McCurdy and Phillips Investment Advisors, LLC (“DDMP”)											51																				51
Restricted common stock awards earned			31,340								53																				53
Stock option expense											84																				84
Dividends declared ($0.84 per share)															(5,990	)															(5,990	)
Proceeds from stock purchase plans			29,777								578																				578
Comprehensive income:
Net income															5,584												26				5,610
Unrealized gain on securities available for sale, net of taxes of $829																			1,557												1,557
Total Comprehensive Income																															7,167
Balance—September 30, 2010 (unaudited)			7,183,800			$	—			$	173,175			$	(4,431	)		$	1,143			$	(4,093	)		$	42			$	165,836
Balance—December 31, 2010			11,971,399			$	—			$	271,350			$	(10,868	)		$	251			$	(4,093	)		$	1,246			$	257,886
Restricted common stock awards expense											257																				257
Stock option expense											134																				134
Stock options exercised			8,000								159																				159
Dividends declared ($0.70 per share)															(8,390	)															(8,390	)
Proceeds from stock purchase plans			27,788								587																				587
Additional proceeds from common stock transactions											(119	)																			(119	)
Distributions to noncontrolling interests																											(1,252	)			(1,252	)
Comprehensive income:
Net income															9,947												71				10,018
Unrealized gain on securities available for sale, net of taxes of $1,263																			2,344												2,344
Total Comprehensive Income																															12,362
Balance—September 30, 2011 (unaudited)			12,007,187			$	—			$	272,368			$	(9,311	)		$	2,595			$	(4,093	)		$	65			$	261,624

See Notes to the Consolidated Financial Statements

 

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Tower Bancorp, Inc. and Subsidiaries

Consolidated St atements of Cash Flows

Nine months ended September 30, 2011 and 2010

(Amounts in thousands, except share and per share data)

 

		2011				2010
		(unaudited)				(unaudited)
Cash flows from operating activities
Net income including noncontrolling interest		$	10,018			$	5,610
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			4,450				4,950
Net accretion			(5,197	)			1,829
Depreciation			4,516				1,981
Amortization of intangible assets			1,093				496
Restricted common stock awards expense			257				—
Stock options expense			134				84
Expense (benefit) of deferred taxes			5,962				(575	)
Decrease (increase) in accrued interest receivable			900				(246	)
(Decrease) in accrued interest payable			(325	)			(6	)
Net increase in the cash surrender value of life insurance			(1,186	)			(1,300	)
Decrease in other assets			7,455				654
(Decrease) increase in other liabilities			(15,443	)			435
Impairment of premises and equipment			—				920
Gain on sale of assets			(4,114	)			(1,403	)
Loans originated for sale			(308,170	)			(96,052	)
Sale of loans			434,808				92,485
Net cash provided by operating activities			135,158				9,862
Cash flows from investing activities
Proceeds from sales and maturities of securities available for sale			124,693				119,638
Purchases of securities available for sale			(172,272	)			(73,801	)
Purchases of bank owned life insurance			—				(12,000	)
Net increase in loans			(2,835	)			(184,928	)
Decrease of investment in restricted investments			2,067				—
Purchases of premises and equipment			(1,252	)			(2,657	)
Proceeds from the sale of premises and equipment			281				24
Net cash used in investing activities			(49,318	)			(154,724	)
Cash flows from financing activities
Distributions to noncontrolling interests			(1,252	)			(26	)
Proceeds from advances on long-term debt			—				6,709
Repayment of other borrowings			(55,040	)			(255	)
Net increase in securities sold under agreements to repurchase			3,950				210
Net (decrease) increase in deposits			(143,249	)			139,248
Proceeds from the issuance of common stock			627				631
Dividends paid on common stock			(8,390	)			(5,990	)
Net cash (used in) provided by financing activities			(203,354	)			140,527
Net (decrease) in cash and cash equivalents			(117,514	)			(4,335	)
Cash and cash equivalents - beginning			248,479				50,600
Cash and cash equivalents - ending		$	130,965			$	46,265
Supplemental disclosure of information:
Interest paid		$	18,581			$	16,636
Income taxes paid		$	—			$	3,550
Supplemental schedule of noncash investing and financing activities
Transfer of long-term debt to short-term borrowings		$	57			$	5,000
Other real estate acquired in settlement of loan			(2,627	)			(48	)
Unrealized gains on investments securities available for sale (net of tax)			2,344				1,557

See Notes to the Consolidated Financial Statements

 

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Tower Bancorp, Inc. and Subsidiary

 

Notes to Unaudit ed Consolidated Financial Statements

September 30, 2011 (Unaudited)

(Amounts in thousands, except share and per share data)

Note 1 - Summary of Significant Accounting Policies

Organization and Nature of Operations

Tower Bancorp, Inc. (the “Company”, “we”, “us”, “our”) is a registered bank holding company that was incorporated in 1983 under the Bank Holding Company Act of 1956, as amended. On March 31, 2009, the Company merged with Graystone Financial Corp. (“Graystone”), a privately held, non-reporting corporation and a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “Graystone Merger”). Pursuant to an Agreement and Plan of Merger between the Company and Graystone (the “Graystone Merger Agreement”), the Company remains the surviving bank holding company and the First National Bank of Greencastle has merged with and into Graystone Bank, the wholly-owned subsidiary of Graystone, with Graystone Bank as the surviving institution under the name “Graystone Tower Bank”(the “Bank”). On April 22, 2010, the Company became a financial holding company pursuant to the Gramm-Leach-Bliley Act of 1999.

On December 10, 2010, the Company acquired First Chester County Corporation (“First Chester”), a publicly held corporation and a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “FCEC Merger”). Pursuant to an Agreement and Plan of Merger between the Company and First Chester (the “FCEC Merger Agreement”), the Company remains the surviving bank holding company and the First National Bank of Chester County (“FNB”) merged with and into the Bank, with the Bank as the surviving institution.

The Bank was originally incorporated on September 2, 2005, as a Pennsylvania-chartered bank and commenced operations on November 10, 2005. As a state chartered bank, the Bank is subject to regulation by the Federal Deposit Insurance Corporation (“FDIC”) and the Pennsylvania Department of Banking and undergoes periodic examinations by these regulatory authorities.

The Bank is a full-service community bank operating forty-nine branches throughout southeastern and central Pennsylvania and Washington County, Maryland. The Bank operates under a single charter through three division brands – “Graystone Bank”, “Tower Bank,” and “1N Bank”.

The principal component of earnings for the Bank is net interest income, which is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. The net interest margin, which is the ratio of net interest income to average earning assets, is affected by several factors including market interest rates, economic conditions, loan and lease demand, deposit activity and funding mix. The Bank seeks to maintain a steady net interest margin and consistent growth of net interest income.

The Bank offers residential mortgage services through its mortgage banking division, Graystone Mortgage, a division of Graystone Tower Bank. During the first two quarters of 2011, the Bank completed an effort to restructure and wind down the residential mortgage operations acquired through the FCEC Merger and has integrated those restructured operations into the Graystone Mortgage Division. Also during the second quarter of 2011 and in connection with the restructuring of its residential mortgage operations, the Bank acquired the 10% membership interest of Graystone Mortgage, LLC, previously held by that entity’s president, and ceased residential mortgage originations through Graystone Mortgage, LLC, with all originations now occurring through the Graystone Mortgage Division.

The Bank also provides a broad range of trust and investment management services and provides services for estates, trust, agency accounts and individual and employer sponsored retirement plans through the Graystone Wealth Management Division. Revenue from the Graystone Wealth Management Division consists primarily of annually recurring asset based fees as well as commissions for brokerage services.

In addition to retail and commercial banking and wealth management services, the Bank offers an array of investment opportunities, including mutual funds, annuities, retirement planning and insurance through Graystone Insurances Services, LLC, a wholly-owned subsidiary of the Bank.

Pending Merger with Susquehanna Bancshares, Inc.

On June 20, 2011, the Company entered into an Agreement and Plan of Merger (the “Susquehanna Merger Agreement”) with Susquehanna Bancshares, Inc. (“Susquehanna”), the parent company of Susquehanna Bank, pursuant to which the Company will merge with and into Susquehanna (the “Susquehanna Merger”), with Susquehanna being the surviving corporation. In addition, in accordance with the terms of the Susquehanna Merger Agreement, Susquehanna Bank and the Bank entered into an Agreement and Plan of Merger, pursuant to which the Bank will merge with and into Susquehanna Bank, with Susquehanna Bank continuing as the surviving bank.

Under the terms of the Susquehanna Merger Agreement, shareholders of the Company will have the opportunity to elect to receive either 3.4696 shares of Susquehanna common stock or $28.00 cash for each share of the Company’s common stock he or she owns immediately prior to completion of the Susquehanna Merger. The Susquehanna Merger Agreement provides that a shareholder may receive a combination of cash and shares of Susquehanna common stock that is different than what he or she may have elected,

 

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however, depending on the elections made by other shareholders, in order to ensure that the total cash consideration paid to the Company’s shareholders at the effective time of the Susquehanna Merger is $88.0 million.

Consummation of the Susquehanna Merger is subject to certain terms and conditions, including, but not limited to, receipt of various regulatory approvals and approval by both the Company’s and Susquehanna’s shareholders.

The Susquehanna Merger is expected to be completed during the first quarter of 2012.

Basis of Presentation

The accompanying consolidated financial statements include the accounts of Tower Bancorp, Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions are eliminated from the consolidated financial statements.

Our accounting and reporting policies conform to general practices within the banking industry and to U.S. generally accepted accounting principles (“U.S. GAAP”). Reclassifications of prior years’ amounts are made whenever necessary to conform to the current year’s presentation.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at 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 loan losses, the potential other-than-temporary impairment of investments, and the valuation of deferred tax assets.

Significant Group Concentrations of Credit Risk

Most of our activities are with customers located within central and southeastern Pennsylvania and Washington County, Maryland. Note 3 discusses the types of securities in which we invest. Note 4 discusses the types of lending in which we engage. We do not have any significant concentrations to any one industry or customer.

Recent Accounting Pronouncements

In September 2011, the FASB issued ASC Update No. 2011-08 that provided new guidance related to evaluating goodwill for impairment. The new guidance provides entities with the option to perform a qualitative assessment of whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount before applying the quantitative two-step goodwill impairment test. If an entity concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it would not be required to perform the quantitative two-step goodwill impairment test. Entities also have the option to bypass the assessment of qualitative factors for any reporting unit in any period and proceed directly to performing the first step of the quantitative two-step goodwill impairment test, as was required prior to the issuance of this new guidance. An entity may begin or resume performing the qualitative assessment in any subsequent period. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. We are in the process of evaluating the method we will use to evaluate goodwill during our annual impairment testing which will occur in the fourth quarter of 2011.

In June 2011, the FASB issued ASC Update No. 2011-05 concerning the presentation of comprehensive income. The amendment provides guidance to improve comparability, consistency, and transparency of financial reporting. The amendment also eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. Instead, entities will be required to present all non-owner changes in the stockholders’ equity as either a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendment will be effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption or January 1, 2012 for us. The adoption of this guidance in 2012 will not impact our financial position result of operation or cash flow.

 

In December 2010, the FASB issued ASC Update No. 2010-28 for all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of Step 1 of the goodwill impairment test is zero or negative. Update No. 2010-28 modifies Step 1 of the goodwill impairment test under FASB ASC Topic 350, Intangibles – Goodwill and Other , requiring the entity to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The entity should consider whether there are adverse qualitative factors in determining whether an interim impairment test between annual testing is necessary. The Update allows an entity to use either the equity or enterprise valuation premise to determine the carrying amount of the reporting unit. On adoption of the Update, the goodwill impairment that results from this requirement to perform Step 2 of the goodwill impairment test would be recognized as a cumulative effect adjustment to the beginning retained earnings in the period of adoption. This provision of Update No. 2010-28 is effective for the annual and interim periods beginning after December 15, 2010, or January 1, 2011 for us. The adoption of Update No. 2010-28 did not have a material impact on our consolidated financial statements.

In July 2010, the FASB issued ASC Update No. 2010-20 concerning disclosures about the credit quality of financing receivables and the allowance for credit losses. Update No. 2010-20 is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. Update No. 2010-20 requires companies to (1) provide enhanced disclosures around the nature of credit risk inherent in the entity’s portfolio of financing receivables; (2) explain how that risk is analyzed and assessed in arriving at the allowance for credit losses; and (3) explain the changes and reasons for changes in the allowance for credit losses. The provisions of Update No. 2010-20 concerning disclosures for the end of a period are effective for interim and annual periods ending on or after December 15, 2010, or December 31, 2010 for us. The provisions of Update No. 2010-20 concerning disclosures about activity that occurs during a reporting period are applicable to us for interim and annual periods beginning on or after December 15, 2010, or the interim period ending on March 31, 2011 for us. In April 2011, the FASB issued ASC Update No. 2011-02. Update No. 2011-02 amended Update No. 2010-20 which provided accounting and disclosure guidance relating to a creditor’s determination of whether a restructuring is a troubled debt restructuring. The amendments clarify the guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. The amendments are effective for the first interim or annual period beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption. The adoption of Update No. 2010-20 and Update No. 2011-02 provides the reader of our financial statements with expanded and enhanced disclosure surrounding the allowance for credit losses. The adoption of this Update did not have a material impact on our consolidated financial statement.

 

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In January 2010, the FASB issued ASC Update No. 2010-06 for improving disclosures about fair value measurements. Update No. 2010-06 requires companies to disclose, and provide the reasons for, all transfers of assets and liabilities between the Level 1 and 2 fair value categories. It also clarifies that companies should provide fair value measurement disclosures for classes of assets and liabilities which are subsets of line items within the balance sheet, if necessary. In addition, Update No. 2010-06 clarifies that companies provide disclosures about the fair value techniques and inputs for assets and liabilities classified within Level 2 or 3 categories. The disclosure requirements prescribed by Update No. 2010-06 are effective for fiscal years beginning after December 15, 2009, and for interim periods within those fiscal years. We have implemented the disclosure requirements of Update No. 2010-06 as part of our 2010 audited financial statements and footnotes as presented in Form 10-K. Update No. 2010-06 also requires companies to reconcile changes in Level 3 assets and liabilities by separately providing information about Level 3 purchases, sales, issuances and settlements on a gross basis. This provision of Update No. 2010-06 is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years, or March 31, 2011 for us. The adoption of Update No. 2010-06 has had no material impact to our fair value measurement disclosures. In May 2011, the FASB issued ASC Update No. 2011-04. Update No. 2011-04 modifies the wording used to describe the requirements in U.S. GAAP for fair value measuring and for disclosing information about fair value measurements to improve consistency between U.S. GAAP and International Financial Reporting Standards (“IFRS”). This provision of Update No. 2011-04 is effective for the annual and interim periods beginning after December 15, 2011, or January 1, 2012 for us. The adoption of this guidance in 2012 will not have a material impact on our consolidated financial statements.

Note 2 – Merger Accounting

On December 28, 2009, we announced the execution of the FCEC Merger Agreement. The FCEC Merger became effective on December 10, 2010. Immediately following the holding company acquisition, First Chester’s wholly-owned subsidiary, FNB, merged with and into the Bank, our wholly-owned subsidiary. The former offices of FNB are now operating under the title “1N Bank, a Division of Graystone Tower Bank” (the “1N Bank Division”).

Pursuant to the terms of the FCEC Merger Agreement, First Chester shareholders received, for each share of First Chester common stock held, 0.356 shares of our common stock (the “Exchange Ratio”). The Exchange Ratio was calculated in accordance with the terms of the FCEC Merger Agreement, and was determined based on First Chester delinquent loans calculated as of November 30, 2010. We paid cash to First Chester shareholders in lieu of any fractional shares. We utilized the closing price of our common stock on December 10, 2010 of $22.14 to determine the fair value of our stock issued as consideration for the FCEC Merger.

The tables below illustrate the reconciliation of shares outstanding and the calculation of the consideration effectively transferred.

 

Reconciliation of Shares Outstanding
First Chester shares outstanding at December 10, 2010 (less treasury shares cancelled)			6,317,096
Exchange ratio			0.356
Tower shares issued to First Chester owners (excludes fractional shares)			2,248,438
Tower shares outstanding at December 10, 2010			7,192,174
Total Tower shares at December 10, 2010			9,440,612
Ownership % held by First Chester stockholders			23.82	%
Ownership % held by Tower stockholders			76.18	%
Purchase Price Consideration (dollars in thousands, except per share data)
First Chester shares outstanding at December 10, 2010 (less treasury shares cancelled)			6,317,096
Exchange ratio			0.356
Tower shares issued to First Chester owners			2,248,438
Purchase price per Tower common share		$	22.14
Total stock consideration paid		$	49,780
Consideration paid for fractional shares			11
Total consideration paid		$	49,791

As a result of the FCEC Merger, we recognized assets acquired and liabilities assumed at their acquisition date fair value as presented below.

 

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Total Purchase Price						$	49,791
Net Assets Acquired:
Cash		$	67,176
Securities available for sale			44,694
Restricted Investments			10,569
Loans			939,699
Accrued interest receivable			2,676
Premises and equipment			26,774
Core deposit intangible			4,440
Leasehold intangible assets			342
Deferred tax asset			15,482
Other assets			23,364
Time deposits			(436,126	)
Deposits other than time deposits			(551,148	)
Borrowings			(80,049	)
Accrued interest payable			(980	)
Leasehold intangible liabilities			(643	)
Other liabilities			(22,919	)
Noncontrolling Interest			(1,069	)
							42,282
Goodwill resulting from FCEC Merger						$	7,509

The following table explains the changes in the fair value of the net assets acquired and goodwill recognized from the original reported amounts in the Form 10-K for the period ended December 31, 2010. Note that the fair value adjustments made to the balances of loans, deferred taxes, and other liabilities continue to be preliminary in nature and are subject to additional change as we obtain further data such as appraisal values and legal opinions to complete valuations based on information present at the closing date. These adjustments may also include liabilities related to legal proceedings, claims and liabilities involving First Chester and its subsidiaries that existed at the time of the FCEC Merger. Based upon the current information related to these legal proceedings and the conditions established in FASB ASC 450, “Accounting for Contingencies,” we cannot reasonably estimate the potential for loss on certain of these matters at this time.

 

Goodwill balance at December 10, 2010		$	4,815
Effect of adjustments to:
Loans			(453	)
Deferred tax asset			191
Other assets			1,695
Other liabilities			1,261
Goodwill balance at September 30, 2011		$	7,509

The goodwill generated by the FCEC Merger consists of synergies and increased economies of scale such as the ability to offer more diverse and more profitable products, added diversity to the branch system to achieve lower cost deposits, an increased legal lending limit, etc. We expect that no goodwill recognized as a result of the FCEC Merger will be deductible for income tax purposes. On December 30, 2010, we had made the decision that we would no longer pursue a sale of the residential mortgage operations acquired as part of the FCEC Merger, also referred to as the AHB Division, as originally intended; rather, we would wind down the operations of the AHB Division to a level that would better align with and integrate into our community banking model. During the first quarter of 2011, we began to fully analyze the results of the AHB Division’s operation and actively use these results to determine the resources necessary to effectuate an orderly wind down of the operations and develop a structure to integrate certain operations of the division at the reduced level of production into our banking model. As a result of our active management and restructuring of the AHB Division’s operations coupled with the significance of the losses incurred, we have identified two reportable segments of our business, the Residential Mortgage segment and the Banking segment. See Note 13 for a further explanation of our reportable segments.

The fair value of the financial assets acquired included loans receivable with a gross amortized cost basis of $987,568. The table below illustrates the fair value adjustments made to the amortized costs basis in order to present a fair value of the loans acquired.

 

Gross amortized costs basis at December 10, 2010		$	987,568
Market rate adjustment			2,280
Credit fair value adjustment on pools of homogeneous loans			(20,510	)
Credit fair value adjustment on distressed loans			(29,639	)
Fair value of purchased loans at December 10, 2010		$	939,699

 

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The market rate adjustment represents the movement in market interest rates, irrespective of credit adjustments, compared to the stated rates of the acquired loans. The credit adjustment made on pools of homogeneous loans represents the changes in credit quality of the underlying borrowers from the loan inception to the acquisition date. The credit adjustment on distressed loans is derived in accordance with Accounting Standard Codification (ASC) 310-30-30, previously known as Statement of Position (SOP) 03-3, “Accounting for Certain Loans Acquired in a Transfer,” and represents the portion of the loan balance that has been deemed uncollectible based on our expectations of future cash flows for each respective loan.

Information about the acquired FNB distressed loan portfolio as of December 10, 2010 is as follows:

 

Contractually required principal and interest at acquisition		$	109,339
Contractual cash flows not expected to be collected (nonaccretable discount)			(36,755	)
Expected cash flows at acquisition			72,584
Interest component of expected cash flows (accretable discount)			17,573
Fair value of acquired loans		$	55,011

Pro-forma Presentation

The following table shows the combined pro forma financial results for the three and nine months ended September 30, 2010, assuming that the FCEC Merger occurred on January 1, 2010:

 

		Pro-forma for Three Months Ended September 30, 2010				Pro-forma for Nine Months Ended September 30, 2010
		(unaudited)				(unaudited)
Statement of Operations
Net interest income		$	25,549			$	73,928
Pre-tax net income			6,609				13,332
Income tax expense			2,608				5,345
Net income			4,001				7,987
Pro-forma net income per share:
Basic		$	0.43			$	0.85
Diluted		$	0.43			$	0.85

 

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Note 3 - Securities Available for Sale

The amortized cost of securities and their approximate fair values at September 30, 2011 and December 31, 2010 are as follows:

 

		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
		September 30, 2011
Equity securities		$	132			$	—			$	—			$	132
U.S. Government sponsored agency securities			252				3				—				255
U.S. Government sponsored agency mortgage-backed securities			49,113				1,022				(46	)			50,089
U.S. Government sponsored agency collateralized mortgage obligations			72,261				1,589				(56	)			73,794
Municipal bonds			17,889				958				—				18,847
Municipal bonds – taxable			10,280				522				—				10,802
Total securities available for sale		$	149,927			$	4,094			$	(102	)		$	153,919
		December 31, 2010
Equity securities		$	195			$	—			$	—			$	195
U.S Treasury securities			5,000				2				—				5,002
U.S. Government sponsored agency securities			7,771				9				—				7,780
U.S. Government sponsored agency mortgage-backed securities			10,787				90				(123	)			10,754
U.S. Government sponsored agency collateralized mortgage obligations			48,018				569				—				48,587
Municipal bonds			10,641				74				(61	)			10,654
Municipal bonds – taxable			10,341				2				(329	)			10,014
SBA pool loan investments			9,557				152				—				9,709
Total securities available for sale		$	102,310			$	898			$	(513	)		$	102,695

Included with our securities available for sale are pledged securities with a fair market value of $71,057 and $86,838 at September 30, 2011 and December 31, 2010, respectively. The securities were pledged to secure public deposits, securities sold under agreements to repurchase and other collateral requirements.

