Bancorp, Inc. - Quarter Report: 2007 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended: March 31, 2007

OR

For the transition period from:              to             

Commission file number: 51018

THE BANCORP, INC.

(Exact name of registrant as specified in its charter)

405 Silverside Road

Wilmington, DE 19809

(Address of principal executive offices) (Zip code)

Registrant’s telephone number, including area code: (302) 385-5000

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

(Check one):    Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of May 7, 2007 there were 13,778,857 outstanding shares of Common Stock, $1.00 par value.

PART I – FINANCIAL INFORMATION

The Bancorp, Inc.

Consolidated Balance Sheets

(in thousands)

The accompanying notes are an integral part of these statements.

The Bancorp Inc.

Consolidated Statements of Income

(in thousands)

The accompanying notes are an integral part of these statements.

THE BANCORP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

For the three months ended March 31, 2007 (unaudited)

The accompanying notes are an integral part of this statement.

The Bancorp, Inc.

Statements of Cash Flows

(in thousands)

(unaudited)

The accompanying notes are an integral part of these statements.

Note 1. Significant Accounting Policies

Basis of Presentation

The financial statements of The Bancorp, Inc. (Company) as of March 31, 2007 and for the three month periods ended March 31, 2007 and 2006 are unaudited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted in this Form 10-Q pursuant to the rules and regulations of the Securities and Exchange Commission. However, in the opinion of management, these interim financial statements include all necessary adjustments to fairly present the results of the interim periods presented. The unaudited interim consolidated financial statements should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The results of operations for the three month period ended March 31, 2007 may not necessarily be indicative of the results of operations for the full year ending December 31, 2007.

Note 2. Stock-based Compensation

The Company accounts for its stock options and phantom stock units under Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment, that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. Under SFAS No. 123(R), all forms of share-based payments to employees, including employee stock options and phantom stock units, would be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award would generally be measured at fair value at the grant date. The impact of this new standard is reflected in the net earnings and related per share amounts for the quarters ended March 31, 2007 and 2006. At March 31, 2007, the Company has two stock-based compensation plans, which are more fully described in its Form 10-K report.

The fair value of each option and phantom stock unit grant is estimated on the date of grant using the Black-Scholes option-pricing model. The significant assumptions utilized in applying the Black-Scholes option pricing model are the risk-free interest rate, expected term, dividend yield, and expected volatility. The risk-free interest rate is the implied yield currently available on the U.S. Treasury zero-coupon issues with a remaining term equal to the expected term used in the assumption for the model. The expected term of an option or phantom award is based on historical experience of similar awards. The dividend yield is determined by dividing per share and phantom stock unit dividend by the grant date stock price. The expected volatility is based on the volatility of the Company’s stock price over a historical period comparable to the expected term. During the first quarter of 2007, the Company granted 10,000 phantom stock units that vest on December 31, 2007. The fair value of the grant was $25.43, which was the fair value of the common stock on the date of the grant. During the first quarter of 2007 the Company granted 12,000 stock options as compared to 1,000 stock options in the first quarter of 2006. The weighted average assumptions used in the Black-Scholes valuation model for the stock options are shown below.

As of March 31, 2007, there was $293,000 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the plans; that cost is expected to be recognized over a period of 3 years. Cash received from option

exercises for the periods ending March 31, 2007 and 2006 was $658,000 and $92,000 respectively. Included in net income for the three months ended March 31, 2007 and 2006 was employee compensation expense of $29,000 and $92,000 respectively. The following tables are a summary of activity in the plans as of March 31, 2007 and changes during the period then ended:

Stock options:

Phantom units:

Note 3. Earnings Per Share

Basic earnings per share for a particular period of time is calculated by dividing net income by the weighted average number of common shares outstanding during that period.

Diluted earnings per share is calculated by dividing net income by the weighted average number of common shares and common share equivalents. The Company’s only outstanding “common share equivalents” are phantom stock units and options to purchase its common stock.

The following schedule shows the Company’s earnings per share for the periods presented:

Note 4. Investment securities

The amortized cost, gross unrealized gains and losses, and fair values of the Company’s investment securities available-for-sale are summarized as follows (in thousands):

The amortized cost and fair value of the Company’s investment securities available-for-sale at March 31, 2007, 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.

Note 5. Loans

Major classifications of loans are as follows (in thousands):

Note 6. Transaction with affiliates

The Company subleases office space in Philadelphia, Pennsylvania and provides technical support to RAIT Investment Trust (RAIT). The Chairman of RAIT is the Chairman and Chief Executive Officer of the Bank and Chief Executive Office of the Company. The Chief Executive Officer of RAIT is the Chairman of the Company. Under the sublease, RAIT pays the Company rent equal to 45% of the rent paid by the Company and an allocation of common area expenses. Under the technical support agreements, the Company provides technical support for RAIT for a current fee of $6,500 a month. RAIT paid the Bank $19,500 and $15,000 respectively for technical support for the three months ended March 31, 2007 and 2006. RAIT paid the Company approximately $124,000 for rent for the first three months of 2007 and $84,000 for the first three months of 2006.

