10-Q 1 b406752_10q.txt QUARTERLY REPORT U. S. 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 March 31, 2005 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from __________________to ____________________ Commission file number 000-32641 JAMES MONROE BANCORP, INC. (Exact Name of Registrant as Specified in its Charter) VIRGINIA 54-1941875 (State or Other Jurisdiction (I.R.S. Employer Identification No.) of Incorporation or Organization) 3033 WILSON BLVD., ARLINGTON, VIRGINIA 22201 (Address of Principal Executive Offices) 703-707-8855 (Registrant's Telephone Number, Including Area Code) N/A (Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report) 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 is an accelerated filer as defined in Rule 12b-2 of the Securities Exchange Act of 1934. Yes |_| No |X|. The number of shares of the registrant's common stock, $1 par value, as of May 13, 2005 is 4,448,752. 1 JAMES MONROE BANCORP, INC. TABLE OF CONTENTS

2 PART I. Financial Information Item 1. Financial Statements JAMES MONROE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS March 31, 2005, December 31, 2004, and March 31, 2004 (Dollars in thousands, except share data)

The accompanying notes are an integral part of these consolidated financial statements. 3 JAMES MONROE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share data)

The accompanying notes are an integral part of these consolidated financial statements. 4 JAMES MONROE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the Three Months Ended March 31, 2005, and 2004 (Dollars in thousands) (Unaudited)

The accompanying notes are an integral part of these consolidated financial statements. 5 JAMES MONROE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Three Months Ended March 31, 2005, and 2004 (Dollars in thousands) (Unaudited)

The accompanying notes are an integral part of these consolidated financial statements. 6 JAMES MONROE BANCORP, INC. AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1. Organization. James Monroe Bancorp, Inc. was incorporated under the laws of the Commonwealth of Virginia on April 9, 1999 to be the holding company for James Monroe Bank. James Monroe Bancorp acquired all of the shares of James Monroe Bank on July 1, 1999 in a mandatory share exchange under which each outstanding share of common stock of James Monroe Bank was exchanged for one share of James Monroe Bancorp common stock. James Monroe Bank, a Virginia chartered commercial bank, which is a member of the Federal Reserve System, is James Monroe Bancorp's sole operating subsidiary. James Monroe Bank commenced banking operations on June 8, 1998. As of March 31, 2005 the Company operated the main office in Arlington, Virginia, one branch in Annandale, Virginia, one branch and a drive-up facility in Leesburg, Virginia, one branch in Fairfax City, Virginia, one branch in Chantilly, Virginia, and one branch in Manassas, Virginia. Basis of Presentation. In the opinion of management, the accompanying unaudited consolidated financial statements of James Monroe Bancorp, Inc. and Subsidiaries (the Company) have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotes required for complete financial statements. In the opinion of management, all adjustments and reclassifications necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ended December 31, 2005, or any other period. The unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2004. Stock Compensation Plans. At March 31, 2005, the Company had three stock based compensation plans. The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of the grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock Based Compensation, to stock based employee compensation. The per share calculations have been restated to reflect the 3-for-2 stock split discussed in Note 7 and all preceding stock splits. THREE MONTHS ENDED MARCH 31, -------------------- 2005 2004 ------ ------- (Dollars in thousands, except per share data) Net income, as reported $ 768 $ 754 Additional expense had the company adopted SFAS No. 123 (112) (336) ----- ----- Pro forma net income $ 656 $ 418 ===== ===== Earnings per share: Basic- as reported $0.17 $0.17 ===== ===== Basic- pro forma $0.15 $0.09 ===== ===== Diluted- as reported $0.16 $0.16 ===== ===== Diluted- pro forma $0.14 $0.09 ===== ===== 7 NOTE 2. EARNINGS PER SHARE The following table discloses the calculation of basic and diluted earnings per share for the three months ended March 31, 2005 and 2004. The average shares outstanding and per share calculations have been restated to reflect the 3-for-2 stock split discussed in Note 7 and all preceding stock splits. THREE MONTHS ENDED MARCH 31, ------------------------- 2005 2004 ---------- ---------- (Dollars in thousands, except per share data) Net Income $ 768 $ 754 ========== ========== Weighted average shares outstanding--basic 4,445,269 4,429,442 Common share equivalents for stock options 247,772 233,298 ---------- ---------- Weighted average shares outstanding--diluted 4,693,041 4,662,740 ========== ========== Earnings per share-basic $ 0.17 $ 0.17 ========== ========== Earnings per share-diluted $ 0.16 $ 0.16 ========== ========== 8 NOTE 3. SECURITIES AVAILABLE FOR SALE Securities available for sale are reported at fair value with unrealized gains and losses (net of income taxes) recorded in stockholders' equity as a component of "accumulated other comprehensive income (loss)." Actual gains and losses on the sales of these securities, if any, are computed using the specific identification method and included in "gain (loss) on sale of securities" on the income statement. The amortized cost and carrying value (estimated market value) of securities available for sale at March 31, 2005, December 31, 2004, and March 31, 2004, are summarized in the tables that follow. The Company classifies all securities as available for sale.

9 Information pertaining to securities with gross unrealized losses at March 31, 2005 and December 31, 2004, aggregated by investment category and length of time that the individual securities have been in a continuous loss position, follows:

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. 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 of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The bonds in an unrealized loss position at March 31, 2005 and December 31, 2004 were temporarily impaired due to the current interest rate environment and not increased credit risk. All securities owned by the Company are payable at par at maturity. Of the securities temporarily impaired at March 31, 2005, 17 are U.S. Government agency issued bonds (Government National Mortgage Association and the Federal Home Loan Bank) rated AAA by Standard and Poor's, 25 are government sponsored enterprise issued bonds (Federal National Mortgage Association and Federal Home Loan Mortgage Corporation) rated AAA by Standard and Poor's, and one is a corporate bond rated BBB by Standard and Poor's. As management has the ability to hold debt securities until maturity, or for the foreseeable future, no declines are deemed to be other than temporary. 10 NOTE 4. LOANS Major classifications of loans at March 31, 2005, December 31, 2004, and March 31, 2004 are summarized in the following table.

Changes in the allowance for loan losses are as follows:

11 The following table presents the amounts of nonperforming assets at the dates indicated.

NOTE 5. DEPOSITS Interest bearing deposits consist of the following:

NOTE 6. TRUST PREFERRED CAPITAL SECURITIES On March 25, 2002, James Monroe Statutory Trust I, a subsidiary of the Company, was formed for the purpose of issuing redeemable trust preferred securities and purchasing the Company's junior subordinated debentures, which are its sole assets. The Company owns all of Trust I's outstanding common securities. On March 26, 2002, $5 million of the trust preferred securities were issued in a pooled underwriting totaling approximately $500 million. The securities bear interest at a rate equal to the three month LIBOR plus 360 basis points, subject to a cap of 11% which is set and payable on a quarterly basis. During 2004, the interest rates ranged from 4.71% to 5.55%. The rate for the quarterly period beginning December 26, 2004 was 6.15%. The rate for the quarterly period beginning March 26, 2005 is 6.69%. The securities have a maturity date of March 25, 2032, and are subject to varying call provisions beginning March 26, 2007. On July 16, 2003, James Monroe Statutory Trust II, a subsidiary of the Company, was formed for the purpose of issuing redeemable trust preferred securities and purchasing the Company's junior subordinated debentures, which are its sole assets. The Company owns all of Trust II's outstanding common securities. On July 31, 2003, $4 million of the trust preferred securities were issued in a private placement transaction. The securities bear interest at a rate equal to the three month LIBOR plus 310 basis points, subject to a cap of 12% which is set and payable on a quarterly basis. During 2004, the interest rates ranged from 4.20% to 5.08%. The rate for the quarterly period beginning December 31, 2004 was 5.66%. The rate for the quarterly period beginning March 31, 2005 is 6.19%. The securities have a maturity date of July 31, 2033, and are subject to ranging call provisions beginning July 31, 2008. 12 The trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital. The portion of the securities not considered as Tier 1 capital will be included in Tier 2 capital. At March 31, 2005, all of the trust preferred securities qualified as Tier 1 capital. The Company and the Trusts believe that, taken together, the Company's obligations under the junior subordinated debentures, the Indentures, the Trust Declarations and the Guarantees entered into in connection with the issuance of the trust preferred securities constitute a full and unconditional guarantee by the Company of the Trusts' respective obligations with respect to the trust preferred securities. Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on the junior subordinated debt securities, which would result in a deferral of distribution payments on the related trust preferred securities. NOTE 7. COMMON STOCK SPLIT On June 1, 2004 the Company issued 1,478,317 additional shares necessary to effect a 3-for-2 common stock split in the form of a 50% stock dividend to shareholders of record on May 14, 2004. The earnings per common share for all periods prior to June 2004 have been restated to reflect the stock split. NOTE 8. RECENT ACCOUNTING PRONOUNCEMENTS On December 16, 2004, the Financial Accounting Standards Board issued Statement No. 123R (revised 2004), "Share-Based Payment," (FAS 123R) that addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company's equity instruments or that may be settled by the issuance of such equity instruments. FAS 123R eliminates the ability to account for share-based compensation transactions using the intrinsic method and requires that such transactions be accounted for using a fair-value-based method and recognized as expense in the consolidated statement of income. The effective date of FAS 123R (as amended by the SEC) is for annual periods beginning after June 15, 2005. The provisions of FAS 123R do not have an impact on the Corporation's results of operations at the present time. In March 2005, the SEC issued Staff Accounting Bulleting No. 107 (SAB 107). SAB 107 expresses the views of the SEC staff regarding the interaction of FAS 123R and certain SEC rules and regulations and provides the SEC staff's view regarding the valuation of share-based payment arrangements for public companies. SAB 107 does not impact the Corporation's results of operations at the present time. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS This Management's Discussion and Analysis and other portions of this report contain forward looking statements within the meaning of the Securities Exchange Act of 1934, as amended, including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies and regarding general economic conditions. In some cases, forward looking statements can be identified by use of such words as "may," "will," "anticipate," "believes," "expects," "plans," "estimates," "potential," "continue," "should," and similar words or phases. These statements are based upon current and anticipated economic conditions, nationally and in the Company's market, interest rates and interest rate policies, competitive factors, government agencies and other third parties, which by their nature are not susceptible to accurate forecast, and are subject to significant uncertainty. Because of these uncertainties and the assumptions on which this discussion and the forward looking statements are based, actual future operations and results in the future may differ materially from those indicated herein. Readers are cautioned against placing undue reliance on any such forward looking statement. INTRODUCTION This Management's Discussion and Analysis reviews the financial condition and results of operations of the Company and its subsidiaries as of and for the three months ended March 31, 2005 and 2004. Some tables cover more than these periods to comply with Securities and Exchange Commission disclosure requirements or to illustrate trends over a period of time. When reading this discussion, reference should be made to the consolidated financial statements and related notes that appear herein and to our consolidated financial statements and footnotes thereto for the year ended December 31, 2004. CRITICAL ACCOUNTING POLICIES There were no changes to the Company's critical accounting policies in the first quarter of 2005. Critical accounting policies are those applications of accounting principles or practices that require considerable judgment, estimation, or sensitivity analysis by management. In the financial service industry, examples, albeit not an all inclusive list, of disclosures that may fall within this definition are the determination of the adequacy of the allowance for loan losses, valuation of mortgage servicing rights, valuation of derivatives or securities without a readily determinable market value, and the valuation of the fair value of intangibles and goodwill. Except for the determination of the adequacy of the allowance for loan losses, the Company does not believe there are other practices or policies that require significant sensitivity analysis, judgments, or estimations. Allowance for Loan Losses. The Company has developed a methodology to determine, on a quarterly basis, an allowance to absorb probable loan losses inherent in the portfolio based on evaluations of the collectibility of loans, historical loss experience, peer bank loss experience, delinquency trends, economic conditions, portfolio composition, and specific loss estimates for loans considered substandard or doubtful. All commercial and commercial real estate loans that exhibit probable or observed credit weaknesses are subject to individual review. If necessary, reserves would be allocated to individual loans based on management's estimate of the borrower's ability to repay the loan given the availability of collateral and other sources of cash flow. Any reserves for impaired loans are measured based on the present rate or fair value of the underlying collateral. The Company evaluates the collectibility of both principal and interest when assessing the need for a loss accrual. A composite allowance factor that considers the Company's and other peer bank loss experience ratios, delinquency trends, economic conditions, and portfolio composition are applied to the total of commercial and commercial real estate loans not specifically evaluated. A percentage of this composite allowance factor is also applied to the aggregate of unused commercial lines of credit which the Company has an obligation to honor but where the borrower has not elected to draw on their lines of credit. Homogeneous loans, such as consumer installment, residential mortgage loans, home equity loans, and smaller consumer loans are not individually risk graded. Reserves are established for each homogeneous pool of loans based on the expected net charge offs from a current trend in delinquencies, losses or historical experience and general economic conditions. The Company has no material delinquencies in these types of loans, and has not, since inception, had a trend or an indication of a trend that would guide the Company in expected material losses in these types of homogeneous pools of loans. The Company's allowance for loan losses is determined based upon a methodology developed by management as described above and is approved by the board of directors each quarter. 14 COMPANY HIGHLIGHTS SINCE DECEMBER 31, 2004 ARE: o Assets grew $13.9 million (3%). o Loans grew $41.6 million (17%). o Deposits grew $13.7 million (3%). o Net interest margin was 3.82% for the first three months of 2005 compared to 3.72% for the full year 2004 and 3.91% during the first three months of 2004. o Asset quality remained strong as nonperforming assets decreased $34,000 to $315,000. The allowance for loan losses totaled 1.11% of total loans outstanding at March 31, 2005. o The Company ended the quarter with adequate capital to support further growth. o Initiatives undertaken during 2004 including the Company's expansion into the Chantilly and Manassas markets, and the opening of a new operations center, were growth oriented initiatives taken after additional capital was raised in the fourth quarter of 2003. While these pro-active initiatives have increased operating expenses, as evidenced by the rise in the Bank's efficiency ratio to 63% for the first quarter of 2005, the Company's focus remains on a long term strategy of expanding our franchise throughout the Northern Virginia market. FINANCIAL OVERVIEW The following discussion provides information about the results of operations and financial condition, liquidity, and capital resources of the Company and should be read in conjunction with our consolidated financial statements and notes thereto for the year ended December 31, 2004. BALANCE SHEET March 31, 2005 vs. December 31, 2004 and March 31, 2004. Total assets increased to $464.6 million at March 31, 2005, an increase of $13.9 million from December 31, 2004, and an increase of $130.2 million from March 31, 2004. The increase in assets since March 31, 2004 resulted from the Company's emphasis on deposit generation. Since March 31, 2004, deposits increased $134.4 million, with noninterest bearing deposits increasing $17.2 million, and interest bearing deposits increasing $117.2 million. With the growth in deposits, the Company was able to fund $102.3 million net increase in loans. Securities increased $32.1 million and overnight investments decreased $14.3 million. Net loans increased $41.6 million from December 31, 2004 funded in part by deposit growth of $13.7 million and a decrease in overnight investments of $33.7 million. RESULTS OF OPERATIONS First Quarter 2005 vs. First Quarter 2004. For the three months ended March 31, 2005, the Company had net income of $768,000, or $.16 per diluted share, compared to $754,000 or $.16 per diluted share, for the comparable period of 2004. Annualized return on average assets was .70% for the three months ended March 31, 2005, compared to .98% for the same three month period in 2004. Return on average equity was 8.36% for the three months ended March 31, 2005, compared with 8.70% for the same three month period in 2004. During the first quarter of 2005, the Company continued to focus on managing its net interest margin, especially in light of the low, but rising, interest rate environment. Beginning in 2001 through June 2003, the Federal Reserve reduced the federal funds target rate an aggregate of 550 basis points. These dramatic reductions over a relatively short period continued to impact the loan and investment portfolios in 2003 and 2004, as loans repriced on a delayed basis or renewed at lower interest rates, and as investment securities matured or were called, and were reinvested at lower rates. This was partially offset by continued repricing upon renewal of certificates of deposit. While the Federal Reserve began to reverse the rate reductions, through a series of seven increases aggregating 175 basis points, beginning on June 30, 2004 through March 22, 2005, the rate reductions and continuing low rate environment have caused a reduction in the net interest margin throughout the period, from 5.09% in 2000 to 4.56% in 2001 to 3.90% in 2002 to 3.73% in 2003 to 3.72% in 2004. Despite these reductions, the Company's practice of managing its interest rate risk process has mitigated the negative effect of such a severely declining and low rate environment. As the rate increases have begun to impact the Company, the net interest margin improved in the first quarter of 2005 compared to the fourth quarter of 2004, increasing to 3.82%. The Company expects that continued increases in the federal funds target rate will further contribute to increased margin as earning assets reprice, while repricing of deposits lags. However, as discussed further under "Liquidity and Interest Rate Sensitivity Management," as a result of competitive factors, market conditions, customer preferences and other factors, the Company may not be able to benefit from further increases in market interest rates. 15 Although the Company has continued to grow in asset size since its inception in 1998 it has been able to control its operating efficiency. Within the past year the Company expanded into the Chantilly and Manassas markets and opened a new operations center. These are growth oriented initiatives taken after additional capital was raised in the fourth quarter of 2003. While these pro-active initiatives have increased operating expenses, as evidenced by the rise in the bank's efficiency ratio to 63% for the first quarter of 2005, the Company's focus remains on a long term strategy of expanding our franchise throughout the Northern Virginia market. The efficiency ratio is a non-GAAP financial measure, which we believe provides investors with important information regarding our operational efficiency. We compute our efficiency ratio by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income, which includes securities gains or losses and gains or losses on the sale of mortgage loans. Comparison of our efficiency ratio with those of other companies may not be possible, because other companies may calculate the efficiency ratio differently. 16 QUARTERLY RESULTS OF OPERATIONS

(1) Information has been adjusted to reflect the 3-for-2 stock split paid on June 1, 2004. (2) Computed by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income, including securities gains or losses and gains or losses on the sale of loans. This is a non-GAAP financial measure, which we believe provides investors with important information regarding our operational efficiency. Comparison of our efficiency ratio with those of other companies may not be possible, because other companies may calculate the efficiency ratio differently. 17 NET INTEREST INCOME, AVERAGE BALANCES AND YIELDS Net interest income is the difference between interest and fees earned on assets and the interest paid on deposits and borrowings. Net interest income is one of the major determining factors in the Bank's performance as it is the principal source of revenue and earnings. Unlike the larger regional or mega-banks that have significant sources of fee income, community banks, such as James Monroe Bank, rely on net interest income from traditional banking activities as the primary revenue source. Table 1 provides certain information relating to the Company's average consolidated statements of financial condition and reflects the interest income on interest earning assets and interest expense of interest bearing liabilities for the quarters ended March 31, 2005 and 2004 and the average yields earned and rates paid during those periods. These yields and costs are derived by dividing income or expense by the average daily balance of the related asset or liability for the periods presented. The Company did not have any tax exempt income during any of the periods presented in Table 1. Nonaccrual loans have been included in the average balances of loans receivable. First Quarter 2005 vs. First Quarter 2004. For the quarter ended March 31, 2005, net interest income increased $1.2 million, or 41%, to $4.0 million from $2.9 million earned during the same period in 2004. This was primarily a result of the increase in the volume of earning assets, and partially offset by increases in rates on interest bearing liabilities which exceeded the increase in rates on interest earning assets. During the quarter ended March 31, 2005, total average earning assets increased by $132.2 million, or 45%, from the same period of 2004. Average loans outstanding grew by $91.7 million, or 52%, during the first quarter of 2005 compared to the same quarter in 2004, and at the same time, the yield on such loans increased by 6 basis points. Average securities increased $30.9 million, or 27%, during the first quarter of 2005 compared to the same period in 2004 and the yield on the securities portfolio increased by 50 basis points. Additional securities were purchased from the liquidity generated throughout the past year and invested in securities at yields greater than federal funds, but less than yields generated by loans. Federal funds sold increased by $8.2 million over the same period last year and the yield on these funds increased by 61 basis points. During the first quarter of 2005, average interest bearing liabilities increased $112.0 million, or 55% from the same period of 2004. Interest bearing deposits increased $117.2 million and borrowings, which includes Federal funds purchased and trust preferred capital notes, decreased $5.2 million. Interest expense paid on these liabilities during the first quarter of 2005 was $1.8 million compared with $962,000 for the same period of 2004. The yield on earning assets increased 27 basis points to 5.49% for the quarter ending March 31, 2005 from 5.22% during the same period in 2004 reflecting the overall rise in interest rates from the first quarter of 2004 to the same period this year. The overall yield on loans increased slightly by 6 basis points while the yield on the securities portfolio increased 50 basis points and the yield on overnight investments increased 61 basis points. The cost of funds rose 36 basis points to 2.25% for the quarter ending March 31, 2005 from 1.89% during the same period in 2004. The resulting effect of the changes in interest rates between the quarters ended March 31, 2005 and 2004, offset by changes in the volume and mix of earning assets and interest bearing liabilities resulted in a relatively stable net interest margin of 3.82% in 2005 versus 3.91% in 2004. Management believes this stability is indicative of the Company's interest rate risk management process. 18 TABLE 1: AVERAGE BALANCE SHEETS, NET INTEREST INCOME, AND YIELDS/RATES

