Marathon Banking Corporation and Subsidiaries Consolidated Financial Statements December 31, 2011 and 2010

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1 Marathon Banking Corporation and Subsidiaries Consolidated Financial Statements

2 Index Page(s) Independent Auditors Report... 1 Consolidated Financial Statements Consolidated Statements of Financial Condition... 2 Consolidated Statements of Income... 3 Consolidated Statements of Stockholders Equity and Comprehensive Income... 4 Consolidated Statements of Cash Flows... 5 Notes to Consolidated Financial Statements

3 Independent Auditors Report Board of Directors Marathon Banking Corporation and Subsidiaries We have audited the consolidated statement of financial condition of Marathon Banking Corporation and Subsidiaries (the Bank ) as of December 31, 2011 and the related consolidated statements of income, stockholders equity and comprehensive income and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Bank s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The consolidated financial statements of the Bank as of and for the year ended December 31, 2010 were audited by other auditors whose report dated May 5, 2011 expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the December 31, 2011 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Marathon Banking Corporation and Subsidiaries as of December 31, 2011, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. New York, New York April 16,

4 Consolidated Statements of Financial Condition Assets Cash and cash equivalents $ 11,318,130 $ 7,694,791 Restricted cash 1,000,000 1,000,000 Interest bearing deposits with banks 216,244, ,661,016 Investment securities available-for-sale, at fair value 37,343,118 46,525,661 (included assets pledged of $31,016,105 and $36,739,945 at, respectively) Investment securities held-to-maturity (fair value of $15,560,882 and $32,006,627 and assets pledged of $14,589,005 and $30,519,934 at, respectively) 14,589,005 30,843,672 Loans receivable, net 545,619, ,255,263 Premises and equipment, net 6,652,490 4,992,297 Accrued interest receivable 2,828,213 2,762,938 Bank owned life insurance 8,500,061 8,206,499 Goodwill 19,036,657 19,036,657 Intangible assets, net 1,849,755 2,751,558 Federal Home Loan Bank and Federal Reserve Bank stock 2,904,450 2,852,250 Other real estated owned 625,000 - Deferred tax asset, net 7,927,248 7,704,160 Other assets 4,442,998 5,391,189 Total assets $ 880,880,295 $ 838,677,951 Liabilities and Stockholders Equity Deposits Noninterest bearing - demand $ 202,196,800 $ 165,242,443 Savings, NOW and money market 284,583, ,441,761 Certificates of deposit, under $100, ,525,176 91,548,719 Certificates of deposit, $100,000 and over 176,893, ,987,102 Total deposits 765,199, ,220,025 Accrued interest payable 823,796 1,107,011 Other liabilities 1,357,910 1,837,398 Subordinated debt 5,155,000 5,155,000 Total liabilities 772,536, ,319,434 Stockholders equity Common stock - $1.00 par value, 200,000 shares authorized, 124,188 shares issued and outstanding, in 2011 and , ,188 Additional paid-in capital 53,649,527 53,649,527 Retained earnings 56,897,604 51,465,154 Accumulated other comprehensive loss (2,327,344) (1,880,352) Total stockholders equity 108,343, ,358,517 Total liabilities and stockholders equity $ 880,880,295 $ 838,677,951 The accompanying notes are an integral part of these consolidated financial statements. 2

5 Consolidated Statements of Income Years Ended Interest and dividend income Loans, including fees $ 32,528,100 $ 33,294,094 Investment securities - taxable 2,928,210 3,981,139 Investment securities - tax exempt 134, ,036 Federal funds sold - 9,135 Total interest and dividend income 35,590,378 37,474,404 Interest expense Deposits 5,481,377 7,087,415 Borrowings 330, ,840 Total interest expense 5,811,629 7,422,255 Net interest income 29,778,749 30,052,149 (Recovery of) provision for loan losses (638,622) 200,000 Net interest income after provision for loan losses 30,417,371 29,852,149 Non-interest income Other-than-temporary impairment ("OTTI") loss on securities (719,316) (160,598) Less: Portion of loss recognized in other comprehensive income, before taxes 231,283 (20,476) Net OTTI charge recognized in earnings (488,033) (181,074) Service fees on deposit accounts 1,560,146 1,490,185 BOLI income 293, ,809 Other income 644, ,244 Total non-interest income 2,009,794 2,238,164 Non-interest expense Salaries and employee benefits 11,160,796 11,613,353 Occupancy and equipment 5,233,255 5,000,381 Data processing 848, ,839 Professional services 1,176,206 1,478,064 Amortization of core deposit intangible 901, ,553 Loss on sale of loans - 586,334 FDIC assessment 1,047,111 1,637,199 OREO expenses 625,000 - Other operating 2,721,402 2,593,260 Total non-interest expense 23,713,604 24,645,983 Income before income taxes 8,713,561 7,444,330 Income taxes 3,276,831 2,403,640 Net income $ 5,436,730 $ 5,040,690 The accompanying notes are an integral part of these consolidated financial statements. 3