The Company also has a sublease for office space in Philadelphia, Pennsylvania with Cohen Bros. & Company d/b/a Cohen & Company (Cohen & Company) commencing in July 2002 under which Cohen & Company pays rent of $6,201 and $6,761 per month for 2007 and 2006 respectively. Cohen & Company paid $18,604 and $20,283 in rent for the three months ended March 31, 2007 and 2006. The Chairman of the Company is the principal of Cohen Bros. Financial LLC which owns a majority of Cohen & Company.

Cohen & Company pays the Company fees of $1,000 per month for technical support and $3,600 per month for telephone system support services. The agreement was terminated in June 2006 but Cohen & Company continued to pay fees for telephone system support services. Telephone support fees paid for the period ended March 31, 2007 were $13,308. Technical and telephone support fees for Cohen Bros. were $13,800 for the period ended March 31, 2006.

The Company maintains deposits for various affiliated companies totaling approximately $269,116,000 and $162,514,000 as of March 31, 2007 and December 31, 2006, respectively. The majority of these deposits are short-term in nature and rates are consistent with market rates.

The Company has entered into lending transactions in the ordinary course of business with directors, executive officers, principal stockholders and affiliates of such persons on the same terms as those prevailing for comparable transactions with other borrowers. At March 31, 2007, these loans were current as to principal and interest payments and, in the opinion of management, do not involve more than normal risk of collectibility. At March 31, 2007 loans to these related parties amounted to $4,001,000.

Note 7. Recently issued accounting standards

Effective January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. FIN 48 establishes a recognition threshold and measurement for income tax positions recognized in the Company’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. In evaluating a tax position for recognition, the Company judgmentally evaluates whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of related appeals or litigation processes, based on the technical merits of the position. If the tax position meets the more-likely-than-not recognition threshold, the tax position is measured and recognized in the Company’s financial statements as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate resolution. In adopting the provisions of FIN 48, the Company recorded an cumulative-effect adjustment to reduce retained earnings by $47,000. The Company recognizes interest and penalties, if any, accrued related to the liability in the provision for income taxes. To the extent interest and penalties are ultimately not assessed, amounts accrued as part of the liability would be adjusted in the Company’s provision for income taxes.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 does not require any new fair value measurements, but rather, it provides enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. However, the application of this Statement may change how fair value is determined. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company does not expect that the financial statement impact will be material to its financial position, results of operations or disclosures.

On February 15, 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The fair value option established by SFAS 159 permits, but does not require, all entities to choose to measure eligible items at fair value at specified election dates. An entity would report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company is currently assessing what the impact of the adoption of this Statement would be on its financial position and/or results of operations.

Part I—Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

Forward-Looking Statements

When used in this Form 10-Q, the words “believes” “anticipates” “expects” and similar expressions are intended to identify forward-looking statements. Such statements are subject to the risks and uncertainties more particularly described in Item 1A,”Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2006. These risks and uncertainties could cause actual results to differ materially. Readers are cautioned not place undue reliance on these forward-looking statements, which speak only as of the date hereof. Except as may be required by applicable law, we undertake no obligation to publicly release the results of any revisions to forward-looking statements which we may make to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect the occurrence of unanticipated events.

In the following discussion we provide information about our results of operations, financial condition, liquidity and asset quality. We intend that this information facilitate your understanding and assessment of significant changes and trends related to our financial condition and results of operations. You should read this section in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operation” included in our Annual Report on Form 10-K for the year ended December 31, 2006.

Critical Accounting Policies and Estimates

Our accounting and reporting policies conform with accounting principles generally accepted in the United States and general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

We believe that the determination of our allowance for loan and lease losses involves a higher degree of judgment and complexity than our other significant accounting policies. We determine our allowance for loan and lease losses with the objective of maintaining a reserve level we believe to be sufficient to absorb our estimated probable credit losses. We base our determination of the adequacy of the allowance on periodic evaluations of our loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, the amount of loss we may incur on a defaulted loan, expected commitment usage, the amounts and timing of expected future cash flows on impaired loans, value of collateral, estimated losses on consumer loans and residential mortgages, and historical loss experience. We also evaluate economic conditions, uncertainties in estimating losses and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from our estimates, we may need additional provisions for loan losses that would adversely impact our earnings.

