LIMESTONE BANCORP, INC. - Quarter Report: 2007 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended September 30, 2007

Or

For the transition period from              to             

Commission file number: 001-33033

PORTER BANCORP, INC.

(Exact name of registrant as specified in its charter)

(502) 499-4800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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  ¨    Non-accelerated filer  x

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

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

7,628,337 shares of Common Stock, no par value, were outstanding at October 25, 2007.

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INDEX

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

The following consolidated financial statements of Porter Bancorp Inc. and Subsidiary, PBI Bank, Inc., are submitted:

Unaudited Consolidated Balance Sheets for September 30, 2007 and December 31, 2006

Unaudited Consolidated Statements of Income for the three and nine months ended September 30, 2007 and 2006

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2007

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006

Notes to Unaudited Consolidated Financial Statements

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PORTER BANCORP, INC. AND SUBSIDIARY

Consolidated Balance Sheets

(amounts in thousands except share data)

See accompanying notes to unaudited consolidated financial statements.

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PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Income

(amounts in thousands, except per share data)

See accompanying notes to unaudited consolidated financial statements.

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PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

For Nine Months Ended September 30, 2007

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

See accompanying notes to unaudited consolidated financial statements.

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PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Cash Flows

For Nine Months Ended September 30, 2007 and 2006

(dollars in thousands)

See accompanying notes to unaudited consolidated financial statements.

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PORTER BANCORP, INC. AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements include Porter Bancorp, Inc. (the “Company”) and its wholly-owned subsidiary, PBI Bank (the “Bank”). All significant inter-company transactions and accounts have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2006 included in the Company’s Annual Report on Form 10-K.

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses and fair values of financial instruments are particularly subject to change.

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation.

New Accounting Standards

In February 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 155, Accounting for Certain Hybrid Financial Instruments-an amendment to FASB Statements No. 133 and 140. This Statement permits fair value re-measurement for any hybrid financial instruments, clarifies which instruments are subject to the requirements of Statement No. 133, and establishes a requirement to evaluate interests in securitized financial assets and other items. The new standard was adopted on January 1, 2007. The adoption of this standard had no impact on the Company’s financial statements.

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN48), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted FIN 48 on January 1, 2007. It had no impact on the Company’s financial statements.

The Company has no unrecognized tax benefits and does not anticipate any increase in unrecognized benefits during 2007 relative to any tax positions taken prior to January 1, 2007. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is the Company’s policy to record such accruals in its income taxes accounts; no such accruals exist as of January 1, 2007. The Company and its subsidiaries file a consolidated U.S. federal income tax return and the Company files a return in the state of Kentucky. These returns are subject to examination by taxing authorities for all years after 2003.

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In September 2006, the FASB ratified the Emerging Issues Task Force’s (EITF) consensus on Issue 06-5, “Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, “Accounting for Purchases of Life Insurance.” FASB Technical Bulletin No. 85-4 requires that assets such as bank owned life insurance be carried at their cash surrender value (CSV) or the amount that could be realized, with changes in CSV reported in earnings. Issue 06-5 requires that a policyholder consider any additional amounts (e.g. claims stabilization reserves and deferred acquisition costs) included in the contractual terms of the policy in determining the amount that could be realized under the insurance contract. Certain life insurance contracts provide the policyholder with an amount that, upon surrender, is greater if all individual policies are surrendered at the same time rather than if the policies were surrendered over a period of time. The Issue requires that policyholders determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy. This Issue is effective for us beginning January 1, 2007. The Issue can be applied as either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption, or (b) a change in accounting principle through retrospective application to all periods. The adoption of Issue 06-5 had no effect on the Company’s financial statements for the nine months ended September 30, 2007.

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The standard is effective for fiscal years beginning after November 15, 2007. The Company has not completed its evaluation of the impact of the adoption of this standard, however, management does not expect the adoption of this statement to have a material impact on its consolidated financial position or results of operations.

In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. The Company has not completed its evaluation of the impact of adoption of EITF 06-4, however, management does not expect the adoption of this statement to have a material impact on its consolidated financial position or results of operations.

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This Statement allows entities to voluntarily choose, at specified election dates, to measure many financial assets and financial liabilities at fair value. The election is made on an instrument-by-instrument basis and is irrevocable. If the fair value option is elected for an instrument, the Statement specifies that all subsequent changes in fair value for that instrument shall be reported in earnings. This Statement is effective for fiscal years beginning after November 15, 2007, which is January 1, 2008 for us. Management has not yet completed its evaluation of the impact of this standard.

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Note 2 – Stock Plans and Stock Based Compensation

At September 30, 2007, the Company has a stock option plan and a stock incentive plan. On December 31, 2005, the Company assumed the 2000 Stock Option Plan of Ascencia Bank, Inc. when the Company acquired the minority interest of Ascencia Bancorp, Inc. On February 23, 2006, the Company adopted the Porter Bancorp, Inc. 2006 Stock Incentive Plan. With regard to the 2000 Option Plan, no additional grants were made subsequent to year-end and none are expected to be made in the future. The 2006 Plan permits the issuance of up to 400,000 shares of the Company’s common stock upon the exercise of stock options or upon the grant of stock awards. As of September 30, 2007, the Company had granted outstanding options to purchase 193,612 shares under the 2000 option plan and 40,316 shares under the 2006 plan. The Company also had awarded under the 2006 plan 42,800 unvested shares net of forfeitures and vesting. As of September 30, 2007, the Company had 316,884 shares available for issue under the 2006 plan. All shares issued under the above mentioned plans came from authorized and unissued shares.

On May 15, 2006, the board of directors approved the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan, which was approved by holders of the Company’s voting common stock on June 8, 2006. Under the terms of the plan, 100,000 shares are reserved for issuance to non-employee directors upon the exercise of stock options granted under the plan. Options granted are granted automatically under the plan at fair market value on the date of grant, vest over a three-year period and have a five-year term. To date the Company has granted options to purchase 53,000 shares to non-employee directors. At September 30, 2007, 47,000 shares remained available for issue under this plan.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123R, “Share Based Payment.” The Company elected to utilize the modified prospective transition method; therefore, prior period results were not restated. Prior to the adoption of SFAS 123R, stock-based compensation expense related to stock options was not recognized in the results of operations if the exercise price was at least equal to the market value of the common stock on the grant date, in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”

SFAS 123R requires all share-based payments to directors, employees, including grants of employee stock options, to be recognized as compensation expense over the service period (generally the vesting period) in the consolidated financial statements based on their fair values. Under the modified prospective method, unvested awards, awards that were granted, modified, or settled on or after January 1, 2006 are measured and accounted for in accordance with SFAS 123R. The impact of forfeitures that may occur prior to vesting is also estimated and considered in the amount recognized.

All stock options have an exercise price that is at least equal to the fair market value of the Company’s stock on the date the options were granted. Options granted generally become fully exercisable at the end of 3 years of continued employment. Options granted under the 2000 plan have a life of 10 years while those granted under the 2006 plan have a life of 5 years.

The following table summarizes stock option activity:

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The following table details stock options outstanding:

The intrinsic value of stock options is calculated based on the exercise price of the underlying awards and the market price of our common stock as of the reporting date. There were no options exercised during the first nine months of 2007. The Company recorded $92,000 of stock option compensation during the nine months ended September 30, 2007 to salaries and employee benefits. Since the stock options are non-qualified stock options, a tax benefit of $32,000 was recognized. No options were modified during the period. As of September 30, 2007, no stock options issued by the Company have been exercised.

The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes based stock option valuation model. This model requires the input of subjective assumptions that will usually have a significant impact on the fair value estimate. Expected volatilities are based on volatilities of similar publicly traded companies due to the limited historical trading activity of the Company’s stock, and other factors. Expected dividends are based on dividend trends and the market price of the Company’s stock price at grant. The Company uses historical data to estimate option exercises within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

The weighted-average assumptions used are summarized as follows:

From time-to-time the Company awards unvested shares to employees. The shares vest at a rate of 10% on each one-year anniversary date of the grant date provided the employee is still employed by the Company at that date. The fair value on the date of grant ranged from $22.13 to $25.50 per share. The Company recorded $80,000 of stock-based compensation during the first nine months of 2007 to salaries and employee benefits. A tax benefit of $28,000 was recognized related to this expense.

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The following table summarizes unvested share activity as of and for the periods indicated:

Unrecognized stock based compensation expense related to stock options and unvested shares for the remainder of 2007 and beyond is estimated as follows (in thousands):

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Note 3 – Securities

The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

Securities pledged at September 30, 2007 and December 31, 2006 had carrying values of approximately $51,725,000 and $32,404,000, respectively, and were pledged to secure public deposits, repurchase agreements, and Federal Home Loan Bank advances.