The amortized cost and fair value of available for sale securities as of September 30, 2011 by contractual maturity are shown below. Expected maturities may differ from contractual maturities due to the issuer’s rights to call or prepay the obligation without penalty.

 

		September 30, 2011
		Amortized Cost				Fair Value
Due in one year or less		$	1,441			$	1,454
Due after one year through five years			3,495				3,691
Due after five years through ten years			7,855				8,262
Due after ten years			15,630				16,497
			28,421				29,904
Mortgage-backed securities (1)			121,374				123,883
Equity securities			132				132
		$	149,927			$	153,919

 

(1)	Mortgage-backed securities include U.S. Government agency mortgage-backed securities, U.S. Government agency collateralized mortgage and Small Business Agency Loan Pool obligations.

 

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The following table presents information related to our gains and losses on the sales of equity and debt securities, and losses recognized for other-than-temporary impairment of investments.

 

		Three Months Ended September 30,
		Gross Realized Gains				Gross Realized Losses				Other-than- temporary Impairment Losses				Net Gains/ (Losses)
2011
Equity securities		$	—			$	—			$	—			$	—
Debt securities			884				—				—				884
Total		$	884			$	—			$	—			$	884
2010
Equity securities		$	10			$	—			$	(70	)		$	(60	)
Debt securities			239				(1	)			—				238
Total		$	249			$	(1	)		$	(70	)		$	178

 

		Nine Months Ended September 30,
		Gross Realized Gains				Gross Realized Losses				Other-than- temporary Impairment Losses				Net Gains/ (Losses)
2011
Equity securities		$	—			$	—			$	(63	)		$	(63	)
Debt securities			999				—				—				999
Total		$	999			$	—			$	(63	)		$	936
2010
Equity securities		$	48			$	(3	)		$	(138	)		$	(93	)
Debt securities			243				(1	)			—				242
Total		$	291			$	(3	)		$	(138	)		$	(149	)

The following table shows gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2011 and December 31, 2010:

 

		Less Than 12 Months								12 Months or More								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
		September 30, 2011
Equity securities		$	—			$	—			$	—			$	—			$	—			$	—
U.S. Government sponsored agency securities			—				—				—				—				—				—
U.S. Government sponsored agency mortgage-backed securities			12,101				(46	)			—				—				12,101				(46	)
U.S. Government sponsored agency collateralized mortgage obligations			6,360				(56	)			—				—				6,360				(56	)
Municipal bonds			—				—				—				—				—				—
Municipal bonds – taxable			—				—				—				—				—				—
Total		$	18,461			$	(102	)		$	—			$	—			$	18,461			$	(102	)
		December 31, 2010
Equity securities		$	—			$	—			$	—			$	—			$	—			$	—
U.S. Treasury securities			—				—				—				—				—				—
U.S. Government sponsored agency securities			—				—				—				—				—				—
U.S. Government sponsored agency mortgage-backed securities			6,084				(123	)			—				—				6,084				(123	)
U.S. Government sponsored agency collateralized mortgage obligations			—				—				—				—				—				—
Municipal bonds			5,415				(61	)			—				—				5,415				(61	)
Municipal bonds – taxable			8,897				(329	)			—				—				8,897				(329	)
SBA pool loan investments			—				—				—				—				—				—
Total		$	20,396			$	(513	)		$	—			$	—			$	20,396			$	(513	)

 

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The previous table includes 4 investment securities at September 30, 2011 where the current fair value is less than the related amortized cost. There were 15 investment securities at December 31, 2010 that had a current fair value less than the related amortized cost. We evaluate all securities for other-than-temporary impairment on at least a quarterly basis. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. It is not our intent to sell the investments available for sale carrying an unrealized loss and believe it is more likely than not that it will not be necessary to sell these securities prior to the recovery of their cost basis or maturity. We identified three equity securities during the first nine months of 2011 with an unrealized loss that was deemed to be other-than-temporary in nature, resulting in an impairment charge of $63.

Note 4 – Loans

The following table presents a summary of the loan portfolio at September 30, 2011 and December 31, 2010:

 

		September 30, 2011				December 31, 2010
Commercial:
Industrial (1)		$	1,079,832			$	1,073,666
Real estate (2)			315,127				305,423
Construction			184,423				183,729
Consumer & other:
Home equity line			175,749				163,905
Other			61,024				65,305
Residential mortgage			247,337				280,154
Total loans			2,063,492				2,072,182
Deferred costs			364				62
Allowance for loan losses			(11,925	)			(14,053	)
Net loans		$	2,051,931			$	2,058,191

 

(1)

The commercial industrial loan category consists of commercial term loans and lines of credit to in-market customers for the purpose of financing equipment purchases, inventory, business expansion, working capital, and other general business purposes. Also included in this category are commercial mortgage loans secured by income producing properties such as apartment complexes, shopping centers, office real estate for lease and hotel properties.

(2)	The commercial real estate loan category consists of commercial mortgage loans secured by owner-occupied commercial real estate.

Immaterial Error Correction

The December 31, 2010 column in the above table has been revised to correct an immaterial error in the classification of loan amounts between loan categories when compared to the same table presented within Note 4 of our annual report as filed on Form 10-K. As of December 31, 2010, certain loans had been reported based on the type of collateral securing the related loan, which is inconsistent with our historical practice of disclosing loans by type based on the purpose of the loan. This reclassification only affected the table presented above as of December 31, 2010 and had no other impact on the financial statements as of or for the year ended December 31, 2010. The impact of the reclassification is presented in the table below.

 

		As reported in the Form 10-K				Adjustments				Adjusted Balance
Commercial:
Industrial		$	921,603			$	152,063			$	1,073,666
Real estate			441,532				(136,109	)			305,423
Construction			179,983				3,746				183,729
Consumer & other:
Home equity line			196,498				(32,593	)			163,905
Other			52,412				12,893				65,305
Residential mortgages:			280,154				—				280,154
Total Loans			2,072,182				—				2,072,182
Deferred costs (fees)			62				—				62
Allowance for loan losses			(14,053	)			—				(14,053	)
Net Loans		$	2,058,191			$	—			$	2,058,191

 

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Overdraft deposits are reclassified as loans and are included in the “Consumer & other: Other” loans in the notes to the consolidated financial statements. At September 30, 2011 and December 31, 2010, total overdraft deposits were $783 and $1,284, respectively.

We had total net purchased loans from unaffiliated banks of $40,498 and $42,124 at September 30, 2011 and December 31, 2010, respectively.

We serviced $142,559 and $216,939 of participation loans for unrelated parties at September 30, 2011 and December 31, 2010, respectively.

We sold $429,248 and $92,485 of residential mortgage loans into the secondary market during the nine months ended September 30, 2011 and 2010, respectively. A gain of $1,076 and $656 was recognized on the sale of these loans for the three months ended September 30, 2011 and 2010, respectively. A gain of $3,672 and $1,250 was recognized on the sale of these loans for the nine months ended September 30, 2011 and 2010, respectively.

Commercial loans are evaluated based on an internally assigned grade system which are assigned at loan origination and reviewed on an annual or on an “as needed” basis. Commercial loans that are classified as “Special Mention” or worse are reviewed on a quarterly basis by our Problem Asset Committee. Meetings are held with loan officers, credit analysts, and senior management to discuss each of the relationships. Loan information is reviewed on a loan by loan basis. This information includes operating results, future cash flows, recent developments and the future outlook, timing and extent of potential losses, collateral valuation, and the potential courses of action. To the extent that these loans are collateral-dependent, they are evaluated based on the fair value of the loan’s collateral. In cases where current appraisals of collateral may not yet be available, prior appraisals are utilized with adjustments for estimates of subsequent declines in value. The excess of the loan balance over the net realizable value of the property collateralizing the loan is charged-off through the allowance for loan losses.

With regard to residential mortgage and consumer loans, we evaluate the loan based on the payment activity of the loan. Once a residential mortgage or consumer loan has reached 90 days delinquent, the loan is considered nonperforming. The credit department will analyze the loan information, including the fair value of collateral to determine our exposure to loss. The excess of the loan balance over the net realizable value of the property collateralizing the loan is charged-off through the allowance for loan losses when the loan becomes 120 days delinquent.

 

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The following table presents the credit quality of our loan portfolio as of September 30, 2011 and December 31, 2010.

 

		As of September 30, 2011
		Commercial: Industrial				Commercial: Real Estate				Commercial: Construction
Pass		$	970,665			$	296,690			$	157,157
Special Mention			24,646				1,954				2,839
Substandard			55,307				6,491				9,430
Doubtful			—				177				751
Acquired distressed loans (1)			29,214				9,815				14,246
Total		$	1,079,832			$	315,127			$	184,423
		Consumer & other: HELOC				Consumer & other: Other				Residential Mortgage
Performing		$	175,279			$	60,207			$	239,833
Nonperforming			446				801				6,113
Acquired distressed loans (1)			24				16				1,391
Total		$	175,749			$	61,024			$	247,337
		As of December 31, 2010
		Commercial: Industrial				Commercial: Real Estate				Commercial: Construction
Pass		$	928,138			$	272,669			$	143,890
Special Mention			47,720				4,370				1,524
Substandard			68,908				18,182				14,822
Doubtful			—				187				5,001
Acquired distressed loans (1)			28,900				10,015				18,492
Total		$	1,073,666			$	305,423			$	183,729
		Consumer & other: HELOC				Consumer & other: Other				Residential Mortgage
Performing		$	162,433			$	64,834			$	273,936
Nonperforming			466				317				3,602
Acquired distressed loans (1)			1,006				154				2,616
Total		$	163,905			$	65,305			$	280,154

 

(1)	Acquired distressed loans include all acquired loans in which a specific credit adjustment was taken upon acquisition, in accordance with Accounting Standards Codification 310-30-30.

 

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The following table presents the aging analysis of the loan portfolio as of September 30, 2011 and December 31, 2010:

 

		30-89 Days Past  Due(1)				Greater Than 90 Days(1)				Total  Past Due(1)				Non- Accrual				Current(1)				Total Loans
		September 30, 2011
Commercial:
Industrial		$	6,623			$	2,771			$	9,394			$	13,654			$	1,056,784			$	1,079,832
Real estate			2,552				—				2,552				2,488				310,087				315,127
Construction			1,496				—				1,496				2,367				180,560				184,423
Consumer & other:
Home equity line			1,162				226				1,388				220				174,141				175,749
Other			1,264				569				1,833				232				58,959				61,024
Residential mortgage			7,194				2,271				9,465				3,842				234,030				247,337
Total		$	20,291			$	5,837			$	26,128			$	22,803			$	2,014,930			$	2,063,492
		December 31, 2010
Commercial:
Industrial		$	21,217			$	—			$	21,217			$	6,320			$	1,046,129			$	1,073,666
Real estate			1,712				5				1,717				2,426				301,280				305,423
Construction			615				—				615				6,011				177,103				183,729
Consumer & other:
Home equity line			478				351				829				115				162,961				163,905
Other			1,094				251				1,345				66				63,894				65,305
Residential mortgage			5,749				818				6,567				2,784				270,803				280,154
Total		$	30,865			$	1,425			$	32,290			$	17,722			$	2,022,170			$	2,072,182

 

(1)	Loan balances do not include non-accrual loans.

Total non-performing assets were $32,933 and $23,794 as of September 30, 2011 and December 31, 2010, respectively. Non-performing assets include those loans which are classified as non-accrual, loans accruing interest that are 90 days past due and other real estate owned. Total other real estate owned was $4,293 and $4,647 as of September 30, 2011 and December 31, 2010, respectively.

We had total impaired loans of $71,842 and $76,982 as of September 30, 2011 and December 31, 2010, respectively.

 

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The following table presents a summary of the impaired loans.

 

		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
		September 30, 2011
With no related allowance recorded:
Commercial:
Industrial		$	37,249			$	53,658			$	—			$	48,003			$	1,191
Real estate			9,194				10,841				—				9,246				52
Construction			15,203				24,001				—				16,546				234
Consumer & other:
Home equity line			245				376				—				265				—
Other			247				293				—				351				4
Residential mortgage			5,233				5,889				—				6,176				—
With an allowance recorded:
Commercial:
Industrial		$	1,872			$	1,872			$	541			$	1,499			$	—
Real estate			—				—				—				—				—
Construction			3,000				3,000				875				6,109				—
Consumer & other:
Home equity line			—				—				—				—				—
Other			—				—				—				—				—
Residential mortgage			—				—				—				—				—
Total:
Commercial:
Industrial		$	39,121			$	55,530			$	541			$	49,502			$	1,191
Real estate			9,194				10,841				—				9,246				52
Construction			18,203				27,001				875				22,655				234
Consumer & other:
Home equity line			245				376				—				265				—
Other			247				293				—				351				4
Residential mortgage			5,233				5,889				—				6,176				—
Total		$	72,243			$	99,930			$	1,416			$	88,195			$	1,481

 

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		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
		December 31, 2010
With no related allowance recorded:
Commercial:
Industrial		$	35,220			$	53,892			$	—			$	5,897			$	119
Real estate			12,815				16,368				—				6,021				346
Construction			17,201				26,256				—				1,810				182
Consumer & other:
Home equity line			1,121				1,255				—				110				1
Other			224				322				—				147				3
Residential mortgage			5,400				6,061				—				1,891				—
With an allowance recorded:
Commercial:
Industrial		$	—			$	—			$	—			$	271			$	—
Real estate			—				—				—				63				—
Construction			5,001				5,001				2,500				4,167				—
Consumer & other:
Home equity line			—				—				—				—				—
Other			—				—				—				—				—
Residential mortgage			—				—				—				—				—
Total:
Commercial:
Industrial		$	35,220			$	53,892			$	—			$	6,168			$	119
Real estate			12,815				16,368				—				6,084				346
Construction			22,202				31,257				2,500				5,977				182
Consumer & other:
Home equity line			1,121				1,255				—				110				1
Other			224				322				—				147				3
Residential mortgage			5,400				6,061				—				1,891				—
Total		$	76,982			$	109,155			$	2,500			$	20,377			$	651

In assessing the adequacy of our credit reserve, we performed an evaluation of expected future cash flows, including the anticipated cash flow from the sale of collateral, and compared that to the carrying amount of the impaired loans. Impaired loans considered to be collateral dependent totaled approximately 93.3% and 92.1% of total impaired loans as of September 30, 2011 and December 31, 2010, respectively. As of September 30, 2011, we determined that impaired loans with a carrying principal balance of $4,872 required a reserve of $1,416. The remaining $67,371 of impaired loans did not require a specific reserve allocation as the future anticipated cash flow, including the collateral values, is expected to be sufficient to fully recover the amounts due on these loans. As of December 31, 2010, we had determined that impaired loans with a carrying principal balance of $5,001 required a reserve of $2,500 with the remaining $71,981 of impaired loans not requiring a specific reserve allocation as the future anticipated cash flow, including the collateral values, is expected to be sufficient to fully recover all amounts due on these loans. During the nine months ended September 30, 2011, we had total loan net charge-offs of $8,023. These charges have been applied against both the allowance for loans losses, as well as against the fair value credit adjustment/discount recorded on performing loans acquired.

In this current real estate environment it has become more common to restructure or modify the terms of certain loans with customers who are experiencing financial stress, known as troubled debt restructurings (“TDRs”). When modifying terms of loans in TDRs, we typically reduce the monthly payment through extending maturity dates or allowing interest-only payments for a period of twelve months or less, however, we do not typically forgive principal. We accrue interest on a TDR once the borrower has demonstrated the ability to perform in accordance with the restructured terms for a period of six consecutive months. At September 30, 2011, we have $12,036 of TDRs. We identified one new TDR during the three months ended September 30, 2011 with a recorded investment of $269. This TDR is included in the tables below as a non accrual and non performing TDR. There were no new TDR’s identified as a result of the clarification in guidance in Accounting Standards Update (“ASU”) 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring . There have been no changes to the recorded investment in TDRs following the modifications of these loans. The following table shows the number and dollar amount of TDRs that are both performing and not performing in accordance with the modified terms at September 30, 2011.

 

		Number of Loans				Recorded Investment
Performing TDRs			9			$	11,226
Non performing TDRs			3				810
Total TDRs			12			$	12,036

TDRs as of September 30, 2011 quantified by loan type classified separately as accrual and non-accrual are presented in the table below.

 

		Accruing				Non Accrual				Total
Commercial
Industrial and agricultural		$	11,128			$	541			$	11,669
Real estate			98				269				367
Construction			—				—				—
Consumer & other
Home equity line			—				—				—
Other			—				—				—
Residential mortgage			—				—				—
Total TDRs		$	11,226			$	810			$	12,036

The reserve for an impaired TDR loan is based upon the present value of the future expected cash flows discounted at the loan’s original effective rate or upon the fair value of the collateral less costs to sell, if the loan is deemed collateral dependent. As of September 30, 2011, we have recorded a specific reserve of $100 against our TDRs. During the three and nine months ended September 30, 2011, we have recorded no charge offs against our TDRs. The remaining balance of TDRs with no specific loan loss provision are considered to be collateral dependent and well-collateralized.

Acquired loans deemed to be impaired at the time of purchase in accordance with Accounting Standard Codification (ASC) 310-30-30, previously known as Statement of Position (SOP) 03-3, “Accounting for Certain Loans Acquired in a Transfer” are included in the balance of impaired loans. However, these purchased impaired loans have been recorded at their fair value based on anticipated future cash flows at the time of acquisition and are considered to be performing loans as we expect to fully collect the new carrying value

 

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(i.e., fair value) of the loans. We regularly evaluate the reasonableness of our anticipated cash flows. Any decreases to the expected cash flows for our original estimate would require us to evaluate the need for an additional allowance for loan losses and could lead to charge-offs of acquired loan balances. Any significant increases in expected cash flows as compared to our original estimate would result in additional interest income to be recognized over the remaining life of the loans.

The following table provides activity for the accretable yield of these purchased impaired loans for the three and nine months ended September 30, 2011.

 

		For Three Months Ended September 30, 2011				For Nine Months Ended September 30, 2011
Accretable yield, beginning balance		$	22,579			$	18,484
Acquisition of impaired loans adjustment			—				(62	)
Accretable yield amortized to interest income			(359	)			(1,104	)
Reclassification from non-accretable difference (1)			—				4,902
Accretable yield, end of period		$	22,220			$	22,220

 

(1)	Reclassification from non-accretable difference represents an increase to the estimated cash flows to be collected on the underlying portfolio.

 

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Note 5 – Allowance for Loan Losses

Changes in the allowance for loan losses were as follows for the three and nine months ended September 30, 2011 and 2010:

 

		Commercial: Industrial				Commercial: Real estate				Commercial: Construction				Consumer & other: Home equity line				Consumer & other: Other				Residential Mortgage				Total
		For the Three Months Ended September 30, 2011
Beginning balance		$	6,501			$	1,260			$	2,455			$	446			$	50			$	1,157			$	11,869
Provision			94				461				—				63				426				256				1,300
Reallocation			159				31				(190	)			—				—				—				—
Charge-offs			(502	)			—				—				—				(437	)			(323	)			(1,262	)
Recoveries			18				—				—				—				—				—				18
Ending balance		$	6,270			$	1,752			$	2,265			$	509			$	39			$	1,090			$	11,925
		For the Three Months Ended September 30, 2010
Beginning balance		$	7,036			$	1,363			$	2,522			$	177			$	36			$	485			$	11,619
Provision			288				—				—				114				73				1,125				1,600
Reallocation			—				—				(494	)			—				—				494				—
Charge-offs			(113	)			—				—				(65	)			(62	)			(271	)			(511	)
Recoveries			6				—				—				—				1				2				9
Ending balance		$	7,217			$	1,363			$	2,028			$	226			$	48			$	1,835			$	12,717

 

		Commercial: Industrial				Commercial: Real estate				Commercial: Construction				Consumer & other: Home equity line				Consumer & other: Other				Residential Mortgage				Total
		For the Nine Months Ended September 30, 2011
Beginning balance		$	7,127			$	1,159			$	4,138			$	242			$	53			$	1,334			$	14,053
Provision			289				450				2,567				259				548				337				4,450
Reallocation			159				31				(190	)			—				—				—				—
Charge-offs			(1,359	)			(8	)			(4,250	)			—				(573	)			(581	)			(6,771	)
Recoveries			54				120				—				8				11				—				193
Ending balance		$	6,270			$	1,752			$	2,265			$	509			$	39			$	1,090			$	11,925
		For the Nine Months Ended September 30, 2010
Beginning balance		$	6,262			$	1,597			$	1,389			$	97			$	32			$	318			$	9,695
Provision			1,795				392				610				394				306				1,453				4,950
Reallocation			—				(360	)			27				—				—				333				—
Charge-offs			(915	)			(266	)			—				(265	)			(291	)			(271	)			(2,008	)
Recoveries			75				—				2				—				1				2				80
Ending balance		$	7,217			$	1,363			$	2,028			$	226			$	48			$	1,835			$	12,717

 

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Note 6 – Other Intangibles

Information concerning total amortizable other intangible assets and liabilities at September 30, 2011 and December 31, 2010 is as follows:

 

		September 30, 2011												December 31, 2010
		Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount				Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Asset:
Core deposits		$	8,339			$	2,281			$	6,058			$	8,339			$	1,188			$	7,151
Leasehold intangible assets			342				67				275				342				—				342
Total		$	8,681			$	2,348			$	6,333			$	8,681			$	1,188			$	7,493
Liabilities:
Leasehold intangible liabilities		$	643			$	119			$	524			$	643			$	—			$	643
Total		$	643			$	119			$	524			$	643			$	—			$	643

Amortization of the core deposit intangible amounted to $343 and $160 for the three months ended September 30, 2011 and 2010, respectively, and $1,093 and $496 for nine months ended September 30, 2011 and 2010, respectively. Amortization of the leasehold intangible assets and liabilities amounted to a net benefit of $16 and $0 for the three months ended September 30, 2011 and 2010, respectively, and a net benefit of $52 and $0 for the nine months ended September 30, 2011 and 2010, respectively and is included within occupancy and equipment expense.

Note 7 – Borrowings

The following is a summary of borrowings at September 30, 2011 and December 31, 2010:

 

		September 30, 2011				December 31, 2010
Federal Home Loan Bank borrowings		$	48,659			$	103,702
Subordinated notes			21,000				21,000
Junior subordinated debentures held by trusts			15,631				15,452
Capital lease obligations			2,653				2,685
Total borrowings		$	87,943			$	142,839

Note 8 - Net Income Per Share and Comprehensive Income

Our basic net income per share is calculated as net income divided by the weighted average number of shares outstanding. For diluted net income per share, net income is divided by the weighted average number of shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents, calculated using the treasury stock method. Our common stock equivalents consist solely of outstanding stock options and restricted stock. The effects of options to issue common stock are excluded from the computation of diluted earnings per share in periods in which the effect would be anti-dilutive.