We account for income taxes under the liability method whereby we determine deferred tax assets and liabilities based on the difference between the carrying values on our financial statements and the tax basis of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax expense (benefit) is the result of changes in deferred tax assets and liabilities.

Results of Operations

Net Income: Net income for the first quarter of 2007 was $3.6 million compared to net income of $2.9 million for the first quarter of 2006. Diluted earnings per share were $0.25 in the first quarter of 2007 as compared to $0.20 for the first quarter of 2006. Return on average assets was 1.08% and return on average equity was 9.54% for the first quarter of 2007 as compared to 1.25% and 8.42% respectively for the first quarter of 2006.

Net Interest Income: Our interest income for the first quarter of 2007 increased to $25.5 million from $16.6 million in the first quarter of 2006, while our net interest income increased to $12.6 million from $10.2 million. Our average loans increased to $1.072 billion for the first quarter of 2007 from $701.1 million for the first quarter of 2006. The primary reason for the increases in our interest income and net interest income was our ability to increase our earning assets through continued organic growth of our loan portfolio.

Our net interest margin for the first quarter 2007 decreased to 3.87% from 4.65% for the first quarter of 2006, a decrease of 78 basis points (.78%). The decreased net interest margin resulted from the following:

For the first quarter of 2007 the average yield on our interest-earning assets increased to 7.88% from 7.53% for first quarter of 2006, an increase of 35 basis points (0.35%). Cost of interest-bearing deposits increased to 4.73% for the first quarter of 2007 from 3.74% for the first quarter of 2006, an increase of 99 basis points (0.99%). The increase in the cost of interest-bearing deposits was the result of continued pricing competition within the market and the consequent increase in the rates we pay on interest-bearing deposits as compared to the first quarter of 2006. Average interest-bearing deposits increased to $1.022 billion from $618.5 million, an increase of $403.3 million or 65.2%.

Average Daily Balances. The following table presents the average daily balances of assets, liabilities and stockholders’ equity and the respective interest earned or paid on interest-earning assets and interest-bearing liabilities, as well as average rates, for the periods indicated:

In the first quarter of 2007, average interest-earning assets increased to $1.297 billion, an increase of $417.3 million, or 47.4% from the first quarter of 2006

Provision for Loan and Lease Losses. Our provision for loan and lease losses was $750,000 for the first quarter of 2007 compared to $600,000 for the first quarter of 2006. At March 31, 2007, our allowance for loan and lease losses amounted to $8.9 million or .80% of total loans. We believe that our allowance is adequate to cover expected losses. For more information about our provisions and allowance for loan and lease losses and our loss experience see “ – Allowance for Loan and Lease Losses” and “ – Summary of Loan and Lease Loss Experience,” below.

Non-Interest Income. Non-interest income was $1.5 million for the first quarter of 2007 as compared to $1.3 million for the first quarter of 2006, an increase of $200,000 or 16%. The principal reasons for the increase of non-interest income were an increase from leasing income and other income. Leasing income increased to $569,000 for the first quarter of 2007, an increase of $169,000 or 42.3%. This is a result of an increase in end of lease fees from a large leasing relationship. Other income increased $97,000 or 41.5% to $331,000. This increase is a result of fees associated with the set up of specialized merchant processing relationships.

Non-Interest Expense. Total non-interest expense was $7.4 million for the first quarter of 2007, as compared to $6.4 million for the first quarter of 2006, an increase of $1.06 million or 16.7%. Salaries and employee benefits amounted to $3.6 million for the first quarter of 2007 as compared to $3.2 million for the first quarter of 3006, an increase of $454,000 or 14.2%. The increase reflects increases in staff for commercial lending and private client staffs. Professional fees increased to $601,000 for the first quarter of 2007, an increase of $190,000 or 46.2%. This increase reflects legal fees of approximately $120,000 for research and compliance matters associated with our processing business. Other operating expense increased to $1.6 million in the first quarter of 2007 as compared to $1.3 million for the same period in 2006. The increase of $216,000 or 15.5% is a result of increase in entertainment costs related to growth in our private client and commercial loan business and deposit account charge-offs.

Liquidity and Capital Resources

Liquidity defines our ability to generate funds to support asset growth, meet deposit withdrawals, satisfy borrowing needs and otherwise operate on an ongoing basis. We invest the funds we do not need for operation primarily in overnight federal funds.

Since commencement of operations, the primary source of funds for our financing activities have been cash inflows from net increases in deposits, which were $158.8 million in the first three months of 2007. We have also used sources outside of our core deposit products to fund our loan growth including the Federal Home Loan Bank and repurchase agreements. As of March 31, 2007,

we did not have any outstanding Federal Home Loan Bank advances, but did have $4.1 million in repurchase obligations. During the first quarter of 2007 we were able to repay our Federal Home Loan Bank advances as result of a combination of our deposit growth and loan repayments of approximately $77.8 million.