6 Consolidated Statements of Stockholders Equity and Comprehensive Income Years Ended Accumulated Common Stock Additional Other Par Paid-In Retained Comprehensive Comprehensive Shares Value Capital Earnings Loss Income Total Balance at January 1, ,188 $ 124,188 $ 53,063,193 $ 46,428,904 $ (1,601,600) $ - $ 98,014,685 Net income ,040,690-5,040,690 5,040,690 Dividends to minority interest (4,440) - - (4,440) Capital contribution , ,334 Other comprehensive loss, net (278,752) (278,752) (278,752) Total comprehensive income 4,761,938 Balance at December 31, , ,188 53,649,527 51,465,154 (1,880,352) - 103,358,517 Net income ,436,730-5,436,730 5,436,730 Dividends to minority interest (4,280) - - (4,280) Other comprehensive loss, net (446,992) (446,992) (446,992) Total comprehensive income $ 4,989,738 Balance at December 31, ,188 $ 124,188 $ 53,649,527 $ 56,897,604 $ (2,327,344) $ 108,343,975 The accompanying notes are an integral part of these consolidated financial statements. 4

7 Consolidated Statements of Cash Flows Years Ended Cash flows from operating activities Net income $ 5,436,730 $ 5,040,690 Adjustments to reconcile net income to net cash provided by operating activities (Recovery of) provision for loan losses (638,622) 200,000 Loss on loan sale - 586,334 Depreciation and amortization of premises and equipment 1,119,016 1,294,293 Amortization of discounts, net of premiums 293,921 95,646 Amortization of intangible assets 901, ,717 Amortization of deferred loan fees (642,754) (665,705) Deferred income tax expense (benefit) 41,990 (667,297) Other-real-estate-owned charge 625,000 - Other-than-temporary impairment loss on securities 488, ,074 Decrease (increase) in accrued interest receivable (65,275) 212,159 Increase in bank owned life insurance (293,562) (288,809) Decrease in other assets 948,191 1,488,797 Decrease in accrued interest payable (283,215) (120,627) Increase (decrease) in other liabilities (479,488) 155,853 Net cash provided by operating activities 7,451,769 8,437,125 Cash flows from investing activities Proceeds from maturities of investment securities available-for-sale 11,308,368 22,675,680 Proceeds from maturities and principal payments of securities held-to-maturity 15,956,960 9,202,532 Proceeds from redemption of Federal Home Loan Bank stock 19,900 10,400 Proceeds from loan sales - 27,501,474 Purchase of investment securities available-for-sale (3,322,145) (6,995,010) Purchase of investment securities held-to-maturity - (10,293,750) Purchase of Federal Home Loan Bank stock (54,500) (4,500) Purchase of Federal Reserve Bank stock (17,600) - Net increase in interest bearing deposits with banks (34,583,098) (63,385,755) Net (increase) decrease in loans (28,332,415) 7,017,073 Purchase of premises and equipment (2,779,209) (140,244) Net cash used in investment activities (41,803,739) (14,412,100) Cash flows from financing activities Net increase (decrease) in deposits 37,979,589 (1,070,962) Dividend paid to minority interest (4,280) (4,440) Net cash provided (used in) by financing activities 37,975,309 (1,075,402) Net increase (decrease) in cash and cash equivalents 3,623,339 (7,050,377) Cash and cash equivalents Beginning of year 7,694,791 14,745,168 End of year $ 11,318,130 $ 7,694,791 Supplemental cash flow disclosures Interest paid $ 6,094,844 $ 7,538,000 Income taxes paid $ 3,209,000 $ 3,520,000 Non-cash activities Capital contribution from loan sale $ - $ 586,334 Transfer of loans to other real estate owned $ 1,250,000 $ - The accompanying notes are an integral part of these consolidated financial statements. 5