A reconciliation of the weighted average shares outstanding used to calculate basic net income per share and diluted net income per share follows:

 

		For the Three Months Ended September 30,								For the Nine Months  Ended September 30,
		2011				2010				2011				2010
Weighted average shares outstanding (basic)			12,007,187				7,144,685				11,993,204				7,134,611
Impact of common stock equivalents			9,537				36				6,011				2,897
Weighted average shares outstanding (diluted)			12,016,724				7,144,721				11,999,215				7,137,508
Common stock equivalents excluded from earnings per share as their effect would have been anti-dilutive			170,237				125,846				173,256				94,969

 

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Comprehensive income is defined as the change in equity from transactions and other events from non-owner sources. It includes all changes in equity except those resulting from investments by stockholders and distributions to stockholders. Comprehensive income includes net income and accounting for certain investments in debt and equity securities.

We have elected to report our comprehensive income in the statement of changes in equity and comprehensive income. The only element of “other comprehensive income” that we have is the unrealized gains or losses on available for sale securities.

The components of the change in net unrealized gains on securities are as follows:

 

		For the Nine Months Ended September 30,
		2011				2010
Gross unrealized holding gains arising during the year		$	4,543			$	2,535
Reclassification adjustment for impairment losses recognized in net income			63				138
Reclassification adjustment for gains realized in net income			(999	)			(287	)
Net unrealized holding gains before taxes			3,607				2,386
Tax effect			(1,263	)			(829	)
Net change		$	2,344			$	1,557

Note 9 – Derivative Instruments

As part of our mortgage banking operations, we originate agency conforming residential loans for sale in the secondary market and to investors in mortgage loans. These loans have been classified as loans held for sale. These loans expose us to variability in their fair value due to changes in interest rates. If interest rates increase, the value of the loans decreases. Conversely, if interest rates decrease, the value of the loans increases.

Loan commitments related to the origination of loans held for sale are accounted for as derivative instruments when a customer locks the interest rate on their loan and we approve the loan with the intent to sell the loan. Such commitments are recorded at fair value as derivative assets or liabilities, with changes in fair value recorded as gains or losses.

To mitigate the effect of interest rate risk on both the held for sale loans and interest rate lock commitments, the Bank historically entered into offsetting derivative contracts, primarily forward transaction agreements. These forward transaction agreements lock in the price for the sale of specific loans or loans to be funded under specific interest rate lock commitments or for a generic group of loans with similar characteristics. A portion of the forward transaction agreements offset previously hedged positions as interest rates change and as the percentage of loans expected to close change. Forward transaction agreements are agreements to sell a certain notional amount of loans at a specified future time period at a specified price. The Bank could incur a loss when pairing out of previously hedged positions. All forward contracts and related hedged positions have been completely unwound during the first quarter of 2011 and replaced with best efforts interest rate lock commitments.

Although the purpose of these derivative instruments is to economically hedge certain risks, there are no hedge designations under ASC 815-10.

The fair value of derivative instruments not designated as hedging instruments under ASC 815-10 at September 30, 2011 and December 31, 2010 are presented in the following table:

 

		September 30, 2011
		Asset Derivative								Liability Derivative
		Fair Value				Notional Value				Fair Value				Notional Value
Loan commitments		$	482			$	19,732			$	—			$	—

 

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		December 31, 2010
		Asset Derivative								Liability Derivative
		Fair Value				Notional Value				Fair Value				Notional Value
Forward transaction agreements		$	930			$	82,250			$	—			$	—
Loan commitments		$	1,241			$	60,298			$	—			$	—

During the three months ended September 30, 2011, forward transaction agreements and loan commitments contributed a net loss of $0 and $179, respectively. During the nine months ended September 30, 2011, forward transaction agreements and interest rate lock commitments contributed a net loss of $930 and $759, respectively.

Note 10 - Financial Instruments with Off-Balance Sheet Risk

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

The following outstanding financial instruments represent credit risk in the following amounts at September 30, 2011 and December 31, 2010:

 

		September 30, 2011				December 31, 2010
Commitments to grant loans		$	53,312			$	57,469
Unfunded commitments under lines of credit			502,893				399,647
Letters of credit			52,810				58,555

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

Outstanding letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank typically requires collateral supporting these letters of credit. We believe that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The amount of the liability as of September 30, 2011 and December 31, 2010 for guarantees under standby letters of credit issued is not material to our consolidated financial statements.

Note 11 - Stock-Based Compensation

At September 30, 2011, we had four equity compensation plans: the 2010 Stock Incentive Plan (the “2010 Plan”); the 2007 Stock Incentive Plan (the “2007 Plan”); the 1995 Non-Qualified Stock Option Plan (the “1995 Plan”); and the Stock Option Plan for Outside Directors (the “Director Plan”). We also assumed the outstanding stock options of First Chester as of December 10, 2010.

2007 Stock Incentive Plan

In May 2007, the shareholders of Graystone approved the 2007 Stock Incentive Plan (the “2007 Plan”). Under the 2007 Plan, we may grant incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, and deferred stock for up to 600,000 shares of common stock to key employees and directors. On March 31, 2009, as a result of the Graystone Merger, we have adopted the provisions of this plan.

Subsequent to the Graystone Merger and as a result of the conversion factor, the total number of shares authorized to be issued under the 2007 Plan equaled 252,000. At September 30, 2011, 49,415 shares were available for issuance under the 2007 Plan.

 

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The following table summarizes the outstanding stock options and restricted stock under the 2007 Plan at September 30, 2011 and December 31, 2010:

Stock Options

 

Date of Issuance		September  30, 2011 Options Outstanding				December  31, 2010 Options Outstanding				Exercise Price				Expiration Date		Options Vested								Unearned Compensation
																September 30, 2011				December 31, 2010				September 30, 2011				December 31, 2010
June 26, 2007			26,145				26,145			$	22.22			June 26, 2017			26,145				26,145			$	—			$	—
January 22, 2008			1,050				1,050			$	30.96			January 22, 2018			1,050				1,050				—				—
July 17, 2008			50,295				56,700			$	30.96			July 17, 2018			50,295				56,700				—				—
September 22, 2009			51,650				52,400			$	26.77			September 22, 2019			20,660				10,480				200				251
November 24, 2009			18,000				36,000			$	19.80			November 24, 2019			3,600				7,200				55				132
			147,140				172,295										101,750				101,575			$	255			$	383

Restricted Stock

 

Date of Issuance		Restricted Shares Issued				Fair Value Per Share				Expiration Date		Shares Vested								Unearned Compensation
												September 30, 2011				December 31, 2010				September 30, 2011				December 31, 2010
September 28, 2010			30,290			$	20.92			N/A			16,138				—			$	295			$	549
			30,290										16,138				—			$	295			$	549

The stock options normally vest over a three to five year vesting period and are expensed over the vesting period. The restricted stock awards have a vesting period of 1 to 5 years and are expensed over the vesting period. 8,000 options issued under this plan were exercised during the nine month period ending September 30, 2011. The aggregate intrinsic value of outstanding unvested stock options at September 30, 2011 and December 31, 2010 was $16 and $68, respectively. As of September 30, 2011, a total of 101,750 options have vested with an intrinsic value of $4. These vested options can be exercised at an average price of $27.47 and have an average remaining life of approximately 6.8 years. The fair values of the options awarded under the 2007 Plan are estimated on the date of grant using the Black-Scholes valuation methodology.

Upon the closing of the Graystone Merger, all of the issued and outstanding stock options originally issued by Graystone converted to options exercisable for our common stock. Additionally, all options became fully vested at the time of conversion. As a result and in accordance with U.S. GAAP, we revalued the converted options as of the conversion date. The re-valuation of the converted options did not result in any incremental costs.

The table below shows the assumptions utilized to value all stock options:

 

Date of Issuance		Dividend Yield				Expected Volatility				Risk Free Interest  Rate				Estimated Forfeitures				Expected Life				Issue-Date Fair  Value
June 26, 2007			4.49%				32.17%				2.31%				0.00%				6 years			$	5.75
January 22, 2008			4.49%				32.17%				2.31%				0.00%				6 years			$	3.70
July 17, 2008			4.49%				32.17%				2.31%				1% – 3%				6.5 years			$	3.80
September 22, 2009			4.00%				31.84%				3.50%				(1	)			(2	)		$	6.63
November 24, 2009			4.00%				32.63%				3.39%				2%				9 years			$	5.00

 

(1)	Estimated forfeitures for stock options issued to executives are 2.00% while the estimated forfeiture for stock options issued to employees is 5.00%.

(2)	Expected life for stock options issued to executives is 9 years while estimated expected life for stock options issued to employees is 7 years.

The dividend yield assumption is based on dividend history and the expectation of future dividend yields. The expected volatility is based on historical volatility using our stock price. The risk-free rate is the U.S. Treasury zero-coupon rate commensurate with the expected life of the options on the date of the grant.

 

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2010 Stock Incentive Plan

In May 2010, the shareholders approved the 2010 Stock Incentive Plan (the “2010 Plan”). The 2010 Plan permits grants of stock options, stock appreciation rights, restricted stock, deferred stock and performance awards (collectively, “Awards”) for up to 400,000 shares of our common stock to key employees and directors. At September 30, 2011, 398,950 shares were available for issuance under the 2010 Plan.

The following table summarizes the restricted stock outstanding under the 2010 Plan at September 30, 2011 and December 31, 2010:

Restricted Stock

 

Date of Issuance		Shares Outstanding				Fair Value Per Share				Expiration Date		Shares Vested								Unearned Compensation
												September 30, 2011				December 31, 2010				September 30, 2011				December 31, 2010
September 28, 2010			1,050			$	20.92			N/A			210				—			$	18			$	21
			1,050										210				—			$	18			$	21

The restricted stock awards have a vesting period of five years and is expensed over the vesting period.

1995 Non-Qualified Stock Option Plan

At September 30, 2011, there were 5,700 options outstanding under the 1995 Plan and there are a total of 27,719 options available to be issued under this plan at September 30, 2011.

The following table summarizes the outstanding non-qualified stock options under the 1995 Plan at September 30, 2011 and December 31, 2010:

 

Date of Issuance		Options Outstanding				Exercise Price				Expiration Date		Options Vested								Unearned Compensation
												September 30, 2011				December 31, 2010				September 30, 2011				December 31, 2010
September 22, 2009			5,700			$	26.77			September 22, 2019			2,280				1,140			$	21			$	27
			5,700										2,280				1,140			$	21			$	27

The assumptions utilized to calculate the issue date fair value of $6.63 are the same as the assumptions used for shares issued under the 2007 Plan.

Stock Option Plan for Outside Directors

At September 30, 2011, there were a total of 11,926 options outstanding under the Director Plan. The options outstanding are all fully vested, have a weighted average exercise price of $38.06 per share, and have a weighted average life to maturity of 5.3 years. We recognized $0 in compensation expense related to the Director Plan during the three and nine months ended September 30, 2011 and 2010. There are a total of 71,152 options available to be issued under this plan at September 30, 2011.

First Chester Stock Option Plans

As part of the FCEC Merger, 181,142 outstanding stock options issued pursuant to plans adopted by First Chester and exercisable in shares of First Chester common stock were converted to 64,487 fully vested stock options exercisable in shares of Tower Bancorp common stock. As of September 30, 2011, there were a total of 42,725 options outstanding with a weighted average exercise price of $48.80 and a weighted average life to maturity of 3.1 years. No additional options are available to be issued under these plans. During the three and nine months ended September 30, 2011, we did not recognize any compensation expense related to the First Chester Stock Option Plans. No options have been exercised from these plans.

 

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The following table presents that total compensation expense recognized related to stock options and restricted stock awards outstanding for the three and nine months ended September 30, 2011 and 2010:

 

		For the Three Months Ended September 30,
		2011				2010
2007 Stock incentive plan		$	73			$	26
2010 Stock incentive plan			1				—
1995 Non-qualified stock option plan			2				2
Total compensation expense		$	76			$	28
		For the Nine Months Ended September 30,
		2011				2010
2007 Stock incentive plan		$	382			$	78
2010 Stock incentive plan			3				—
1995 Non-qualified stock option plan			6				6
Total compensation expense		$	391			$	84

Stock Purchase Plans

During the second quarter of 2009, the Board of Directors approved a Dividend Reinvestment and Stock Purchase Plan (“Plan”) to provide the shareholders with the opportunity to use cash dividends, as well as optional cash payments of up to $50 per quarter, to purchase additional shares of our common stock. Pursuant to the Susquehanna Merger Agreement, the Company agreed to suspend the Plan effective June 21, 2011. During the first nine months of 2011, approximately $503 in capital has been raised under the Plan. Since the Plan’s inception, the Plan has raised approximately $1,624.

Also during the second quarter of 2009, the Board of Directors and shareholders approved an Employee Stock Purchase Plan (“Employee Plan”) to provide the our employees with the opportunity to purchase shares of our common stock directly. Pursuant to the Susquehanna Merger Agreement, the Company agreed to suspend the Employee Plan effective July 1, 2011. During the first nine months of 2011, approximately $84 in capital has been raised under the Employee Plan. Since the Employee Plan’s inception, the Employee Plan has raised approximately $291.

Note 12 - Fair Value Measurements

Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. We determine the fair value of the financial instruments based on the fair value hierarchy. We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from outside independent sources. Unobservable inputs are inputs that reflect the assumptions that market participants would use in pricing the asset or liability based on the best information available in the circumstances. Three levels of inputs are used to measure fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input significant to the fair value measurement.

 

		Level 1:		Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
		Level 2:		Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
		Level 3:		Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

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For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2011 and December 31, 2010 are as follows:

 

		September 30, 2011				Quoted Prices (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Equity securities		$	132			$	—			$	—			$	132
U.S. Government sponsored agency securities			255				—				255				—
U.S. Government sponsored agency mortgage-backed securities			50,089				—				50,089				—
Collateralized mortgage obligations			73,794				—				73,794				—
Municipal bonds			18,847				—				18,847				—
Municipal bonds – taxable			10,802				—				10,802				—
Commercial servicing rights			411				—				—				411
Derivative instruments			482				—				—				482
		$	154,812			$	—			$	153,787			$	1,025
		December 31, 2010				Quoted Prices (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Equity securities		$	195			$	—			$	—			$	195
U.S. Treasury securities			5,002				5,002				—				—
U.S. Government sponsored agency securities			7,780				—				7,780				—
U.S. Government sponsored agency mortgage-backed securities			10,754				—				10,754				—
Collateralized mortgage obligations			48,587				—				48,587				—
Municipal bonds			10,654				—				10,654				—
Municipal bonds – taxable			10,014				—				10,014				—
SBA pool loan investments			9,709				—				9,709				—
Commercial servicing rights			520				—				—				520
Derivative instruments			2,147				—				—				2,147
		$	105,362			$	5,002			$	97,498			$	2,862

The valuation technique to measure the fair values for the items in the tables above are as follows:

Securities available for sale

As quoted market prices for the investments in securities available for sale held at the Bank, such as government agency bonds, corporate bonds, municipal bonds, etc, are not readily available, a matrix pricing model, combined with broker-dealer pricing indicators are used to value these investments. The matrix pricing model takes into consideration yields/prices of securities with similar characteristics, including credit quality, industry, and maturity to determine a fair value measure.

For equity securities held, we have determined which securities are traded in active markets versus inactive markets. For those securities traded in active markets, we have recorded the securities at quoted market prices. In cases where the securities are deemed to trade in inactive markets, we have adjusted market prices for to reflect the illiquidity of the securities.

Commercial servicing rights

The fair value of commercial servicing rights (“MSRs”) was estimated using Level 3 inputs. MSRs do not trade in an active, open market with readily observable prices. As such, we determine the fair value of the MSRs using a projected cash flow model that considers loan rates and maturities, discount rate assumptions, estimated servicing revenue and expenses, and estimated prepayment speeds.

 

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Derivative instruments

The fair value of interest rate lock commitments (derivative loan commitments) and forward sales commitments are estimated using a process similar to mortgage loans held for sale. Interest rate lock commitments are recorded as a recurring Level 3. Loan commitments and best efforts commitments are assigned a probability that the related loan will be funded and the commitment will be exercised. We rely on historical “pull-through” percentages in establishing probability. Forward sale commitments are recorded as a recurring Level 3.

The following table presents reconciliations of our assets measured at fair value on a recurring basis using unobservable inputs (Level 3) for the three and nine months ended September 30, 2011 and 2010, respectively:

 

2011		Equity Securities				Commercial Servicing  Rights				Derivative Instruments
Balance, June 30, 2011		$	132			$	462			$	661
New interest rate lock contracts originated			—				—				1,079
Matured / expired derivative commitments			—				—				(1,258	)
Other than temporary impairment			—				—				—
Change in fair value			—				(51	)			—
Balance, September 30, 2011		$	132			$	411			$	482
2010						Equity Securities				Commercial Servicing  Rights
Balance, June 30, 2010						$	154			$	514
Transfers in from level 2							38				—
Change in fair value							(72	)			(63	)
Balance, September 30, 2010						$	120			$	451

 

2011		Equity Securities				Commercial Servicing Rights				Derivative Instruments
Balance, December 31, 2010		$	195			$	520			$	2,147
New interest rate lock contracts originated			—				—				2,578
Matured / expired derivative commitments			—				—				(4,225	)
Other than temporary impairment			(63	)			—				—
Change in fair value			—				(109	)			(18	)
Balance, September 30, 2011		$	132			$	411			$	482
2010						Equity Securities				Commercial Servicing Rights
Balance, December 31, 2009						$	49			$	—
Transfers in from level 2							176				473
Sale of securities in level 3							(33	)			—
Change in fair value							(72	)			(22	)
Balance, September 30, 2010						$	120			$	451

For financial assets and liabilities measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2011 and December 31, 2010 are as follows:

 

		September 30, 2011				Quoted Prices (Level 1)				Significant  Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Loans held for sale		$	30,095			$	—			$	—			$	30,095
Impaired loans			22,803				—				—				22,803
Other real estate owned			4,293				—				—				4,293
Total assets		$	57,191			$	—			$	—			$	57,191

 

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		December 31, 2010				Quoted Prices (Level 1)				Significant  Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Loans held for sale		$	147,281			$	—			$	—			$	147,281
Impaired loans			17,722				—				—				17,722
Other real estate owned			4,647				—				—				4,647
Loans purchased (1)(2)			763,771				—				—				763,771
Core deposit intangible asset (1)			4,440				—				—				4,440
Leasehold intangible assets (1)			342				—				—				342
Premises and equipment (1)			26,724				—				—				26,724
Total assets		$	964,927			$	—			$	—			$	964,927
Time deposits (1)		$	436,126			$	—			$	436,126			$	—
Borrowings (1)			80,049				—				80,049				—
Leasehold intangible liabilities(1)			643				—				—				643
Total liabilities		$	516,818			$	—			$	516,175			$	643

 

(1)– Assets and liabilities are presented at fair value as of the date of the FCEC Merger.

(2)– Balance does not include the loans held for sale that were acquired as part of the FCEC Merger.

The valuation technique to measure the fair values for the items in the tables above are as follows:

Loans held for sale

Loans held for sale include residential mortgage loans which are measured at the lower of aggregate cost or fair value. The fair value is measured as the price that secondary market investors were offering for loans with similar characteristics.

Impaired loans

Under U.S GAAP, a loan is classified as impaired when it is possible that the bank will be unable to collect all or part of the loan balance due based on the contractual agreement, including the interest as well as the principal. Based on this guidance, we consider all loans placed in non-accrual status as being impaired and subject to an impairment analysis in accordance with ASC 310-10-35. Loans acquired through the FCEC Merger and Graystone Merger that were deemed impaired, were recorded using a discounted cash flow model in accordance with ASC 310-30 at the time of acquisition even though we consider these loans to be collateral dependent. The carrying amounts of these loans at September 30, 2011 and December 31, 2010 were $49,440 and $59,260, respectively. These loans are not included in the preceding table.

Impaired loans included in the preceding table are those for which we have measured impairment based on the fair value of underlying collateral. The balance of impaired loans consists of loans deemed impaired in accordance with our accounting policy disclosed within our “Critical Accounting Policies.” Fair value is determined primarily based upon independent third party appraisals of the properties. At September 30, 2011, $17,931 of impaired loans were measured using the fair value of underlying collateral and $4,872 of impaired loans were measured using a discounted cash flow model. At December 31, 2010, $12,721 of impaired loans were measured using the fair value of underlying collateral and $5,001 of impaired loans were measured using a discounted cash flow model.

Other real estate owned

Other real estate owned consists of twenty-five properties totaling $4,293 at September 30, 2011 and twenty-two properties totaling $4,647 at December 31, 2010. These properties have been acquired through the foreclosure process and are currently in the process of being sold. These properties are recorded at their lower of cost or fair value less costs to sell.

Loans purchased

In conjunction with the FCEC Merger, the loans purchased were recorded at their acquisition date fair value. In order to record the loans at fair value, we made three different types of fair value adjustments. A market rate adjustment was made to adjust for the movement in market interest rates, irrespective of credit adjustments, compared to the stated rates of the acquired loans. A credit adjustment was made on pools of homogeneous loans representing the changes in credit quality of the underlying borrowers from the loan inception to the acquisition date. The credit adjustment on distressed loans represents the portion of the loan balance that has been deemed uncollectible based on our expectations of future cash flows for each respective loan.

Core deposit intangible assets

The fair value assigned to the core deposit intangible asset represents the future economic benefit of the potential cost savings from acquiring core deposits in the FCEC Merger compared to the cost of obtaining alternative funding such as brokered

 

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deposits from market sources. We utilized an income valuation approach to present value the estimated future cash savings in order to determine the fair value of the intangible asset.

Premises and equipment

Premises and equipment acquired through the FCEC Merger has been assigned an acquisition date fair value through the use of independent appraisals and internal discounted cash flow models. Both approaches utilized an income based valuation approach to determine the fair value for the premises and equipment based on the highest and best use concept.

Time deposits

Time deposits acquired through the FCEC Merger have been recorded at their acquisition date fair value. In order to derive the fair value, we adjusted the amortized cost basis of the deposits to reflect the current interest rates paid on time deposits at the time of acquisition. The fair value adjustment reflects the movement in interest rates from inception of the deposit to the acquisition date.

Borrowings

Borrowings assumed through the FCEC Merger were recorded at their acquisition date fair value. The fair value adjustment to the carrying value of the borrowings represents the movement in interest rates from the inception of the individual borrowings to the acquisition date.