19 Table 2 shows the composition of the net change in net interest income for the periods indicated, as allocated between the change due to changes in the volume of average earning assets and interest bearing liabilities, and the changes due to changes in interest rates. As the table shows, the increase in net interest income of $1.2 million for the quarter ended March 31, 2005, as compared to the quarter ended March 31, 2004, is due to the growth in the volume of earning assets and interest bearing liabilities. While the slight rise in interest rates has, to date, had minimal impact on interest income, it has had a greater impact on interest expense. Management has controlled its exposure to changes in interest rates such that dramatic declines in rates from 2001 through 2003 and the continued low interest rate environment has resulted in a modest $126,000 decline of net interest income during the first quarter of 2005 compared to the same quarter last year, whereas the growth in earning assets and deposits resulted in an increase of $1.3 million to net interest income. Interest income increased $2.0 million during the first quarter of 2005 compared to the first quarter of 2004 as higher yielding loans grew at a faster pace than lower yielding securities and overnight investments resulting in a $1.8 million increase in interest income attributable to asset growth while changes in rates resulted in growth of interest income of $181,000. Interest expense during these comparable quarters increased $794,000 or 83%, from $962,000 in interest expense in 2004 to $1.8 million in interest expense in 2005. The overall cost of interest bearing liabilities increased 36 basis points from 1.89% in 2004 to 2.25% in 2005. TABLE 2

20 PROVISION AND ALLOWANCE FOR LOAN LOSSES The provision for loan losses is based upon a methodology that includes among other factors, a specific evaluation of commercial and commercial real estate loans that are considered special mention, substandard or doubtful. All other loans are then categorized in pools of loans with common characteristics. A potential loss factor is applied to these loans which considers the historical charge off history of the Company and its peer group, trends in delinquencies and loan grading, current economic conditions, and factors that include the composition of the Company's loan portfolio. At March 31, 2005, the Company had a $173,000 impaired loan on nonaccrual status and an additional $142,000 in loans on nonaccrual status or past due 90 days or more and still accruing. See Note 4 to the unaudited consolidated financial statements for additional information regarding the Company's asset quality and allowance for loan losses. While the dollar volume of total nonperforming loans at March 31, 2005 is approximately the same as the volume of such loans at March 31, 2004 and December 31, 2004, the percentage of total loans represented by such nonperforming loans has declined significantly from 0.18% at March 31, 2004 to 0.14% at December 31, 2004 to 0.11% at March 31, 2005. A methodology established in 2003 determining an appropriate allowance for loan losses was approved by the Audit Committee and the Board of Directors. The quarterly provision is approved by the Board. The methodology is reevaluated on a quarterly basis. Pending the development of a negative trend with respect to past due loans or charge offs or significant changes in economic conditions, the Company continues to maintain an allowance it believes is adequate. As reflected in Table 3 below, the allowance is allocated among the various categories of loans based upon the methodology described herein. TABLE 3 The following table shows the allocation of the allowance for loan losses at the dates indicated. The allocation of portions of the allowance to specific categories of loans is not intended to be indicative of future losses, and does not restrict the use of the allowance to absorb losses in any category of loans. See Note 4 to the unaudited consolidated financial statements included in this report for additional information regarding the allowance for loan losses and nonperforming assets.

LOANS The loan portfolio is the largest component of earning assets and accounts for the greatest portion of total interest income. At March 31, 2005, total loans were $291.6 million, a 54% increase from the $189.3 million in loans outstanding at March 31, 2004. Total loans at March 31, 2005 represented a 17% increase from the $250.0 million of loans at December 31, 2004. In general, loans are internally generated with the exception of a small percentage of participation loans purchased from other local community banks. Lending activity is largely confined to our market of Northern Virginia. We do not engage in highly leveraged transactions or foreign lending activities. Loans in the commercial category, as well as commercial real estate mortgages, consist primarily of short term (five year or less final maturity) and/or floating or adjustable rate commercial loans made to small to medium sized companies. We do not have any agricultural loans in the portfolio. There are no substantial loan concentrations to any one industry or to any one borrower. 21 Virtually all of the Company's commercial real estate mortgage and development loans, which account for approximately 68% of our total loans at March 31, 2005, relate to property in the Northern Virginia market. As such, they are subject to risks relating to the general economic conditions in that market, and the market for real estate in particular. While the region has experienced some decline in economic activity during 2002 and 2003, the local real estate market remains generally strong, and the Company attempts to mitigate risk though careful underwriting, including primary reliance on the borrower's financial capacity and ability to repay without resort to the property, and lends primarily with respect to properties occupied or managed by the owner. The Company's 1-4 family residential real estate loans are generally not the typical purchase money first mortgage loan or refinancing, but are loans made for other purposes and the collateral obtained is a first deed of trust on the residential property of the borrower. The underlying loan would have a final maturity much shorter than the typical first mortgage and may be a variable or fixed rate loan. As reflected in Table 4, 29% of the Company's loans are fixed rate loans and 94% of the Company's loans reprice or have a maturity date that falls within five years. Consumer loans consist primarily of secured installment credits to individuals. The consumer portfolio, which includes consumer loans, home equity loans, and 1-4 family residential loans, represents 5.1% of the loan portfolio at March 31, 2005, as compared to 7.0% at March 31, 2004 and 5.8% at December 31, 2004. TABLE 4 Table 4 shows the maturities of the loan portfolio and the sensitivity of loans to interest rate fluctuations at March 31, 2005. Maturities are based on the earlier of contractual maturity or repricing date. Demand loans, loans with no contractual maturity and overdrafts are represented in one year or less.

22 INVESTMENT SECURITIES The Company currently, and for all periods shown, classifies its entire securities portfolio as available for sale. Increases in the portfolio have occurred whenever deposit growth has outpaced loan demand and the forecast for loan growth is such that the investment of excess liquidity in investment securities (as opposed to short term investments such as federal funds) is warranted. In general, our investment philosophy is to acquire high quality government agency securities or high grade corporate bonds, with a maturity of five to six years or less in the case of fixed rate securities. In the case of mortgage backed securities, the policy is to invest only in those securities whose average expected life is projected to be approximately five to six years or less. Mortgage backed securities with a maturity of ten years or more are either adjustable rate securities or the expected life of the mortgage pool is generally no more than five or six years. To the extent possible, we attempt to "ladder" the one time call dates for all our securities. The Company's investment policy is driven by its interest rate risk process and the need to minimize the effect of changing interest rates to the entire balance sheet. The following table provides information regarding the composition of our investment portfolio at the dates indicated. TABLE 5

TABLE 6 The following table provides information regarding the maturity composition of our investment portfolio, at fair value, at March 31, 2005.

23 LIQUIDITY AND INTEREST RATE SENSITIVITY MANAGEMENT The primary objectives of asset and liability management are to provide for the safety of depositor and investor funds, assure adequate liquidity, and maintain an appropriate balance between interest sensitive earning assets and interest bearing liabilities. Liquidity management involves the ability to meet the cash flow requirements of customers, who may be depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. We define liquidity for these purposes as the ability to raise cash quickly at a reasonable cost without principal loss. The primary liquidity measurement we utilize is called the Basic Surplus, which captures the adequacy of our access to reliable sources of cash relative to the stability of our funding mix of deposits. Accordingly, we have established borrowing facilities with other banks (Federal funds) and the Federal Home Loan Bank as sources of liquidity in addition to the deposits. The Basic Surplus approach enables us to adequately manage liquidity from both tactical and contingency perspectives. At March 31, 2005, our Basic Surplus ratio (net access to cash and secured borrowings as a percentage of total assets) was approximately 18.9% compared to the present internal minimum guideline range of 5% to 10%. Financial institutions utilize a number of methods to evaluate interest rate risk. Methods range from the original static gap analysis (the difference between interest sensitive assets and interest sensitive liabilities repricing during the same period, measured at a specific point in time), to running multiple simulations of potential interest rate scenarios, to rate shock analysis, to highly complicated duration analysis. One tool that we utilize in managing our interest rate risk is the matched funding matrix. The matrix arrays repricing opportunities along a time line for both assets and liabilities. The longer term, more fixed rate sources are presented in the upper left hand corner while the shorter term, more variable rate items, are at the lower left. Similarly, uses of funds, such as assets, are arranged across the top moving from left to right. The body of the matrix is derived by allocating the longest fixed rate funding sources to the longest fixed rate assets and shorter term variable sources to shorter term variable uses. The result is a graphical depiction of the time periods over which we expect to experience exposure to rising or falling rates. Since the scales of the liability and assets sides are identical, all numbers in the matrix would fall within the diagonal lines if we were perfectly matched across all repricing time frames. Numbers outside the diagonal lines represent two general types of mismatches: liability sensitive in time frames when numbers are to the left of the diagonal line and asset sensitive in time frames when numbers are to the right of the diagonal line. At March 31, 2005, we were modestly liability sensitive in the short term and then we become asset sensitive out beyond three years. This is primarily caused by the assumptions used in allocating a repricing term to nonmaturity deposits--demand deposits, savings accounts, and money market deposit accounts. The actual impact due to changes in interest rates is difficult to quantify in that the administrative ability to change rates on these products is influenced by competitive market conditions in changing rate environments, prepayments of loans, customer demands, and many other factors. These products may not reprice consistently with assets such as variable rate commercial loans or other loans that immediately reprice as the prime rate changes. While the traditional gap analysis and the matched funding matrix show a general picture of our potential sensitivity to changes in interest rates, it cannot quantify the actual impact of interest rate changes. Thus, the Company manages its exposure to possible changes in interest rates by simulation modeling or "what if" scenarios to quantify the potential financial implications of changes in interest rates. In practice, each quarter approximately 14 different "what if" scenarios are