8 1. Organization Marathon Banking Corporation ( the Company ) is a registered bank holding company and is a majority-owned subsidiary of Piraeus Bank S.A., Athens, Greece. The Company s only substantive business activity is the ownership and operation of Marathon National Bank of New York ( the Bank ). The Company also owns a nonbank subsidiary, Marathon Statutory Trust II ( the Trust ) and the Bank owns the following nonbank subsidiaries, MNBNY Holdings Inc. ( MNBNY Holdings ), Marathon Realty Investors Inc. ( the REIT ) and Marathon National Bank Employer s Trust ( the Employer s Trust ). The Bank is a federally chartered, Federal Deposit Insurance Corporation ( FDIC ) insured commercial bank, which provides a range of financial services to individual and corporate customers through its branches located within the Boroughs of Queens, Brooklyn, Staten Island, and Manhattan, New York, Nassau County, New York, and Fort Lee, New Jersey. Although the Bank offers numerous financial services, its lending activity is concentrated primarily on residential and commercial real estate secured loans located within New York City and surrounding counties in New York. The Company, primarily through its Bank subsidiary, competes with other banking and financial institutions in its primary market communities. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for savings and time deposits as well as loans. Such institutions, as well as consumer financial and insurance companies, may be considered competitors of the Bank with respect to one or more of the services it renders. The Company and the Bank are subject to regulations of certain state and federal agencies and, accordingly, they are periodically examined by those regulatory authorities. As a consequence of the regulation of commercial banking activities, the Bank s business is particularly susceptible to being affected by future state and federal legislation and regulations. Marathon Statutory Trust II (the Trust) was formed in December 2006 under the laws of the State of Delaware. The sole purpose of the Trust was issuing and selling Preferred Securities and Common Securities and using the sales proceeds to acquire Junior Subordinated Debentures (the Debentures) issued by the Company. The Company owns all of the Trust s common stock. For further details on the Trust refer to Note 10 and Note 12. In June 2006, the Bank formed MNBNY Holdings a wholly owned subsidiary. MNBNY Holdings is incorporated in New York State and is the holding company of the REIT. In June 2006, the Bank formed a real estate investment trust, Marathon Realty Investors Inc. ( the REIT ). Upon formation, the Bank transferred residential and commercial real estate loans and mortgage backed securities to the REIT. By transferring these assets to the REIT, the Bank can reduce its New York State and New York City effective tax rate. The REIT produces no federal income tax savings. The Bank owns 100% of the REIT s common stock, and the REIT is included in these consolidated financial statements. The Employer s Trust was formed in December 2002 under the laws of the State of Delaware. The sole purpose of the Employer s Trust is to purchase Bank Owned Life Insurance. The Bank owns all of the Employer s Trust common stock. MBNY Holdings, the REIT, and the Employer's Trust are consolidated in these financial statements. 6

9 2. Summary of Significant Accounting Policies Basis of Financial Statement Presentation The consolidated financial statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of the Company and the Bank and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the statement of financial condition and the reported amounts of revenues and expenses during the reporting periods. Therefore, actual results could differ from those estimates. The principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan losses, goodwill, intangible assets (core deposit intangibles), deferred tax assets and investments (valuation and other-than-temporary impairment). The evaluation of the adequacy of the allowance for loan losses includes an analysis of the individual loans and overall risk characteristics and size of the different loan portfolios, and takes into consideration current economic and market conditions, and the capability of specific borrowers to pay specific loan obligations, as well as current loan collateral values. However, actual losses on specific loans, which also are encompassed in the analysis, may vary from estimated losses. Substantially all outstanding goodwill and core deposit intangible resulted from the Company s acquisition of Interbank of New York in January 2004 and of a branch of Ocwen Federal Savings in June If the benefits from these acquisitions do not continue to be derived, or the Company changes its business plan, impairment may be recognized related to these assets. The Company evaluates securities for other-than-temporary impairment and calculates the estimated fair value periodically and with increased frequency when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer s financial condition, the Company may consider whether the securities are issued by the Federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the issuer s financial condition. Investment Securities The Company classifies its securities as held-to-maturity or available-for-sale. Investment securities, specifically debt securities, for which the Company has the positive ability and intent to hold until maturity are classified as held-to-maturity. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. These investment securities are carried at amortized cost. Investment securities which are held for indefinite periods of time, which management intends to use as part of its asset/liability strategy, or which may be sold in response to changes in interest rates, changes in prepayment risk, increases in capital requirements or other similar factors, are classified as available-for-sale and are carried at fair value. Unrealized gains and losses, net of the related tax effect, are excluded from earnings and are reported in accumulated other comprehensive income, a separate component of equity, until realized. 7