The following information should not be interpreted as an estimate of the fair value for the entire company since a fair value calculation is only provided for a limited portion of our assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between our disclosures and those of other companies may not be meaningful.

 

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The estimated fair values of our financial instruments were as follows as of September 30, 2011 and December 31, 2010:

 

		September 30, 2011								December 31, 2010
		Carrying Amount				Fair Value				Carrying Amount				Fair Value
Financial assets:
Cash, due from banks, and federal funds sold		$	130,965			$	130,965			$	248,479			$	248,479
Securities available for sale			153,919				153,919				102,695				102,695
Restricted investment in bank stock			12,629				12,629				14,696				14,696
Loans held for sale			30,095				30,095				147,281				147,281
Loans, net of allowance for loan losses			2,051,931				2,100,114				2,058,191				2,072,690
Accrued interest receivable			6,956				6,956				7,856				7,856
Derivative instruments			482				482				2,147				2,147
Financial liabilities:
Deposits			2,153,772				2,119,339				2,299,898				2,257,753
Securities sold under agreements to repurchase			10,555				10,555				6,605				6,605
Short-term borrowings			56				56				55,039				55,039
Long-term debt			87,887				94,906				87,800				83,167
Accrued interest payable			1,625				1,625				1,950				1,950
		Nominal Amount				Fair Value				Nominal Amount				Fair Value
Off-balance sheet financial instruments:
Commitments to grant loans		$	64,823			$	—			$	57,469			$	—
Unfunded commitments under lines of credit			491,382				491				399,647				454
Letters of credit			52,810				319				58,555				149

The following methods and assumptions were used to estimate the fair values of our financial instruments at September 30, 2011 and December 31, 2010.

Cash and cash equivalents (carried at cost)

The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.

Restricted investment in bank stock (carried at cost)

The carrying amount of restricted investment in bank stock approximates fair value, and considers the limited marketability of such securities.

Loans held for sale (carried at lower of cost or fair value)

The carrying amounts of loans held for sale approximate their fair value.

Loans (carried at cost)

The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. This method of estimating fair value does not incorporate the exit price concept of fair value but is a permitted methodology for purposes of this disclosure.

Accrued interest receivable and payable (carried at cost)

The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.

Deposits (carried at cost)

The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.

 

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Short-term borrowings (carried at cost)

The carrying amounts of short-term borrowings approximate their fair values.

Long-term debt (carried at cost)

Fair values of FHLB advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party. The carrying amount of the subordinated debt is considered its fair value as these borrowings were only marketed to closely related investors.

Off-balance sheet financial instruments (disclosed at cost)

Fair values for the Bank’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing as well as reserves for unfunded commitments representing the estimate of losses associated with unused commitments.

Note 13 – Segment Information

Beginning in the first quarter of 2011, operating segments have been determined to be reportable based upon our internal profitability reporting system. The reportable segments are Banking and Residential Mortgage. Our Banking segment includes all of the banking operations, exclusive of activities related to originating residential mortgages for the purpose of selling to the secondary market and the sale of residential mortgages. The Residential Mortgage segment originates and services residential mortgage loans for consumers primarily within our geographic footprint and sells these loans servicing released in the secondary market. The Residential Mortgage segment does not originate sub-prime mortgage loans. The funding of loans originated by the Residential Mortgage segment is providing by the Banking segment. This loan and any interest related to these loans are eliminated during consolidation.

The financial information of our segments was compiled utilizing the accounting policies described in Note 1. These accounting policies and processes are highly subjective and, are based on authoritative guidance similar to GAAP. Income taxes are allocated to the Banking segment based on our effective tax rate and to the Residential Mortgage segment based on our statutory tax rate. As a result, the financial information of the reported segments is not necessarily comparable with similar information reported by other financial institutions.

 

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The following table presents the selected financial information for our reportable segments. Since the first quarter of 2011 was the first period in which separate reportable segments were identified, the information related to the three and nine months ended September 30, 2010 is being presented for comparability purposes and has not been previously presented.

 

		Three Months Ended September 30, 2011
		Banking Segment				Residential Mortgage  Segment				Elimination				Total
Interest income		$	29,823			$	547			$	(155	)		$	30,215
Interest expense			6,310				161				(155	)			6,316
Net interest income			23,513				386				—				23,889
Provision for loan losses			1,300				—				—				1,300
Noninterest income			4,597				1,086				—				5,683
Noninterest expenses			17,864				1,511				—				19,375
Income before income taxes			8,946				(39	)			—				8,907
Income tax expense			2,703				(17	)			—				2,686
Net income including noncontrolling interest		$	6,243			$	(22	)		$	—			$	6,221
Less: income from noncontrolling interest			—				2				—				2
Net income		$	6,243			$	(24	)		$	—			$	6,219
Total average assets		$	2,532,234			$	29,480			$	(26,427	)		$	2,535,287
		Three Months Ended September 30, 2010
		Banking Segment				Residential Mortgage Segment				Elimination				Total
Interest income		$	18,966			$	—			$	(70	)		$	18,896
Interest expense			5,525				70				(70	)			5,525
Net interest income			13,441				(70	)			—				13,371
Provision for loan losses			1,600				—				—				1,600
Noninterest income			2,322				656				—				2,978
Noninterest expenses			10,582				368				—				10,950
Income before income taxes			3,581				218				—				3,799
Income tax expense			1,201				74				—				1,275
Net income including noncontrolling interest		$	2,380			$	144			$	—			$	2,524
Less: income from noncontrolling interest			—				22				—				22
Net income		$	2,380			$	122			$	—			$	2,502
Total average assets		$	1,601,578			$	14,564			$	(15,283	)		$	1,600,859

 

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		Nine Months Ended September 30, 2011
		Banking Segment				Residential Mortgage  Segment				Elimination				Total
Interest income		$	89,401			$	2,353			$	(861	)		$	90,893
Interest expense			18,186				931				(861	)			18,256
Net interest income			71,215				1,422				—				72,637
Provision for loan losses			4,450				—				—				4,450
Noninterest income			12,154				3,699				—				15,853
Noninterest expenses			58,515				11,199				—				69,714
Income before income taxes			20,404				(6,078	)			—				14,326
Income tax expense			6,134				(1,826	)			—				4,308
Net income including noncontrolling interest		$	14,270			$	(4,252	)		$	—			$	10,018
Less: income from noncontrolling interest			4				67				—				71
Net income		$	14,266			$	(4,319	)		$	—			$	9,947
Total average assets		$	2,591,525			$	56,546			$	(48,889	)		$	2,599,182
		Nine Months Ended September 30, 2010
		Banking Segment				Residential Mortgage Segment				Elimination				Total
Interest income		$	55,087			$	—			$	(134	)		$	54,953
Interest expense			16,630				134				(134	)			16,630
Net interest income			38,457				(134	)			—				38,323
Provision for loan losses			4,950				—				—				4,950
Noninterest income			6,099				1,250				—				7,349
Noninterest expenses			31,608				857				—				32,465
Income before income taxes			7,998				259				—				8,257
Income tax expense			2,559				88				—				2,647
Net income including noncontrolling interest		$	5,439			$	171			$	—			$	5,610
Less: income from noncontrolling interest			—				26				—				26
Net income		$	5,439			$	145			$	—			$	5,584
Total average assets		$	1,554,688			$	10,650			$	(11,223	)		$	1,554,115

 

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

Unless the context otherwise requires, the terms “we”, “us” and “our” refer to Tower Bancorp, Inc. and its subsidiaries on a consolidated basis. The following discussion and analysis, the purpose of which is to provide investors and others with information that we believe to be necessary for an understanding our current financial condition, changes in financial condition and results of operations. The following discussion and analysis should be read in conjunction with the consolidated financial statements, notes and other information contained in this Report.

Forward-Looking Statements

We have made, and may continue to make, certain forward-looking statements in this Report, including information incorporated by reference in this Report. These forward-looking statements are intended to be covered by the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not statements of historical fact, and can be identified by the use of forward-looking terminology such as “believe,” “expect,” “may,” “will,” “should,” “project,” “plan,” “seek,” “target,” “intend” or “anticipate” or the negative thereof or comparable terminology. Forward-looking statements include discussions of our strategy, financial projections and estimates and the underlying assumptions, statements regarding plans, objectives, expectations or consequences of various transactions, and statements about the future performance, operations, products and services. These forward-looking statements are subject to various assumptions, risks, uncertainties and other factors discussed in this Report and in our other filings with the Securities and Exchange Commission, including, but not limited to the following: market risk; changes or adverse developments in economic, political, or regulatory conditions; a continuation or worsening of the current disruption in credit and other markets; the effect of competition and interest rates on net interest margin and net interest income; investment strategy and income growth; investment securities gains; declines in the value of securities which may result in charges to earnings; changes in rates of deposit and loan growth; asset quality and the impact on assets from adverse changes in the economy and in credit or other markets and resulting effects on credit risk and asset values; balances of risk-sensitive assets to risk-sensitive liabilities; salaries and employee benefits and other expenses; amortization of intangible assets; capital and liquidity strategies and other financial and business matters for future periods.

Additionally, certain of these forward-looking statements relate to our proposed merger with Susquehanna Bancshares, Inc., including the expected date of closing and effects of the merger agreement. The actual results of the merger could vary materially as a result of a number of factors, including: the possibility that competing offers may be made; the possibility that various closing conditions for the transaction may not be satisfied or waived; and the possibility that the merger agreement may be terminated.

Because of the possibility of changes in these assumptions, actual results could differ materially from those contained in any forward-looking statements. We encourage readers of this Report to understand forward-looking statements to be strategic objectives rather than absolute targets of future performance. Forward-looking statements are qualified in their entirety by the risk factors and cautionary statements contained in this Report and speak only as of the date they are made. We do not undertake any obligation to update publicly any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events except as required by law.

Additional Information

Our common stock is listed for quotation on the Global Select Market of The NASDAQ Stock Market under the symbol “TOBC.” Additional information can be found through our website at www.towerbancorp.com. Electronic copies of our 2010 Annual Report on Form 10-K are available free of charge by visiting the “SEC Filings” section of our website at www.towerbancorp.com. Electronic copies of quarterly reports on Form 10-Q and current reports on Form 8-K are also available. These reports are posted as soon as reasonably practicable after they are electronically filed with the Securities and Exchange Commission (SEC).

Where we have included website addresses in this Report, such as our website address, we have included those addresses as inactive textual references only. Except as specifically incorporated by reference into this Report, information on those websites is not part hereof.

OVERVIEW

Our discussion and analysis of the changes in the consolidated results of operations, financial condition, and cash flows is set forth below for the periods indicated. Through the Bank, we provide banking and banking related services to our customers within our principal market areas consisting of Centre, Chester, Cumberland, Dauphin, Delaware, Franklin, Fulton, Lancaster, Lebanon, and York Counties of Pennsylvania and Washington County, Maryland. The purpose of the following discussion and analysis is to provide investors and others with information that we believe to be necessary in understanding the financial condition, changes in financial condition, and results of operations of our company. Our discussion and analysis should be read in conjunction with the consolidated financial statements, notes, and other information contained in this Report.

Mergers and Acquisitions

On June 20, 2011, the Company entered into an Agreement and Plan of Merger (the “Susquehanna Merger Agreement”) with Susquehanna Bancshares, Inc. (“Susquehanna”), the parent company of Susquehanna Bank, pursuant to which the Company will merge with and into Susquehanna (the “Susquehanna Merger”), with Susquehanna being the surviving corporation. In addition, in accordance with

 

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the terms of the Susquehanna Merger Agreement, Susquehanna Bank and the Bank entered into an Agreement and Plan of Merger, pursuant to which the Bank will merge with and into Susquehanna Bank, with Susquehanna Bank continuing as the surviving bank.

Under the terms of the Susquehanna Merger Agreement, shareholders of the Company will have the opportunity to elect to receive either 3.4696 shares of Susquehanna common stock or $28.00 cash for each share of the Company’s common stock he or she owns immediately prior to completion of the Susquehanna Merger. The Susquehanna Merger Agreement provides that a shareholder may receive a combination of cash and shares of Susquehanna common stock that is different than what he or she may have elected, however, depending on the elections made by other shareholders, in order to ensure that the total cash consideration paid to the Company’s shareholders at the effective time of the Susquehanna Merger is $88.0 million.

Consummation of the Susquehanna Merger is subject to certain terms and conditions, including, but not limited to, receipt of various regulatory approvals and approval by both the Company’s and Susquehanna’s shareholders.

The Susquehanna Merger is expected to be completed during the first quarter of 2012.

On December 10, 2010, the Company completed its acquisition of First Chester County Corporation (“First Chester”) in an all-stock transaction valued at approximately $49.8 million (the “FCEC Merger”). As part of the FCEC Merger, First Chester shareholders received 0.356 shares of the Company’s common stock, valued at $7.88 per share of First Chester common stock based on the closing price of the Company’s common stock of $22.14 per share at the time of acquisition.

Pursuant to the merger agreement with First Chester (the “FCEC Merger Agreement”), the Company is the surviving bank holding company and First Chester’s wholly-owned subsidiary, The First National Bank of Chester County (“FNB”), merged with and into the Graystone Tower Bank (“Bank”), with the Bank as the surviving institution.

Prior to the FCEC Merger, FNB conducted certain mortgage banking activities through its American Home Bank Division (“AHB Division”). Pursuant to the FCEC Merger Agreement, First Chester and FNB initiated efforts to sell the AHB Division, including, without limitation, the interests of FNB in certain mortgage-banking related joint ventures and activities related thereto. No sale agreement related to the AHB Division was executed prior to consummation of the FCEC Merger. On December 30, 2010, the Company announced that it would commence winding down the operations of the AHB Division in an orderly fashion. The Company has recognized a total restructuring charge of $2.1 million in connection with this action, of which approximately $1.4 million was recognized in 2010 and $688 thousand was recognized during the first nine months of 2011. During the second quarter of 2011, the restructuring of the AHB Division was completed and its remaining operations were transferred into the Graystone Mortgage Division of the Bank. The Graystone Mortgage Division, which consists of the restructured AHB Division and mortgage activities previously conducted by Graystone Mortgage, LLC, incurred a net loss of approximately $24 thousand during the third quarter of 2011. While it appears that the residential mortgage loan pipeline has stabilized and we anticipate the financial performance of the Graystone Mortgage Division to improve, such improvements are limited by the current economic difficulties and could be further limited by legislative and regulatory developments affecting the mortgage industry. Additionally, we continue to retain contingent liabilities relating to the prior operations of the AHB Division as well as actions undertaken in connection with the wind down. These matters could adversely affect our financial condition, results of operations, reputation and prospects.

In connection with the FCEC Merger, on December 10, 2010, the Company terminated the Bank’s relationship and relinquished its investment interest in Dellinger, Dolan, McCurdy and Phillips Investment Advisors, LLC, (“DDMP Advisors, LLC”) through which the Bank previously offered investment advisory services to certain customers. The Company recognized an expense of approximately $1.5 million during the fourth quater 2010 related to the termination of our business relationship with DDMP Advisors, LLC.

As a result of these transactions, the Bank now serves ten counties in Central and Southeastern Pennsylvania and one county in Maryland. The Bank operates as the subsidiary of the Company through three banking divisions – “Graystone Bank, a division of Graystone Tower Bank”, consisting of the former Graystone Bank branches, “Tower Bank, a division of Graystone Tower Bank,” consisting of the former branches of The First National Bank of Greencastle and “1N Bank, a Division of Graystone Tower Bank” consisting of the former branches of FNB. The Bank also provides a broad range of trust and investment management services and provides services for estates, trust, agency accounts and individual and employer sponsored retirement plans through the Graystone Wealth Management Division. The operating philosophy will continue to be a community-oriented financial services company with a strong customer focus. These transactions have enhanced our business opportunities due to the Bank having a greater market share, market presence and the ability to offer more diverse and more profitable products, as well as a broader based and geographically diversified branch system to enhance deposit collection and reduce funding costs, and a higher legal lending limit to originate larger and more profitable commercial loans. We believe that the merger of the banks into one surviving bank will provide greater efficiency, customer service, and product delivery than we would achieve by operating under a multi-bank holding company structure.

 

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RESULTS FROM OPERATIONS

Summary Financial Results

For the three and nine months ended September 30, 2011 as compared with the three and nine months ended September 30, 2010, the FCEC Merger has had a significant impact on our results of operations. The operating results reported herein for the three and nine months ended September 30, 2011 include the results for the combined entity. Consequently, comparisons of our current results of operation to the three and nine months ended September 30, 2010 may not be particularly meaningful.

We recognized net income of approximately $6.2 million or $0.52 per diluted share for the three months ended September 30, 2011, compared to $2.5 million or $0.35 per diluted share for the three months ended September 30, 2010. During the three months ended September 30, 2011, the Residential Mortgage segment incurred a net loss of $24 thousand as we better aligned the support cost structure of the business segment with its production levels.

Net interest income before provision for loan loss increased $10.5 million for the three months ended September 30, 2011 compared to the same period in 2010. In addition to the net interest income contributed by the inclusion of the 1N Bank Division, the improvement in net interest income was also due to a reduction in the average rate paid on interest bearing liabilities from the third quarter of 2010 to the third quarter of 2011. Noninterest income increased $2.7 million primarily as a result of the FCEC Merger and gains on the sale of investment securities. Gains on the sale of investment securities were $884 thousand and $248 thousand for the quarters ending September 30, 2011 and September 30, 2010, respectively. The increase in noninterest expense was $8.4 million and is due to increases across all categories with the most significant increases coming from salary and benefit expense, occupancy expense and other operating expense, which increased $4.2 million, $2.2 million and $919 thousand, respectively, as compared to the three months ended September 30, 2010. These increases in noninterest income and expense can be attributed to the FCEC Merger and our balance sheet growth over the last twelve months.

During the nine months ending September 30, 2011, we recognized net income of approximately $9.9 million or $0.83 per diluted share as compared to $5.6 million or $0.78 per diluted share during the same period in 2010. During the nine months ending September 30, 2011, the Residential Mortgage segment incurred a net loss of $4.3 million, due primarily to the restructuring of our Residential Mortgage operations.

Net interest income before provision for loan loss increased $34.3 million during the nine months ending September 30, 2011 compared to the same period in 2010. In addition to the net interest income contributed by the inclusion of the 1N Bank Division, the improvement in net interest income was also due to a reduction in the average rate paid on interest bearing liabilities during the nine months ending September 30, 2011 as compared to the same period in 2010. Noninterest income increased $8.5 million due to increases in the service charges on deposit accounts, fiduciary fees and brokerage commission, other services charges, commissions and fees, gains on the sale of mortgage loans, and other miscellaneous income which increased $990 thousand, $2.6 million, $1.3 million, $2.4 million and $1.2 million, respectively, compared to the nine months ended September 30, 2010. The increase in noninterest expense was $37.2 million and is due to increases across all categories with the most significant increases coming from salary and benefit expense, occupancy expense, advertising and promotion expense, data processing, professional services fees, other operating expense, and restructuring charges, which increased $18.3 million, $7.1 million, $1.0 million, $1.5 million, $1.7 million, $4.6 million, and $1.6 million, respectively, as compared to the nine months ended September 30, 2010. These increases in noninterest income and expense can be attributed to the FCEC Merger and our balance sheet growth over the last twelve months.

Beginning in 2011, operating segments have been determined to be reportable based upon a change in the use of our internal profitability reporting system by our executive management team. The reportable segments are Banking and Residential Mortgage. Our Banking segment includes all of the banking operations, exclusive of activities related to originating residential mortgages for the purpose of selling to the secondary market and the sale of residential mortgages. The Residential Mortgage segment originates and services residential mortgage loans for consumers principally located within our geographic footprint and sells these loans servicing released in the secondary market. The funding of loans originated by the Residential Mortgage segment is provided by the Banking segment. All loans and related interest between segments are eliminated during consolidation.

Net income associated with the Banking segment increased $3.9 million or 162.3% during the three months ended September 30, 2011 compared to the same period in 2010. During the nine months ending September 30, 2011, net income associated with the Banking segment increased $8.8 million or 162.3% compared to the same period in 2010. This increase was the result of added activity from the FCEC Merger and organic growth. Net income associated with the Residential Mortgage segment decreased $146 thousand during the three months ended September 30, 2011 compared to the same period in 2010. During the nine months ending September 30, 2011, net income associated with the Residential Mortgage segment decreased $4.5 million compared to the same period in 2010. This decrease was a result of the operations of the AHB Division, which was acquired as part of the FCEC Merger, as well as restructuring costs associated with the wind down of the AHB Division.

Three Months Ended September 30, 2011 compared to Three Months Ended September 30, 2010

Net Interest Income

Net interest income is the most significant component of our net income. Net interest income increased $10.5 million or 78.8% to approximately $23.9 million for the three months ended September 30, 2011, as compared to approximately $13.4 million for 2010.

 

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We principally utilize in-market deposits to fund loans and investments, while strategically obtaining additional funding from short-term and long-term borrowings when advantageous rates and maturities can be obtained. We use brokered deposits on a limited basis as an interest rate risk management tool. Brokered deposits, exclusive of reciprocal deposits, represent approximately 7.1% of total deposits, on our consolidated balance sheet at September 30, 2011 and approximately 7.9% at September 30, 2010. In connection with our growth plans and ongoing focus to improve our net interest spread, we may continue to supplement in-market deposits with brokered deposits and additional short-term and long-term borrowings, including additional borrowings from the Federal Home Loan Bank and federal funds lines with correspondent banks, based upon prevailing economic conditions, deposit availability and pricing, interest rates and other factors at such time.

The following table provides a comparative average balance sheet and net interest income analysis for the three months ended September 30, 2011 as compared to the same period in 2010. Interest income and average rates are presented on a fully taxable-equivalent (FTE) basis, using a statutory Federal tax rate of 35% for 2011 and 34% for 2010.

 

		For the Three Months Ended September 30,
		2011												2010
		Average Balance				Interest				Average Rate				Average Balance				Interest				Average Rate
		(dollars in thousands)
Interest-earning assets:
Federal funds sold and other (1)		$	6,255			$	2				0.13	%		$	16,801			$	24				0.57	%
Investment securities (2)			204,724				1,199				2.32	%			175,533				1,071				2.42	%
Loans (3)			2,069,430				29,065				5.57	%			1,270,993				17,852				5.57	%
Total interest-earning assets			2,280,409				30,266				5.27	%			1,463,327				18,947				5.14	%
Other assets			254,878												137,532
Total assets		$	2,535,287											$	1,600,859
Interest-bearing liabilities:
Interest-bearing non-maturity deposits		$	1,012,046				1,409				0.55	%		$	794,970				2,138				1.07	%
Time deposits			848,526				3,550				1.66	%			423,415				2,354				2.21	%
Borrowings			97,131				1,357				5.54	%			85,863				1,033				4.77	%
Total interest-bearing liabilities			1,957,703				6,316				1.28	%			1,304,248				5,525				1.68	%
Noninterest-bearing transaction accounts			294,520												116,974
Other liabilities			23,937												13,738
Equity			259,127												165,899
Total liabilities and equity		$	2,535,287											$	1,600,859
Net interest spread											3.99	%											3.46	%
Net interest income and interest rate margin FTE						$	23,950				4.17	%						$	13,422				3.64	%
Tax equivalent adjustment							(91	)											(51	)
Net interest income						$	23,859											$	13,371
Ratio of average interest-earning assets to average interest-bearing liabilities			116.5	%											112.2	%

 

(1)	Amounts exclude cash balances held at the Federal Reserve and any interest earned thereon.

(2)	The average yields for investment securities available for sale are reported on a fully taxable-equivalent basis at a rate of 35% for 2011 and 34% for 2010.

(3)	Average loan balances include non-accrual loans.

 

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The following table summarizes the changes in FTE interest income and expense due to changes in average balances (volume) and changes in rates:

 

		Three Months Ended September 30, 2011 vs. September 30, 2010
		Increase (Decrease) Due to
		Volume				Rate				Total
		(dollars in thousands)
Interest income:
Federal funds sold		$	(15	)		$	(7	)		$	(22	)
Investment securities			178				(50	)			128
Loans			11,215				(2	)			11,213
Total interest income			11,378				(59	)			11,319
Interest expense:
Interest-bearing non-maturity deposits			584				(1,313	)			(729	)
Time deposits			2,363				(1,167	)			1,196
Borrowings			136				188				324
Total interest expenses			3,083				(2,292	)			791
Net interest income		$	8,295			$	2,233			$	10,528

Interest income increased approximately $11.3 million, or 59.9%. This increase was caused by approximately $817.1 million or 55.8% increase in the average balance of interest-earning assets and a shift in the mix of interest earning assets. During the quarter ending September 30, 2011, loans comprised 90.8% of total interest-earning assets as compared to 86.7% for the same period in 2010. The improvement in the average rate earned on total average interest earning assets is partly attributable to the higher percentage allocation to loans relative to lower earning assets such as federal funds sold and investment securities. For the quarter ending September 30, 2011, the average rate for interest-earning assets increased 13 basis points as compared to the same period in 2010.

Interest income on investment securities increased approximately $128 thousand, or 12.0%. The average balance of investments held by the Bank increased from $175.5 million at September 30, 2010 to $204.7 million at September 30, 2011, which resulted in an increase of approximately $178 thousand in interest income. The average interest rate earned on securities for the quarter ending September 30, 2011 decreased 10 basis points when compared to the same period in 2010.

Average yields on loans remained stable at 5.57% during the three months ended September 30, 2011 as compared to the three months ended September 30, 2010. The Federal Reserve maintained the intended federal funds target rate in the range of 0 basis points to 25 basis points during both three-month periods ended September 30, 2011 and 2010. This rate continues to place downward pressure on the prime rate and all other lending rates. Fixed rate and adjustable rate loans, which represent approximately 24.3% and 41.0%, respectively, of total average loans held at September 30, 2011, do not reprice immediately when short-term rates decline. Additionally, the total effect of downward loan repricing on variable rate loans will not coincide with the decrease in the aforementioned rates due to the fact that approximately 74.4% of our total variable rate loans at September 30, 2011 contain interest rate floors. Conversely, any benefit associated with an increase in interest rates in the future might not be immediately realized due to the use of interest rate floors. Presumably, an increase in future interest rates would cause repricing in all assets and liabilities linked to variable rate indices; however, as deposit products may experience any increase on a relatively immediate basis, loan products with floors in place would require a rate increase such that the resulting rate earned on the loan would exceed the floor. Refer to Item 3 Quantitative and Qualitative Disclosures About Market Risk for a more detailed discussion of interest rate risk.

Interest expense increased $791 thousand, or 14.3%, during the three months ended September 30, 2011 compared to the same period in 2010. This increase was caused by approximately $653.5 million or 50.1% increase in the average balance of interest-bearing liabilities, which resulted in approximately $3.1 million increase to interest expense. This increase, however, was predominately offset by a 40 basis point reduction in the average rate paid on interest-bearing liabilities, which resulted in a reduction of interest expense of approximately $2.3 million. This reduction in average rates paid on interest-bearing liabilities was the result of lower rates paid on interest-bearing non-maturity deposit accounts and time deposits, which can be attributed to both the low cost deposits acquired through the FCEC Merger and our efforts to reduce rates paid on deposits while still remaining competitive in our markets.

The amortization of premiums and discounts on interest-earning assets and interest-bearing liabilities acquired in the FCEC Merger had a positive impact on the net interest margin. Exclusive of these items, the yield on interest earning assets would have been 5.01%, the cost of interest bearing liabilities would have been 1.40%, and net interest margin would have been 3.83% for the three months ended September 30, 2011.

 

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Provision for Loan Losses and Allowance for Loan Losses

The provision for loan losses is the expense necessary to maintain the allowance for loan losses at a level adequate to absorb management’s estimate of probable losses in the loan portfolio. Our provision for loan loss is based upon management’s continuous review of the loan portfolio. The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain risks associated with new loans, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets we serve.

The following table presents the activity in the allowance for loan losses for the three months ended September 30, 2011 and 2010:

 

		For the Three Months Ended September 30,
		2011				2010
		(dollars in thousands)
Balance at beginning of period		$	11,869			$	11,619
Provision for loan losses			1,300				1,600
Charge-offs:
Commercial:
Industrial			(502	)			(113	)
Real estate			—				—
Construction			—				—
Consumer:
Home equity line			—				(65	)
Other			(437	)			(62	)
Residential mortgages			(323	)			(271	)
Total charge-offs			(1,262	)			(511	)
Recoveries:
Commercial:
Industrial			18				6
Real estate			—				—
Construction			—				—
Consumer:
Home equity line			—				—
Other			—				1
Residential mortgages			—				2
Total recoveries			18				9
Net charge-offs			(1,244	)			(502	)
Balance at end of period		$	11,925			$	12,717

We continue to operate in a challenging economic environment. We have adjusted our allowance for loan loss in accordance with our assessment process, which took into consideration risks related to the overall composition of our loan portfolio, the status of the current economic environment and other qualitative factors, and the results of our risk assessment process over delinquent and problem loans. The provision for loan losses for the three months ended September 30, 2011 totaled $1.3 million, a decrease of $300 thousand compared to the same period in 2010. The gross loan charge-offs that were applied to the allowance for loan loss during the three months ended September 30, 2011 consisted of 4 commercial industrial loans, 5 other consumer loans, and 4 residential mortgage loans and totaling $1.3 million. Net allowance for loan loss charge-offs were 0.24% of average loans on an annualized basis. Our allowance for loan loss as a percentage of loans was 0.58% at September 30, 2011, compared to 0.65% at December 31, 2010.

 

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The following table presents changes in the credit quality adjustment on loans purchased for the three months ended September 30, 2011 and 2010:

 

		For the Three Months Ended September 30,
		2011				2010
		(dollars in thousands)
Balance at beginning of period		$	17,828			$	1,676
Credit fair value adjustment mark			—				—
Net Loan Accretion			(1,186	)			(95	)
Charge-offs:
Commercial:
Industrial			(356	)			(50	)
Real estate			(8	)			—
Construction			—				—
Consumer:
Home equity line			(52	)			(5	)
Other			(70	)			(45	)
Residential mortgages			(587	)			—
Total charge-offs			(1,073	)			(100	)
Recoveries:
Commercial:
Industrial			128				8
Real estate			10				—
Construction			—				—
Consumer:
Home equity line			3				—
Other			16				20
Residential mortgages			—				—
Total recoveries			157				28
Net charge-offs			(916	)			(72	)
Balance at end of period		$	15,726			$	1,509

The gross loan charge-offs that were applied to the credit quality adjustment on purchased loans for the three months ended September 30, 2011 consisted of 7 commercial industrial loans, 1 commercial real estate loan, 2 consumer home equity lines, 8 other consumer loans, and 3 residential mortgages totaling $1,073 thousand. Net credit mark charge-offs were 0.18% of average loans for the third quarter 2011 on an annualized basis.

The total gross loan charge-offs during the three months ended September 30, 2011 consisted of 34 loans totaling $2.3 million. Net total loan charge-offs were 0.41% of average loans for the three months ended September 30, 2011 on an annualized basis. Our adjusted (Non-GAAP) allowance for loan loss, that is the allowance for loan losses adjusted to include the credit quality adjustment on loans purchased, as a percentage of loans was 1.36% at September 30, 2011, compared to 1.66% at December 31, 2010. See an explanation of the Non-GAAP measures later in this filing within Management’s Discussion and Analysis of our loan portfolio performance. Determining the level of the allowance for probable loan loss at any given point in time is difficult, particularly during uncertain economic periods. We must make estimates using assumptions and information that is often subjective and changing rapidly. The review of the loan portfolio is a continuing process in light of a changing economy and the dynamics of the banking and regulatory environment. In our opinion, the allowance for loan loss is adequate to meet probable incurred loan losses at September 30, 2011. There can be no assurance, however, that we will not sustain loan losses in future periods that could be greater than the size of the allowance at September 30, 2011. We believe that the allowance for loan loss is appropriate based on applicable accounting standards.

Noninterest Income

In addition to our focus on increasing net interest income through growth of interest-earning assets and expansion in our net interest margin, we remain committed to increasing non-interest income as a way to improve profitability and diversify our sources of revenue.

Noninterest income was approximately $5.7 million and $3.0 million for the three months ended September 30, 2011 and 2010, respectively.

 

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The following table presents the components of noninterest income:

 

		September 30, 2011				September 30, 2010				Increase (Decrease)
										$				%
		(dollars in thousands)
Service charges on deposit accounts		$	1,130			$	832			$	298				35.8	%
Fiduciary fees and brokerage commissions			905				87				818				940.2	%
Other service charges, commissions and fees			1,003				493				510				103.4	%
Gain on sale of mortgage loans originated for sale			1,076				656				420				64.0	%
Impairment losses on securities available for sale			—				(70	)			70				(100.0	)%
Increase in cash surrender value of bank owned life insurance			390				566				(176	)			(31.1	)%
Other income			1,179				414				765				184.8	%
Total noninterest income		$	5,683			$	2,978			$	2,705				90.8	%

The $2.7 million or 90.8% increase in total noninterest income from the three months ended September 30, 2010 to the same period in 2011 is distributed across most noninterest income categories as a result of the FCEC Merger and gains on sales of securities. Fiduciary fees and brokerage commissions increased due to income received from the Wealth Management Division which was acquired as part of the FCEC Merger. As of September 30, 2011, the Wealth Management Division administered or provided investment management services to accounts that held assets with an aggregate market value of approximately $464.3 million. Gains on the sale of investment securities, which are incorporated into other income, were $884 thousand and $248 thousand for the quarters ending September 30, 2011 and September 30, 2010, respectively.

Noninterest Expense

The following table presents the components of noninterest expenses for the three months ended September 30, 2011 and 2010:

 

		September 30, 2011				September 30, 2010				Increase
										$				%
		(dollars in thousands)
Salaries and employee benefits		$	9,770			$	5,521			$	4,249				77.0	%
Occupancy and equipment			4,031				1,805				2,226				123.3	%
Amortization of intangible assets			343				160				183				114.4	%
FDIC insurance premiums			526				564				(38	)			(6.7	)%
Advertising and promotion			508				231				277				119.9	%
Data processing			1,162				740				422				57.0	%
Communication			298				278				20				7.2	%
Professional service fees			700				385				315				81.8	%
Other operating expenses			2,068				1,149				919				80.0	%
Restructuring charges			61				—				61				n/a
Merger related expenses			(92	)			117				(209	)			(178.6	)%
Total noninterest expenses		$	19,375			$	10,950			$	8,425				76.9	%

Salary and employee benefits increased $4.2 million or 77.0% for the three months ending September 30, 2011 when compared to September 30, 2010. The increased level of salary expense was primarily driven by personnel costs in connection with the FCEC Merger. In addition to the FCEC merger, we added additional personnel to our operations, finance, credit and lending departments to support our growth between September 30, 2010 and September 30, 2011. We also implemented general merit increases for all eligible employees between September 30, 2010 and September 30, 2011.

Occupancy and equipment expense increased $2.2 million or 123.3%. The increase was principally related to the FCEC Merger. Additional increases to occupancy and equipment expense related to additional branch offices during 2010 and 2011 and a second corporate center building which we occupied beginning in the fourth quarter of 2010.

Advertising and promotion expenses for the three months ending September 30, 2011 exceeded that of the same period in 2010 due to the expanded geographic area of the Company.

The costs related to data processing and communications expenses increased as a result of the FCEC Merger, which caused increased processing volume by our core bank processing system and increased communications expenses for phone and internet usage and upgraded services.

 

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Professional service expense increases are directly related to increased audit, consulting and legal services given the rapid growth in the Bank, between September 30, 2010 and September 30, 2011.

Restructuring charges totaled $61 thousand for the three months ended September 30, 2011 relating to losses incurred in connection with the wind down of the acquired First Chester residential mortgage operations. Merger expenses totaled ($92) thousand for the three months ended September 30, 2011 as a result of the final adjustment of merger expense accruals recorded at December 31, 2010, which were based on estimates at that time.

Other operating expenses increased $919 thousand or 80.0% that were principally a result of the FCEC Merger.

Income Tax Expense

Income tax expense was $2.7 million and $1.3 million for the three months ended September 30, 2011 and 2010, respectively. Our effective tax rate for the three months ended September 30, 2011 was 30.2%. The effective tax rate was positively impacted by tax free income generated by the purchase of bank owned life insurance, dividends deductions for dividends paid on ESOP shares, and earnings from tax-exempt securities, which had the greatest impact in reducing our effective tax rate. Our effective tax rate was 33.8% for the three months ended September 30, 2010. The statutory tax rates for 2011 and 2010 were 35.0% and 34.0%, respectively.

Nine Months Ended September 30, 2011 compared to Nine Months Ended September 30, 2010

Net Interest Income

Net interest income increased $34.3 million or 89.5% to approximately $72.6 million for the nine months ended September 30, 2011, as compared to approximately $38.3 million for 2010.

The following table provides a comparative average balance sheet and net interest income analysis for the nine months ended September 30, 2011 as compared to the same period in 2010. Interest income and average rates are presented on a fully taxable-equivalent (FTE) basis, using a statutory Federal tax rate of 35% for 2011 and 34% for 2010.

 

		For the Nine Months Ended September 30,
		2011												2010
		Average Balance				Interest				Average Rate				Average Balance				Interest				Average Rate
		(dollars in thousands)
Interest-earning assets:
Federal funds sold and other (1)		$	15,821			$	15				0.13	%		$	20,010			$	98				0.65	%
Investment securities (2)			197,883				3,732				2.52	%			181,018				3,358				2.48	%
Loans (3)			2,093,762				87,243				5.57	%			1,202,259				51,632				5.74	%
Total interest-earning assets			2,307,466				90,990				5.27	%			1,403,287				55,088				5.25	%
Other assets			291,716												150,828
Total assets		$	2,599,182											$	1,554,115
Interest-bearing liabilities:
Interest-bearing non-maturity deposits		$	1,045,110				4,347				0.56	%		$	749,017				6,470				1.15	%
Time deposits			852,020				9,928				1.56	%			425,697				7,175				2.25	%
Borrowings			104,281				3,981				5.10	%			85,691				2,985				4.66	%
Total interest-bearing liabilities			2,001,411				18,256				1.22	%			1,260,405				16,630				1.76	%
Noninterest-bearing transaction accounts			310,712												114,534
Other liabilities			30,515												14,138
Equity			256,544												165,038
Total liabilities and equity		$	2,599,182											$	1,554,115
Net interest spread											4.05	%											3.48	%
Net interest income and interest rate margin FTE						$	72,734				4.21	%						$	38,458				3.66	%
Tax equivalent adjustment							(262	)											(135	)
Net interest income						$	72,472											$	38,323
Ratio of average interest-earning assets to average interest-bearing liabilities			115.3	%											111.3	%

 

(1)	Amounts exclude cash balances held at the Federal Reserve and any interest earned thereon.

(2)	The average yields for investment securities available for sale are reported on a fully taxable-equivalent basis at a rate of 35% for 2011 and 34% for 2010.

(3)	Average loan balances include non-accrual loans.

 

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The following table summarizes the changes in FTE interest income and expense due to changes in average balances (volume) and changes in rates:

 

		Nine Months Ended September 30, 2011 vs. September 30, 2010
		Increase (Decrease) Due to
		Volume				Rate				Total
		(dollars in thousands)
Interest income:
Federal funds sold		$	(21	)		$	(62	)		$	(83	)
Investment securities			313				61				374
Loans			38,286				(2,675	)			35,611
Total interest income			38,578				(2,676	)			35,902
Interest expense:
Interest-bearing non-maturity deposits			2,558				(4,681	)			(2,123	)
Time deposits			7,186				(4,433	)			2,753
Borrowings			648				348				996
Total interest expenses			10,392				(8,766	)			1,626
Net interest income		$	28,186			$	6,090			$	34,276

Interest income increased approximately $35.9 million, or 65.4%. This increase was caused by approximately $904.2 million or 64.4% increase in the average balance of interest-earning assets, which resulted in approximately $38.6 million increase to interest income and a shift in the mix of interest earning assets. During the nine months ending September 30, 2011, loans comprised 90.7% of total average interest-earning assets as compared to 85.7% for the same period in 2010. The improvement in the average rate earned on total average interest earning assets is partly attributable to the higher percentage allocation to loans relative to lower earning assets such as federal funds sold and investment securities. For the nine months ending September 30, 2011, the average rate for interest-earning assets increased 2 basis points as compared to the same period in 2010.

Interest income on investment securities increased approximately $374 thousand, or 11.1%. The average balance of investments held by the Bank increased from $181.0 million at September 30, 2010 to $197.9 million at September 30, 2011, which resulted in an increase of approximately $313 thousand in interest income. The interest rates earned on securities as compared to prior year increased 4 basis points on the average rate for an increase of interest income of $61 thousand.

Average yields on loans decreased 17 basis points or 3.0%, from 5.74% during the nine months ended September 30, 2010 to 5.57% during the nine months ended September 30, 2011. The Federal Reserve maintained the intended federal funds target rate within a range between 0 basis points and 25 basis points during both nine month periods ended September 30, 2011 and 2010. This rate continues to place downward pressure on the prime rate and all other lending rates. Fixed rate and adjustable rate loans, which represent approximately 24.3% and 41.0%, respectively, of total average loans held at September 30, 2011, do not reprice immediately when short-term rates decline. Additionally, the total effect of downward loan repricing on variable rate loans will not coincide with the decrease in the aforementioned rates due to the fact that approximately 74.4% of our total variable rate loans at September 30, 2011 contain interest rate floors. Conversely, any benefit associated with an increase in interest rates in the future might not be immediately realized due to the use of interest rate floors. Presumably, an increase in future interest rates would cause repricing in all assets and liabilities linked to variable rate indices; however, as deposit products would experience any increase on a relatively immediate basis, loan products with floors in place would require a rate increase such that the resulting rate earned on the loan would exceed the floor. Refer to Item 3 Quantitative and Qualitative Disclosures About Market Risk for a more detailed discussion of interest rate risk.

Interest expense increased $1.6 million, or 9.8%, during the nine months ended September 30, 2011 compared to the same period in 2010. This increase was caused by approximately $741.0 million or 58.8% increase in the average balance of interest-bearing liabilities, which resulted in approximately $10.4 million increase to interest expense. This increase, however, was predominately offset by a 54 basis point reduction in the average rate paid on interest-bearing liabilities, which resulted in a reduction of interest expense of approximately $8.8 million. This reduction in average rates paid on interest-bearing liabilities was the result of lower rates paid on interest-bearing non-maturity deposit accounts and time deposits, which can be attributed to both the low cost deposits acquired through the FCEC Merger and our efforts to reduce rates paid on deposits while still remaining competitive in our markets.

The amortization of premiums and discounts on interest-earning assets and interest-bearing liabilities acquired in the FCEC Merger had a positive impact on the net interest margin. Exclusive of these items, the yield on interest earning assets would have been 5.07%,

 

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the cost of interest bearing liabilities would have been 1.40%, and net interest margin would have been 3.86% for the nine months ended September 30, 2011.

 

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Provision for Loan Losses and Allowance for Loan Losses

The following table presents the activity in the allowance for loan losses for the nine months ended September 30, 2011 and 2010:

 

		For the Nine Months Ended September 30,
		2011				2010
		(dollars in thousands)
Balance at beginning of period		$	14,053			$	9,695
Provision for loan losses			4,450				4,950
Charge-offs:
Commercial:
Industrial			(1,357	)			(915	)
Real estate			(8	)			(266	)
Construction			(4,250	)			—
Consumer:
Home equity line			—				(265	)
Other			(574	)			(291	)
Residential mortgages			(582	)			(271	)
Total charge-offs			(6,771	)			(2,008	)
Recoveries:
Commercial:
Industrial			53				75
Real estate			120				—
Construction			—				2
Consumer:
Home equity line			9				—
Other			11				1
Residential mortgages			—				2
Total recoveries			193				80
Net charge-offs			(6,578	)			(1,928	)
Balance at end of period		$	11,925			$	12,717

We continue to operate in a challenging economic environment. We have adjusted our allowance for loan loss in accordance with our assessment process, which took into consideration risks related to the overall composition of our loan portfolio, the status of the current economic environment and other qualitative factors, and the results of our risk assessment process over delinquent and problem loans. The provision for loan losses for the nine months ended September 30, 2011 totaled $4.5 million, a decrease of $500 thousand compared to the same period in 2010. The gross loan charge-offs that were applied to the allowance for loan loss during the nine months ended September 30, 2011 consisted of 13 commercial industrial loans, 1 commercial real estate loan, 1 commercial construction loan relationship, 9 other consumer loans, and 11 mortgage loans totaling $6.8 million. The increase in charge-offs was primarily caused by a $4.3 million charge off on a commercial loan relationship totaling $5.0 million which had been identified as non-performing during the first quarter of 2010. Though the loan was to be secured by pledges of loans and mortgages securing the loans extended to third parties, the collateral positions had not been perfected resulting in the loan being unsecured. The borrower had agreed to refinance the credit with additional collateral and cash flows from a newly formed entity, which agreement was contained within a plan of reorganization filed with the bankruptcy court in May 2011. However, the lead bank in this agreement withdrew from the financing arrangement in July 2011. Based upon its evaluation of the status of the bankruptcy proceedings and negotiations with the borrower, the Company believed that it was appropriate to charge off $4.3 million related to this credit during the second quarter of 2011. Net allowance for loan loss charge-offs were 0.42% of average loans on an annualized basis. Our allowance for loan loss as a percentage of loans was 0.58% at September 30, 2011, compared to 0.65% at December 31, 2010.