The Company 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 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 in the issuer 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 results of reviews of the issuer’s financial condition.

As of September 30, 2007, the Company has 62 equity securities. Of these securities, ten had an unrealized loss of $130,000 and had been in an unrealized loss position for less than twelve months and thirteen had an unrealized loss of $118,000 and had been in an unrealized loss position for more than twelve months. Management monitors the credit quality and current market pricing for these equity securities monthly. Management has made a practice of selling equity securities where recovery does not seem likely but does not have the present intent to sell securities with unrealized losses. As of September 30, 2007, there are no securities management would classify as other than temporarily impaired.

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Note 4 – Loans

Loans were as follows:

Activity in the allowance for loan losses was as follows:

Impaired loans were as follows:

Nonperforming loans were as follows:

Nonperforming loans include all impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.

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Note 5 – Advance from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank (FHLB) were as follows:

Each advance is payable according to its individual terms and is subject to a prepayment penalty. The advances were collateralized by first mortgage loans, under a blanket lien arrangement. At September 30, 2007, the Bank had unused borrowing capacity of $118.2 million with the FHLB.

Note 6 – Earnings per Share

The factors used in the earnings per share computation follow:

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Unvested shares of common stock of 35,300 for 2007 and 38,050 for 2006, along with stock options for 286,928 shares of common stock for 2007 and options for 251,820 shares of common stock for 2006, were not considered in computing earnings per common share because they were anti-dilutive.

Note 7 – Total Comprehensive Income

Total comprehensive income was as follows:

Note 8 – Subsequent Acquisition of Ohio County Bancshares, Inc.

On October 1, 2007, the Company acquired 100% of the outstanding shares of Ohio County Bancshares, Inc. (OCB). Operating results of OCB will be included in the consolidated financial statements of the Company beginning in the fourth quarter of 2007. As a result of the acquisition, the Company expects to further improve its market share in the Bowling Green, Ohio County, and Owensboro markets, expand its customer base to improve deposit fee income, provide an opportunity to market additional products and services to new customers, and reduce operating costs through economies of scale. The aggregate purchase price was $12.0 million. Approximately $6.0 million was paid in cash and $6.0 million was paid through the issuance of the Company’s common stock to OCB shareholders. The purchase price resulted in approximately $3.2 million in goodwill, and $3.5 million in core deposit intangible.

Total assets of approximately $111.5 million were acquired, which includes approximately $84.0 million in loans, and $17.4 million in investments. Liabilities assumed in the acquisition totaled approximately $106.2 million, which includes $94.4 million in deposits and $5.6 million in Federal Home Loan Bank advances.

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Item 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations

This item analyzes our financial condition, change in financial condition and results of operations. This section should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part I, Item 1, of this report.

Cautionary Note Regarding Forward-Looking Statements

This report contains statements about the future expectations, activities and events that constitute forward-looking statements under the Private Securities Litigation Reform Act. Forward-looking statements are based on our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of our control. Factors that could contribute to differences in our results include, but are not limited to the factors listed in Part 2, Item 1A – Risk Factors in this report and the more detailed risks identified, and the cautionary statements included in our December 31, 2006 Annual Report on Form 10-K.

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. We caution you however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. The forward-looking statements included in this report speak only as of the date of the report. We have no duty, and do not intend, to update these statements unless applicable laws require us to do so.

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Overview

Porter Bancorp, Inc. (NASDAQ: PBIB) is a Louisville, Kentucky-based bank holding company which operates 13 full-service banking offices in ten counties through its wholly-owned subsidiary, PBI Bank. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt, and extend south along the Interstate 65 corridor to Tennessee. We serve south central and southern Kentucky from banking offices in Cumberland, Butler, Green, Hart, Edmonson, Warren and Barren Counties. In June 2007, we expanded into central Kentucky by opening a loan production office in the state’s second largest city Lexington, in Fayette County. Our market area has experienced annual positive deposit growth rates in recent years with the trend expected to continue for the next few years.

On October 1, 2007, we completed the acquisition of Ohio County Bancshares and its wholly-owned subsidiary, Kentucky Trust Bank. Kentucky Trust Bank operates six retail banking offices in three central Kentucky counties, including the Beaver Dam, Bowling Green, and Owensboro markets.

On October 25, 2007, we announced that PBI Bank had signed a definitive agreement to acquire Paramount Bank in Lexington, Kentucky. Paramount Bank is a division of SCB Bank, the bank subsidiary of Blue River Bancshares, Inc. (OTC: BRBI) of Shelbyville, Indiana. Paramount has approximately $75 million in assets. The acquisition is valued at approximately $5 million and will be paid in cash. The proposed acquisition is expected to close at the beginning of the first quarter of 2008.

For the three and nine months ended September 30, 2007, respectively, the Company reported net income of $3.3 million and $10.6 million. This compares to net income of $3.8 million and $10.6 million for the same periods of 2006. Basic and diluted earnings per share were $0.44 and $1.40 for the three and nine months ended September 30, 2007, respectively, compared with $0.59 and $1.67 for the same periods of 2006. The reduction in earnings per share between periods is partially attributable to the issuance of 1,250,000 shares of common stock in our initial public offering in September 2006.

Highlights for the quarter and nine months ended September 30, 2007 consist of the following:

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The following discussion and analysis covers the primary factors affecting our performance and financial condition.

Results of Operations

The following table summarizes components of income and expense and the change in those components for the three months ended September 30, 2007 compared with the same period of 2006:

Net income of $3,299,000 for the three months ended September 30, 2007 decreased $510,000, or 13.4%, from $3,809,000 for the comparable period of 2006. This decrease in earnings was primarily attributable to increased provision for loan losses and other non-interest expense, which was partially offset by increased net interest income. The increase in net interest income was attributable to growth in our loan portfolio partially offset by the reduction in net interest margin reflecting the effect of a flat yield curve, Federal Reserve interest rate reductions, and the use of higher cost deposits to fund our loan growth. Provision for loan losses increased $1.2 million, or 443.5%, compared with the third quarter of 2006 as a result of strong growth in our loan portfolio requiring a larger provision to remain consistent with historical experience, and our current assessment of borrowers’ ability to repay, and our collateral positions related to impaired and non-performing loans.

Non-interest income decreased from the prior year due to decreased gain on sales of loans originated for sale, decreased gain on sales of government guaranteed loans, which reflects the cyclical nature of this type of income, and decreased secondary market brokerage fees. These decreases were partially offset by increased service charges on deposit accounts.

Non-interest expense increased from the prior year due to salary and employee benefits expense increasing $366,000, or 13.3%, from the prior year third quarter as a result of annual employee performance evaluation adjustments and planned staff increases related to our expansion into new markets. We incurred expense related to other real estate owned of $226,000 during the third quarter of 2007 compared with $49,000 for the same

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period of 2006. Loan collection expense was $98,000 for the current year third quarter compared to $7,000 for the third quarter of 2006. The increases in OREO expenses and loan collection expenses are primarily attributable to our efforts to foreclose, complete construction, and sell single family homes connected to certain borrowing relationships with residential builders suffering from the recent downturn in the housing market. We continue to monitor our portfolio very closely administering proactive collection efforts as prudently possible. FDIC insurance expense increased $59,000, or 355.1%, from the prior year third quarter as a result of the impact of provisions of the FDIC reform act of 2005 taking effect during the quarter.

The following table summarizes components of income and expense and the change in those components for the nine months ended September 30, 2007 compared with the same period of 2006:

Net income of $10,589,000 for the nine months ended September 30, 2007 decreased $53,000, or -0.5%, from $10,642,000 for the comparable period of 2006. This decrease in earnings was primarily attributable to increased provision for loan losses, increased other non-interest expense, and lower non-interest income, which was partially offset by increased net interest income. The increase in net interest income was attributable to growth in our loan portfolio partially offset by the reduction in net interest margin reflecting the effect of a flat yield curve, Federal Reserve interest rate reductions, and the use of higher cost deposits to fund our loan growth. Provision for loan losses increased $1.8 million, or 174.5%, in comparison to the first nine months of 2006 as a result of strong growth in our loan portfolio, requiring a larger provision to remain consistent with historical experience, and our current assessment of borrowers’ ability to repay and our collateral positions related to impaired and non-performing loans. Non-interest income decreased from the prior year due to decreased gain on sales of loans originated for sale, decreased gain on sales of government guaranteed loans, which reflects the cyclical nature of this type of income, and decreased service charges on deposit accounts. Service charges on deposit accounts decreased as a result of changes in product fee structures which we believe will make certain products more competitive, thereby increasing product sales over time.