10 In accordance with FASB ASC Debt and Equity Securities, a decline in market value of a debt security below amortized cost that is deemed other than temporary is charged to earnings for the credit-related other-than-temporary impairment ( OTTI ) resulting in the establishment of a new cost basis for the security, while the non-credit related OTTI is recognized in other comprehensive income ( OCI ) if there is no intent to sell or the Company will not be required to sell the security. If an equity security is deemed other-than-temporarily impaired, the full impairment is considered to be credit-related and a charge to earnings would be recorded. Realized gains and losses on sales of securities are recognized in the consolidated statements of income upon sale. The Company had no securities held for trading purposes at. Loans and Allowance for Loan Losses Loans receivable, which management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are reported at their principal amounts outstanding, and adjusted for charge-offs, allowance for loan losses, and deferred fees or costs on originated loans. Interest on loans is credited to income primarily based on the rate applied to the principal amount outstanding. When management believes there is sufficient doubt as to the ultimate collectability of interest on any loan, accrual of applicable interest is discontinued. For all classes of loans receivable, the accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain in accrual status when the loan is 90 days or more past due if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest previously accrued on the loan is reversed from income. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal amount outstanding. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan. The Company s management maintains the allowance for loan losses at a level considered adequate to provide for loan losses. Management considers the accounting policy on the allowance for loan losses to be the most critical and requires complex management judgment as discussed below. The judgments made regarding the allowance for loan losses can have a material effect on the results of operations of the Company. Management evaluates the adequacy of the allowance on a quarterly basis. The allowance is increased or decreased by provisions charged or recoveries of expense and reduced by net charge-offs. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. The level of the allowance is based on management s evaluation of losses inherent in the loan portfolio at the statement of financial condition dates after consideration of appraised collateral values, financial condition of the borrowers, and prevailing and anticipated economic conditions. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more 8

11 information becomes available. Credit reviews of the loan portfolio, designed to identify potential charges to the allowance, are made on a periodic basis during the year by senior management. The allowance calculation methodology includes segregation of the total loan portfolio into segments. The Company s loans receivable portfolio is comprised of the following segments: commercial real estate, residential real estate, commercial and industrial and consumer. The segments of the Bank s loan receivable portfolio are further disaggregated into classes based on the associated risks within those segments. This allows management to better monitor risk and performance. The commercial real estate loans are disaggregated into the following three classes: construction, non-residential, and multifamily. Construction loans, which include land loans, are comprised mostly of non-owner occupied projects, whereby the property is generally under development and tends to have more risk than the owner occupied loans. Non-residential loans include long-term loans financing commercial properties and include both owner and non-owner occupied properties. Repayment of these loans is dependent upon either the ongoing cash flow of the borrowing entity or the resale of or lease of the subject property. Commercial real estate loans typically require a loan to value ratio of not greater than 80% and vary in terms. Commercial and industrial loan segment consists of loans made for purposes of financing the activities of commercial customers. The assets financed through commercial and industrial loans are used within the business for its ongoing operations. Repayment of commercial and industrial loans generally comes from the cash flow of the business or the ongoing operations of assets. Company s credit policies determine advance rates against the different forms of collateral that can be pledged against commercial and industrial and commercial real estate loans. Typically, the majority of loans will be limited to a percentage of their underlying collateral values such as real estate values, equipment, eligible accounts receivable and inventory. Individual loan advance rates may be higher or lower depending upon the financial strength of the borrower and/or term of the loan. Residential real estate loan segment is secured by the borrower s residential real estate in first and second lien positions. Residential mortgages have varying loan rates depending on the financial condition of the borrower and the loan to value ratio. Residential mortgages have amortizations up to 30 years. Consumer loans are disaggregated into home equity loans, overdraft lines of credit and other consumer loans. The majority of these loans are unsecured. The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated quarterly for commercial real estate, construction and commercial and industrial loans or when credit deficiencies arise, such as delinquent loan payments, for residential and consumer loans. See Note 4 for the risk categories and definitions used by the Company. The allowance is comprised of both individual valuation allowances, loan pool valuation allowances and an unallocated component. If the allowance for loan losses is not sufficient to cover actual loan losses, the Company s earnings could decrease. Individual valuation allowances are established in connection with specific loan reviews and the asset classification process including the procedures for impairment testing under FASB Accounting Standard Codification ( ASC ) No. 310, Receivables. When the measurement of the 9