 

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The following table presents changes in the credit quality adjustment on loans purchased for the nine months ended September 30, 2011 and 2010:

 

		For the Nine Months Ended September 30,
		2011				2010
		(dollars in thousands)
Balance at beginning of period		$	21,693			$	2,942
Credit fair value adjustment mark			—				—
Net Loan Accretion			(4,518	)			(495	)
Charge-offs:
Commercial:
Industrial			(427	)			(377	)
Real estate			(58	)			(160	)
Construction			—				—
Consumer:
Home equity line			(604	)			(19	)
Other			(98	)			(210	)
Residential mortgages			(587	)			(263	)
Total charge-offs			(1,774	)			(1,029	)
Recoveries:
Commercial:
Industrial			239				27
Real estate			23				—
Construction			—				—
Consumer:
Home equity line			9				1
Other			54				61
Residential mortgages			—				2
Total recoveries			325				91
Net charge-offs			(1,449	)			(938	)
Balance at end of period		$	15,726			$	1,509

The gross loan charge-offs that were applied to the credit quality adjustment on purchased loans for the nine months ended September 30, 2011 consisted of 12 commercial industrial loans, 3 commercial real estate loans, 12 consumer home equity lines, 21 Other consumer loans, and 3 residential mortgage loans totaling $1.8 million. Net credit mark charge-offs were 0.09% of average loans for the nine months ended September 30, 2011 on an annualized basis.

The total gross loan charge-offs during the nine months ended September 30, 2011 consisted of 86 loans totaling $8.5 million. Net total loan charge-offs were 0.51% of average loans for the nine months ended September 30, 2011 on an annualized basis. Our adjusted (Non-GAAP) allowance for loan loss, that is the allowance for loan losses adjusted to include the credit quality adjustment on loans purchased, as a percentage of loans was 1.36% at September 30, 2011, compared to 1.66% at December 31, 2010. See an explanation of the Non-GAAP measures later in this filing within Management’s Discussion and Analysis of our loan portfolio performance. Determining the level of the allowance for probable loan loss at any given point in time is difficult, particularly during uncertain economic periods. We must make estimates using assumptions and information that is often subjective and changing rapidly. The review of the loan portfolio is a continuing process in light of a changing economy and the dynamics of the banking and regulatory environment. In our opinion, the allowance for loan loss is adequate to meet probable incurred loan losses at September 30, 2011. There can be no assurance, however, that we will not sustain loan losses in future periods that could be greater than the size of the allowance at September 30, 2011. We believe that the allowance for loan loss is appropriate based on applicable accounting standards.

 

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Noninterest Income

Noninterest income was approximately $15.9 million and $7.3 million for the nine months ended September 30, 2011 and 2010, respectively.

The following table presents the components of noninterest income:

 

		September  30, 2011				September  30, 2010				Increase (Decrease)
										$				%
		(dollars in thousands)
Service charges on deposit accounts		$	3,367			$	2,377			$	990				41.6	%
Fiduciary fees and brokerage commissions			2,868				225				2,643				1,174.7	%
Other service charges, commissions and fees			2,857				1,563				1,294				82.8	%
Gain on sale of mortgage loans originated for sale			3,672				1,250				2,422				193.8	%
Impairment losses on securities available for sale			(63	)			(138	)			75				54.3	%
Increase to cash surrender value of bank owned life insurance			1,186				1,300				(114	)			(8.8	)%
Other income			1,966				772				1,194				154.7	%
Total noninterest income		$	15,853			$	7,349			$	8,504				115.7	%

The $8.5 million or 115.7% increase in total noninterest income from the nine months ending September 30, 2010 to the same period in 2011 is distributed across most noninterest income categories as a result of the FCEC Merger and gains on sales of securities. Gains on the sale of investment securities, which are incorporated into other income, were $1.02 million and $287.5 thousand for the nine months ending September 30, 2011 and September 30, 2010, respectively. Fiduciary fees and brokerage commissions increased due to income received from Wealth Management Division which was acquired as part of the FCEC Merger. As of September 30, 2011, the Wealth Management Division administered or provided investment management services to accounts that held assets with an aggregate market value of approximately $464.3 million.

Noninterest Expense

The following table presents the components of noninterest expenses for the nine months ended September 30, 2011 and 2010:

 

		September  30, 2011				September  30, 2010				Increase
										$				%
		(dollars in thousands)
Salaries and employee benefits		$	34,177			$	15,906			$	18,271				114.9	%
Occupancy and equipment			12,353				5,236				7,117				135.9	%
Amortization of intangible assets			1,093				496				597				120.4	%
FDIC insurance premiums			2,184				1,500				684				45.6	%
Advertising and promotion			1,770				740				1,030				139.2	%
Data processing			3,413				1,894				1,519				80.2	%
Communication			1,377				771				606				78.6	%
Professional service fees			2,862				1,197				1,665				139.1	%
Impairment of long-lived assets			—				920				(920	)			(100.0	)%
Other operating expenses			8,157				3,501				4,656				133.0	%
Restructuring charges			1,635				—				1,635				n/a
Merger related expenses			693				304				389				128.0	%
Total noninterest expenses		$	69,714			$	32,465			$	37,249				114.7	%

Salary and employee benefits increased $18.3 million or 114.9% for the nine months ending September 30, 2011 when compared to September 30, 2010. The increased level of salary expense was primarily driven by personnel costs in connection with the FCEC Merger. In addition to the FCEC Merger, we added personnel to our operations, finance, credit and lending departments to support our growth between September 30, 2010 and September 30, 2011. We also implemented general merit increases for all eligible employees between September 30, 2010 and September 30, 2011.

Occupancy and equipment expense increased $7.1 million or 135.9%. Additional increases to occupancy and equipment expense related to additional branch offices during 2011 and a second corporate center building which we occupied beginning in the fourth quarter of 2010.

As of April 1, 2011, FDIC insurance premiums are no longer based on the level of insured deposits. Rather the assessment is based on average total assets less average tangible equity. The increase in FDIC insurance premiums of $684 thousand for the nine months ended September 30, 2011 as compared to September 30, 2010 is principally due to the increase in the Bank’s average total assets less average tangible equity.

 

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Advertising and promotion expenses for the nine months ending September 30, 2011 exceeded that of 2010 due to the FCEC Merger that was completed during December of 2010, which resulted in additional signage and advertising needs to communicate with our customers during the first quarter of 2011. Additionally, we initiated a checking account, a small business loan and a home equity line of credit campaign during 2011, which resulted in increased advertising costs during the nine months ending September 30, 2011.

The costs related to data processing and communications expenses increased as a result of the FCEC Merger, which caused increased processing volume by our core bank processing system and increased communications expenses for phone and internet usage and upgraded services.

Professional service expenses increases are directly related to increased audit, consulting and legal services given the rapid growth in the Bank, between September 30, 2010 and September 30, 2011.

Restructuring charges totaled $1.6 million for the nine months ended September 30, 2011. The restructuring charges included $617 thousand related to payments made to members of our Board of Directors who resigned from the Board following the FCEC Merger and $334 thousand incurred for lease termination costs and leasehold improvement write-off’s as a result of restructuring the acquired First Chester residential mortgage operations. The remaining increase relates primarily to liabilities related to legal proceedings, claims, and other liabilities directly related to the wind down of the acquired First Chester residential mortgage operations.

Other operating expenses increased $4.7 million or 133.0%. These increases were principally a result of the FCEC Merger.

Income Tax Expense

Income tax expense was $4.3 million and $2.6 million for the nine months ended September 30, 2011 and 2010, respectively. Our effective tax rate for the nine months ended September 30, 2011 was 30.1%. The effective tax rate was positively impacted by tax free income generated by the purchase of bank owned life insurance, dividends deductions for dividends paid on ESOP shares, and earnings from tax-exempt securities, which had the greatest impact in reducing our effective tax rate. Our effective tax rate was 32.1% for the nine months ended September 30, 2010. The statutory tax rates for 2011 and 2010 were 35.0% and 34.0%, respectively.

FINANCIAL CONDITION

Total Assets

Total assets decreased by $207.6 million, or 7.6%, to $2.54 billion at September 30, 2011 as compared to $2.75 billion at December 31, 2010. This decrease primarily related to a decrease in cash and due from banks of $103.3 million and a decrease in loans held for sale of $117.2 million. The decrease in loans held for sale is the direct result of the wind-down efforts related to the acquired First Chester residential mortgage operations, coupled with an overall decrease in residential mortgage loan demand due to current economic conditions.

Loans held for investment

Our gross loan balance decreased by $8.3 million, or 0.4%, to $2.06 billion as of September 30, 2011. During the first nine months of 2011, the outstanding balance of commercial loans and consumer loans grew $16.5 million and $7.6 million, respectively. These increases were offset by a decrease in the residential mortgage portfolio of $32.8 million. The decrease in residential mortgages is a product of our strategy to actively reduce our exposure to interest rate risk. The Company has experienced lower levels of loan originations than anticipated given the continued uncertain economic conditions and increased competition for high quality loans in the Company’s markets. However, we believe that there continues to be opportunities to bring quality existing credits into the Bank from our competitors, coupled with demand for commercial and consumer loans to credit qualified businesses and individuals within our market areas.

 

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See the table below for a detail of the loan balances, net of unearned income and allowance for loan losses at September 30, 2011 and the changes from December 31, 2010:

 

		September  30, 2011				December  31, 2010				Increase (Decrease)
										$				%
		(dollars in thousands)
Commercial:
Industrial		$	1,079,832			$	1,073,666			$	6,166				0.6	%
Real estate			315,127				305,423				9,704				3.2	%
Construction			184,423				183,729				694				0.4	%
Consumer & other:
Home equity line			175,749				163,905				11,844				7.2	%
Other			61,024				65,305				(4,281	)			(6.6	)%
Residential mortgages			247,337				280,154				(32,817	)			(11.7	)%
Total Loans			2,063,492				2,072,182				(8,690	)			(0.4	)%
Deferred costs (fees)			364				62				302				487.1	%
Allowance for loan losses			(11,925	)			(14,053	)			(2,128	)			(15.1	)%
Net Loans		$	2,051,931			$	2,058,191			$	(6,260	)			(0.3	)%

The commercial loan portfolio continues to be the largest component of our loan portfolio, representing 76.5% and 75.4% of total loans at September 30, 2011 and December 31, 2010, respectively. In addition, the Bank has $116.8 million in loan participations without recourse sold to unaffiliated banks through September 30, 2011, where the Bank maintains the servicing rights with these relationships. Currently, the Bank is participating in 31 loans purchased from unaffiliated banks. The total outstanding balance of these loans is $40.5 million. The borrowers on these loans are in-market customers.

Loans, held for sale

Loans originated and intended for sale in the secondary market are primarily residential mortgage loans originated through the Bank’s Graystone Mortgage Division. Loans held for sale decreased $117.2 million from $147.3 million at December 31, 2010 to $30.1 million at September 30, 2011. The decrease in loans held for sale is the direct result of the wind-down efforts of the acquired First Chester residential mortgage operations, coupled with an overall decrease in residential mortgage loan demand due to the current economic conditions.

The following is a summary of our lending activities based on our current loan portfolio.

Lending Activities

The Bank’s principal lending activity has been the origination of business and commercial real estate loans, commercial and industrial loans, and personal consumer loans to customers located within our primary market areas. The Bank generally releases the servicing rights on residential mortgage loans that it sells which results in additional gains on sale. The Bank also originates and retains various types of home equity and consumer loan products in its loan portfolio.

Commercial Lending

The Bank’s commercial loan portfolio includes business term loans and lines of credit issued to small and medium size companies within our the market areas, some of which are secured in part by additional owner occupied real estate. Additionally, the Bank makes secured and unsecured commercial loans and extends lines of credit for the purpose of financing equipment purchases, inventory, business expansion, working capital, and other general business purposes. The terms of these loans generally range from less than 1 year to 7 years with a maximum interest rate term to not exceed 10 years and amortization periods not to exceed 25 years, carrying a fixed interest rate or a variable interest rate indexed to LIBOR or prime rate. It is the Bank’s standard practice to issue lines of credit due on demand, accruing interest at a variable interest rate indexed to either LIBOR or prime rate.

The Bank originates commercial real estate loans secured predominantly by first liens on apartment complexes, office buildings, lodging facilities and industrial and warehouse properties. The maximum term that the Bank offers for commercial real estate loans is generally not more than 10 years, with a payment schedule based on not more than a 25-year amortization schedule and a maximum loan-to-value of 80%. The current policy with regard to these loans is to minimize the risk by emphasizing diversification of these property types.

Additionally, the Bank offers construction and land development financing secured by the corresponding real estate and other collateral as necessary to meet the underwriting standards. Terms for construction and land development financing vary based on the depth of the project usually requiring a maximum loan-to-value ratio of 65% to 80% and a term typically ranging from 12 to 36

 

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months. The construction/development loan application process includes the same criteria which are required for the permanent commercial mortgage loans, as well as a submission of completed plans, specifications, and cost estimates related to the proposed construction. The Bank uses these items in addition to an independent outside appraisal ordered from our approved appraisal list to determine the value of the subject property. The appraisal is an important component because construction loans involve additional risks related to advancing loan funds upon the security of the project under construction, which is of uncertain value prior to the completion of construction and subsequent pro-forma lease-up. Additional underwriting considerations for these projects include but are not limited to, market analysis, and the borrower’s debt service capacity during the project, environmental evaluations, and pre-sale activity.

Residential Real Estate Lending

The majority of the residential mortgage loans on our balance sheet were acquired through the FCEC Merger or the Graystone Merger. The Bank originates mortgage loans through its Graystone Mortgage Division to enable the Bank’s customers to finance residential real estate, both owner occupied and non-owner occupied, in the primary market areas. The Bank generally offers traditional fixed-rate and adjustable-rate mortgage (“ARM”) products, with monthly payment options, that have maturities up to 30 years, and maximum loan amounts generally up to $750 thousand.

The Bank generally sells newly originated conventional 15 to 30 year fixed-rate loans as well as FHA and VA loans in the secondary market to wholesale lenders. The LTV requirements for residential real estate loans vary depending on the secondary market investor. Loans with LTVs in excess of 80% are required to carry private mortgage insurance. The Bank generally originates loans that meet accepted secondary market underwriting standards.

Home Equity Lending

The Bank offers fixed-rate, fixed-term, monthly home equity loans, and prime-based home equity lines of credit (“HELOCs”) in the Bank’s market areas. The Bank offers both fixed-rate and floating-rate home equity products in amounts up to 85% of the appraised value of the property (including the first mortgage) with a maximum loan amount generally up to $1 million. The Bank offers monthly fixed-rate home equity loans and HELOCs with repayment terms generally up to 15 years. The minimum line of credit is $10 thousand and the maximum generally up to $1 million with exceptions as approved.

Consumer Loans

The Bank offers a variety of fixed-rate installment and variable rate line-of-credit consumer loans, including direct automobile loans as well as personal secured and unsecured loans. Terms of these loans range from 6 months to 72 months and generally do not exceed $50 thousand. Secured loans are collateralized by vehicles, savings accounts, or certificates of deposit.

 

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Loan Portfolio Performance

The table below sets forth, for the periods indicated, information with respect to our non-accrual loans, accruing loans greater than 90 days past due, total non-performing loans, other real estate owned, total non-performing assets, and selected asset quality ratios.

 

		September 30, 2011				December 31, 2010
		(dollars in thousands)
Total loans outstanding, net of unearned income		$	2,093,951			$	2,219,525
Daily average balance of loans			2,093,762				1,289,625
Non-accrual loans		$	22,803			$	17,722
Accruing loans greater than 90 days past due			5,837				1,425
Total non-performing loans			28,640				19,147
Other real estate owned			4,293				4,647
Total non-performing assets		$	32,933			$	23,794
Allowance for loan losses		$	11,925			$	14,053
Credit fair value adjustment on loans purchased			15,726				21,693
Adjusted (Non-GAAP) allowance for loan losses		$	27,651			$	35,746
Non-accrual loans to total loans (1)			1.12	%			0.82	%
Non-performing assets to total assets			1.30	%			0.87	%
Non-performing loans to total loans (1)			1.40	%			0.89	%
Allowance for loan losses to total loans(1)			0.58	%			0.64	%
Adjusted (Non-GAAP) allowance for loans losses to total loans (1)			1.36	%			1.66	%
Allowance for loan losses to non-performing loans			41.64	%			73.40	%
Adjusted (Non-GAAP) allowance for loan losses to non-performing loans			96.55	%			186.69	%

 

(1)	Total loans excludes purchased impaired loans accounted for under ASC 310-30 acquired as part of mergers and acquisitions. The total balance of these loans, net of fair value mark, is $54.7 million as of September 30, 2011, and $61.6 million as of December 31, 2010.

GAAP requires that expected credit losses associated with loans obtained in an acquisition be reflected at fair value as of each respective acquisition date and prohibits the carryover of the acquired entity’s allowance for loan losses. Accordingly, we believe that presentation of the adjusted (Non-GAAP) allowance for loan losses, consisting of the allowance for loan losses plus the credit fair value adjustment on loans purchased in merger transactions, is useful for investors to understand the complete allowance that is recorded as a representation of future expected losses over the Bank’s loan portfolio.

The accounting estimates for loan losses are subject to changing economic conditions. At September 30, 2011, the non-accrual loans totaled $22.8 million compared to $17.7 million at December 31, 2010. Of the $22.8 million of total non-accrual loans at September 30, 2011, $18.5 million or 81.2% related to commercial loans, $452 thousand or 2.0% to consumer loans and $3.8 million or 16.8% to residential mortgage loans.

As of September 30, 2011, total impaired loans were $71.8 million. Included in impaired loans are loans on which we have stopped accruing interest in accordance with the loan accounting policy and impaired loans purchased as a result of mergers and acquisitions. The Bank discontinues the accrual of interest on a loan when the contractual payment of principal or interest has become 90 days past due or we have serious doubts about further collectability of principal or interest, even though the loan is currently performing. The impaired loan balance includes $1.2 million of impaired loans acquired as part of the merger with Graystone Financial Corp., and $48.3 million of impaired loans as part of the FCEC Merger, which were recorded at their individual fair values as determined based on our estimate of future cash flows. In order to reflect these purchased loans at fair value, the carrying value of these loans was reduced at the time of the mergers. The fair value mark for these impaired loans was $30.0 million at September 30, 2011.

 

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For the remaining impaired loans, we performed an evaluation of expected future cash flows, including the anticipated cash flow from the sale of collateral. Based on these evaluations, we have determined that a reserve of $1.4 million is required against the impaired loans at September 30, 2011.

At September 30, 2011, the Bank performed a detailed review of the non-performing loans and of their related collateral and believes the allowance for loan losses remains adequate for the level of risk inherent in the loan portfolio. It is the Bank’s policy that non-performing loans will remain classified as non-performing until such time that the loan becomes current on all principal and interest payments and remains current for a period of six months. Loans where the original terms have been modified are not considered to be performing until the borrower demonstrates their performance under the modified terms for a period of at least six months.

During 2010, the banking industry experienced increasing defaults in mortgage loans coupled with decreasing values of real estate values as a result of an economic downturn. In addition, the prolonged economic downturn present throughout 2010 and continuing into 2011 contributed to delinquencies of $50.0 and $48.9 million as of December 31, 2010 and September 30, 2011, respectively.

Other real estate owned consists of twenty-five properties totaling $4.3 million at September 30, 2011. These properties have been acquired through the foreclosure process and are currently in the process of being sold. These properties are recorded at their lower of cost or fair value less costs to sell.

Securities Available for Sale

The following table presents the amortized cost and fair value of investment securities for September 30, 2011 and December 31, 2010.

 

		September 30, 2011								December 31, 2010
		(dollars in thousands)
		Amortized Cost				Fair Value				Amortized Cost				Fair Value
Equity securities		$	132			$	132			$	195			$	195
U.S Treasury securities			—				—				5,000				5,002
U.S Government sponsored agency securities			252				255				7,771				7,780
U.S. Government sponsored agency mortgage-backed securities			49,113				50,089				10,787				10,754
U.S. Government sponsored agency collateralized mortgage obligations			72,261				73,794				48,018				48,587
Municipal bonds			17,889				18,847				10,641				10,654
Municipal bonds - taxable			10,280				10,802				10,341				10,014
SBA pool loan investments			—				—				9,557				9,709
Total securities available for sale		$	149,927			$	153,919			$	102,310			$	102,695

At September 30, 2011, total available for sale securities were $153.9 million, an increase of $51.2 million from total available for sale securities of $102.7 million at December 31, 2010. Upon completion of the FCEC Merger during the fourth quarter 2010, we sold a majority of securities from the acquired the First Chester investment portfolio to realign the holdings with our overall investment strategy and investment policies. Funds from the sale of the securities acquired from the First Chester investment portfolio as well as funds held in cash and other short-term investments were used to purchase the investments.

During the first nine months of 2011, we identified three equity securities with unrealized losses that were deemed to be other than temporary in nature resulting in a $63 thousand impairment charge.

Bank-owned Life Insurance

At September 30, 2011, the total cash surrender value of the bank-owned life insurance (“BOLI”) was $40.9 million. The BOLI was purchased as a means to offset a portion of current and future employee benefit costs. The Bank's deposits and proceeds from the sale of investment securities were used to fund the BOLI. Earnings from the BOLI are recognized as other income and are treated as tax-free earnings. The BOLI is profitable from the appreciation of the cash surrender value of the pool of insurance, and its tax advantage.

 

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Deposits

Total deposits at September 30, 2011 were $2.154 billion, a decrease of $146.1 million from total deposits of $2.300 billion at December 31, 2010.

The table below presents the increases in deposits by type at September 30, 2011 as compared to December 31, 2010.

 

		September 30, 2011								December 31, 2010								Increase/(Decrease)
		(dollars in thousands)
		Amount				%				Amount				%				Amount				%
Non-interest bearing transaction accounts		$	292,619				13.6	%		$	301,210				13.1	%		$	(8,591	)			(2.9	)%
Interest checking accounts			346,758				16.1	%			305,701				13.3	%			41,057				13.4	%
Money market accounts			501,651				23.3	%			651,760				28.3	%			(150,109	)			(23.0	)%
Savings accounts			152,889				7.1	%			160,305				7.0	%			(7,416	)			(4.6	)%
Time deposits, other			859,855				39.9	%			880,922				38.3	%			(21,067	)			(2.4	)%
Total deposits		$	2,153,772				100.0	%		$	2,299,898				100.0	%		$	(146,126	)			(6.4	)%

The Bank continues to manage the size, mix, and cost of the deposit portfolio with the goal of lowering current deposit costs and positioning the cost of the portfolio in the future. In-market non-maturity deposits have decreased by $130.0 million between December 31, 2010 and September 30, 2011. In-market time deposits decreased $24.0 million between December 31, 2010 and September 30, 2011. The decrease in money market and time deposits were the result of management’s focus on lowering the cost of deposits through decreases in money market interest rates and allowing higher cost short term time deposits to mature without renewal as we remained focused on our strategy of growing low-cost in-market deposits. We realized a decrease of 10 basis points in the weighted average rate of in-market deposits between December 31, 2010 and September 30, 2011.

