10-Q 1 mon-910q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 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, 2010 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File No. 0-31951 ------- MONROE BANCORP -------------- (Exact name of registrant as specified in its charter) Indiana 35-1594017 ------- ---------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 210 East Kirkwood Avenue Bloomington, IN 47408 --------------------- (Address of principal executive offices) (Zip Code) (812) 336-0201 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ ] No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [X] (Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Outstanding Shares of Common Stock on November 5, 2010: 6,229,778 MONROE BANCORP AND SUBSIDIARY FORM 10-Q

2 Part I. Financial Information Item 1. Financial Statements MONROE BANCORP AND SUBSIDIARY Consolidated Condensed Balance Sheets (Dollars in thousands, except per share data)

See notes to consolidated condensed financial statements. 3 MONROE BANCORP AND SUBSIDIARY Consolidated Condensed Statements of Operations (Unaudited) (Dollars in thousands, except per share data)

See notes to consolidated condensed financial statements. 4 MONROE BANCORP AND SUBSIDIARY Consolidated Condensed Statements of Operations (Unaudited) (Dollars in thousands, except per share data)

See notes to consolidated condensed financial statements. 5 MONROE BANCORP AND SUBSIDIARY Consolidated Condensed Statement of Shareholders' Equity For the Nine Months Ended September 30, 2010 (Unaudited) (Dollars in thousands)

See notes to consolidated condensed financial statements. 6 MONROE BANCORP AND SUBSIDIARY Consolidated Condensed Statements of Cash Flows (Unaudited) (Dollars in thousands)

See notes to consolidated condensed financial statements. 7 Note 1: Basis of Presentation ----------------------------- The consolidated condensed financial statements include the accounts of Monroe Bancorp (the "Company") and its wholly-owned subsidiary, Monroe Bank, a state-chartered bank (the "Bank") and the Bank's wholly-owned subsidiaries, Sycamore Property Investments, LLC, HIE Enterprises, LLC, MB Portfolio Management, Inc. ("MB"), the Bank's majority-owned subsidiary CBAI CDE III, LLC, and MB's majority-owned subsidiary MB REIT, Inc. A summary of significant accounting policies is set forth in Note 1 of Notes to Financial Statements included in the December 31, 2009, Annual Report to Shareholders. All significant intercompany accounts and transactions have been eliminated in consolidation. The interim consolidated condensed financial statements have been prepared in accordance with instructions to Form 10-Q, and therefore do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. The interim consolidated condensed financial statements at September 30, 2010, and for the three and nine months ended September 30, 2010 and 2009, have not been audited by independent accountants, but reflect, in the opinion of Management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for such periods. The consolidated condensed balance sheet of the Company as of December 31, 2009 has been derived from the audited consolidated balance sheet of the Company as of that date. Certain information and note disclosures normally included in the Company's annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K filed with the Securities and Exchange Commission. The results of operations for the period are not necessarily indicative of the results to be expected for the year. Note 2: Earnings Per Share -------------------------- The number of shares used to compute basic and diluted earnings (loss) per share was as follows:

Options to purchase 30,000 shares at $6.00 per share, 5,500 shares at $10.12 per share, 16,500 shares at $12.73 per share, 5,500 shares at $14.73 per share, 25,000 shares of common stock at $16.00 per share, 10,000 shares of common stock at $16.83, and 170,000 shares of common stock at $22.00 per share were outstanding at September 30, 2010 and options to purchase 5,500 shares at $10.12 per share, 22,000 shares at $12.05 per share, 16,500 shares at $12.73 per share, 11,000 shares at $14.73 per share, 30,000 shares of common stock at $16.00 per 8 share, 13,000 shares of common stock at $16.83, and 210,000 shares of common stock at $22.00 per share were outstanding at September 30, 2009, but were not included in the computation of diluted earnings per share for the nine months ended September 30, 2010 and 2009, respectively because the options were antidilutive.

Options to purchase 30,000 shares at $6.00 per share, 5,500 shares at $10.12 per share, 16,500 shares at $12.73 per share, 5,500 shares at $14.73 per share, 25,000 shares of common stock at $16.00 per share, 10,000 shares of common stock at $16.83, and 170,000 shares of common stock at $22.00 per share were outstanding at September 30, 2010 and options to purchase 5,500 shares at $10.12 per share, 22,000 shares at $12.05 per share, 16,500 shares at $12.73 per share, 11,000 shares at $14.73 per share, 30,000 shares of common stock at $16.00 per share, 13,000 shares of common stock at $16.83, and 210,000 shares of common stock at $22.00 per share were outstanding at September 30, 2009, but were not included in the computation of diluted earnings per share for the three months ended September 30, 2010 and 2009, respectively because the options were antidilutive. 9 Note 3: Investment Securities ------------------------------

The amortized cost and fair value of securities available for sale and held to maturity at September 30, 2010, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. 10

Securities with a carrying value of $75,333,000 and $85,854,000 were pledged at September 30, 2010 and December 31, 2009, respectively, to secure certain deposits and for other purposes as permitted or required by law. Proceeds from sales of securities available for sale were $73,193,000 and $65,388,000 for the nine months ended September 30, 2010 and September 30, 2009, respectively. Gross gains of $612,000 and $1,648,000 were realized on sales and $28,000 and $8,000 were realized on redeemed available for sale securities in the nine months ended September 30, 2010 and September 30, 2009, respectively. Proceeds from sales of securities available for sale were $32,826,000 and $12,637,000 for the three months ended September 30, 2010 and September 30, 2009, respectively. Gross gains of $332,000 and $263,000 were realized on sales in the three months ended September 30, 2010 and September 30, 2009, respectively. The Bank realized gains of $15,000 and $1,000 on redeemed available for sale securities in the three months ended September 30, 2010 and September 30, 2009, respectively. There were no sales of held to maturity securities during the nine months ended September 30, 2010 or September 30, 2009. Trading securities, which consist of mutual funds held in a rabbi trust associated with the directors' and executives' deferred compensation plans, are recorded at fair value. Unrealized holding gains on trading securities of $72,000 were included in earnings in the nine months ended September 30, 2010 while unrealized holding gains on trading securities of $467,000 were included in earnings in the nine months ended September 30, 2009. Unrealized holding gains on trading securities of $141,000 were included in earnings in the three months ended September 30, 2010 while unrealized holding gains on trading securities of $377,000 were included in earnings in the three months ended September 30, 2009. Certain investments in debt and marketable equity securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at September 30, 2010 and December 31, 2009 was $17,424,000 and $51,162,000, which is approximately 13.7 percent and 43.4 percent respectively, of the Company's available for sale and held to maturity investment portfolio. Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these securities are temporary. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified. 11 The following table shows our investments' 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, 2010 and December 31, 2009:

The unrealized losses on the Company's investments in direct obligations of U.S. government agencies, corporate bonds, mortgage-backed securities and municipal securities were primarily caused by changes in interest rates. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2010. Note 4: Loans and Allowance ---------------------------- September 30, December 31, 2010 2009 --------------------------- Commercial and industrial loans ....... $ 80,669 $ 81,102 Real estate loans ..................... 388,690 424,964 Construction loans .................... 56,118 62,351 Installment loans ..................... 13,977 15,722 --------- --------- 539,454 584,139 Allowance for loan losses ............. (16,082) (15,256) --------- --------- Loans, net of allowance for loan losses $ 523,372 $ 568,883 ========= ========= 12

At September 30, 2010 and December 31, 2009, accruing loans delinquent 90 days or more totaled $1,559,000 and $1,053,000, respectively. Non-accruing loans at September 30, 2010 and December 31, 2009 were $25,518,000 and $20,603,000, respectively. Note 5: Fair Value Measurements -------------------------------- The Company recognizes fair values in accordance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 820. ASC Topic 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: Level 1: Quoted prices in active markets for identical assets or liabilities, Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities, Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Below is a description of the valuation methodologies used for instruments measured at fair value on a recurring and non-recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy. Trading and Available for Sale Securities Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, certain market information, and quoted prices of securities with similar characteristics or discounted cash flows. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond's term and conditions. Level 13 2 securities include federal agencies, residential mortgage-backed securities (agencies) and municipal securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. At this time the Company has no securities classified as Level 3 securities. The Company obtains fair value measurements from an independent pricing service. Impaired Loans (Collateral Dependent) Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value include using the fair value of the collateral for collateral dependent loans. If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method. Other Real Estate Owned Other real estate owned are reported at fair value less cost to sell and are measured using Level 3 inputs within the fair value hierarchy. Level 3 inputs for other real estate owned included third party appraisals adjusted for cost to sell. The following table presents the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a recurring and non-recurring basis and the level within the ASC Topic 820 fair value hierarchy in which the fair value measurements fall: 14

The following methods and assumptions were used to estimate the fair value of all other financial instruments not recognized in the accompanying balance sheets: Cash, Cash Equivalents and Interest-Bearing Time Deposits - The fair value of cash, cash equivalents and interest-bearing time deposits approximates carrying value. Held-to-maturity Securities - The fair value is based on quoted market prices, if available. If a quoted price is not available, fair value is estimated using quoted market prices for similar securities. Loans - The fair value for loans is estimated using discounted cash flow analyses that use interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Interest Receivable/Payable - The fair values of interest receivable/payable approximate carrying values. FHLB Stock - Fair value of FHLB stock is based on the price at which it may be resold to the FHLB. Deposits - The fair values of noninterest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. The carrying amounts for variable rate, fixed-term 15 certificates of deposit approximate their fair values at the balance sheet date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits. Borrowings - The fair value of Federal Home Loan Bank advances and other long-term debt are estimated using a discounted cash flow calculation, based on current rates for similar debt. For short-term borrowings, carrying value approximates fair value. Off-Balance Sheet Commitments - Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans, and standby letters of credit and are generally of a short-term nature. The fair value of such commitments is based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The estimated fair values of the Company's financial instruments are as follows: September 30, 2010 -------------------- Carrying Fair Amount Value -------------------- Assets Cash and cash equivalents .............. $105,081 $105,081 Interest-bearing time deposits ......... 7,750 7,750 Trading account securities ............. 3,644 3,644 Investment securities available for sale 121,798 121,798 Investment securities held to maturity . 5,743 5,862 Loans including loans held for sale, net 530,977 543,261 Interest receivable .................... 2,172 2,172 Stock in FHLB .......................... 2,353 2,353 Liabilities Deposits ............................... 666,201 673,264 Borrowings ............................. 105,667 104,606 Interest payable ....................... 1,042 1,042 Off-Balance Sheet Commitments ............ -- -- December 31, 2009 -------------------- Carrying Fair Amount Value -------------------- Assets Cash and cash equivalents .............. $ 50,131 $ 50,131 Trading account securities ............. 3,385 3,385 Investment securities available for sale 110,813 110,813 Investment securities held to maturity . 7,052 7,059 Loans including loans held for sale, net 572,109 574,568 Stock in FHLB .......................... 2,353 2,353 Interest receivable .................... 2,402 2,402 Liabilities Deposits ............................... 634,254 613,354 Borrowings ............................. 106,056 99,511 Interest payable ....................... 918 918 Off-Balance Sheet Commitments ............ -- -- 16 Note 6: Other Comprehensive Income (Loss) ------------------------------------------

Note 7: Borrowings ------------------- On July 17, 2009, $13 million of Tier 2 capital was raised by the Company through the issuance of Subordinated Debentures. The Subordinated Debentures were issued as the result of a public offering. The Subordinated Debentures carry an interest rate of 10 percent and will mature on June 30, 2019. The Company has the right to call the Subordinated Debentures at any time after three years. The Subordinated Debentures were issued pursuant to the prospectus filed as part of the Company's registration statement under the Securities Act of 1933. On July 23, 2009, the Company's Board of Directors voted to provide $10 million of the net proceeds of the offering to the Bank, as additional capital, with the remaining proceeds to be used by the Company for general corporate purposes. Note 8: Reclassifications -------------------------- Reclassifications of certain amounts in the 2009 consolidated condensed financial statements have been made to conform to the 2010 presentation. Note 9: Contingencies ---------------------- The Company and Bank are from time to time subject to other claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of the Company. Note 10: New Accounting Pronouncements --------------------------------------- In January 2010, the FASB issued Accounting Standards Update ("ASU") No. 2010-06, "Improving Disclosures About Fair Value Measurements," which added disclosure requirements about transfers in and out of Levels 1 and 2, clarified existing fair value disclosure requirements about the appropriate level of disaggregation, and clarified that a description of valuation techniques and inputs used to measure fair value was required for recurring and nonrecurring Level 2 and 3 fair value measurements. Management has determined the adoption of these provisions of this ASU only affected the disclosure requirements for fair value measurements and as a result did not have a material effect on the Company's financial position or results of operations. This ASU also requires that Level 3 activity about purchases, sales, issuances, and settlements be presented on a gross basis rather than as a net number as currently permitted. This provision of the ASU is effective for the Company's reporting period ending March 31, 2011. Management has determined the adoption of this guidance will not have a material effect on the Company's financial position or results of operations. 17 In July 2010, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2010-20, "Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses which added disclosure requirements about an entity's allowance for loan losses and the credit quality of its financing receivables. The required disclosures include a roll forward of the allowance for credit losses on a portfolio segment basis and information about modified, impaired, non-accrual and past due loan and credit quality indicators. ASU 2010-20 will be effective for the Company's reporting period ending December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Management has determined the adoption of this guidance will not have a material effect on the Company's financial position or results of operations. Note 11: Pending Merger ----------------------- On October 5, 2010, the Company and Old National Bancorp ("Old National") entered into a definitive agreement (the "Merger Agreement") pursuant to which the Company will be merged with and into Old National and at the same time as or as soon as practicable after such merger, the Company's bank subsidiary, Monroe Bank, will be merged into Old National's bank subsidiary, Old National Bank. Under the terms of the Merger Agreement, holders of the Company's common stock will receive 1.275 shares of Old National common stock for each share of the Company common stock held by them. The exchange ratio will adjust if the price of Old National common stock (calculated near the closing date) exceeds $10.98 per share. In such event, the Company's shareholders will receive $14.00 of Old National common stock for each share of Company common stock held by them. The exchange ratio is subject to other adjustments under certain circumstances if delinquent loans (as defined in the Merger Agreement) of the Company exceed specified amounts as of the tenth day prior to the closing of the merger or if, as of the end of the month prior to the closing, the consolidated shareholders' equity of the Company, as adjusted pursuant to the Merger Agreement, falls below the consolidated shareholders' equity of the Company as of June 30, 2010. Based upon the closing price of $10.47 per share of Old National common stock the day before the transaction was announced, the transaction is valued at approximately $83.5 million. The transaction value will change due to fluctuations in the price of Old National common stock. The merger is expected to close on January 1, 2011 or early in the first quarter of 2011, and is subject to approval by federal and state regulatory authorities and the Company's shareholders and the satisfaction of the closing conditions set forth in the Merger Agreement. Item 2. Management's Discussion and Analysis of Financial Condition and ------- Results of Operations --------------------------------------------------------------- (Table dollar amounts in thousands) General ------- Monroe Bancorp is a one-bank holding company formed under Indiana law in 1984. The Company holds all of the outstanding stock of Monroe Bank, which was formed in 1892. Banking is the primary business activity of the Company. The Bank, with its primary offices located in Bloomington, Indiana, conducts business from seventeen locations in Monroe, Jackson, Lawrence, Hendricks and Hamilton counties in Indiana. Approximately 77 percent of the Bank's deposits are in Monroe County and are concentrated in and around the city of Bloomington. The Bank is a traditional community bank which provides a variety of financial services to its customers, including: o accepting deposits; o making commercial, mortgage and personal loans; o originating fixed and variable rate residential mortgage loans for sale into the secondary market; 18 o providing personal and corporate trust services; o providing investment advisory and brokerage services; and o providing annuities and other investment products. The majority of the Bank's revenue is derived from interest and fees on loans and investments, and the majority of its expense is interest paid on deposits and general and administrative expenses related to its business. On October 5, 2010, the Boards of Directors of Monroe Bancorp and Old National Bancorp entered into an agreement to merge the two companies. If the merger is approved by the shareholders of Monroe Bancorp and all other closing conditions are satisfied, each shareholder of Monroe Bancorp shall receive 1.275 shares of Old National Bancorp common stock for each share of their Monroe Bancorp common stock owned before the merger, subject to certain adjustments as described in the Merger Agreement. See Note 11 to the consolidated condensed financial statements of the Company. Interested parties should refer to the Merger Agreement for details as to possible adjustments to the 1.275 exchange rate. However, the following information is provided to assist in the evaluation of the possible impact of two adjustments that relate directly to the Company's financial performance. The exchange rate will be reduced if the aggregate amount of the Company's delinquent loans, as defined in the Merger Agreement, exceeds $59,720,000 as of the tenth day prior to the merger. Delinquent loans, as defined in the Merger Agreement, were $53,520,000 at June 30, 2010 and $53,118,000 at September 30, 2010. The exchange rate will also be reduced if, as of the end of the month prior to the closing of the merger, Monroe Bancorp's shareholders' equity (computed in accordance with the terms of the Merger Agreement) is less than $55,640,000. Monroe Bancorp's shareholders' equity, computed in accordance with the terms of the Merger Agreement, was $56,640,000 at June 30, 2010 and $56,985,000 at September 30, 2010. Critical Accounting Policies ---------------------------- The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements on pages 27 to 28 of the 2009 Annual Report to Shareholders. Certain of these policies are important to the portrayal of the Company's financial condition, since they require Management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management has identified these policies in the Critical Accounting Policies section