12 impaired loan is less than the recorded investment in the loan, the impairment is recorded through an individual valuation allowance. Pursuant to our policy, loan losses must be charged-off in the period the loans, or portions thereof, are deemed uncollectible. A loan is considered to be impaired, when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Assumptions and judgments by management, in conjunction with outside sources, are used to determine whether full collectability of a loan is not reasonably assured. The Company measures impairment based on the present value of expected future cash flows discounted at the loan s original effective interest rate, except that as a practical expedient, it may measure impairment based on a loan s observable market price, or the fair value of the collateral if the loan is collateral dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. Assumptions and judgments are also used to determine the estimates of the fair value of the underlying collateral or the present value of expected future cash flows or the loan s observable market value. Individual valuation allowances could differ materially as a result of changes in these assumptions and judgments. The fair value of the collateral is determined based upon recent appraised values. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. The evaluation of the need and amount of the allowance for impaired loans and whether a loan can be removed from impairment status is made on a quarterly basis. The Company s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition. Loan pool valuation allowances represent loss allowances that have been established to recognize the inherent risks associated with our lending activities, but which, unlike individual allowances, have not been allocated to particular problem assets. Pool evaluations are broken down into loans with homogenous characteristics by loan class within each loan segment. The determination of the adequacy of the valuation allowance is a process that takes into consideration a variety of factors. The Company has developed a range of valuation allowances necessary to adequately provide for probable incurred losses inherent in each class of loans. We consider our own charge-off history along with the growth in the portfolio as well as the Company s credit administration and asset management philosophies and procedures, and concentrations in the portfolio when determining the allowances for each pool. In addition, we evaluate and consider the credit s risk rating which includes management s evaluation of: cash flow, collateral, guarantor support, financial disclosures, industry trends and strength of borrowers management, the impact that economic and market conditions may have on the portfolio as well as known and inherent risks in the portfolio. Finally, we evaluate and consider the allowance ratios and coverage percentages of both peer group and regulatory agency data. These evaluations are inherently subjective because, even though they are based on objective data, it is management s interpretation of that data that determines the amount of the appropriate allowance. If the evaluations prove to be incorrect, the 10

13 allowance for loan losses may not be sufficient to cover losses inherent in the loan portfolio, resulting in additions to the allowance for loan losses. An unallocated component is maintained to cover uncertainties that could affect management s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Loans whose terms are modified are classified as troubled debt restructurings if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a temporary reduction in interest rate or an extension of a loan s stated maturity date, but may also include rescheduling of future cash flows, and reduction in the face amount of the debt or reduction of past accrued interest. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification. Loans classified as troubled debt restructurings are designated as impaired. The Company s troubled debt restructured modifications are made for short periods of time (12 month terms) in order to aggressively monitor and track performance. The short-term modifications performance is monitored for continued payment performance for an additional period of time after the expiration of the concession. Balance reductions and annualized loss rates are also important metrics that are monitored. The main objective of the modification programs is to reduce the payment burden for the borrower and improve the net present value of the Company s expected cash flows. The Credit Risk Committee is comprised of members of both management and the Board of Directors. The adequacy of the allowance is analyzed quarterly, with any adjustment to a level deemed appropriate by the Credit Risk Committee, based on its risk assessment of the entire portfolio. Based on the Credit Risk Committee s review of the classified loans and the overall allowance levels as they relate to the entire loan portfolio at, management believes the allowance for loan losses has been established at levels sufficient to cover the probable incurred losses in the Company s loan portfolio. Future additions or reductions to the allowance may be necessary based on changes in economic, market or other conditions. Changes in estimates could result in a material change in the allowance. In addition, various regulatory agencies, as an integral part of the examination process, periodically review the allowance for loan losses. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments of the information available to them at the time of their examination. The Company has financial and performance letters of credit which it accounts for under FASB ASC 460 Guarantees. FASB ASC 460 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. Financial letters of credit require the Company to make payment if the customer s financial condition deteriorates, as defined in the agreements. Guarantees are fully collateralized by the guarantee's deposits held at the Company. Financial Instruments The Company discloses the estimated fair value of its assets and liabilities considered to be financial instruments. Financial instruments requiring disclosure consist primarily of investment securities, loans and deposits. 11

14 Premises and Equipment Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on the straight-line method using the estimated lives of the assets. Estimated lives are 5 to 40 years for building and improvements and 3 to 10 years for furniture, fixtures and equipment. Amortization of leasehold improvements is calculated on a straight-line basis over the terms of the related leases or the life of the asset, whichever is shorter. The cost of maintenance and repairs is charged to expense as incurred, whereas significant renovations are capitalized. Income Taxes The Company files a consolidated federal tax return and various combined and separate company state and local tax returns. The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Company s assets and liabilities. Deferred tax assets are also recognized for available tax carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect when temporary differences and carry forwards are realized or settled. The deferred tax asset is subject to reduction by a valuation allowance in certain circumstances. This valuation allowance is recognized if, based on an analysis of available evidence, management determines that it is more likely than not that some portion or all of the deferred tax asset will not be realized. The valuation allowance is subject to ongoing adjustment based on changes in circumstances that affect management s judgment about the realization of the deferred tax asset. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense or in certain limited circumstances to equity. Income tax expense includes the amount of taxes payable for the current year, and the deferred tax benefit or expense for the period. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date. The Company follows the authoritative guidance on accounting for uncertainty in tax positions (ASC 740), which requires the Company to determine whether a tax position is more likely than not to be sustained upon examination including resolution of any related appeals or litigation process, based on the technical merits of the position. The guidance describes how uncertain tax positions should be recognized, measured, presented and disclosed in the consolidated financial statements. For tax positions meeting the more likely than not threshold, the tax benefit recognized in the consolidated financial statements is the greatest benefit that has a greater than fifty percent likelihood of being realized upon settlement with the relevant taxing authorities. The Company classifies interest and penalties related to tax positions as a component of income tax expense. Goodwill and Identifiable Intangible Assets The assets (including identifiable intangible assets) and liabilities acquired in a business combination are recorded at fair value at the date of acquisition. Goodwill is recognized for the excess of the acquisition cost over the fair values of the net assets acquired and is not subsequently amortized. Identifiable intangible assets are amortized on a straight-line or accelerated basis, over their estimated lives. Management assesses the recoverability of goodwill at least on an annual basis and all intangible assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. If carrying amount exceeds fair value, an impairment charge is recorded to income. At the annual impairment tests did not result in recognizing an impairment of goodwill. 12

15 Comprehensive Income Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the statement of financial condition. Such items, along with net income, are components of comprehensive income. Other comprehensive income (loss) and related tax effects are presented in the following table: December 31, 2011 December 31, 2010 Before Deferred Net Before Deferred Net Tax Tax of Tax Tax Tax of Tax Amount Benefit Amount Amount Benefit Amount Unrealized holding losses arising during period $ (1,200,102) $ 457,756 $ (742,346) $ (630,673) $ 245,229 $ (385,444) Credit-related OTTI recognized in earnings 488,033 (192,679) 295, ,074 (74,382) 106,692 Other comprehensive loss $ (712,069) $ 265,077 $ (446,992) $ (449,599) $ 170,847 $ (278,752) Cash and Cash Equivalents The Company considers cash on hand, amounts due from banks, and Federal funds sold as cash and cash equivalents. Generally, federal funds are purchased and sold for one-day periods. The Company maintains various deposit accounts with other banks to meet normal fund transaction requirements and to compensate other banks for certain correspondent services. The withdrawal or usage restrictions on these balances did not have a significant impact on the operations of the Company as of December 31, 2011 or Bank-Owned Life Insurance The Company purchased bank owned life insurance ( BOLI ) on a chosen group of employees. The Bank is the owner and sole beneficiary of the policies. This pool of insurance, due to tax advantages available to banks, is profitable to the Bank. This profitability is used to offset a portion of future benefit cost increases. The Bank s deposits fund the BOLI and the earnings from BOLI are recognized as BOLI income as part of non-interest income. Income earned from the BOLI was approximately $294,000 and $289,000, in 2011 and 2010, respectively. BOLI is carried at cash surrender value. Death benefit proceeds received in excess of the policies cash surrender value are recognized in income upon receipt. Other Real Estate Owned Other Real Estate Owned ( OREO ) consists of properties acquired by foreclosure. OREO is recorded at the lower of cost or fair value less estimated costs to sell the property at the date of transfer to OREO. The fair value is determined through independent third party appraisals or property evaluations. Subsequently, if the fair value of an asset, less the estimated cost to sell, declines to less than the carrying amount of the asset, the deficiency is recognized in the period in which it becomes known and is included in non-interest expense. Gains and losses realized from the sale of OREO as well as any net income or loss from the operations of the properties are included in non-interest income or non-interest expenses, as appropriate. Advertising Costs The Bank expenses advertising costs as incurred. As of total advertising expenses were approximately $198,000 and $116,000, respectively. 13