The Bank uses various brokered deposit products as tools to manage deposit costs, interest rate risk, and the mix of deposits. The non-maturity deposit accounts include $73.9 million and $69.0 million of brokered deposits at September 30, 2011 and December 31, 2010, respectively. The brokered money market products are indexed to the one-month LIBOR and provide an effective funding source for LIBOR-indexed lending. The time deposits include $149.2 million and $183.1 million of brokered and quick rate time deposits at September 30, 2011 and December 31, 2010, respectively. The total brokered time deposits include reciprocal brokered time deposits of $35.5 million and $49.9 million at September 30, 2011 and December 31, 2010, respectively. Reciprocal brokered time deposits are deposits that have been placed into a deposit placement service which allows us to place our customers’ funds in FDIC-insured time deposits at other banks and at the same time, receive an equal sum of funds from customers of other banks within the deposit placement service. Overall, total brokered deposits decreased to $187.8 million or approximately 8.7% of the total deposits at September 30, 2011 as compared to $194.4 million or 8.5% of total deposits at December 31, 2010. Total brokered deposits, exclusive of reciprocal deposits, represented 7.1% and 6.3% of total deposits at September 30, 2011 and December 31, 2010, respectively.

Money market deposits at September 30, 2011 decreased by $150.1 million or 23.0% from December 31, 2010 as a result of a decrease in in-market deposits of $155.0 million, and an increase in brokered money market deposits of $4.9 million. Time deposit balances at September 30, 2011 decreased by $21.1 million or 2.4% from December 31, 2010. This decrease reflected a decrease of $19.5 million of out-of-market brokered and quick rate time deposits, and a decrease of $1.6 million of in-market time deposits in the Bank’s portfolio. We realized a decrease of 66 basis points in the weighted average rate of time deposits between December 31, 2010 and September 30, 2011. Time deposits represent 39.9% of total deposits at September 30, 2011 compared to 38.3% of total deposits at December 31, 2010.

The average balances and weighted average rates paid on deposits for the first nine months of 2011 and 2010 are presented in the table below:

 

		September 30, 2011								September 30, 2010								Increase/(Decrease) in average balance
		Average Balance				Average Rate				Average Balance				Average Rate				$				%
Non-interest bearing transaction accounts		$	310,712				N/A			$	114,534				N/A			$	196,178				171.3	%
Interest checking accounts			316,768				0.54	%			114,829				0.43	%			201,939				175.9	%
Money market accounts			567,580				0.61	%			551,394				1.40	%			16,186				2.9	%
Savings accounts			160,762				0.40	%			82,794				0.52	%			77,968				94.2	%
Time deposits, other			852,020				1.56	%			425,697				2.25	%			426,323				100.1	%
Total		$	2,207,842				0.86	%		$	1,289,248				1.42	%		$	918,594				71.3	%

 

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As reflected above, we have decreased the average rate on our total deposits by 56 basis points between the first nine months of 2011 and the first nine months of 2010. We have been able to grow our deposits from an average of $1.289 billion to $2.208 billion between the nine months ended September 30, 2010 and the nine months ended September 30, 2011 primarily as a result of acquisition-related growth.

Short-Term Borrowings and Long-Term Debt

Short-term borrowings decreased by $55.0 million to $56 thousand at September 30, 2011 from $55.0 million at December 31, 2010. The decrease in short-term borrowings was due to the maturity of FHLB advances of $55.0 million during the first nine months of 2011. At December 31, 2010 and September 30, 2011, short-term borrowings consisted of advances from the Federal Home Loan Bank of Pittsburgh and current obligations under capital leases. Advances from the Federal Home Loan Bank of Pittsburgh totaled $0 and $55.0 million as of September 30, 2011 and December 31, 2010, respectively. The current obligation under capital leases was $56 thousand and $39 thousand as of September 30, 2011 and December 31, 2010, respectively.

At September 30, 2011, long-term debt of $87.9 million consisted of $48.7 million in advances from the FHLB that had a maturity of greater than one year, $21.0 million of subordinated debt, $15.6 million of junior subordinated debentures held in trusts and $2.6 million in obligations under capital leases. The total average rate incurred on borrowings and securities sold under agreement to repurchase during the first nine months of 2011 was 5.10% compared to an average rate of 4.66% during the first nine months of 2010.

Stockholders’ Equity and Capital Adequacy

Total stockholders’ equity for December 31, 2010 and September 30, 2011 was $256.6 million and $261.6 million, respectively. Total stockholders’ equity for the year to date includes increases from net income of $9.9 million, unrealized gains on securities available for sale of $2.3 million and equity proceeds received from the Dividend Reinvestment and Employee Stock Purchase Plans of $1.0 million offset by dividends declared of $8.4 million.

We are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on the consolidated financial statements. The regulations require that banks maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined), and Tier I capital to average assets (as defined). As of September 30, 2011, we met the minimum requirements. In addition, our capital ratios exceeded the amounts required to be considered “well capitalized” as defined in the regulations.

On June 12, 2009, we issued, to private investors, $9.0 million of subordinated notes bearing an annual interest rate of 9.00% maturing on June 30, 2014. On February 5, 2010, we issued an additional $12.0 million in subordinated notes bearing annual interest of 9.00% maturing on June 30, 2015. Each note may be redeemed at our discretion and contains a maturity date of July 1, 2014. We contributed the net proceeds of $17.0 million from the sale of the notes to the Bank, as Tier 1 capital to support the Bank’s continued growth, including ongoing lending activities in its local markets. The Notes are intended to qualify as Tier 2 capital for regulatory purposes, to the extent permitted. In accordance with applicable regulatory treatment one-fifth of the original principal amount of the Notes will be excluded each year from Tier 2 capital during the last five years prior to maturity.

The following table summarizes Graystone Tower Bank and Tower Bancorp, Inc.’s regulatory capital ratios in comparison to regulatory requirements:

 

		September 30, 2011				December 31, 2010				Minimum Capital Adequacy
Graystone Tower Bank
Total Capital (to Risk Weighted Assets)			13.10	%			11.79	%			8.00	%
Tier I Capital (to Risk Weighted Assets)			12.48	%			11.10	%			4.00	%
Tier I Capital (to Average Total Assets)			10.09	%			12.57	%			4.00	%
		September 30, 2011				December 31, 2010				Minimum Capital Adequacy
Tower Bancorp, Inc.
Total Capital (to Risk Weighted Assets)			13.39	%			13.24	%			8.00	%
Tier I Capital (to Risk Weighted Assets)			12.24	%			11.83	%			4.00	%
Tier I Capital (to Average Total Assets)			9.92	%			13.45	%			4.00	%

As shown in the table the September 30, 2011 ratio of the Tier I Capital (to Average Total Assets) decreases from December 31, 2010 by 244 basis points and 349 basis points for the Bank and the Company, respectively. This decrease is the result of realizing the full benefit of the First Chester acquisition from an equity perspective while the average assets only contributed 20 days to the ratio for the quarter.

Dividends paid are generally provided from dividends paid to us from the Bank. The Federal Reserve Board, which regulates bank holding companies, establishes guidelines which indicate that cash dividends should be covered by current year earnings and the debt

 

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to equity ratio of the holding company must be below thirty percent. Additionally, we are required to consult with the Federal Reserve Board before declaring dividends and are directed to strongly consider eliminating, deferring, or reducing dividends we pay to our shareholders if (1) our net income available to shareholders for the past four quarters net of dividends previously paid during that period, is not sufficient to fully fund the dividends, (2) our prospective rate of earnings retention is not consistent with our capital needs and overall current and prospective financial condition, or (3) we will not meet, or are in danger of not meeting, our minimum regulatory capital adequacy ratios. The Bank is subject to certain restrictions on the amount of dividends that it may declare due to regulatory considerations. The Pennsylvania Banking Code provides that cash dividends may be declared and paid only out of accumulated net earnings. As a result of the merger and acquisition, $24.4 million of accumulated earnings related to the pre-merger retained earnings of First National Bank of Greencastle and $37.9 million of accumulated earnings related to the pre-merger retained earnings of First National Bank of Chester County, were transferred and reclassified into additional paid-in capital of the Bank. Based on approval received from the Pennsylvania Department of Banking, these amounts have been included in amounts available for distribution as dividends. We declared the payment of dividends in January 2011 and in April 2011 of $0.28 per share outstanding and in July 2011 and October 2011 of $0.14 per share outstanding, in each case in excess of earnings for the preceding four quarters. We believed that the declaration and payment of such dividends did not jeopardize our ability to operate in a safe and sound manner. The Federal Reserve Bank of Philadelphia issued no objection letters regarding the quarterly payment of the dividends during 2011. The Board of Directors concluded that the current level of dividend payments was appropriate following careful consideration of management’s analysis of current and future earnings, coupled with the current economic conditions and regulatory environment facing the banking industry. We can give no assurance whether we will request or receive no objection from the Federal Reserve to declare and pay dividends in the future with respect to which the above described conditions are not met.

During the second quarter of 2009, the Board of Directors approved a Dividend Reinvestment and Stock Purchase Plan (“Plan”) to provide the shareholders with the opportunity to use cash dividends, as well as optional cash payments of up to $50 per quarter, to purchase additional shares of our common stock. Pursuant to the Susquehanna Merger Agreement, the Company suspended the Plan effective June 21, 2011. During the first nine months of 2011, approximately $503 thousand in capital has been raised under the Plan. Since the Plan’s inception, the Plan has raised approximately $1.6 million.

Also during the second quarter of 2009, the Board of Directors and shareholders approved an Employee Stock Purchase Plan (“Employee Plan”) to provide the our employees with the opportunity to purchase shares of our common stock directly. As a result of the Susquehanna Merger Agreement, the Company suspended the Employee Plan effective July 1, 2011. During the first nine months of 2011, approximately $84 thousand in capital has been raised under the Employee Plan. Since the Employee Plan’s inception, the Employee Plan has raised approximately $291 thousand.

 

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Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk principally includes liquidity risk, interest rate risk, and market price risk which are discussed below.

Liquidity Risk

We manage our liquidity position on a daily basis as part of the daily settlement function and continuously as part of the formal asset liability management process. Our liquidity is maintained by managing several variables including, but not limited to:

 

•

Pricing and dollar amount of core deposit products;

 

•

Pricing and dollar amount of in-market time deposits;

 

•

Growth rate of the loan portfolio (including the sale of loans on a participation basis);

 

•

Purchase and sale of federal funds;

 

•

Purchase and sale of investment securities;

 

•

Use of wholesale funding such as brokered deposits; and

 

•

Use of borrowing capacity at the FHLB.

We maintain a detailed liquidity contingency plan designed to respond to an overall decline in the condition of the banking industry or a challenge specific to our company. On a quarterly basis, the Enterprise Risk Committee (“ERC”) of the board of directors reviews a comprehensive liquidity analysis along with any changes to the liquidity contingency plan.

As of September 30, 2011, we had a maximum borrowing capacity at the Federal Home Loan Bank of Pittsburgh (“FHLB”) of approximately $888.2 million, of which, approximately $49.1 million, exclusive of fair value adjustments, was used in the form of borrowings. Accordingly, we had unused borrowing capacity of $839.1 million at the FHLB. Based on the FHLB capital stock owned by the Bank as of September 30, 2011, we can access approximately $115.0 million of funding without the need to purchase additional FHLB stock. As of September 30, 2011, we had unsecured federal fund lines availability at five correspondent banks totaling $55.5 million. There were no funds drawn upon these facilities as of September 30, 2011.

We participate in obtaining wholesale funding sources in addition to core demand deposits. As of September 30, 2011, we had Certificate of Deposit Account Registry Service (“CDARS”) reciprocal deposits as an alternative source of funds in the amount of $35.5 million. We participate in a brokerage sweep program that provides for the deposit of funds with the benefit of insurance from the FDIC. The balance of this funding as of September 30, 2011 was approximately $73.9 million. We also issue brokered time deposits. As of September 30, 2011, the dollar amount of brokered time deposits, other than CDARS, was $78.4 million. Brokered deposits, exclusive of CDARS reciprocal deposits accounted for approximately 7.1% and 6.3% of total deposits as of September 30, 2011 and December 31, 2010, respectively. Time deposits comprise approximately $859.9 million or 39.9% of our deposit liabilities at September 30, 2011.

At September 30, 2011, liquid assets (defined as cash and cash equivalents, loans held for sale, and securities available for sale exclusive of securities pledged as collateral or used in connection with customer repurchase agreements) totaled approximately $233.8 million or 10.8% of total deposits. This compares to $411.6 million, or 17.9%, of total deposits, at December 31, 2010. The decrease in liquid assets between December 31, 2010 and September 30, 2011 reflected a repositioning of the balance that included a reduction in loans held for sale and the reduction of cash balances to improve the net interest margin.

It is our opinion that our liquidity position at September 30, 2011, is adequate to respond to fluctuations “on” and “off” balance sheet. In addition, we know of no trends, demands, commitments, events or uncertainties that may result in, or that are reasonably likely to result in our inability to meet anticipated or unexpected liquidity needs.

Interest Rate Risk

We actively manage our interest rate sensitivity position. Interest rate sensitivity is the matching or mismatching of the repricing and rate structure of the interest-bearing assets and liabilities. Our primary objectives of interest rate risk management are to neutralize adverse impacts to net interest income arising from interest rate movements and to attain sustainable growth in net interest income. The Management Asset Liability Committee (“MALCO”) is primarily responsible for developing and implementing asset liability management strategies in accordance with the Asset and Liability Management Policy and Procedures (the “ALM Policy”) approved by the board of directors. The MALCO generally meets on a monthly basis and is comprised of members of our senior management team. The ERC of the board of directors meets on a quarterly basis to review the guidelines established by MALCO and the results of our interest rate risk analysis.

We manage interest rate sensitivity by changing the volume, mix, pricing and repricing characteristics of our assets and liabilities. We have not entered into separate derivative contracts such as interest rate swaps, caps, and floors.

 

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The interest rate characteristics and interest repricing characteristics of the loan portfolio at September 30, 2011 are set forth in the tables below. Adjustable-rate loans represent loans that are currently in a fixed-rate, but are subject to repricing to either a fixed or variable rate at the related next repricing date.

 

Interest Rate Characteristics		Percentage of Portfolio
Fixed-rate loans			24.3	%
Adjustable-rate loans			41.0	%
Variable-rate loans			34.7	%
Total			100.0	%

 

Repricing Structure		Percentage of Portfolio
One month or less			35.6	%
Two to six months			6.7	%
Six to twelve months			5.9	%
One to two years			11.4	%
Two to three years			9.1	%
Three to five years			18.0	%
Greater than five years			13.3	%
Total			100.0	%

As of September 30, 2011, the loan portfolio contained $734.1 million of loans in the variable-rate interest mode. Of these loans, 74.4% had interest rate floors. The majority of these loans are indexed to prime, 1-Month LIBOR, and 3-Month LIBOR (i.e. the index plus a spread). While the interest rate floors provide us with interest rate protection given that the prime rate and LIBOR rates, plus the applicable spread, are substantially below these floors, these loans will not generate incremental income in an upward rising environment until the floors have been pierced. The compression on net interest margin related to these relationships will be influenced by a number of variables including, but not limited to, the volatility of the respective indices, the speed at which rates rise, and the interest rate sensitivity of deposit costs. To date, we have elected to manage this risk without the use of derivative contracts.

As of September 30, 2011, the residential mortgage loan portfolio, exclusive of the loans held for sale, contained $247.7 million of mortgages of which $98.4 million will reprice over the next twelve months. The residential mortgage loan portfolio, exclusive of the loans held for sale that will reprice over the next twelve months have a current weighted average interest rate of approximately 4.75%. A majority of these mortgage loans are indexed to the one-year Treasury rate (i.e. the index plus a spread). In the current rate environment, these loans will reprice to new rates that are below the current contractual rates thereby putting pressure on net interest margin. In the event that the one-year Treasury rate rises, the loss of interest income from repricing will be lessened. We have been actively encouraging customers to refinance these loans into fixed-rate loans through our mortgage division as a means of locking in historically low interest rates. Furthermore, we expect that newly originated mortgage loan volume will principally be underwritten and sold into the secondary market through the Graystone Mortgage Division. To date, we have elected to manage this risk without the use of derivative contracts.

As of September 30, 2011, we reported deposit liabilities of approximately $2.2 billion and securities sold under agreements to repurchase of approximately $10.6 million. Comparatively, we reported deposit liabilities of approximately $2.3 billion and securities sold under repurchase agreements of approximately $6.6 million at December 31, 2010.

The maturity structure of the time deposit portfolio as of September 30, 2011 is summarized below.

 

Certificates of Deposits Maturity Structure		Dollars (millions)				Percentage
One month or less		$	26.6				3.1	%
Over one month through one year			471.1				54.8	%
Over one year through two years			92.9				10.8	%
Over two years			269.3				31.3	%
Total		$	859.9				100.0	%

As noted above, approximately $497.7 million of time deposits with a weighted average rate of 1.62% will mature over the next year. Given existing market conditions, we expect to retain a significant portion of the maturing time deposit portfolio in the form of new time deposits or non-maturity deposit accounts at interest rates that are generally comparable or lower than the current rates of the time deposits maturing over the next year, except for that portion of the time deposit portfolio that we target for longer maturities. We are actively seeking to extend the weighted average life of the time deposit portfolio, which may result in renewing a portion of the time deposit portfolio at rates that are higher than the rates of time deposits maturing over the next year.

 

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We use several tools to assess and measure interest rate risk including interest rate simulation analysis that is prepared on a quarterly basis. Each analysis is largely dependent on many assumptions and variables with past behaviors that may not prove to be effective predictors of future outcomes. These assumptions are reviewed on at least a quarterly basis.

Gap Analysis

We use gap analysis to compare the relationship of assets that are expected to reprice during a specific time frame (“Rate Sensitive Assets” or “RSA”) as compared to liabilities that are scheduled to reprice during an identical time period (“Rate Sensitive Liabilities” or “RSL”). When the ratio is greater than one, RSA exceed RSL and potentially exposes the Bank to a risk of a decline in interest rates by virtue of a larger amount of assets repricing at lower interest rates than rate sensitive liabilities. The converse would be true of a RSA/RSL ratio less than 1.0. While gap analysis can be useful in evaluating the relationship of RSA to RSL, it does not capture other critical interest rate risk variables such as the extent of change that will take place when a RSA or RSL reprices, prepayment considerations, and other factors. Under the ALM Policy, the interest rate simulation report measures the ratio of RSA to RSL at a one-year time frame. The ALM Policy has established an acceptable relationship of RSA to RSL to a range of 80% to 120%.

We use the following methodology in computing repricing gap. This methodology is noteworthy given the current interest rate environment. First, we classify variable-rate loans with current interest rates below loan floors as Rate Sensitive Assets. As of September 30, 2011, we have $546.3 million of loans that are currently in the variable rate mode with interest rates indexed to the prime rate, the one-month LIBOR, and the three-month LIBOR that are subject to contractual floors. The majority of these loans have current interest rates determined by the contractual floors. To the extent that these loans will not reprice until the floor has been pierced, these loans are technically not rate sensitive. However, for purposes of computing repricing gap, we have treated these loans as rate-sensitive to capture their behavior in more traditional interest rate environments. Second, we have classified all interest-bearing non-maturity deposits as repricing immediately. We believe that this methodology is more conservative in comparison to other methodologies that assume non-maturity deposits reprice across time. Lastly, we have classified the balance of cash on deposit at the Federal Reserve Bank as an asset that will reprice within “1 to 3 months” time period. We have used this treatment to reflect the daily, repricing of the Federal Funds effective rate and the deployment of such funds into investments and loans. We recognize that this methodology has the potential to highlight the inherent weaknesses of repricing gap analysis. For this reason, we emphasize the metrics of net interest income at risk and economic value of equity at risk when evaluating interest rate risk.

At September 30, 2011, our balance sheet was liability sensitive with a cumulative gap ratio at one year of approximately 90.3%. The gap ratio is within our policy guidelines. In large part, the liability sensitive position of the balance sheet is due to the transaction, savings and money market account balances in the deposit portfolio that are classified as repricing immediately as described above. The mix of the deposit portfolio is an intentional strategy designed to strengthen on-balance sheet liquidity, acquire lower cost in-market deposits, and address consumer demand for FDIC-insured liquid deposits. We believe the interest rate sensitivity of our non-maturity deposit portfolio is less than that of the prime rate. Accordingly, the lower level of interest rate sensitivity will partially mitigate the general effects of liability sensitivity. As of September 30, 2011, 87.3% of liability funding was originated within markets we serve.

 

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The table below summarizes the repricing gap as of September 30, 2011.