While we recorded a gain of $284,000 from the sale of loans originated for sale in the first nine months of 2006, we had no revenue from this activity in the first nine months of 2007. This is the result of the company’s strategic decision during the latter portion of 2006 to migrate from higher-overhead residential secondary market correspondent lending to lower-overhead residential secondary market brokerage. We recorded brokerage revenue of $232,000 during the first nine months of 2007 compared with $122,000 for the same period of 2006.

The increase in non-interest expense from the prior year is primarily due to increased salary and employee benefits expense, and loan related expense. Salary and employee benefits expense increased $417,000, or 4.8%, from the first nine month of 2006 as a result of annual employee performance evaluation adjustments and planned staff increases related to our expansion into new markets. We incurred expense related to other real estate owned of $327,000 during the first nine months of 2007 compared with $172,000 for the same period of

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2006. Loan collection expense was $229,000 for the first nine months of 2007 compared to $36,000 for the same period of 2006. The increases in OREO expenses and loan collection expenses are primarily attributable to our efforts to foreclose, complete construction, and sell single family homes connected to certain borrowing relationships with residential builders suffering from the recent downturn in the housing market. We continue to monitor our portfolio very closely administering proactive collection efforts as prudently possible.

Net Interest Income – Our net interest income was $10,736,000 for the three months ended September 30, 2007, an increase of $1,457,000, or 15.7%, compared with $9,279,000 for the same period of 2006. Net interest spread and margin were 3.03% and 3.60%, respectively, for the third quarter of 2007, compared with 3.47% and 3.95%, respectively, for the third quarter of 2006. Net interest income was $30,600,000 for the nine months ended September 30, 2007, an increase of $2,867,000, or 10.3%, compared with $27,733,000 for the same period of 2006. Net interest spread and margin were 3.13% and 3.73%, respectively, for the first nine months of 2007, compared with 3.56% and 4.00%, respectively, for the first nine months of 2006.

Net interest margin for the third quarter of 2007 declined to 3.60% compared with 3.95% for the third quarter of 2006. Our yield on earning assets increased to 7.96% for the third quarter of 2007 compared to 7.87% for the third quarter of 2006 while our cost of funds increased to 4.93% for the third quarter of 2007 compared to 4.40% for the third quarter of 2006. Net interest margin decreased 9 basis points from our margin of 3.69% in the second quarter of 2007. Our yield on earning assets remained unchanged from 7.96% earned during the second quarter of 2007 while our cost of funds increased 7 basis points from 4.86%. This was due in part to our use of promotional pricing in our marketing efforts to attract premium customers in our new markets, Federal Reserve interest rate reductions, and the use of higher cost deposits to fund our loan growth.

Our average interest-earning assets were $1.1 billion for the nine months ended September 30, 2007, compared with $936.8 million for the nine months ended September 30, 2006, an 18.2% increase primarily attributable to loan growth. Average loans were $962.8 million for the nine months ended September 30, 2007, compared with $807.1 million for the nine months ended September 30, 2006, a 19.3% increase. Our total interest income increased by 23.1% to $65.8 million for the nine months ended September 30, 2007, compared with $53.5 million for the same period of 2006. The change was due to a combination of higher interest rates and higher loan volume.

Our average interest-bearing liabilities increased by 16.1% to $971.6 million for the nine months ended September 30, 2007, compared with $836.9 million for the nine months ended September 30, 2006. Our total interest expense increased by 36.8% to $35.2 million for the nine months ended September 30, 2007, compared with $25.8 million during the same period of 2006, due primarily to an increase in the volume of, and higher interest rates paid on, certificates of deposit and NOW and money market deposit accounts (MMDA’s). Our average volume of certificates of deposit increased by 13% to $713.2 million for the nine months ended September 30, 2007, compared with $631.4 million for the nine months ended September 30, 2006. The average interest rate paid on certificates of deposits increased to 5.09% for the nine months ended September 30, 2007, compared with 4.25% for the nine months ended September 30, 2006. Our average volume of NOW and MMDA’s increased by 69.6% to $141.8 million for the nine months ended September 30, 2007, compared with $83.6 million for the first nine month of 2006. The average rate paid on NOW and MMDA’s increased to 3.78% for the nine months ended September 30, 2007, compared with 2.13% for the first nine months of 2006. The increase in cost of funds was the result of the continued repricing of certificates of deposit at maturity at higher interest rates and increases in MMDA rates driven by increases in market rates and competition.

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Average Balance Sheets

The following table presents the average balance sheets for the three month periods ending September 30, 2007 and 2006, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.