evaluated which include the following scenarios: Static Rates, Most Likely Rate Projection, Rising Rate Environment, Declining Rate Environment, Ramp Up 100bp and 200bp over 12-months, and Ramp Down 100bp and 200bp over 12-months scenarios. In addition, 8 rate shock scenarios are modeled at 50bp up and 50bp down increments but not below zero. At March 31, 2005, the following 12-month impact on net interest income is estimated to range from a positive impact of 6.3% in a rising rate scenario, to a negative impact of (2.4)% if rates decline 200 basis points from current levels. In the rate shock scenarios the 12-month impact on net interest income is estimated to range from a positive impact of 0.71% if rates were to immediately increase 200 basis points, to a negative impact of (6.12)% if rates were to immediately decline 200 basis points. The Company believes these ranges of exposure to changes in interest rates to be well within acceptable range given a wide variety of potential rate change scenarios. This process is performed each quarter to ensure the Company is not materially at risk to possible changes in interest rates. 24 The following are the projected potential percentage impact on the Company's net interest income over the next 12 months for the scenarios the Company believes are most likely to occur, but measured against a static interest rate environment as of March 31, 2005. The Company is positioned to improve earnings if rates continue to rise. With respect to further reductions in rates, the Company would experience further negative implications on margins and earnings; however, the Company does not believe that a 100 basis point decline is realistic given that interest rates remain near historically low levels, and in light of the Federal Reserve's indications with respect to the interest rate environment. Thus management believes the exposure to further changes in interest rates would not have a material negative effect on the results of operations. Static Rates -0- % Most Likely Rates 4.5 % Ramp Up 100bp- 12 months 0.8 % Ramp Up 200bp- 12 months 1.9 % Ramp Down 100bp- 12 months (0.8)% Rising Rate Scenario 6.3 % Low Rate Environment 1.5 % NONINTEREST INCOME AND EXPENSE Noninterest income consists primarily of service charges on deposit accounts, gains on sales of loans and fees and other charges for banking services. Noninterest expense consists primarily of salary and benefit costs and occupancy and equipment expense. To date, the company has not been required to pay any premiums for deposit insurance. To the extent that deposit premiums may become required, the Company's results of operations will be adversely affected. The following table shows the detail of noninterest income for the three month periods ended March 31, 2005 and 2004. TABLE 7 The categories of noninterest income that exceed 1% of operating revenue are as follows: THREE-MONTHS ENDED MARCH 31, ---------------- (Dollars in thousands) 2005 2004 ------ ------ Service charges on deposit accounts $ 75 $ 84 Cash management fees 28 24 Other fee income 59 70 Gain on sale of mortgages 162 63 Gain on sale of securities 8 40 ---- ---- Total noninterest income $332 $281 ==== ==== The increase in noninterest income during the three month period ended March 31, 2005 compared to the same period last year is due in large part to an increase in the gain on sale of mortgages. Gains on sales of securities declined in the first quarter of 2005 compared to the same period last year. 25 TABLE 8 The categories of noninterest expense that exceed 1% of operating revenue are as follows: THREE-MONTHS ENDED MARCH 31, -------------------- (Dollars in thousands) 2005 2004 -------- ------- Salaries and benefits $1,611 $1,023 Occupancy cost, net 307 165 Equipment expense 167 74 Professional fees 38 45 Data processing costs 148 116 Courier and express services 12 41 Advertising and public relations 61 44 State franchise tax 82 65 Compliance expense 43 - Other 284 124 ------ ------ Other noninterest expense $2,753 $1,697 ====== ====== Noninterest expense increased $1.1 million from $1.7 million to $2.8 million for the first three months of 2005, as compared to the same period in 2004. Approximately 56% of this increase is in salary and benefit costs. During 2004 the Company added personnel to staff the newly opened branches and administrative staff to support the growth in customers and transactions being processed. Occupancy costs and equipment costs increased over the first quarter of 2004 as two new banking offices and an operations center were opened in the third quarter of 2004. The increase in state franchise tax is due to the increased capital of the Bank from earnings retention and capital infusions in 2004 and 2005. DEPOSITS AND OTHER BORROWINGS The principal sources of funds for the Bank are core deposits (demand deposits, NOW accounts, money market accounts, savings accounts and certificates of deposit less than $100,000) from the local market areas surrounding the Bank's offices. The Bank's deposit base includes transaction accounts, time and savings accounts and accounts which customers use for cash management and which provide the Bank with a source of fee income and cross marketing opportunities as well as a low cost source of funds. Time and savings accounts, including money market deposit accounts, also provide a relatively stable and low cost source of funding. 26 TABLE 9 The following table reflects deposits by category for the periods indicated.

TABLE 10 The following table indicates the amount of certificates of deposit of less than $100,000 and $100,000 or more, and their remaining maturities as of March 31, 2005.

CAPITAL MANAGEMENT Management monitors historical and projected earnings, asset growth, as well as its liquidity and various balance sheet risks in order to determine appropriate capital levels. At March 31, 2005, stockholders' equity increased $635,000 to $36.3 million from the $35.6 million in equity at March 31, 2004 as a result of the $3.0 million increase in retained earnings over the past twelve months offset by the decline in other comprehensive income of $2.6 million resulting from unrealized losses on securities. In addition, $209,000 was contributed to capital from the exercise of options and sale of shares in the Company's KSOP plan. Capital Requirement. A comparison of the Company's and the Bank's regulatory capital at March 31, 2005, compared to minimum regulatory capital guidelines is shown in the table that follows. 27 TABLE 11 Minimum Minimum To Be Actual Guidelines "Well Capitalized" ------ ---------- ------------------ Total Risk-Based Capital Company 15.8% 8.0% N/A Bank 12.0% 8.0% 10.0% Tier 1 Risk-Based Capital Company 14.7% 4.0% N/A Bank 11.0% 4.0% 6.0% Tier 1 Leverage Ratio Company 10.5% 4.0% N/A Bank 8.0% 4.0% 5.0% ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Please refer to Item 2 of this report, "Management's Discussion and Analysis of Financial Condition and Results of Operations", under the caption "Liquidity and Interest Rate Sensitivity Management." ITEM 4. CONTROLS AND PROCEDURES The Company's management, under the supervision and with the participation of the Chief Executive Officer, Chief Operating Officer, and Chief Financial Officer, evaluated, as of the last day of the period covered by this report, the effectiveness of the design and operation of the Company's disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer, Chief Operating Officer, and Chief Financial Officer concluded that the Company's disclosure controls and procedures were adequate. There were no changes in the Bank's internal control over financial reporting (as defined in Rule 13a-15 under the Securities Act of 1934) during the quarter ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, the Bank's internal control over financial reporting. 28 PART II. Other Information Item 1. Legal Proceedings None Item 2 - Unregistered Sale of Equity Securities and Use of Proceeds. (a) Sales of Unregistered Securities. None (b) Use of Proceeds. Not Applicable. (c) Purchases of Securities. None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information (a) Required Form 8-K Disclosures None (b) Changes in Procedures for Director Nominations by Security Holders. None Item 6. Exhibits Number Description ------ ----------- 3(a) Articles of Incorporation of James Monroe Bancorp (1) 3(b) Bylaws of James Monroe Bancorp (2) 4(a) Indenture, dated as of March 26, 2002 between James Monroe Bancorp, Inc. and State Street Bank and Trust Company of Connecticut, National Association, as trustee (3) 4(b) Amended and Restated Declaration of Trust, dated as of March 26, 2002 among James Monroe Bancorp, Inc., State Street Bank and Trust Company of Connecticut, National Association, as Institutional Trustee, and John R. Maxwell, David W. Pijor and Richard I. Linhart as Administrators (3) 4(c) Guarantee Agreement dated as of March 26, 2002, between James Monroe Bancorp, Inc. and State Street Bank and Trust Company of Connecticut, National Association, as trustee (3) 4(d) Indenture, dated as of July 31, 2003 between James Monroe Bancorp, Inc. and U.S. Bank, National Association, as trustee (3) 4(e) Amended and Restated Declaration of Trust, dated as of July 31, 2003 among James Monroe Bancorp, Inc., U.S. Bank, National Association, as Institutional Trustee, and John R. Maxwell, David W. Pijor and Richard I. Linhart as Administrators (3) 4(f) Guarantee Agreement dated as of July 31, 2003, between James Monroe Bancorp, Inc. and U.S. Bank, National Association, as trustee (3) 10(a) Employment contract between James Monroe Bancorp and John R. Maxwell(4) 10(b) Employment contract between James Monroe Bancorp and Richard I. Linhart (5) 10(c) James Monroe Bancorp 1998 Management Incentive Stock Option Plan (6) 10(d) James Monroe Bancorp 2000 Director's Stock Option Plan (7) 10(e) James Monroe Bancorp, Inc. 2003 Equity Compensation Plan (8) 11 Statement re: Computation of Per Share Earnings Please refer to Note 2 to the financial statements included in this report. 21 Subsidiaries of the Registrant 31(a) Certification of Chief Executive Officer 31(b) Certification of Chief Operating Officer 31(c) Certification of Chief Financial Officer 32(a) Certification of Chief Executive Officer 32(b) Certification of Chief Operating Officer 32(c) Certification of Chief Financial Officer 29 -------------------------- (1) Incorporated by reference to exhibit 3(a) to the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004. (2) Incorporated by reference to exhibit 3(b) to the Company's registration statement on Form SB-2 (No. 333-38098). (3) Not filed in accordance with the provisions of Item 601(b)(4)(iii) of Regulation SK. The Company agrees to provide a copy of these documents to the Commission upon request. (4) Incorporated by reference to exhibit of same number to the Company's Annual Report on Form 10-KSB for the year ended December 31, 2002. (5) Incorporated by reference to exhibit of same number to the Company's Annual Report on Form 10-KSB for the year ended December 31, 2003. (6) Incorporated by reference to exhibit 10(b) to the Company's registration statement on Form SB-2 (No. 333-38098). (7) Incorporated by reference to exhibit 10(c) to the Company's registration statement on Form SB-2 (No. 333-38098). (8) Incorporated by reference to exhibit 10(e) to the Company's Quarterly Report on Form 10-QSB for the quarter ended June 30, 2003. 30 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. Date: May 13, 2005 BY: /s/John R. Maxwell ------------------------------------ John R. Maxwell, President & Chief Executive Officer Date: May 13, 2005 BY: /s/ Richard I. Linhart ------------------------------------ Richard I. Linhart, Executive Vice President & Chief Operating Officer Date: May 13, 2005 BY: /s/ John J. Brough ------------------------------- John J. Brough, Senior Vice President & Chief Financial Officer 31

MONROE JAMES BANCORP INC 10-Q