of the Management's Discussion and Analysis on pages 9 to 10 of the 2009 Annual Report to Shareholders. There have been no changes in these critical accounting policies since the date of the 2009 Annual Report to Shareholders. Non-GAAP Financial Measures --------------------------- In January 2003, the United States Securities and Exchange Commission ("SEC") issued Regulation G, "Conditions for Use of Non-GAAP Financial Measures." A non-GAAP financial measure is a numerical measure of a company's historical or future performance, financial position, or cash flow that excludes (includes) amounts or adjustments that are included (excluded) in the most directly comparable measure calculated in accordance with generally accepted accounting principles ("GAAP"). Regulation G requires companies that present non-GAAP financial measures to disclose a numerical reconciliation to the most directly comparable measurement using GAAP as well as the reason why the non-GAAP measure is an important measure. Management has used the following non-GAAP financial measures throughout this quarterly report on Form 10-Q. o In the "Net Interest Income / Net Interest Margin" section, the discussion is focused on tax-equivalent rates and margin. Municipal bond and municipal loan interest has been converted to a tax-equivalent rate using a federal tax rate of 34 percent. Management believes a discussion of the changes in tax-equivalent rates and margin is more relevant because it better explains changes in after-tax net income. 19 o In the "Noninterest Income / Noninterest Expense" section of this document, we report noninterest income and noninterest expense without the effect of unrealized gains and losses on securities in a grantor trust ("rabbi trust") which is a non-GAAP financial measure. Other income includes realized and unrealized securities gains and losses and capital gain dividends on trading securities (mutual funds) held in a rabbi trust in connection with the Company's Directors' and Executives' Deferred Compensation Plans. These securities are held as trading securities, and hence, unrealized gains and losses are recognized on the income statement. Any unrealized or realized loss on securities held in the rabbi trust net of any dividend, interest and capital gain dividend income earned on the securities in the rabbi trust (included in net interest income) are directly offset by a decrease to directors' fee/deferred executive compensation expense (included in other expense), and conversely, any net realized or unrealized gain combined with interest, dividends and capital gain dividends earned on the securities in the trust are directly offset by an increase to directors' fee/deferred executive compensation expense. These offsets are included in the line item identified on pages 4 and 5 of the consolidated financial statements as "Appreciation in directors' and executives' deferred compensation plans." The activity in the rabbi trust has no effect on the Company's net income. Therefore, Management believes a more accurate comparison of current and prior year noninterest income and noninterest expense can be made if the rabbi trust realized and unrealized gains, losses, capital gain dividends and offsetting appreciation (depreciation) on the deferred compensation plans and trustee fees are removed. Results of Operations --------------------- Overview -------- The Company had net income for the third quarter of 2010 of $239,000, a 66.3 percent decrease from net income of $710,000 for the same quarter last year. Basic and diluted earnings per share for the third quarter of 2010 were $0.038, down 66.7 percent from $0.114 basic and diluted earnings per share for the third quarter of 2009. Annualized return on average equity ("ROAE") for the third quarter of 2010 decreased to 1.69 percent compared to 4.95 percent for the third quarter of 2009. The annualized return on average assets ("ROAA") was 0.11 percent for the third quarter of 2010 compared to 0.34 percent for the same period of 2009. Net loss for the first nine months of 2010 was $510,000, a 119.7 percent decrease from net income of $2,592,000 for the same period last year. Basic and diluted (loss) per share for the first nine months of 2010 were $(0.082), down 119.7 percent from $0.417 basic and diluted earnings per share for the same period of 2009. Annualized ROAE for the nine months ended September 30, 2010 decreased to (1.21) percent compared to 6.14 percent for the first nine months of 2009. The annualized ROAA was (0.08) percent for the nine months ended September 30, 2010 compared to 0.42 percent for the first nine months of 2009. The decline in net income for the third quarter of 2010 compared to the third quarter of 2009 resulted primarily from an increase in the provision for loan losses and a decrease in loan interest income. The provision for loan losses totaled $3,200,000 for the third quarter of 2010 compared to $2,200,000 for the same period of 2009. Loan interest income totaled $7,353,000 for the third quarter of 2010 compared to $8,535,000 for the same period of 2009 due primarily to a $65,488,000 decrease in loans. Net interest income for the third quarter of 2010, after the provision for loan losses, decreased $1,343,000 or 34.6 percent from the third quarter of 2009. The decline in net income for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 resulted primarily from an increase in the provision for loan losses, a decrease in gains from the sale of available for sale ("AFS") securities and interest expense on the subordinated debt that was issued in July 2009. The provision for loan losses totaled $10,900,000 for the nine months ended September 30, 2010 compared to $7,000,000 for the same period of 2009. Gains from the sale of AFS securities totaled $640,000 for the nine months ended September 30, 2010 compared to $1,656,000 for the same period of 2009. The interest expense on the subordinated debt (including amortization of debt issuance costs) totaled $1,033,000 for the nine months ended September 30, 2010 compared to $287,000 for the nine months ended September 30, 2009. Net interest income for the nine months ended September 30, 2010, after the provision for loan losses, decreased $4,915,000, or 44.4 percent from the same period in 2009. 20 The following items affected third quarter and year-to-date results: o General Economic Conditions in the Real Estate Markets - Among the primary areas of Management focus during 2009 and 2010 were managing the deterioration of asset quality resulting from slowing economic activity and stresses in the residential housing markets. Nonperforming assets and 90-day past due loans totaled $40,548,000 (4.8 percent of total assets) at September 30, 2010 compared to $38,451,000 (4.5 percent of total assets) at June 30, 2010 and $21,622,000 (2.6 percent of total assets) at September 30, 2009. The provision for loan losses for the nine months ended September 30, 2010 totaled $10,900,000, a $3,900,000 increase over the $7,000,000 provision made during the same period of 2009 due to Management's assessment of potential losses in the Bank's loan portfolio. o Securities Gains - Securities gains of $640,000 were realized from sales of AFS securities during the first nine months of 2010 compared to $1,656,000 in the same period of 2009. o Subordinated debt interest expense - Subordinated debt interest expense (including amortization of debt issuance costs) incurred in the first nine months of 2010 totaled $1,033,000 compared to $287,000 in the same period of 2009. The Company issued $13,000,000 of subordinated debt on July 17, 2009. o Compensation Expenses - Total compensation expenses (salaries, incentive compensation and benefits) decreased by $471,000 or 5.3 percent to $8,413,000 for the first nine months of 2010 compared to $8,884,000 for the first nine months of 2009 due primarily to a reduction in staff levels and changes to some of the Bank's incentive compensation plans. Net Interest Income / Net Interest Margin ----------------------------------------- The following table presents information to assist in analyzing net interest income. The table of Average Balance Sheets and Interest Rates presents the major components of interest-earning assets and interest-bearing liabilities, related interest income and expense and the resulting yield or cost. Interest income presented in the table has been adjusted to a tax-equivalent basis assuming a 34 percent tax rate. The tax-equivalent adjustment recognizes the income tax savings when comparing taxable and tax-exempt assets. 21