 

		Repricing Gap Report as of September 30, 2011
		(dollars in thousands)
		1 to 3 Months				3 to 6 Months				6 to 12 Months				12 to 24 Months				24 to 36 Months				36 to 60 Months				Greater than 60 months / non-rate sensitive				Total
Assets
Cash, due from banks, and federal funds sold		$	99,431			$	—			$	—			$	—			$	—			$	—			$	31,534			$	130,965
Securities (1)			7,283				6,696				12,523				19,863				16,509				27,414				76,260				166,548
Loans			916,134				123,929				215,572				323,482				223,622				220,886				58,401				2,082,026
Other Assets			—				—				—				—				—				—				159,785				159,324
Total assets		$	1,022,848			$	130,625			$	228,095			$	343,345			$	240,131			$	248,300			$	325,980			$	2,539,324
Liabilities
Non-interest bearing deposits		$	—			$	—			$	—			$	—			$	—			$	—			$	292,619			$	292,619
Interest-bearing transaction and savings deposits			1,001,298																								—				1,001,298
Time deposits			118,051				139,750				259,760				97,917				60,550				174,567				9,260				859,855
Total deposits			1,119,349				139,750				259,760				97,917				60,550				174,567				301,879				2,153,772
Borrowings, including repurchase agreements			10,611				—				—				5,000				9,000				12,000				61,887				98,498
Other liabilities			—				—				—				—				—				—				25,430				25,430
Total liabilities		$	1,129,960			$	139,750			$	259,760			$	102,917			$	69,550			$	186,567			$	389,196			$	2,277,700
			—				—				—				—				—				—				—				—
Equity			—				—				—				—				—				—				261,624				261,624
Total liabilities and equity		$	1,129,960			$	139,750			$	259,760			$	102,917			$	69,550			$	186,567			$	650,820			$	2,539,324
Period repricing gap			(107,112	)			(9,125	)			(31,665	)			240,428				170,581				61,733				(324,840	)
Cumulative repricing gap			(107,112	)			(116,237	)			(147,902	)			92,526				263,107				324,840				0
Period repricing gap percentage			90.5	%			93.5	%			87.8	%			333.6	%			345.3	%			133.1	%			50.1	%
Cumulative repricing gap percentage			90.5	%			90.8	%			90.3	%			105.7	%			115.5	%			117.2	%			100.0	%

 

(1)	Includes equity investments available for sale and restricted investments

 

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Net Interest Income at Risk

We assess the percentage change in net interest income assuming interest rate shocks (upward and downward) of 100, 200, and 300 basis points. Given the current rate environment, we limited the downward shock to 100 basis points, but included an upward shock of 400 basis points. This analysis captures the timing of the repricing of RSA and RSL as well as the degree of change (“beta”) in the interest rates of particular asset and liability products that occurs as interest rates move upward or downward. Under the ALM Policy, the interest rate simulation report measures the percentage change in net interest income for one year assuming interest rate shocks of 100, 200, and 300 basis points. The ALM Policy has established an acceptable negative percentage change in net interest income under 100, 200, and 300 basis point shocks of 20%.

The table below summarizes the Net Interest Income at Risk modeling results as of September 30, 2011.

 

		Actual				Policy
Net Interest Income: Up 100 Bps (%)			1.74	%			20.0	%
Net Interest Income: Up 200 Bps (%)			5.73	%			20.0	%
Net Interest Income: Up 300 Bps (%)			9.72	%			20.0	%
Net Interest Income: Up 400 Bps (%)			13.55	%			N/A
Net Interest Income: Down 100 Bps (%)			(2.17	)%			20.0	%

Economic Value of Equity at Risk

We assess the present value of cash inflows of cash, investments, loans, bank-owned life insurance policies, when applicable, netted against the present value of cash outflows from deposits, repurchase agreements, borrowings, and other interest-bearing liabilities, all discounted to a measurement date. This measure is expressed as the percentage change in the present value of such cash flows when interest rates are shocked (upward and downward) at 100, 200, and 300 basis points. Under the ALM Policy, the interest rate simulation reports measures the percentage change in economic value of equity at risk assuming interest rate shocks of 100, 200, and 300 basis points. Given the current rate environment, we limited the downward shock to 100 basis points, but included an upward shock of 400 basis points. The ALM Policy has established an acceptable negative percentage change in economic value of equity at risk under 100, 200, and 300 basis point shocks of 20%.

The table below summarizes the Economic Value of Equity at Risk as of September 30, 2011.

 

		Actual				Policy
Economic Value of Equity: Up 100 Bps (%)			(3.07	)%			20.0	%
Economic Value of Equity: Up 200 Bps (%)			(5.00	)%			20.0	%
Economic Value of Equity: Up 300 Bps (%)			(7.53	)%			20.0	%
Economic Value of Equity: Up 400 Bps (%)			(9.26	)%			N/A
Economic Value of Equity: Down 100 Bps (%)			10.14	%			20.0	%

Market Price Risk

As of September 30, 2011, our investment portfolio had a market value of approximately $166.5 million. The investment portfolio is comprised of two separate components each of which is managed pursuant to a board approved investment policy. At the holding company level, we have a portfolio of equity securities of financial institutions (the “Equity Portfolio”) with a market value of approximately $132 thousand. At the bank level, the Bank has a portfolio with a market value of approximately $153.8 million comprised of debt securities summarized below and certain restricted investments related to business relationships with the Federal Home Loan Bank of Pittsburgh and a correspondent bank. As of December 31, 2010, we had an investment portfolio with a market value of approximately $117.4 million of which $117.2 million was held at the bank level and $195 thousand was held at the holding company level.

The investment portfolio held by the Bank increased $36.6 million during the nine months ended September 30, 2011 compared to December 31, 2010. The increase is the direct result of completing the investment portfolio restructuring following the FCEC merger. The investment portfolio consists mostly of agency CMO’s, agency mortgage backed securities, agency securities, and highly rated general obligation municipal bonds. The weighted average life of the bank investment portfolio is 3.50 years. The weighted average life of the bank investment portfolio has decreased 0.06 years between December 31, 2010 and September 30, 2011. We believe that the off balance sheet liquidity sources of the bank and the ability to raise in-market deposits at reasonable prices adequately mitigates the cash flow variability of the investment portfolio.

 

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The securities available for sale in the bank portfolio at September 30, 2011 consisted of U.S. Government agency securities, U.S. Government agency mortgage-backed securities; U.S. Government Agency collateralized mortgage obligations, and municipal bonds. The Government National Mortgage Association collateralized mortgage obligations are secured by the full, faith, credit and taxing power of the United States of America and carry a zero risk weighting for regulatory capital purposes.

The table below summarizes the maturity structure of the portfolio as of September 30, 2011.

 

		Within 1 year								After 1 year but within 5 years								After 5 years but within 10 years								After 10 years								Total
		(dollars in thousands)
		Fair Value				W/A yield				Fair Value				W/A yield				Fair Value				W/A yield				Fair Value				W/A yield				Fair Value				W/A yield
U.S Government sponsored agency securities			—				—				255				1.02	%			—				—				—				—				255				1.02	%
Municipal bonds (1)			1,454				3.00	%			3,436				3.79	%			8,262				4.07	%			16,497				3.95	%			29,649				3.92	%
Asset-backed securities (2)			—				—								—				—				—				—				—				123,883				2.69	%
Other securities (3)			—				—				—				—				—				—				—				—				12,629				—
Graystone Tower Bank Portfolio		$	1,454							$	3,691							$	8,262							$	16,497							$	166,416				2.70	%
Investment portfolio of equity securities held at the holding company																																			132
Total investment securities																																		$	166,548

 

(1)	Municipal securities include both non-taxable and taxable municipal bonds.

(2)	Asset-backed securities include U.S. Government sponsored agency mortgage-backed securities and U.S. Government sponsored agency collateralized mortgage obligations.

(3)	Equity investments in business relationship banks such as the Federal Home Loan Bank and correspondent banks.

 

Item 4.

Controls and Procedures.

We maintain a system of controls and procedures designed to ensure that information required to be disclosed by us in reports that we file with the Securities and Exchange Commission (the “Commission”) is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2011. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting management to information required to be included in our periodic Securities and Exchange Commission filings.

There were no changes in our internal control over financial reporting during the nine months ended September 30, 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

Item 1.

Legal Proceedings.

The nature of our business generates a certain amount of legal proceedings involving matters arising in the ordinary course of business. Based on current knowledge, advice of counsel, available insurance coverage and established reserves, management does not anticipate, at the present time, that the aggregate liability, if any, arising out of such legal proceedings will have a material adverse effect on our consolidated financial position or liquidity. However, given the inherent uncertainties involved in these matters, some of which are beyond our control, and the amount or indeterminate damages sought in some of these matters, there can be no assurance that an adverse outcome in one or more of these matters would not be material to our results of operations or cash flows for any particular future reporting period.

On July 1, 2011, Stephan Bushansky, a purported shareholder of the Company, filed a purported shareholder derivative action in the Court of Common Pleas of Dauphin County, Pennsylvania captioned Bushansky v. Tower Bancorp, Inc., et al. , No. 2011 CV 6519EQ (the “Dauphin County Lawsuit”). The lawsuit names as defendants the Company, each of the current members of the Company’s Board of Directors (the “Director Defendants”) and Susquehanna. The complaint alleges that the Director Defendants breached their fiduciary duties by failing to maximize stockholder value in connection with the proposed merger with Susquehanna and also alleges that the Company and Susquehanna aided and abetted those alleged breaches of fiduciary duty. The complaint seeks injunctive relief to prevent the consummation of the Company’s pending merger with Susquehanna or, in the event the merger is consummated, damages resulting from the defendants’ alleged wrongful conduct.

On September 26, 2011, Edgar L. Johnson, Jr., another purported shareholder of the Company, filed a separate purported shareholder derivative action in the United States District Court for the Middle District of Pennsylvania captioned Johnson v. Tower Bancorp, Inc., et al. , No. 1:11-CV-01777-WWC (the “Federal Lawsuit” and, together with the Dauphin County Lawsuit, the “Lawsuits”). The Federal Lawsuit names as defendants the Company and each of the current members of the Company’s Board of Directors and alleges, among other things, that the Company directors breached their fiduciary duties in connection with its approval of the merger agreement with Susquehanna in that the consideration offered to the Company’s shareholders was alleged to be inadequate and the process used to negotiate the merger agreement was alleged to be unfair, and that such breaches of fiduciary duty were exacerbated by preclusive transaction protection devices. The complaint seeks, among other things, an unspecified amount of monetary damages and injunctive relief.

The Federal Lawsuit also alleges that the disclosure contained in the preliminary joint proxy statement/prospectus, dated August 17, 2011 (the “Joint Proxy Statement/Prospectus”) and included in the registration statement on Form S-4 filed by Susquehanna with the Securities and Exchange Commission (the “SEC”) (File No. 333-176367) (the “Registration Statement”), failed to provide required material information necessary for the Company’s shareholders to make a fully informed decision concerning the Susquehanna Merger Agreement and the transactions contemplated thereby.

Also in connection with the proposed merger with Susquehanna, the Company has received three letters from attorneys representing three separate purported shareholders, including Messrs. Bushansky and Johnson (the three purported shareholders being collectively referred to in the remainder of this discussion as the “Plaintiffs”), demanding that the Board remedy alleged breaches of fiduciary duties in connection with the merger (the “Demand Letters”). The Demand Letters assert that the Company’s directors breached their fiduciary duties by causing the Company to enter into the Susquehanna Merger Agreement. Among other things, the Demand Letters allege that the merger is unfair to the Company’s shareholders. The Demand Letters request that the Company’s board terminate the Susquehanna Merger Agreement or take action to, among other things, ensure that the consideration paid to the Company’s shareholders is fair and to recover alleged damages on behalf of the Company.

On September 28, 2011, solely to avoid the costs, risks and uncertainties inherent in litigation, the Company and the other named defendants entered into a Memorandum of Understanding with the Plaintiffs. Under the terms of the memorandum, the Company, the other named defendants and the Plaintiffs have agreed to settle the Lawsuits and demands subject to court approval. Pursuant to the terms of the memorandum, the Company agreed to make available additional information to its shareholders. The additional information is contained in the definitive Joint Proxy Statement/Prospectus included in an amendment to the Registration Statement filed by Susquehanna with the SEC. In return, the Plaintiffs have agreed to the dismissal of the Lawsuits and to withdraw all motions filed in connection with such lawsuit, and to withdraw any previous demands, subject to confirmatory discovery being conducted by Plaintiffs. If the court approves the settlement contemplated in the memorandum, the Lawsuits will be dismissed with prejudice. If the settlement is finally approved by the court, it is anticipated that it will resolve and release all claims in all actions that were or could have been brought challenging any aspect of the proposed merger, the Susquehanna Merger Agreement, and any disclosure made in connection therewith. In connection with the settlement, Plaintiffs intend to seek an award of attorneys’ fees and expenses not to exceed $332,500, subject to court approval, and the Company has agreed not to oppose Plaintiffs’ application. The amount of the fee award to class counsel will ultimately be determined by the court. This payment will not affect the amount of merger consideration to be paid in the merger. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the court will approve the settlement even if the parties were to enter into such stipulation. In such event, the proposed settlement as contemplated by the Memorandum of Understanding may be terminated.

The Company and the other named defendants have vigorously denied, and continue to vigorously deny, that they have committed or aided and abetted in the commission of any violation of law or engaged in any of the wrongful acts that were alleged in the Lawsuits and Demand Letters, and expressly maintain that, to the extent applicable, they diligently and scrupulously complied with their fiduciary and other legal burdens and are entering into the contemplated settlement solely to eliminate the burden and expense of further litigation and to put the claims that were or could have been asserted to rest. Nothing in this Quarterly Report on Form 10-Q, the Memorandum of Understanding or any stipulation of settlement shall be deemed an admission of the legal necessity or materiality under applicable laws of any of the additional information contained in the definitive Joint Proxy Statement/Prospectus filed by Susquehanna with the SEC and mailed to Company and Susquehanna shareholders.

 

Item 1A.

Risk Factors.

There have been no material changes from the risk factors as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, except for the following risk factors which have been amended or added since December 31, 2010.

We will be subject to business uncertainties and contractual restrictions while the merger with Susquehanna Bancshares, Inc. is pending.

Uncertainties about the effect of our pending merger with Susquehanna Bancshares, Inc. (“Susquehanna”) on our business may have an adverse effect on us. These uncertainties may also impair our ability to attract, retain and motivate strategic personnel until the merger is consummated, and could cause our customers and others that deal with us to seek to change their existing business relationship, which could negatively impact Susquehanna upon consummation of the merger. In addition, the merger agreement restricts us from taking certain specified actions without Susquehanna’s consent until the merger is consummated. These restrictions may prevent us from pursuing or taking advantage of attractive business opportunities that may arise prior to the completion of the merger.

The merger agreement limits our ability to pursue alternatives to the merger with Susquehanna.

The merger agreement contains terms and conditions that make it more difficult for us to engage in a business combination with a party other than Susquehanna. Subject to limited exceptions, we are required to convene a special meeting of shareholders and our board of directors is required to recommend approval of the merger agreement. If our board of directors determines to accept a superior acquisition proposal from a competing third party, we will be obligated to pay a $13.5 million termination fee to Susquehanna. A competing third party may be discouraged from considering or proposing an acquisition of us, including an acquisition on better terms than those offered by Susquehanna, due to the termination fee and our obligations under the merger agreement. Further, the termination fee might result in a potential competing third party acquirer proposing a lower per share price than it might otherwise have proposed to acquire us.

Tower shareholders cannot be sure of the market value of the Susquehanna common stock that they will receive in the merger.

The merger agreement provides that Tower shareholders will have the opportunity to elect to receive in exchange for each share of Tower common stock they own immediately prior to completion of the merger a cash payment of $28.00, subject to a proration so that $88 million of the merger consideration is paid in cash, or the right to receive a number of shares of Susquehanna common stock equal to an “Exchange Ratio.” At the time the merger agreement was signed, the Exchange Ratio was set at 3.4696.

 

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Except under limited circumstances, if Susquehanna’s stock price declines prior to the completion of the merger, Susquehanna will not be required to adjust the Exchange Ratio. As a result, the market price of shares of Susquehanna common stock that a Tower shareholder receives in the merger may decline from the date when the merger agreement was signed to the closing of the merger, even if Tower exercises its right to terminate the merger agreement because of a threshold decline in the Susquehanna stock price and Susquehanna decides to increase the Exchange Ratio.

In addition, relative prices of Susquehanna common stock and Tower common stock are likely to change between the date of the joint proxy statement/prospectus mailed to Tower shareholders in connection with the special meeting at which Tower shareholders will be asked to approve the merger, the date of the special meeting, the deadline by which Tower shareholders will be required to elect the form of merger consideration they prefer to receive, and the date that the merger is completed. The market prices of Susquehanna and Tower common stock may change as a result of a variety of factors, including general market and economic conditions, changes in business, operations and prospects, and regulatory considerations. Many of these factors are beyond the control of Susquehanna and Tower. As Susquehanna and Tower market share prices fluctuate, the value of the shares of Susquehanna common stock that a Tower shareholder will receive will correspondingly fluctuate. It is impossible to predict accurately the market price of Susquehanna common stock upon, or after completion of, the merger. Accordingly, it is also impossible to predict accurately the market value of the consideration to be received by shareholders of Tower in the merger upon their exchange of shares of Tower common stock for shares of Susquehanna common stock.

Failure to complete the merger could negatively affect the market price of our common stock.

If the merger is not completed for any reason, we will be subject to a number of material risks, including the following:

 

•

the market price of our common stock may decline to the extent that the current market price of our shares reflects a market assumption that the merger will be completed;

 

•

costs relating to the merger, such as legal, accounting and financial advisory fees, and, in specified circumstances, termination fees, must be paid even if the merger is not completed; and

 

•

the diversion of management’s attention from the day-to-day business operations and the potential disruption to our employees and business relationships during the period before the completion of the merger may make it difficult to regain financial and market positions if the merger does not occur.

After the merger is completed, our shareholders will become Susquehanna shareholders and will have different rights that may be less advantageous than their current rights.

Upon completion of the merger, our shareholders will become Susquehanna shareholders. Differences in Tower’s articles of incorporation and bylaws and Susquehanna’s articles of incorporation and bylaws will result in changes to the rights of our shareholders who become Susquehanna shareholders.

Litigation relating to the merger could require us to incur significant costs and suffer management distraction, as well as delay and/or enjoin the merger.

Three individuals claiming to be shareholders of Tower have made separate demands under Pennsylvania law on Tower’s board of directors, requesting the board to remedy alleged failures to engage in an independent and fair process in connection with the merger. Two of these individuals have filed separate shareholder derivative actions challenging Tower’s pending merger with Susquehanna, and alleging, among other things, that Tower’s directors failed to fulfill their fiduciary duties with regard to the merger with Susquehanna. The plaintiffs in these actions generally seek, among other things, injunctive relief to prevent the consummation of Tower’s merger with Susquehanna or, in the event the merger is consummated, monetary damages. Tower and Susquehanna also could be subject to additional demands or litigation related to the merger whether or not the merger is consummated.

On September 28, 2011, solely to avoid the costs, risks and uncertainties inherent in litigation, Tower and the other named defendants entered into a Memorandum of Understanding with the plaintiffs in both lawsuits and the purported shareholder who submitted the third demand letter. Under the terms of the memorandum, Tower, the other named defendants and the plaintiffs have agreed to settle the lawsuits and demands subject to court approval. If the court approves the settlement contemplated in the memorandum, the lawsuits will be dismissed with prejudice. If the settlement is finally approved by the court, it is anticipated that it will resolve and release all claims in all actions that were or could have been brought challenging any aspect of the proposed merger, the merger agreement, and any disclosure made in connection therewith. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the court will approve the settlement even if the parties were to enter into such stipulation. In such event, the proposed settlement as contemplated by the Memorandum of Understanding may be terminated. While there can be no assurance as to the ultimate outcomes of the demands or the litigation, neither Tower nor Susquehanna believes that their resolution will have a material adverse effect on its respective financial position, results of operations or cash flows.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

None.

 

Item 3.

Defaults Upon Senior Securities.

None.

 

Item 4.

(Removed and Reserved).

None

 

Item 5.

Other Information.

None

 

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Item 6.

Exhibits.

 

Exhibits No.		Exhibits Title
2.1		Agreement and Plan of Merger by and between Tower Bancorp, Inc. and Susquehanna Bancshares, Inc., dated as of June 20, 2011 ( Incorporated by reference to Exhibit 2.1 to Registrant’s Current Report on Form 8-K filed on June 21, 2011)
2.2		Amendment No. 1 to the Agreement and Plan of Merger by and between Tower Bancorp, Inc. and Susquehanna Bancshares, Inc., dated September 28, 2011 (Incorporated by reference to Exhibit 2.1 to Registrant’s Current Report on Form 8-K filed on October 3, 2011)
3.1		Amended and Restated Articles of Incorporation, as amended (Incorporated by reference to Exhibit 3.1 to Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011)
3.2		Amended and Restated Bylaws of Tower Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 to Registrant’s Current Report on Form 8-K filed on July 27, 2010)
4.1		Form of Subordinated Note due July 1, 2014 (Incorporated by reference to Exhibit 4.1 to Registrant’s Current Report on Form 8-K filed on June 12, 2009)
4.2		Form of Subordinated Note Due July 1, 2015 (Incorporated by reference to Exhibit 4.1 to Registrant’s Current Report on Form 8-K filed on February 8, 2010)
31.1		Certification of President and Chief Executive Officer of Tower Bancorp, Inc. Pursuant to Securities and Exchange Commission Rule 13a-14(a) / 15d-14(a)
31.2		Certification of Chief Financial Officer of Tower Bancorp, Inc. Pursuant to Securities and Exchange Commission Rule 13a-14(a) / 15d-14(a)
32.1		Certification of President and Chief Executive Officer of Tower Bancorp, Inc. Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished, not filed)
32.2		Certification of Chief Financial Officer of Tower Bancorp, Inc. Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished, not filed)

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

						TOWER BANCORP, INC.
						(Registrant)
Date:		November 9, 2011				/s/A NDREW S. S AMUEL
						Andrew S. Samuel
						Chief Executive Officer
						(Principal Executive Officer)
Date:		November 9, 2011				/s/ Mark S. Merrill
						Mark S. Merrill
						Chief Financial Officer
						(Principal Financial Officer)

 

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EXHIBIT INDEX

 

Exhibits No.		Exhibits Title
2.1		Agreement and Plan of Merger by and between Tower Bancorp, Inc. and Susquehanna Bancshares, Inc., dated as of June 20, 2011 ( Incorporated by reference to Exhibit 2.1 to Registrant’s Current Report on Form 8-K filed on June 21, 2011)
2.2		Amendment No. 1 to the Agreement and Plan of Merger by and between Tower Bancorp, Inc. and Susquehanna Bancshares, Inc., dated September 28, 2011 (Incorporated by reference to Exhibit 2.1 to Registrant’s Current Report on Form 8-K filed on October 3, 2011)
3.1		Amended and Restated Articles of Incorporation, as amended (Incorporated by reference to Exhibit 3.1 to Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011)
3.2		Amended and Restated Bylaws of Tower Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 to Registrant’s Current Report on Form 8-K filed on July 27, 2010)
4.1		Form of Subordinated Note due July 1, 2014 (Incorporated by reference to Exhibit 4.1 to Registrant’s Current Report on Form 8-K filed on June 12, 2009)
4.2		Form of Subordinated Note Due July 1, 2015 (Incorporated by reference to Exhibit 4.1 to Registrant’s Current Report on Form 8-K filed on February 8, 2010)
31.1		Certification of President and Chief Executive Officer of Tower Bancorp, Inc. Pursuant to Securities and Exchange Commission Rule 13a-14(a) / 15d-14(a)
31.2		Certification of Chief Financial Officer of Tower Bancorp, Inc. Pursuant to Securities and Exchange Commission Rule 13a-14(a) / 15d-14(a)
32.1		Certification of President and Chief Executive Officer of Tower Bancorp, Inc. Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished, not filed)
32.2		Certification of Chief Financial Officer of Tower Bancorp, Inc. Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished, not filed)

 

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