16 Recent Accounting Pronouncements In April 2011, the FASB issued ASU No , which amends the authoritative accounting guidance under ASC Topic 310 Receivables. The update provides clarifying guidance as to what constitutes a troubled debt restructuring. The update provides clarifying guidance on a creditor s evaluation of the following: (1) how a restructuring constitutes a concession and (2) if the debtor is experiencing financial difficulties. The amendments in this update are effective for the first interim or annual period beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption. Adoption of this update is not expected to have a material effect on the Company s results of operations or financial condition. In May 2011, the FASB issued ASU No , which amends the authoritative accounting guidance under ASC Topic 820 Fair Value Measurement. The amendments in this update clarify how to measure and disclose fair value under ASC Topic 820. The amendments in this update are effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. Adoption of this update is not expected to have a material effect on the Company s results of operations or financial condition. In June 2011, the FASB issued ASU No , which amends the authoritative accounting guidance under ASC Topic 220 Comprehensive Income. The amendments eliminate the option to present components of other comprehensive income in the statement of stockholders equity. Instead, the new guidance requires entities to present all non-owner changes in stockholders equity either as a single continuous statement of comprehensive income or as two separate but consecutive statements. The amendments in this update are effective for the first interim or annual period beginning on or after December 15, 2011 and must be applied retrospectively. Adoption of this update is not expected to have a material effect on the Company s results of operations or financial condition. In September 2011, the FASB issued ASU No , which amends the authoritative accounting guidance under ASC Topic 350 Intangibles Goodwill and Other. The amendments in the update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. The amendments in this update are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity s financial statements for the most recent annual or interim period have not yet been issued. The early adoption of this update did not have a material effect on the Company s results of operations or financial condition. Reclassifications of Prior Year Amounts Certain prior year amounts have been reclassified to conform to the current year presentation, such reclassifications had no impact on net income or stockholders equity as previously reported. 3. Investment Securities The amortized cost, gross unrealized gains and losses, and fair value of the Company s investment securities available-for-sale and held-to-maturity are as follows: 14

17 December 31, 2011 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Available-for-sale U.S. Government and agencies $ 1,663,806 $ 109,471 $ - $ 1,773,277 Mortgage-backed securities 21,359, ,840 1,403,215 20,808,022 State and municipal obligations 3,313,007 58,686-3,371,693 Corporate bonds 10,331, ,466 9,657,025 Trust preferred securities 4,397,563-2,701,382 1,696,181 Other equity securities 22,750 14,170-36,920 Total available-for-sale securities $ 41,088,014 $ 1,034,167 $ 4,779,063 $ 37,343,118 Held-to-maturity Mortgage-backed securities $ 12,589,005 $ 930,037 $ - $ 13,519,042 Corporate bonds 2,000,000 41,840-2,041,840 Total held-to-maturity securities $ 14,589,005 $ 971,877 $ - $ 15,560,882 December 31, 2010 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Available-for-sale U.S. Government and agencies $ 2,327,338 $ 144,300 $ - $ 2,471,638 Mortgage-backed securities 29,954,247 1,054,838 1,310,390 29,698,695 State and municipal obligations 5,322, ,852-5,449,062 Corporate bonds 6,995,484 2,796 95,910 6,902,370 Trust preferred securities 4,936,459-2,953,363 1,983,096 Other equity securities 22,750-1,950 20,800 Total available-for-sale securities $ 49,558,488 $ 1,328,786 $ 4,361,613 $ 46,525,661 Held-to-maturity Mortgage-backed securities $ 28,843,672 $ 1,114,502 $ 81,207 $ 29,876,967 Corporate bonds 2,000, ,660-2,129,660 Total held-to-maturity securities $ 30,843,672 $ 1,244,162 $ 81,207 $ 32,006,627 The securities portfolio is reviewed on a quarterly basis for the presence of OTTI. During the second quarter of 2009 new OTTI guidance issued by the FASB was adopted for debt securities that requires credit related OTTI be recognized in earnings while non-credit related OTTI be recognized in other comprehensive income ( OCI ) if there is no intent to sell or the Company will not be required to sell the security. If an equity security is deemed other-than-temporarily impaired, the full impairment is considered to be credit-related and a charge to earnings would be recorded. The new guidance also required that previously recorded impairment charges which did not relate to a credit loss should be reclassified from retained earnings to accumulated other comprehensive income ( AOCI ). 15

18 During 2011, four pooled trust preferred securities, all of which had a previous credit related impairment charge, were deemed to have additional credit related OTTI loss in the amount of $328,192. The Company received cash flow scenarios from a third party which were utilized by management to analyze these securities for potential OTTI. At December 31, 2011, the pooled trust preferred securities had a non-credit related OTTI of $2,701,382, or $1,674,857, net of tax. After the impact of the credit related OTTI loss, the cost basis of these pooled trust preferred securities was $4,397,563 at December 31, There is no intent to sell nor is it more likely than not that the Company will be required to sell these securities. Additionally, two of the four private label CMOs were deemed to have credit related OTTI loss in the amount of $159,841. At December 31, 2011, the private label CMOs had a non-credit related OTTI of $371,870, or $229,550, net of tax. After the impact of the credit related OTTI loss, the cost basis of these CMO securities was $2,830,447 at December 31, There is no intent to sell nor is it more likely than not that the Company will be required to sell the pooled trust preferred securities or the private label CMOs. During 2010, three pooled trust preferred securities, of which two had a previous credit related impairment charge during 2009, were deemed to have additional credit related OTTI loss in the amount of $181,074. The Company received cash flow scenarios from a third party which were utilized by management to analyze these securities for potential OTTI. At December 31, 2010, the pooled trust preferred securities had a non-credit related OTTI of $2,953,363, or $1,831,085, net of tax. After the impact of the credit related OTTI loss, the cost basis of these pooled trust preferred securities was $4,936,459 at December 31, There is no intent to sell nor is it more likely than not that the Company will be required to sell these securities. A credit-related OTTI loss in the amount of $994,529 was recorded on pooled trust preferred securities in 2009 based on cash flow analyses. The Company received cash flow scenarios from a third party which were utilized by management to analyze these securities for potential OTTI. The decrease in credit quality of the securities coupled with the net present value of the discounted cash flows resulted in management s determination that the securities were other-than-temporarily impaired. The non-credit related OTTI of $2,854,621, or $1,769,865, net of tax, was recognized in OCI. After the impact of the cumulative effect adjustment, the cost basis of these pooled trust preferred securities was $4,909,303, at December 31, There is no intent to sell nor is it more likely than not that the Company will be required to sell these securities. The following table presents a roll-forward of the cumulative credit loss component of OTTI recognized in earnings on debt securities for which a non-credit component of OTTI was recognized in other comprehensive income. OTTI recognized in earnings is presented as an addition in two components, based upon whether the current period is the first time a debt security was credit impaired (initial credit impairment) or is not the first time a debt security was credit impaired (subsequent credit impairment). Changes in the cumulative credit loss component of OTTI recognized in earnings for credit-impaired debt securities for the year ending December 31, 2011 and 2010 were as follows: 16

19 December 31, Beginning cumulative OTTI credit loss $ 1,477,527 $ 1,296,453 Add: Initial OTTI credit losses 159,841 - Subsequent OTTI credit losses 328, ,074 Less: Realized losses for securities sold - - Securities intended or required to be sold - - Increase in expected cash flows on debt securities - - Ending cumulative OTTI credit loss 1,965,560 1,477,527 The amortized cost and fair value of debt securities at December 31, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Available-for-sale Held-to-maturity Amortized Fair Amortized Fair Cost Value Cost Value Due in one year or less $ 4,479,738 $ 4,582,682 $ - $ - Due in one year to five years 11,354,119 11,172,741 2,481,232 2,534,741 Due in five years to ten years 3,765,356 3,518,848 7,679,929 8,222,545 Due after ten years 21,466,051 18,031,927 4,427,844 4,803,596 $ 41,065,264 $ 37,306,198 $ 14,589,005 $ 15,560,882 The tables below indicate the length of time individual securities have been in a continuous unrealized loss position for which OTTI has not been recognized as of December 31, 2011: 2011 Less than 12 Months 12 Months or Longer Total Number of Fair Unrealized Fair Unrealized Fair Unrealized Securities Value Losses Value Losses Value Losses Available-for-sale securities Mortgage-backed securities 6 $ - $ - $ 4,503,260 $ (1,403,215) $ 4,503,260 $ (1,403,215) Corporate bonds 9 5,138,255 (193,236) 4,518,770 (481,230) 9,657,025 (674,466) Trust preferred securities 6 199,306 (436,224) 1,496,875 (2,265,158) 1,696,181 (2,701,382) Total temporarily impaired investment securities 21 $ 5,337,561 $ (629,460) $ 10,518,905 $ (4,149,603) $ 15,856,466 $ (4,779,063) The unrealized losses over twelve months reported above on mortgage-backed, corporate bonds and trust preferred securities are not credit related. The market values on these securities are related to financial and liquidity stresses in the fixed income market. The Company has no intent to sell nor is it more likely than not that the Company will be required to sell any of the securities. In assessing the mortgage-backed securities, the Company considered a variety of factors including: Each security has a diverse pool of underlying mortgages The underlying mortgages were originated in 2004 and These vintages have outperformed subsequent years due to tighter underwriting standards. 17