(1) Interest income on tax-exempt securities has been adjusted to a tax equivalent basis using a marginal income tax rate of 34%. (2) Nonaccrual loans are included in average loan balances and loan fees are included in interest income. Net interest income is the primary source of the Company's earnings. It is a function of the net interest margin and the volume of average earning assets. The net interest margin as a percent of average earning assets was 2.95 percent for the first nine months of 2010, down from 3.15 percent for the same period in 2009 and was 2.89 percent for the third quarter of 2010, down from 3.17 percent for the same period in 2009. Adjusting for tax-exempt income and expense, as discussed in the "Non-GAAP Financial Measures" section, the tax-equivalent net 23 interest margin as a percent of average earning assets was 2.95 percent for the first nine months of 2010, down from 3.20 percent for the same period last year and was 2.90 percent for the quarter ended September 30, 2010, down from 3.20 percent for the same quarter last year. The 25 basis point drop in the tax-equivalent net interest margin during the first nine months of 2010 compared to the same period in 2009 and the 30 basis point drop in the third quarter of 2010 compared to 2009 were primarily the result of higher balances of nonperforming assets and the increased investment in Federal Funds Sold and interest bearing deposits that the Company has maintained as part of its liquidity risk management program in 2010. Net interest income was $17,056,000 for the nine months ended September 30, 2010 compared to $18,071,000 for the same period in 2009, a decrease of 5.6 percent. Adjusting for tax-exempt income and expense, as discussed in the "Non-GAAP Financial Measures" section, tax-equivalent net interest income was $17,090,000 for the nine months ended September 30, 2010 compared to $18,345,000 for the same period in 2009, a decrease of 6.8 percent, primarily due to $746,000 of additional subordinated debt interest expense in the first nine months of 2010 compared to 2009. Net interest income was $5,741,000 for the three months ended September 30, 2010 compared to $6,084,000 for the same period in 2009, a decrease of 5.6 percent. Adjusting for tax-exempt income and expense, as discussed in the "Non-GAAP Financial Measures" section, tax-equivalent net interest income was $5,750,000 for the three months ended September 30, 2010 compared to $6,132,000 for the same period in 2009, a decrease of 6.6 percent. Noninterest Income / Noninterest Expense ---------------------------------------- Total noninterest income for the first nine months of 2010 was $8,751,000 compared to $8,861,000 for the same period in 2009. Excluding the effect of the Company's deferred compensation plan, discussed in the "Non-GAAP Financial Measures" section, noninterest income for the nine months ended September 30, 2010 was $8,682,000 compared to $8,595,000 for the same period of 2009, an increase of $87,000 or 1.0 percent. The effect of the Company's deferred compensation plan for the first nine months of 2010 was a $69,000 increase in noninterest income compared to a $266,000 increase in the same period of 2009. Significant changes in noninterest income occurred primarily in the following areas: o Securities gains of $640,000 were realized from sales of AFS securities during the first nine months of 2010 compared to $1,656,000 in the same period of 2009. o Bank Owned Life Insurance ("BOLI") income was $1,005,000 in the first nine months of 2010 compared to $477,000 in the same period of 2009 due to the receipt of death benefit proceeds under that program. The Company did not purchase additional BOLI during 2010. Total noninterest income for the third quarter of 2010 was $3,249,000, an $836,000 or 34.6 percent increase from $2,413,000 for the same period in 2009. Excluding the effect of the Company's deferred compensation plan, discussed in the "Non-GAAP Financial Measures" section, noninterest income totaled $3,108,000 for the third quarter of 2010 compared to $2,237,000 for the same period of 2009, an increase of $871,000 or 38.9 percent largely due to a $724,000 decrease in net loss on foreclosed assets. Net loss on foreclosed assets totaled $37,000 in the third quarter of 2010 compared to a net loss of $761,000 loss in the same period in 2009. The increased loss in the third quarter of 2009 resulted primarily from declines in market values in the residential housing market and declining general economic conditions during the Company's holding period for these assets. Total noninterest expense was $16,473,000 for the first nine months of 2010 compared to $16,775,000 for the same period in 2009. Excluding the effect of the Company's deferred compensation plan, discussed in the "Use of Non-GAAP Financial Measures" section, total noninterest expense for the first nine months of 2010 was $16,225,000, a $237,000 or 1.4 percent decrease from $16,462,000 for the same period in 2009, resulting primarily from total compensation expenses (salaries, incentive compensation and benefits) decreasing by $471,000 or 5.3 percent to $8,413,000 in the first nine months of 2010 compared to $8,884,000 in 24 the first nine months of 2009. The decrease in total compensation expenses was due primarily to a reduction in staff levels and changes to some of the Bank's incentive compensation plans. The effect of the Company's deferred compensation plan for the first nine months of 2010 was a $248,000 increase in noninterest expense compared to a $313,000 increase in the same period of 2009. Total noninterest expense was $5,602,000 for the third quarter of 2010 compared to $5,429,000 for the same period in 2009. Excluding the effect of the Company's deferred compensation plan, discussed in the "Use of Non-GAAP Financial Measures" section, total noninterest expense for the third quarter of 2010 was $5,453,000, a $211,000 or 4.0 percent increase from $5,242,000 for the same period in 2009, primarily due to a $166,000 or 59.3 percent increase in FDIC insurance premium expense in the third quarter of 2010 compared to the same period in 2009 due to an increase in the Company's insurance premium rate. The effect of the Company's deferred compensation plan for the third quarter of 2010 was a $149,000 increase in noninterest expense compared to a $187,000 increase in the same period of 2009. Income Taxes ------------ The Company records a provision for income taxes currently payable, along with a provision for those taxes payable in the future. Such deferred taxes arise from differences in timing of certain items for financial statement reporting rather than income tax reporting. The major differences between the effective tax rate applied to the Company's financial statement income and the federal and state statutory rate of approximately 40 percent are interest on tax-exempt securities, the Bank's investment in CBAI CDE III, LLC, and the increase in cash surrender value of the Bank's owned life insurance. The deferred tax assets and liabilities represent decreases or increases in taxes expected to be paid in the future because of future reversals of temporary differences in the bases of assets and liabilities as measured by tax laws and their bases as reported in the financial statements. Deferred tax assets are also recognized for tax attributes such as net operating loss carryforwards and tax credit carryforwards. The net deferred tax asset was $5,382,000 at September 30, 2010, an increase of $371,000 or 7.4 percent compared to $5,011,000 at September 30, 2009. The increase in the net deferred tax asset was primarily due to timing differences in the amount of provision for loan loss that was expensed in 2009 and 2010 compared to the charge-offs experienced. Management estimates charge-offs in future periods will exceed provision for loan loss expense and the Company's projected future taxable income will enable the Company to utilize the net deferred tax asset. In the third quarter of 2010, the Company recorded an additional deferred tax asset valuation allowance of $403,000 to reduce deferred state tax assets to the amount Management concluded was expected to be utilized in future periods. The Company adjusts its unrecognized tax benefits as necessary when additional information becomes available. The reassessment of the Company's unrecognized tax benefits may have a material impact on its effective tax rate in the period in which it occurs. The Company's effective tax benefit rate was 67.4 percent for the nine months ended September 30, 2010 compared to an effective tax rate of 17.9 percent for the same period in 2009. The magnitude of the Company's effective tax benefit rate for the first nine months of 2010 is less meaningful since the Company experienced a net loss for the period and has multiple sources of tax-exempt income. Financial Condition ------------------- Assets and Liabilities ---------------------- Total assets of the Company at September 30, 2010 were $838,122,000 an increase of 4.4 percent or $35,671,000 compared to $802,451,000 at December 31, 2009. Loans (including loans held for sale) totaled $547,059,000 at September 30, 2010 compared to $587,365,000 at December 31, 2009, a decrease of 6.9 percent. Deposits increased to $666,201,000 at September 30, 2010 compared to $634,254,000 at December 31, 2009, an increase of $31,947,000 or 5.0 percent, primarily due to a $27,240,000 increase in interest-bearing checking and NOW accounts. Borrowings decreased to $105,667,000 at September 30, 2010 compared to $106,056,000 at December 31, 2009. 25 Capital ------- Shareholders' equity decreased by $255,000 at September 30, 2010 compared to December 31, 2009. This decrease was a result of a year-to-date net loss of $510,000, ESOT shares forfeited of $6,000, and dividends paid of $187,000 offset by option expense of $12,000, unrealized gain on securities in the Company's available for sale securities portfolio totaling $422,000 (net of tax) and common stock sold of $14,000. The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies and are assigned to a capital category. The assigned capital category is largely determined by three ratios that are calculated according to the regulations: total risk adjusted capital, Tier 1 capital, and Tier 1 leverage ratios. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures of the entity. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios. There are five capital categories defined in the regulations ranging from well capitalized to critically undercapitalized. Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations. At September 30, 2010 and December 31, 2009, the Company and the Bank were categorized as well capitalized and met all applicable capital adequacy requirements. Effective April 29, 2010, the Bank entered into a memorandum of understanding ("MOU") with the Federal Deposit Insurance Corporation (the "FDIC") and the Indiana Department of Financial Institutions (the "DFI"). The MOU is an informal administrative agreement in which the Bank has agreed to take various actions and comply with certain requirements to facilitate improvement in its financial condition. In accordance with the MOU, the Bank agreed among other things to maintaining a leverage capital ratio (tier 1 capital to average assets) of not less than 8.00 percent and a total risk-based capital ratio of not less than 12.00 percent. As of September 30, 2010 and December 31, 2009, the actual and required capital amounts and ratios are as follows: 26

(1) As defined by regulatory agencies On July 22, 2010, the Board of Directors of the Company adopted a resolution requiring the Company to obtain the written approval of the Federal Reserve Bank of Chicago (the "Federal Reserve") at least thirty days prior to the declaration or payment of corporate dividends, any increase in debt or issuance of trust preferred obligations, or the redemption of any Company stock. The resolution was adopted at the direction of the Federal Reserve and will remain in effect until the Federal Reserve authorizes its rescission. Classification of Assets, Allowance for Loan Losses, and Nonperforming Loans ---------------------------------------------------------------------------- The Bank currently classifies loans internally to assist Management in addressing collection and other risks. The Bank maintains a "watch list" representing credits that require above average attention in order to mitigate the risk of default or loss. Over the periods noted below, the watch list consisted of the following:

As of September 30, 2010, 58.8 percent of the Watch List exposure was less than thirty days past due, compared to 56.8 percent as of June 30, 2010 and 72.6 percent as of September 30, 2009. Of the $69,457,000 of loans on the watch list on September 30, 2010, $55,351,000 (79.7 percent) were originated out of the Central Indiana (greater Indianapolis) offices. The majority of the internally classified loans are secured with real estate which reduces the potential losses on those loans. In addition, the Company maintains an allowance for loan losses based upon its quarterly analysis of 27 losses inherent in the loan portfolio. The allowance for loan losses was $16,082,000, or 2.98 percent of portfolio loans (excluding loans held for sale) at September 30, 2010 compared to $15,256,000, or 2.61 percent of portfolio loans at December 31, 2009. A portion of classified loans consists of non-accrual loans. The Bank had nonperforming assets (non-accrual loans, restructured loans, OREO and 90-days past due loans still accruing) totaling $40,548,000 or 4.84 percent of total assets at September 30, 2010 compared to $25,424,000 or 3.17 percent of total assets at December 31, 2009. In the third quarter of 2010, $1,935,000 of new specific reserves were allocated to sixteen of the Company's existing loans. The addition of these specific reserves resulted primarily from updated independent appraisals of the real estate securing these loans which had, based on the appraisals, decreased in market value. Management believed an increased allowance for loan losses was prudent given the addition of these specific reserves combined with the Company's historical charge-off trends. Thus, a higher provision for loan losses was expensed in the third quarter of 2010 to increase the allowance for loan losses. During the third quarter of 2010, the Bank had net loan charge-offs totaling $4,611,000 compared to $1,979,000 in the third quarter of 2009. Past due loans (30 days or more) were 5.66 percent of total loans at September 30, 2010 compared to 3.73 percent of total loans at September 30, 2009. Liquidity --------- Liquidity refers to the ability of a financial institution to generate sufficient cash to fund current loan demand, meet savings deposit withdrawals and pay operating expenses. The primary sources of liquidity are cash, interest-bearing deposits in other financial institutions, marketable securities, loan repayments, increased deposits and total institutional borrowing capacity. Cash Requirements Management believes that the Company has adequate liquidity and adequate sources for obtaining additional liquidity if needed. Members of the Company's internal Asset/Liability Committee (ALCO) regularly discuss projected loan demand and appropriate funding sources to manage the Company's gap position and minimize interest rate risk. Short-term liquidity needs resulting from normal deposit/withdrawal functions are provided by the Company retaining a portion of cash generated from operations and through utilizing federal funds and repurchase agreements. Long-term liquidity and other liquidity needs are provided by the ability of the Company to borrow from the Federal Home Loan Bank of Indianapolis ("FHLB") and to obtain brokered certificates of deposit ("CDs"). FHLB advances were $17,272,000 at September 30, 2010 compared to $17,371,000 at December 31, 2009. At September 30, 2010, the Company had excess borrowing capacity at the FHLB of $46,231,000 as limited by the FHLB collateral limit. In terms of managing the Company's liquidity, Management's primary focus is on increasing deposits to fund future growth. Over the past year, the Company has also utilized alternative funding sources. In July 2005, the Company began using brokered CDs as an alternate source of funding. As of September 30, 2010, the Company had $54,345,000 of brokered CDs on its balance sheet, compared to $46,201,000 at December 31, 2009 and $46,201,000 at September 30, 2009. At the bank holding company level, the Company primarily uses cash to pay dividends to shareholders and to pay interest on its subordinated debt. Historically, the main source of funding for the holding company has been dividends from the Bank. During the first three quarters of 2010, the Bank paid no dividends to the holding company. Were it not for the FDIC and DFI Memorandum of Understanding, the amount of dividends the Bank could pay to the parent company without prior regulatory approval as of October 1, 2010 was $1,844,000, versus $1,368,000 at January 1, 2010. As discussed in Note 12 to the Consolidated Financial Statements (page 37 of the 2009 Annual Report to Shareholders) and Item 1 of the December 31, 2009 Form 10-K, the Bank is subject to many regulations and, among other things, may be limited in its ability to pay dividends or transfer funds to the holding company. Effective April 29, 28 2010, the Bank entered into a memorandum of understanding with the FDIC and DFI and will refrain from paying cash dividends to the Company without prior regulatory approval. On July 22, 2010, the Board of Directors of the Company adopted a resolution requiring the Company to obtain the written approval of the Federal Reserve prior to the declaration or payment of corporate dividends, any increase in debt or issuance of trust preferred obligations, or the redemption of any Company stock. Accordingly, consolidated cash flows as presented in the Consolidated Statements of Cash Flows on page 7 may not represent cash immediately available to the holding company. Sources and Uses of Cash The following discussion relates to the Consolidated Statements of Cash Flows (page 7 of the consolidated condensed financial statements). During the nine months ended September 30, 2010, $15,420,000 of cash was provided by operating activities, compared to $11,091,000 provided during the same period in 2009. The increase in the cash provided in this area was primarily a result of the $4,887,000 net increase in interest payable and other liabilities. During the first nine months of 2010, $6,327,000 was provided by investing activities, compared to $31,026,000 being provided in the same period of 2009. The decrease in the cash provided in this category occurred primarily due to the $27,111,000 net decrease in the cash provided in activities related to available for sale and held to maturity securities. During the first nine months of 2010, $33,203,000 of cash was provided by financing activities compared to $698,000 provided during the same period in 2009. The increase in cash provided by financing activities was primarily the result of a $67,262,000 increase in the net change in certificates of deposit offset by a $24,943,000 decrease in the net change in noninterest-bearing, interest-bearing demand and savings deposits. Overall, net cash and cash equivalents increased $54,950,000 during the nine months ended September 30, 2010 compared to an increase of $42,815,000 in the same period of 2009. Impact of Inflation and Changing Prices --------------------------------------- The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles. These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time, due to inflation. The primary assets and liabilities of the Company are monetary in nature. Consequently, interest rates generally have a more significant impact on performance than the effects of inflation. Interest rates, however, do not necessarily move in the same direction or with the same magnitude as the price of goods and services. In a period of rapidly rising interest rates, the liquidity and the maturity structure of the Company's assets and liabilities are critical to the maintenance of acceptable performance levels. The Company constantly monitors the liquidity and maturity structure of its assets and liabilities, and believes active asset/liability management has been an important factor in its ability to record consistent earnings growth through periods of interest rate volatility. Other ----- The Securities and Exchange Commission maintains a Web site that contains reports, proxy and information statements, and other information regarding registrants that file electronically with the Commission, including Monroe Bancorp (ticker symbol MROE). The address is http://www.sec.gov. Forward-Looking Statements -------------------------- This Quarterly Report on Form 10-Q contains forward-looking statements about the Company which we believe are within the meaning of the Private Securities Litigation Reform Act of 1995. This Form 10-Q contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words "believe," "expect," "anticipate," "intend," "plan," "estimate" or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could" or "may" or words of similar meaning. These forward-looking statements, 29 by their nature, are subject to risks and uncertainties. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) changes in competitive pressures among depository institutions; (2) changes in the interest rate environment; (3) changes in prepayment speeds, charge-offs and loan loss provisions; (4) changes in general economic conditions, either national or in the markets in which the Company does business; (5) legislative or regulatory changes adversely affecting the business of the Company; (6) changes in real estate values or the real estate markets; (7) the Company's business development efforts in new markets in and around Hendricks and Hamilton Counties; and (8) the potential failure to obtain shareholder and regulatory approval for the merger with Old National or to satisfy other conditions to the merger on the terms set forth in the Merger Agreement or within the proposed timeframes. Further information on other factors which could affect the financial results of the Company is included in the Company's filings with the Securities and Exchange Commission. Item 3. Quantitative and Qualitative Disclosures about Market Risk ------- ---------------------------------------------------------- Market risk of the Company encompasses exposure to both liquidity risk and interest rate risk and is reviewed on an ongoing basis by management and quarterly by the Asset/Liability Committee ("ALCO") and the Board of Directors. Liquidity was addressed as part of the discussion entitled "Liquidity." The Company's interest-earning assets are primarily funded by interest-bearing liabilities. These financial instruments have varying levels of sensitivity to changes in market interest rates resulting in market risk. We are subject to interest rate risk to the extent that our interest-bearing liabilities with short and intermediate-term maturities reprice more rapidly, or on a different basis, than our interest-earning assets. Management uses several techniques to measure interest rate risk. Interest rate risk exposure is measured using an interest rate sensitivity analysis to determine the change in the net economic value (Economic Value of Equity or EVE) of its cash flows from assets and liabilities in the event of hypothetical changes in interest rates. Management also forecasts the net interest income that the Company's current balance sheet would yield over the next twelve months assuming the same hypothetical changes in interest rates. A third method used by the Company to measure interest rate risk is an interest rate sensitivity gap analysis. The gap analysis is utilized to quantify the repricing characteristics of the Company's assets and liabilities. Management believes that its forecast of changes in net interest income under various rate shocks is the more valuable and easiest to interpret interest rate risk measurement technique. Management believes that interested parties will derive a better understanding of how the Company's intermediation activities will perform under different rate scenarios from its presentation of projected net interest income under various rate shocks. This should help users of the information form clearer opinions of the Company's interest rate sensitivity. The Company's Board of Directors adopted an interest rate risk policy which established a 20 percent maximum increase or decrease in net interest income in the event of a sudden and sustained 2 percent (200 basis point) increase or decrease in interest rates. The Company's interest sensitivity position at September 30, 2010 remained consistent with the Company's primary goal of maximizing interest margin while maintaining a relatively low exposure to interest rate risk. The following charts summarize the results of Management's forecast of net interest income that would be generated by the Company's September 30, 2010 and December 31, 2009 balance sheets under a variety of sudden and sustained interest rate changes (shocks). In both cases, due to current economic conditions, Management feels it is appropriate to perform and analyze upward interest rate shocks ranging from 100 basis points to 400 basis points. In all cases the interest rate shocks reveal how the Company's balance sheet as of the shock date can be expected to perform in terms of net interest income. The shocks do not reflect any steps that Management might take to counteract that change. 30 Projected Change in Net Interest Income - September 30, 2010 ----------------------------------------------------------------------- Projected Net Interest $ Change Income Over the in Net Interest % Change in Change in Inter Next Twelve Months Income Net Interest Rate (basis points) (in thousands) (in thousands) Income ----------------------------------------------------------------------- +400 $ 19,224 $ (2,574) (11.81)% +300 19,798 (2,000) (9.18) +200 20,414 (1,384) (6.35) +100 20,895 (903) (4.14) 0 21,798 -- -- -100 21,815 17 0.08 -200 21,200 (598) (2.74) For comparative purposes, the following table summarizes the results of management's forecast of net interest income that would be generated by the Bank's December 31, 2009 balance sheet under various rate shocks: Projected Change in Net Interest Income - December 31, 2009 ----------------------------------------------------------------------- Projected Net Interest $ Change Income Over the in Net Interest % Change in Change in Inter Next Twelve Months Income Net Interest Rate (basis points) (in thousands) (in thousands) Income ----------------------------------------------------------------------- +400 $ 19,907 $ (2,658) (11.78)% +300 20,610 (1,955) (8.66) +200 21,317 (1,248) (5.53) +100 21,814 (751) (3.33) 0 22,565 -- -- -100 22,813 248 1.10 -200 22,303 (262) (1.16) Management believes a meaningful and sustained decline in interest rates is unlikely over the next twelve months, while an increase in rates over the next twelve months is certainly possible. The September 30, 2010 table indicates that the Bank's interest rate risk profile has become modestly more sensitive to rising rates relative to the December 31, 2009 projections. The Company's September 30, 2010 balance sheet is projected to produce 9.18% less net interest income over the next twelve months if subjected to a 300 basis point immediate and sustained interest rate shock. This result is largely driven by the Company having more liabilities, primarily deposits, which would reprice over the twelve-month horizon than assets. As a result, net interest expense would increase faster than interest income in the event of an upward rate shock. The results from the Company's rate shock analyses continue to indicate the interest rate sensitivities of the Bank's assets and liabilities are relatively well matched. The estimated changes in net interest income calculated as of September 30, 2010 are within the approved guidelines established by the Board of Directors. Computations of prospective effects of hypothetical interest rate changes are based on a number of assumptions, including relative levels of market interest rates, loan prepayments and deposit run-off rates, and should not be relied upon as indicative of actual results. These computations do not contemplate actions management may undertake in response to changes in interest rates. Certain shortcomings are inherent in the method of computing the estimated net interest income under hypothetical rate shocks. Actual results may differ from that information presented in the table above should market conditions vary from the assumptions used in preparation of the table information. If interest rates 31 remain or decrease below current levels, the proportion of adjustable rate loans in the loan portfolio could decrease in future periods due to refinancing activity. Also, in the event of an interest rate change, prepayment and early withdrawal levels would likely be different from those assumed in the table. Lastly, the ability of many borrowers to repay their adjustable rate debt may decline during a rising interest rate environment. Item 4T. Controls and Procedures. -------- ----------------------- (a) Evaluation of disclosure controls and procedures. Monroe Bancorp's Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of September 30, 2010, an evaluation was performed under the supervision and with the participation of Management, including the Chief Executive Officer (the Company's principal executive officer) and Chief Financial Officer (the Company's principal financial officer), of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as of September 30, 2010 were effective in ensuring material information required to be disclosed in this Quarterly Report on Form 10-Q was recorded, processed, summarized, and reported on a timely basis and are designed to ensure that information required to be disclosed in the Quarterly Report was accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure. (b) Changes in internal controls over financial reporting. There were no changes in the Company's internal control over financial reporting identified in connection with the Company's evaluation of controls that occurred during the quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Part II - Other Information --------------------------- Item 1. Legal Proceedings. ------- ------------------ None Item 1A. Risk Factors. -------- ------------- There have been no material changes in the risk factors from those described in our 2009 Annual Report on Form 10-K except as set forth below. The Recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act may have a material impact on our operations. On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Reform Act") into law. This new law broadly affects the financial services industry by establishing a framework for systemic risk oversight, creating a resolution authority, mandating higher capital and liquidity requirements, requiring banks to pay increased fees to regulatory agencies and containing numerous other provisions aimed at strengthening the sound operation of the financial services sector. The full impact of the Dodd-Frank Act on our business and operations may not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased compliance costs. We are required to comply with the terms of a memorandum of understanding issued by the Federal Deposit Insurance Corporation and the Indiana Department of Financial Institutions and lack of compliance could result in additional regulatory actions. 32 Effective April 29, 2010, the Bank entered into a memorandum of understanding with the FDIC and the DFI. In accordance with the MOU, the Bank agreed, among other things, to (a) maintain certain capital ratios; (b) refrain from paying cash dividends without prior regulatory approval; and (c) develop and implement plans to reduce the amounts of its assets classified "Substandard" or "Doubtful" in its most recent FDIC examination. The MOU will remain in effect until modified or terminated by the FDIC and the DFI. On July 22, 2010, the Board of Directors of the Company adopted a resolution requiring the Company to obtain the written approval of the Federal Reserve at least thirty days prior to the declaration or payment of corporate dividends, any increase in debt or issuance of trust preferred obligations, or the redemption of any Company stock. The resolution was adopted at the direction of the Federal Reserve and will remain in effect until the Federal Reserve authorizes its rescission. The Board of Directors and Management of the Bank have been taking action and implementing programs intended to comply with the requirements of the MOU. Notwithstanding the efforts of the Board of Directors and Management of the Bank, the FDIC or the DFI may determine that the issues raised by the MOU have not been addressed satisfactorily, or that any current or past actions, violations or deficiencies could be the subject of further regulatory enforcement actions. Such enforcement actions could involve penalties or limitations on our business at the Bank and negatively affect our ability to implement our business plan, as well as our financial condition and results of operations. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. ------- ------------------------------------------------------------ Stock Repurchased During the Third Quarter of 2010 -------------------------------------------------- No stock was repurchased by the Company during the fiscal quarter ended September 30, 2010. The Company's stock repurchase plan was announced June 16, 2006. The total dollar amount approved was $10,000,000. Under this repurchase program, the Company purchased 417,792 shares of stock at an average price of $17.29 per share totaling $7,224,000. The Company's most recent stock repurchase transaction took place on August 7, 2007. The plan has no expiration date, but the Board of Directors may terminate the plan at any time. The Board of Directors suspended repurchase activities beginning in the fourth quarter of 2007 and as of September 30, 2010, the Board of Directors has not determined when stock repurchases will recommence. Item 3. Defaults upon Senior Securities. ------- -------------------------------- Not applicable. Item 4. (Removed and Reserved). ------- ----------------------- Item 5. Other Information. ------- ------------------ Not applicable. Item 6. Exhibits. ------- --------- Exhibit No: Description of Exhibit: ----------- ----------------------- 2(i) Agreement and Plan of Merger among Monroe Bancorp and Old National Bancorp dated October 5, 2010 is incorporated by reference to Exhibit 2.1 of Registrant's Form 8-K filed October 6, 2010. 33 3(i) Monroe Bancorp Articles of Incorporation are incorporated by reference to registrant's Form 10 filed November 14, 2000 (File No. 000-31951). 3(ii) Monroe Bancorp Amended and Restated By-laws, amended April 29, 2010, are incorporated by reference to registrant's Form 8-K filed May 4, 2010 (File No. 000-31951). 4 Indenture dated as of July 17, 2009 by and between Wells Fargo Bank, N.A., and Monroe Bancorp is incorporated by reference to registrant's Form 8-K filed July 23, 2009 (File No. 000-31951). 10(i) Voting Agreement is incorporated by reference to Exhibit 10.1 to Registrant's Form 8-K filed October 6, 2010 (File No. 000-31951). 31(i) Certification for Quarterly Report on Form 10-Q by Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31(ii) Certification for Quarterly Report on Form 10-Q by Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32(i) Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32(ii) Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 34 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MONROE BANCORP Date: November 8, 2010 By: /s/ Mark D. Bradford ---------------- -------------------------------------- Mark D. Bradford, President and Chief Executive Officer (Principal Executive Officer) Date: November 8, 2010 By: /s/ Gordon M. Dyott ---------------- -------------------------------------- Gordon M. Dyott, Exec. Vice President, Chief Financial Officer (Principal Financial Officer) 35 Exhibit Index ------------- Exhibit No: Description of Exhibit: ----------- ------------------------ 2(i) Agreement and Plan of Merger among Monroe Bancorp and Old National Bancorp dated October 5, 2010 is incorporated by reference to Exhibit 2.1 of Registrant's Form 8-K filed October 6, 2010. 3(i) Monroe Bancorp Articles of Incorporation are incorporated by reference to registrant's Form 10 filed November 14, 2000 (File No. 000-31951). 3(ii) Monroe Bancorp Amended and Restated By-laws, amended April 29, 2010, are incorporated by reference to registrant's Form 8-K filed May 4, 2010 (File No. 000-31951). 4 Indenture dated as of July 17, 2009 by and between Wells Fargo Bank, N.A., and Monroe Bancorp is incorporated by reference to registrant's Form 8-K filed July 23, 2009 (File No. 000-31951). 10(i) Voting Agreement is incorporated by reference to Exhibit 10.1 to Registrant's Form 8-K filed October 6, 2010 (File No. 000-31951). 31(i) Certification for Quarterly Report on Form 10-Q by Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31(ii) Certification for Quarterly Report on Form 10-Q by Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32(i) Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32(ii) Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 36

MONROE BANCORP 10-Q