Funding was directed primarily at cash outflows required for loans, which were $37.2 million in the first three months of 2007. At March 31, 2007 we had outstanding commitments to fund loans, including unused lines of credit, of $401.2 million.

We must comply with capital adequacy guidelines issued by the Federal Deposit Insurance Corporation, or FDIC. A bank must, in general, have a leverage ratio of 5.0%, a ratio of Tier I capital to risk-weighted assets of 6.0% and a ratio of total capital to risk-weighted assets of 10.0% in order to be considered “well capitalized.” A Tier I leverage ratio is the ratio of Tier 1 capital to average assets for the period. “Tier I capital” includes common shareholders’ equity, certain qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less goodwill. At March 31, 2007 we were “well capitalized” under banking regulations.

The following table sets forth the regulatory capital amounts and ratios for the periods indicated:

Asset and Liability Management

The management of rate sensitive assets and liabilities is essential to controlling interest rate risk and optimizing interest margins. An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market rates. Interest rate sensitivity measures the relative volatility of a bank’s interest margin resulting from changes in market interest rates.

We monitor and control interest rate risk through a variety of techniques, including use of traditional interest rate sensitivity analysis (also known as “gap analysis”). Traditional gap analysis involves arranging our interest-earning assets and interest-bearing liabilities by repricing periods and then computing the difference (or “interest rate sensitivity gap”) between the assets and liabilities that are estimated to reprice during each time period and cumulatively through the end of each time period.

Gap analysis requires estimates as to when individual categories of interest-sensitive assets and liabilities will reprice, and assumes that assets and liabilities assigned to the same repricing period will reprice at the same time and in the same amount. Gap analysis does not account for the fact that repricing of assets and liabilities is discretionary and subject to competitive and other pressures. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income. During a period of rising interest rates, a positive gap would tend to result in an increase in net interest income while a negative gap would tend to affect net interest income adversely.

The following table sets forth the estimated maturity/repricing structure of our interest-earning assets and interest-bearing liabilities at March 31, 2007. Except as stated below, the amounts of assets or liabilities shown which reprice or mature during a particular period were determined in accordance with the contractual terms of each asset or liability. The majority of interest-bearing demand deposits and savings deposits are assumed to be “core” deposits, or deposits that will generally remain with us regardless of market interest rates. Therefore, 50% of the core interest checking deposits and 25% of core savings and money market deposits are shown as maturing or repricing within the “1 – 90 days” column with the remainder shown in the “1 – 3 years” column. We estimate the repricing characteristics of these deposits based on historical performance, past experience at other institutions and other deposit behavior assumptions. However, we may choose not to reprice liabilities proportionally to changes in market interest rates for competitive or other reasons. Payments of fixed-rate loans and mortgage-backed securities are scheduled based on their anticipated cash flow, including prepayments based on historical data and current market trends. The table does not necessarily indicate the impact of general interest rate movements on our net interest income because the repricing of certain categories of assets and liabilities is beyond our control as, for example, prepayments of loans and withdrawal of deposits. As a result, certain assets and liabilities indicated as repricing within a stated period may in fact reprice at different times and at different rate levels.

The method used to analyze interest rate sensitivity in this table has a number of limitations. Certain assets and liabilities may react differently to changes in interest rates even though they reprice or mature in the same or similar time periods. The interest rates on certain assets and liabilities may change at different times than changes in market interest rates, with some changing in advance of changes in market rates and some lagging behind changes in market rates. Additionally, the actual prepayments and withdrawals we experience when interest rates change may deviate significantly from those assumed in calculating the data shown in the table.

Financial Condition

General. Our total assets at March 31, 2007 were $1.394 billion, of which our total loans were $1.102 billion. At December 31, 2006 our total assets were $1.335 billion, of which our total loans were $1.064 billion. Our portfolio of commercial, commercial mortgage and construction loans grew $42.4 million, or 5.3%, from year-end 2006 to $844.5 million at March 31, 2007.

Investment portfolio. For detailed information on the composition and maturity distribution of our investment portfolio, see Note 3 to the Notes to Financial Statements contained in this Quarterly Report on Form 10-Q. Total investment securities increased to $114.8 million on March 31, 2007, a decrease of $1.2 million or 0.99% from year-end 2007.

Loan Portfolio. Total loans increased to $1.102 billion at March 31, 2007 from $1.065 billion at December 31, 2006 an increase of $37.6 million or 3.5%.

The following table summarizes our loan portfolio by loan category for the periods indicated: