UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2014

or

oTransition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                          to                         

Commission File Number:  0-24557

CARDINAL FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Virginia (State or other jurisdiction of incorporation or organization) 54-1874630 (I.R.S. Employer Identification No.)

8270 Greensboro Drive, Suite 500
McLean, Virginia	22102
(Address of principal executive offices)	(Zip Code)

(703) 584-3400

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer o	Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company o

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

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

32,029,777 shares of common stock, par value $1.00 per share, outstanding as of November 5, 2014

CARDINAL FINANCIAL CORPORATION

INDEX TO FORM 10-Q

PART I — FINANCIAL INFORMATION		3
Item 1. Financial Statements:		3
	Consolidated Statements of Condition At September 30, 2014 (unaudited) and December 31, 2013	3
	Consolidated Statements of Income For the Three and Nine Months Ended September 30, 2014 and 2013 (unaudited)	4
	Consolidated Statements of Comprehensive Income For the Three and Nine Months Ended September 30, 2014 and 2013 (unaudited)	5
	Consolidated Statements of Changes in Shareholders’ Equity For the Nine Months Ended September 30, 2014 and 2013 (unaudited)	6
	Consolidated Statements of Cash Flows For the Nine Months Ended September 30, 2014 and 2013 (unaudited)	7
	Notes to Consolidated Financial Statements (unaudited)	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		49
Item 3. Quantitative and Qualitative Disclosures About Market Risk		80
Item 4. Controls and Procedures		81
PART II — OTHER INFORMATION		81
Item 1. Legal Proceedings		81
Item 1A. Risk Factors		81
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		81
Item 3. Defaults Upon Senior Securities		81
Item 4. Mine Safety Disclosures		81
Item 5. Other Information		81
Item 6. Exhibits		82
SIGNATURES		83

2

PART I — FINANCIAL INFORMATION

Item 1.  Financial Statements

CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION

September 30, 2014 and December 31, 2013

(In thousands, except share data)

			September 30,			December 31,
			2014			2013
			(Unaudited)
Assets
Cash and due from banks			$	21,390		$	18,285
Federal funds sold			26,170			10,924
Total cash and cash equivalents			47,560			29,209
Investment securities available-for-sale			330,415			349,319
Investment securities held-to-maturity (market value of $5,300 and $5,527 at September 30, 2014 and December 31, 2013, respectively)			6,072			6,477
Investment securities - trading			4,724			3,890
Total investment securities			341,211			359,686
Other investments			19,394			19,068
Loans held for sale			313,525			373,993
Loans receivable, net of deferred fees and costs			2,489,293			2,040,168
Allowance for loan losses			(29,537		)	(27,864		)
Loans receivable, net			2,459,756			2,012,304
Premises and equipment, net			25,385			20,389
Deferred tax asset, net			3,183			5,395
Goodwill and intangibles, net			37,012			10,144
Bank-owned life insurance			32,418			32,063
Accrued interest receivable and other assets			35,481			31,979
Total assets			$	3,314,925		$	2,894,230
Liabilities and Shareholders’ Equity
Non-interest bearing deposits			$	553,629		$	433,749
Interest bearing deposits			1,871,176			1,625,110
Total deposits			2,424,805			2,058,859
Other borrowed funds			476,828			475,232
Mortgage funding checks			15,510			6,528
Escrow liabilities			2,242			1,572
Accrued interest payable and other liabilities			27,473			31,507
Total liabilities			2,946,858			2,573,698
Common stock, $1 par value	2014	2013
Shares authorized	50,000,000	50,000,000
Shares issued and outstanding	32,028,727	30,332,685	32,029			30,333
Additional paid-in capital			201,066			174,001
Retained earnings			125,814			111,323
Accumulated other comprehensive income, net			9,158			4,875
Total shareholders’ equity			368,067			320,532
Total liabilities and shareholders’ equity			$	3,314,925		$	2,894,230

See accompanying notes to consolidated financial statements.

3

CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Three and Nine Months Ended September 30, 2014 and 2013

(In thousands, except per share data)

(Unaudited)

	Three Months Ended September30,					Nine Months Ended September30,
	2014		2013			2014		2013
Interest income:
Loans receivable	$	26,684	$	21,988		$	77,261	$	63,759
Loans held for sale	3,553		4,141			9,326		13,258
Federal funds sold	9		28			50		244
Investment securities available-for-sale	2,824		2,767			8,873		7,388
Investment securities held-to-maturity	37		44			112		148
Other investments	132		84			416		240
Total interest income	33,239		29,052			96,038		85,037
Interest expense:
Deposits	3,054		3,166			8,881		9,937
Other borrowed funds	2,269		2,194			6,661		6,554
Total interest expense	5,323		5,360			15,542		16,491
Net interest income	27,916		23,692			80,496		68,546
Provision for loan losses	—		157			2,541		(432		)
Net interest income after provision for loan losses	27,916		23,535			77,955		68,978
Non-interest income:
Service charges on deposit accounts	571		507			1,641		1,498
Loan fees	340		364			951		857
Title insurance & other related income	—		169			—		918
Investment fee income	128		195			554		1,143
Realized and unrealized gains (losses) on mortgage banking activities	6,567		(102		)	24,188		17,386
Net realized gain on investment securities-trading	39		18			381		100
Net realized gain on investment securities-available for sale	682		—			665		—
Management fee income	—		374			21		1,483
Increase in cash surrender value of bank-owned life insurance	111		124			356		306
Gain (loss) on sale of real estate	—		—			—		30
Other income	13		9			44		38
Total non-interest income	8,451		1,658			28,801		23,759
Non-interest expense:
Salary and benefits	10,726		9,992			33,586		30,367
Occupancy	2,601		1,981			7,776		6,148
Professional fees	783		786			2,476		3,247
Depreciation	972		808			2,789		2,331
Data processing & communications	1,603		1,212			4,905		3,481
FDIC insurance premiums	391		401			1,119		1,049
Mortgage loan repurchases and settlements	—		111			83		(49		)
Merger and acquisition expenses	64		304			5,733		304
Amortization of intangibles	185		49			578		148
Other operating expenses	4,890		5,400			14,155		15,950
Total non-interest expense	22,215		21,044			73,200		62,976
Income before income taxes	14,152		4,149			33,556		29,761
Provision for income taxes	4,710		1,168			11,391		9,796
Net income	$	9,442	$	2,981		$	22,165	$	19,965
Earnings per common share - basic	$	0.29	$	0.10		$	0.69	$	0.65
Earnings per common share - diluted	$	0.29	$	0.10		$	0.68	$	0.64
Weighted-average common shares outstanding - basic	32,482		30,692			32,345		30,654
Weighted-average common shares outstanding - diluted	32,934		31,060			32,772		31,053

See accompanying notes to consolidated financial statements.

4

CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Three and Nine Months Ended September 30, 2014 and 2013

(In thousands)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Net income	$	9,442		$	2,981		$	22,165		$	19,965
Other comprehensive income:
Unrealized gain (loss) on available-for-sale investment securities:
Unrealized holding gain (loss) arising during the period, net of tax benefit of $345 thousand and net of tax expense of $2.8 million for the three and nine months ended September 30, 2014, respectively, net of tax expense $39,000 and net of tax benefit of $3.5 million for the three and nine months ended September 30, 2013.	(576		)	76			5,166			(6,802		)
Plus: reclassification adjustment for net gains included in net income net of tax expense of $226 thousand and $220 thousand for the three and nine months ended September 30, 2014 and $0 for each of the three and nine months ended September 30, 2013.	(456		)	—			(445		)	—
	(1,032		)	76			4,721			(6,802		)
Unrealized gain (loss) on derivative instruments designated as cash flow hedges, net of tax expense of $141 thousand and net of tax benefit of $241 thousand for the three and nine months ended September 30, 2014, respectively and net of tax benefit of $369 thousand and $392 thousand for the three and nine months ended September 30, 2013, respectively.	254			(716		)	(438		)	(577		)
Comprehensive income	$	8,664		$	2,341		$	26,448		$	12,586

See accompanying notes to consolidated financial statements.

5

CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Nine Months Ended September 30, 2014 and 2013

(In thousands)

(Unaudited)

									Accumulated
				Additional					Other
	Common	Common		Paid-in		Retained			Comprehensive
	Shares	Stock		Capital		Earnings			Income			Total
Balance, December 31, 2012	30,226	$	30,226	$	172,021	$	92,777		$	13,042		$	308,066
Stock options exercised	55	55		427		—			—			482
Stock compensation expense, net of tax benefit	—	—		877		—			—			877
Dividends on common stock of $0.17 per share	—	—		—		(5,143		)	—			(5,143		)
Change in accumulated other comprehensive income	—	—		—		—			(7,379		)	(7,379		)
Net income	—	—		—		19,965			—			19,965
Balance, September 30, 2013	30,281	$	30,281	$	173,325	$	107,599		$	5,663		$	316,868
Balance, December 31, 2013	30,333	$	30,333	$	174,001	$	111,323		$	4,875		$	320,532
Stock options exercised	79	79		696		—			—			775
Stock compensation expense, net of tax benefit	—	—		1,178		—			—			1,178
Shares issued from acquisition of United Financial Banking Companies, Inc.	1,617	1,617		25,191		—			—			26,808
Dividends on common stock of $0.24 per share	—	—		—		(7,674		)	—			(7,674		)
Change in accumulated other comprehensive income	—	—		—		—			4,283			4,283
Net income	—	—		—		22,165			—			22,165
Balance, September 30, 2014	32,029	$	32,029	$	201,066	$	125,814		$	9,158		$	368,067

See accompanying notes to consolidated financial statements.

6

CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2014 and 2013

(In thousands)

(Unaudited)

	2014			2013
Cash flows from operating activities:
Net income	$	22,165		$	19,965
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	2,789			2,331
Amortization of premiums, discounts and intangibles	831			89
Provision for loan losses	2,541			(432		)
Loans held for sale originated	(2,231,469		)	(4,713,809		)
Proceeds from the sale of loans held for sale	2,316,125			5,193,605
Realized and unrealized gains on mortgage banking activities	(24,188		)	(17,386		)
Purchase of investment securities-trading	(1,496		)	(1,218		)
Unrealized gain on investment securities-trading	(381		)	(100		)
Unrealized gain on investment securities-available for sale	(665		)	—
Gain on sale of other real estate owned	—			(30		)
Stock compensation expense, net of tax benefits	1,178			877
Increase in cash surrender value of bank-owned life insurance	(356		)	(306		)
Increase in accrued interest receivable and other assets	2,968			9,136
Decrease in accrued interest payable, escrow liabilities and other liabilities	(5,595		)	(4,718		)
Net cash provided by operating activities	84,447			488,004
Cash flows from investing activities:
Net purchases of premises and equipment	(133		)	(3,019		)
Proceeds from the sale of investment securities available-for-sale	10,617			—
Proceeds from the sale of mortgage-backed securities available-for-sale	11,285			—
Proceeds from maturity and call of investment securities available-for-sale	32,119			11,244
Purchase of investment securities available for sale	(24,483		)	(58,887		)
Purchase of mortgage-backed securities available for sale	(6,208		)	(63,584		)
Purchase of other investments	(6,189		)	(1		)
Proceeds from the sale of other investments	6,762			255
Redemptions of investment securities available-for-sale	14,237			30,493
Redemptions of investment securities held-to-maturity	404			1,552
Acquisitions, net of cash and cash equivalents	36,472			—
Net decrease in loans receivable, net of deferred fees and costs	(211,721		)	(159,636		)
Net cash used in investing activities	(136,838		)	(241,583		)
Cash flows from financing activities:
Net increase (decrease) in deposits	70,742			(161,682		)
Net increase (decrease) in other borrowed funds - short term	22,917			(36,954		)
Net increase (decrease) in mortgage funding checks	8,982			(41,539		)
Proceeds from FHLB advances	275,000			—
Repayment of FHLB advances	(300,000		)	—
Stock options exercised	775			482
Dividends on common stock	(7,674		)	(5,143		)
Net cash provided by (used in) financing activities	70,742			(244,836		)
Net increase in cash and cash equivalents	18,351			1,585
Cash and cash equivalents at beginning of the year	29,209			67,140
Cash and cash equivalents at end of the period	$	47,560		$	68,725
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	16,141		$	16,543
Income taxes	9,235			9,720
Acquisition of noncash assets and liabilities:
Assets acquired	265,364			—
Liabilities assumed	301,836			—
Supplemental schedule of noncash investing and financing activities:
Unsettled sales of investment securities available for sale	$	(2,815	)	$	—
Unsettled purchases of investment securities available-for-sale	—			5,175

See accompanying notes to consolidated financial statements.

7

CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

Note 1

Organization

Cardinal Financial Corporation (the “Company” or “Cardinal”) is incorporated under the laws of the Commonwealth of Virginia as a financial holding company whose activities consist of investment in its wholly-owned subsidiaries. The principal operating subsidiary of the Company is Cardinal Bank (the “Bank”), a state-chartered institution and its subsidiary, George Mason Mortgage, LLC (“George Mason”), a mortgage banking company based in Fairfax, Virginia. In addition to the Bank, the Company has one nonbank subsidiary, Cardinal Wealth Services, Inc. (“CWS”), an investment services subsidiary.

On January 16, 2014, the Company announced the completion of its acquisition of United Financial Banking Companies, Inc. (“UFBC”), the holding company of The Business Bank (“TBB”), pursuant to a previously announced definitive merger agreement.  The merger of UFBC into Cardinal was effective January 16, 2014.  Under the terms of the merger agreement, UFBC shareholders received $19.13 in cash and 1.154 shares of the Company’s common stock in exchange for each share of UFBC common stock they owned immediately prior to the merger. TBB, which was headquartered in Vienna, Virginia, merged into Cardinal Bank effective March 8, 2014.

Basis of Presentation

In the opinion of management, the accompanying consolidated financial statements have been prepared in accordance with the requirements of Regulation S-X, Article 10. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. However, all adjustments that are, in the opinion of management, necessary for a fair presentation have been included. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results to be expected for the full year ending December 31, 2014. The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes to financial statements that are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Note 2

Business Combinations

On January 16, 2014, the Company acquired UFBC, the holding company for The Business Bank, a commercial bank with approximately $356 million in assets, after purchase accounting adjustments.  For each share of UFBC common stock outstanding, the shareholders of UFBC received a fixed exchange ratio of $19.13 in cash and 1.154 shares of the Company’s common stock.  The total consideration for the acquisition was $54.3 million, which was comprised of $26.8 million in cash and 1.6 million shares of the Company’s common stock.

In connection with the acquisition, the Company acquired all of the voting and common shares of UFBC Capital Trust I (the “Trust”), which is a wholly-owned subsidiary established for the sole purpose of issuing $5.0 million of floating rate junior subordinated deferrable interest debentures (“trust preferred securities”).  These trust preferred securities are due in 2035 and have an interest rate of LIBOR (London Interbank Offering Rate) plus 2.10%, which adjusts quarterly.  The Trust is an unconsolidated subsidiary since the Company is not the primary beneficiary of this entity.  The additional $155,000 that is payable by the Company to the Trust represents the Company’s unfunded capital investment in the Trust.

8

Merger and acquisition expense was $0.1 and $5.7 million for the three and nine months ended September 30, 2014, respectively, which are primarily related to legal and accounting costs, contract termination expenses, system conversion and integration expenses, employee retention and severance payments.

The following table sets forth the assets acquired and liabilities assumed in the acquisition at their estimated fair values as of the closing date of the transaction:

	January 16, 2014
	(in thousands)
Assets acquired:
Cash and cash equivalents	$	63,313
Investment securities available-for-sale	16,278
Loans	238,272
Premises and equipment	7,652
Accrued interest receivable	522
Goodwill	24,706
Other intangible assets	2,740
Other assets	2,640
Total assets acquired	$	356,123
Liabilities assumed:
Deposits:
Non-interest bearing	90,206
Savings, NOW and money market	131,312
Certificates of deposit	73,686
Total deposits	295,204
Junior subordinated debentures issued to Trust	3,679
Other liabilities	2,953
Total liabilities assumed	$	301,836
Total consideration paid	$	54,287

The fair value estimates are subject to change for up to one year after the closing date of the transaction if additional information relative to closing dates fair values becomes available.  As the Company continues to analyze the acquired assets and liabilities, there may be adjustments recorded to the carrying values.

Fair Value Measurement of Assets Acquired and Liabilities Assumed

Below are the methods used to determine the fair values of the significant assets acquired and liabilities assumed in the acquisition.

Cash and cash equivalents.  The carrying amount of cash and cash equivalents was used as a reasonable estimate of fair value.

Investment securities available for sale.  The estimated fair values of investment securities available-for-sale was based on reliable and unbiased evaluations by an industry-wide valuation service.  This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information.  Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.

Loans. The acquired loan portfolio was segregated into one of two categories for valuation purposes: purchased credit impaired loans and performing loans.  Purchased credit impaired loans were identified as those loans that were nonaccrual prior to the business combination and those loans that had been identified as potentially impaired.  Potentially impaired loans were those loans that were identified during the credit review process where there was an indication that the borrower did not have sufficient cash flows to service the loan in accordance with its terms.  Performing loans were those loans that were currently performing in accordance with the loan contract and do not appear to have any significant credit issues.

9

For loans that were identified as performing, the fair values were determined using a discounted cash flow analysis (the “income approach”).  Performing loans were segmented into pools based on loan type (1-4 family residential, commercial, commercial owner occupied, construction and development), and further segmented based on payment type (fully amortizing, non-fully amortizing balloon, or interest only), rate type (fixed versus variable), and remaining maturity.  The estimated cash flows expected to be collected for each loan was determined using a valuation model that included the following key assumptions: prepayment speeds, expected credit loss rates and discount rates.  Prepayment speeds were influenced by many factors including, but not limited to, current yields, historic rate trends, payment types, interest rate type, and the duration of the individual loan.  Expected credit loss rates were based on recent and historical default and loss rates observed for loans with similar characteristics, and further influenced by a credit review by management and a third party consultant on a selection of loans within the acquired portfolio.  The discount rates used were based on rates market participants might charge for cash flows with similar risk characteristics at the acquisition date.  The market rates were estimated using a build up approach which included assumptions with respect to loan servicing costs, interest rate volatility, and systemic risk, among other factors.

For loans that were identified as purchased credit impaired (“PCI”), either the above income approach was used or the asset approach was used.  The income approach was used for PCI loans where there was an expectation that the borrower would more likely than not continue to pay based on the current terms of the loan contract.  Management used the asset approach for all nonaccrual loans to reflect market participant assumptions.  Under the asset approach, the fair value of each loan was determined based on the estimated values of the underlying collateral.

The methods used to estimate the Level 3 fair values of loans are extremely sensitive to the assumptions and estimates used.  While management attempted to use assumptions and estimates that best reflected the acquired loan portfolios and current market conditions, a greater degree of subjectivity is inherent in these values than in those determined in active markets.

The difference between the fair value and the expected cash flows from acquired loans will be accreted to interest income over the remaining term of the loans in accordance with Accounting Standards Codification (“ASC”) topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality.”  See Note 7 for further details.

Premises and equipment.  The land and buildings acquired were recorded at fair value as determined by third party appraisals.

Other intangible assets.  Other intangible assets consisting of core deposit intangibles (“CDI”) are measures of the value of non-interest checking, savings, interest-bearing checking, and money market deposits that are acquired in a business combination excluding certificates of deposit with balances over $250,000 and high yielding interest bearing deposit accounts, which the Company determines customer related intangible assets as non-existent.  The fair value of the CDI stemming from any given business combination is based on the present value of the expected cost savings attributable to the core deposit funding, relative to an alternative funding source.  The CDI is being amortized over an estimated useful life of 6.7 years to approximate the existing deposit relationships acquired.

Deposits.  The fair values of deposit liabilities with no stated maturity (non-interest checking, savings, interest-bearing checking, and money market deposits) are equal to the carrying amounts payable on demand.  The fair values of the certificates of deposit represent contractual cash flows, discounted to present value using interest rates currently offered by market participants on deposits with similar characteristics and remaining maturities.

Junior subordinated debentures issued to Trust.  There is no active market for trust preferred securities issued by UFBC Capital Trust I; therefore, the fair value of junior subordinated debentures was estimated utilizing the income approach.  Under the income approach, the expected cash flows over the remaining estimated life of the debentures were discounted at the prevailing market rate.  The prevailing market rate was based on: (i) a third-party broker opinion; (ii) implied market yields for recent trust preferred sales; and (iii) new trust preferred issuances for instruments with similar long durations.

10

Note 3

Stock-Based Compensation

At September 30, 2014, the Company had two stock-based employee compensation plans, the 1999 Stock Option Plan (the “Option Plan”) and the 2002 Equity Compensation Plan (the “Equity Plan”).

In 1998, the Company adopted the Option Plan pursuant to which the Company may grant stock options for up to 625,000 shares of the Company’s common stock to employees and members of the Company’s and its subsidiaries’ boards of directors. As of November 23, 2008, the Option Plan expired, and therefore, there are no shares of common stock available to grant under this plan.

In 2002, the Company adopted the Equity Plan. The Equity Plan was amended in 2011 to increase the number of shares available under the plan and extend the term to 2021.  The Equity Plan authorizes the granting of options, which may be incentive stock options or non-qualified stock options, stock appreciation rights, restricted stock awards, phantom stock awards and performance share awards to directors, eligible officers and key employees of the Company.  There were 393,768 shares of the Company’s common stock available for future grants and awards in the Equity Plan as of September 30, 2014.

Stock options are granted with an exercise price equal to the common stock’s fair market value at the date of grant. Director stock options have ten year terms and vest and become fully exercisable at the grant date. Most employee stock options have ten year terms and vest and become fully exercisable in 20% increments beginning after their first year of service. Certain stock options granted to executive officers of the Company have ten year terms and vest in increments of 25% with immediate vesting of the first 25% on the date of grant and vesting of the remaining three increments on the anniversary date of the grant.  Stock options granted to executive officers during the first quarter of 2014 have ten year terms with one-third of the options vested on the grant date and the remaining unvested options vesting over the next two years.

The Company has only made awards of stock options under the Option Plan and the Equity Plan.

Total expense related to the Company’s share-based compensation plans for the three months ended September 30, 2014 and 2013 was $206,000 and $125,000, respectively. Total expense related to the Company’s share-based compensation plans for the nine months ended September 30, 2014 and 2013 was $919,000 and $561,000, respectively.  The total income tax benefit recognized in the income statement for share-based compensation arrangements was $68,000 and $41,000 for the three months ended September 30, 2014 and 2013, respectively. For the nine months ended September 30, 2014 and 2013, total income tax benefit recognized in the income statement for share-based compensation arrangements was $304,000 and $185,000, respectively.

Options granted for the three and nine months ended September 30, 2014 were 19,250 and 312,500, respectively. Options granted for the three and nine months ended September 30, 2013 were 3,000 and 270,500, respectively. The weighted average per share fair value of stock option grants for the three and nine months ended September 30, 2014 was $6.06 and $5.64, respectively. The weighted average per share fair value of stock option grants for the three and nine months ended September 30, 2013 was $6.18 and $5.82, respectively.  The fair values of the options granted during all periods ended September 30, 2014 and 2013 were estimated as of the grant date using the Black-Scholes option-pricing model based on the following weighted average assumptions:

11

	Three months ended				Nine months ended
	September 30,				September 30,
	2014		2013		2014		2013
Estimated option life	6.5 Years		6.5 Years		6.5 Years		6.5 Years
Risk free interest rate	2.06 - 2.29%		2.05 - 2.15%		2.06 - 2.34%		1.14 - 2.15%
Expected volatility	37.4	%	39.5	%	37.4	%	39.5	%
Expected dividend yield	1.8	%	1.23	%	1.8	%	1.23	%

Expected volatility is based upon the average annual historical volatility of the Company’s common stock. The estimated option life is derived from specific historical data to estimate the expected term of the option, such as employee option exercise and employee post-vesting departure behavior. The risk free interest rate is based upon the seven-year U.S. Treasury note rate in effect at the time of grant.  The expected dividend yield is based upon implied and historical dividend declarations.

Stock option activity during the nine months ended September 30, 2014 is summarized as follows:

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
	Number of		Exercise		Contractual	Intrinsic
	Shares		Price		Term (Years)	Value
Outstanding at December 31, 2013	1,011,553		$	12.03
Granted	312,500		16.94
Exercised	(79,160	)	9.79
Forfeited	(5,450	)	13.36
Outstanding at September 30, 2014	1,239,443		$	13.41	6.09	$	4,539,676
Options exercisable September 30, 2014	846,693		$	12.29	4.91	$	4,043,573

The intrinsic value of options exercised during the three and nine months ended September 30, 2014 and was $402,000 and $624,000, respectively. The intrinsic value of options exercised during the three and nine months ended September 30, 2013 and was $165,000 and $466,000, respectively.

A summary of the status of the Company’s non-vested stock options and changes during the nine months ended September 30, 2014 is as follows:

			Weighted
			Average
	Number of		Grant Date
	Shares		Fair Value
Balance at December 31, 2013	289,150		$	5.29
Granted	312,500		5.64
Vested	(204,750	)	5.37
Forfeited	(4,150	)	5.25
Balance at September 30, 2014	392,750		$	5.53

At September 30, 2014, there was $1.7 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the plans. The cost is expected to be recognized over a weighted average period of 2.4 years. The total fair value of shares that vested during the three months ended September 30, 2014 and 2013 was $23,000 and $15,000, respectively. The total fair value of shares that vested during the nine months ended September 30, 2014 and 2013 was $1.1 million and $704,000, respectively.

12

Note 4

Segment Information

The Company operates in three business segments: commercial banking, mortgage banking, and wealth management services.  As of June 30, 2013, the Company merged the remaining operations of its trust division and Wilson/Bennett Capital Management, Inc., both of which had been included in the wealth management services segment, into CWS.  Results for the nine months ended September 30, 2013 include the operations of these subsidiaries.

The commercial banking segment includes both commercial and consumer lending and provides customers with such products as commercial loans, real estate loans, business financing and consumer loans. In addition, this segment provides customers with several choices of deposit products including demand deposit accounts, savings accounts and certificates of deposit. The mortgage banking segment engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis. The wealth management services segment provides investment and financial advisory services to businesses and individuals, including financial planning, retirement/estate planning, and investment management.

Information about the reportable segments and reconciliation of this information to the consolidated financial statements at and for the three and nine months ended September 30, 2014 and 2013 is as follows:

At and for the Three Months Ended September 30, 2014 (in thousands):

						Wealth Management
	Commercial		Mortgage			and					Intersegment
	Banking		Banking			Trust Services		Other			Elimination			Consolidated
Net interest income	$	27,302	$	794		$	—	$	(180	)	$	—		$	27,916
Provision for loan losses	—		—			—		—			—			—
Non-interest income	1,609		6,685			113		44			—			8,451
Non-interest expense	13,375		7,514			108		1,218			—			22,215
Provision for income taxes	5,176		41			2		(509		)	—			4,710
Net income (loss)	$	10,360	$	(76	)	$	3	$	(845	)	$	—		$	9,442
Total Assets	$	3,256,306	$	352,598		$	2,405	$	386,639		$	(683,023	)	$	3,314,925
Average Assets	$	3,188,855	$	352,621		$	2,418	$	388,497		$	(689,673	)	$	3,242,718

At and for the Three Months Ended September 30, 2013 (in thousands):

						Wealth Management
	Commercial		Mortgage			and					Intersegment
	Banking		Banking			Trust Services		Other			Elimination			Consolidated
Net interest income	$	23,110	$	750		$	—	$	(168	)	$	—		$	23,692
Provision for loan losses	157		—			—		—			—			157
Non-interest income	1,010		441			195		22			(10		)	1,658
Non-interest expense	11,100		8,764			101		1,089			(10		)	21,044
Provision for income taxes	4,291		(2,722		)	33		(434		)	—			1,168
Net income (loss)	$	8,572	$	(4,851	)	$	61	$	(801	)	$	—		$	2,981
Total Assets	$	2,762,206	$	335,253		$	2,195	$	325,271		$	(620,519	)	$	2,804,406
Average Assets	$	2,745,832	$	409,394		$	2,172	$	321,867		$	(711,107	)	$	2,768,158

13

At and for the Nine Months Ended September 30, 2014 (in thousands):

					Wealth Management
	Commercial		Mortgage		and					Intersegment
	Banking		Banking		Trust Services		Other			Elimination			Consolidated
Net interest income	$	78,842	$	2,177	$	—	$	(523	)	$	—		$	80,496
Provision for loan losses	2,541		—		—		—			—			2,541
Non-interest income	3,475		24,443		484		399			—			28,801
Non-interest expense	44,363		23,544		321		4,972			—			73,200
Provision for income taxes	11,874		1,180		57		(1,720		)	—			11,391
Net income (loss)	$	23,539	$	1,896	$	106	$	(3,376	)	$	—		$	22,165
Total Assets	$	3,256,306	$	352,598	$	2,405	$	386,639		$	(683,023	)	$	3,314,925
Average Assets	$	3,054,416	$	302,635	$	2,346	$	385,890		$	(590,005	)	$	3,155,282

At and for the Nine Months Ended September 30, 2013 (in thousands):

							Wealth Management
	Commercial			Mortgage			and						Intersegment
	Banking			Banking			Trust Services			Other			Elimination			Consolidated
Net interest income	$	67,410		$	1,665		$	—		$	(529	)	$	—		$	68,546
Provision for loan losses	(517		)	85			—			—			—			(432		)
Non-interest income	2,530			20,000			1,143			112			(26		)	23,759
Non-interest expense	31,296			27,222			1,472			3,012			(26		)	62,976
Provision for income taxes	13,062			(2,028		)	(111		)	(1,127		)	—			9,796
Net income (loss)	$	26,099		$	(3,614	)	$	(218	)	$	(2,302	)	$	—		$	19,965
Total Assets	$	2,762,206		$	335,253		$	2,195		$	325,271		$	(620,519	)	$	2,804,406
Average Assets	$	2,780,602		$	461,212		$	2,342		$	328,183		$	(780,701	)	$	2,791,638

The Company did not have any operating segments other than those reported. Parent company financial information is included in the “Other” category and represents an overhead function rather than an operating segment. The parent company’s most significant assets are its net investments in its subsidiaries. The parent company’s net interest expense is comprised of interest income from short-term investments and interest expense on trust preferred securities.

14

Note 5

Earnings Per Share

The following is the calculation of basic and diluted earnings per share for the three and nine months ended September 30, 2014 and 2013.  There were no antidilutive outstanding stock options excluded from the weighted average shares outstanding for the diluted earnings per share calculation for each of the three and nine months ended September 30, 2014. Antidilutive stock options excluded from the weighted average shares outstanding for the diluted earnings per share calculation for the three and nine months ended September 30, 2013 were 2,030 and 721, respectively. These stock options have exercise prices that were greater than the average market price of the Company’s common stock for the periods presented.

	Three Months Ended				Nine Months Ended
(In thousands,	September 30,				September 30,
except per share data)	2014		2013		2014		2013
Net income available to common shareholders	$	9,442	$	2,981	$	22,165	$	19,965
Weighted average common shares - basic	32,482		30,693		32,345		30,654
Weighted average common shares - diluted	32,934		31,060		32,772		31,053
Earnings per common share - basic	$	0.29	$	0.10	$	0.69	$	0.65
Earnings per common share - diluted	$	0.29	$	0.10	$	0.68	$	0.64

Weighted average shares for the basic earnings per share calculation is increased by the number of shares required to be issued under the Company’s various deferred compensation plans.  These plans provide for a Company match, such match must be in the common stock of the Company.  Employees who participate in the Company’s deferred compensation plans can allocate, at their discretion, their contributions to various investment options, including an option to invest in Company Common Stock.  The incremental weighted average shares attributable to the deferred compensation plans included in diluted outstanding shares assumes the participants opt to invest all of their contributions into the Company’s Common Stock investment option.

The following shows the composition of basic outstanding shares for the three and nine months ended September 30, 2014 and 2013:

	Three Months Ended		Nine Months Ended
	September 30,		September 30,
(in thousands)	2014	2013	2014	2013
Weighted average common shares outstanding	32,005	30,270	31,887	30,259
Weighted average shares attributable to the deferred compensation plans	477	423	458	395
Total weighted average shares - basic	32,482	30,693	32,345	30,654

15

The following shows the composition of diluted outstanding shares for the three and nine months ended September 30, 2014 and 2013:

	Three Months Ended		Nine Months Ended
	September 30,		September 30,
(in thousands)	2014	2013	2014	2013
Weighted average shares outstanding - basic (from above)	32,482	30,693	32,345	30,654
Incremental weighted average shares attributable to deferred compensation plans	279	215	263	204
Weighted average shares attributable to stock options	173	153	164	160
Incremental Shares from stock option plan	—	—	—	35
Total weighted average shares - diluted	32,934	31,061	32,772	31,053

Note 6

Investment Securities

The approximate fair value and amortized cost of investment securities at September 30, 2014 and December 31, 2013 are shown in the table below.

	September 30, 2014
	Gross		Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(In thousands)	cost		Gains		Losses			value
Investment Securities Available-for-Sale
U.S. government-sponsored agencies	$	56,437	$	2,973	$	(297	)	$	59,113
Mortgage-backed securities	122,162		5,816		(50		)	127,928
Municipal securities	134,264		6,434		(51		)	140,647
Pooled trust preferred & corporate securities	2,574		153		—			2,727
Total	$	315,437	$	15,376	$	(398	)	$	330,415
Investment Securities Held-to-Maturity
Mortgage-backed securities	2,067		116		—			2,183
Pooled trust preferred securities	4,005		—		(888		)	3,117
Total	$	6,072	$	116	$	(888	)	$	5,300

16

	December 31, 2013
	Gross		Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(In thousands)	cost		Gains		Losses			value
Investment Securities Available-for-Sale
U.S. government-sponsored agencies	$	75,562	$	2,914	$	(1,548	)	$	76,928
Mortgage-backed securities	144,609		3,566		(346		)	147,829
Municipal securities	113,716		3,426		(404		)	116,738
U.S. treasury securities	4,992		37		—			5,029
Pooled trust preferred securities	2,795		—		—			2,795
Total	$	341,674	$	9,943	$	(2,298	)	$	349,319
Investment Securities Held-to-Maturity
Mortgage-backed securities	2,472		145		—			2,617
Pooled trust preferred securities	4,005		—		(1,095		)	2,910
Total	$	6,477	$	145	$	(1,095	)	$	5,527

The fair value and amortized cost of investment securities by contractual maturity at September 30, 2014 and December 31, 2013 are shown below.  Expected maturities may differ from contractual maturities because many issuers have the right to call or prepay obligations with or without call or prepayment penalties.

	September 30, 2014
	Available-for-Sale				Held-to-Maturity
	Amortized		Fair		Amortized		Fair
(In thousands)	Cost		Value		Cost		Value
Within One Year	$	5,827	$	5,908	$	—	$	—
After 1 year but within 5 years	35,167		36,715		—		—
After 5 years but within 10 years	56,364		60,458		—		—
After 10 years	95,917		99,406		4,005		3,117
Mortgage-backed securities	122,162		127,928		2,067		2,183
Total	$	315,437	$	330,415	$	6,072	$	5,300

	December 31, 2013
	Available-for-Sale				Held-to-Maturity
	Amortized		Fair		Amortized		Fair
(In thousands)	cost		Value		cost		Value
Within One Year	$	8,549	$	8,690	$	—	$	—
After 1 year but within 5 years	30,120		31,672		—		—
After 5 years but within 10 years	61,665		64,876		—		—
After 10 years	96,731		96,252		4,005		2,910
Mortgage-backed securities	144,609		147,829		2,472		2,617
Total	$	341,674	$	349,319	$	6,477	$	5,527

17

The following table shows the Company’s investment securities’ gross unrealized losses and their fair value, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position at September 30, 2014 and December 31, 2013.

At September 30, 2014

Investment Securities Available-for-
Sale	Less than 12 months					12 months or more					Total
(In thousands)	Fair Value		Unrealized loss			Fair Value		Unrealized loss			Fair Value		Unrealized loss
U.S. government sponsored agencies	$	—	$	—		$	19,791	$	(297	)	$	19,791	$	(297	)
Mortgage-backed securities	4,829		(47		)	295		(3		)	5,124		(50		)
Municipal securities	8,956		(51		)	—		—			8,956		(51		)
Total temporarily impaired securities	$	13,785	$	(98	)	$	20,086	$	(300	)	$	33,871	$	(398	)

Investment Securities Held-to-
Maturity	Less than 12 months				12 months or more					Total
(In thousands)	Fair Value		Unrealized loss		Fair Value		Unrealized loss			Fair Value		Unrealized loss
Pooled trust preferred securities	$	—	$	—	$	3,117	$	(888	)	$	3,117	$	(888	)
Total temporarily impaired securities	$	—	$	—	$	3,117	$	(888	)	$	3,117	$	(888	)

At December 31, 2013

Investment Securities Available-for-
Sale	Less than 12 months					12 months or more					Total
(In thousands)	Fair Value		Unrealized loss			Fair Value		Unrealized loss			Fair Value		Unrealized loss
U.S. government sponsored agencies	$	38,554	$	(1,548	)	$	—	$	—		$	38,554	$	(1,548	)
Mortgage-backed securities	46,563		(335		)	318		(11		)	46,881		(346		)
Municipal securities	30,452		(404		)	—		—			30,452		(404		)
Total temporarily impaired securities	$	115,569	$	(2,287	)	$	318	$	(11	)	$	115,887	$	(2,298	)

Investment Securities Held-to-
Maturity	Less than 12 months				12 months or more					Total
(In thousands)	Fair Value		Unrealized loss		Fair Value		Unrealized loss			Fair Value		Unrealized loss
Pooled trust preferred securities	$	—	$	—	$	2,910	$	(1,095	)	$	2,910	$	(1,095	)
Total temporarily impaired securities	$	—	$	—	$	2,910	$	(1,095	)	$	2,910	$	(1,095	)

The Company completes reviews for other-than-temporary impairment at least quarterly.  As of September 30, 2014, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency.  Investment securities which carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk.  At September 30, 2014, 99% of the Company’s mortgage-related securities are guaranteed by the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Government National Mortgage Association (GNMA).

The Company has $1.7 million in non-government non-agency mortgage-related securities.  These securities are rated from AAA to AA.  The various protective elements on the non agency securities may change in the future if market conditions or the financial stability of credit insurers changes, which could impact the ratings of these securities.

At September 30, 2014, certain of the Company’s investment grade securities were in an unrealized loss position.  Investment securities with unrealized losses are a result of pricing changes due to recent and negative conditions in the current market environment and not as a result of permanent credit impairment.  Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government.  Other mortgage-backed securities and municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due.  The Company does not intend to sell nor does the Company believe it will be required to sell any of the temporarily impaired securities prior to the recovery of the amortized cost.

18

The Company owns four pooled trust preferred securities which were all previously classified as held-to-maturity within the investment securities portfolio.  As a result of the issuance of the final rules to implement Section 619 of the Financial Reform Act, commonly known as the “Volcker Rule” (the “Final Rule”), only two of the four investments were exempt from the covered fund definition.  For the two investments that were not exempt as a result of the Final Rule, the Company will be required to divest its investment in these particular pooled trust preferred securities prior to the effectiveness of the Final Rule on July 21, 2015.  As a result of this new regulation, these two investments which have a par value of $2.4 million and a carrying value of $2.1 million at September 30, 2014, were reclassified to the available-for-sale investment securities portfolio.   The Company recorded an other-than-temporary impairment of $300,000 for the year ended December 31, 2013, which was determined based on the market bid price of these investments.  No further impairment was recorded for the three and nine months ended September 30, 2014.

The par value of the two pooled trust preferred securities still classified as held-to-maturity totaled $4.0 million at September 30, 2014.  The collateral underlying these structured securities are instruments issued by financial institutions.  The Company owns the A-3 tranches in each issuance.  Each of the bonds is rated by more than one rating agency.  One security has a composite rating of A- and the other security has a composite rating of BBB+.  Observable trading activity remains limited for these types of securities.  The Company has estimated the fair value of the securities through the use of internal calculations and through information provided by external pricing services.  Given the level of subordination below the A-3 tranches, and the actual and expected performance of the underlying collateral, the Company expects to receive all contractual interest and principal payments recovering the amortized cost basis of each of the securities, and concluded that these securities are not other-than-temporarily impaired.  The Company continuously monitors the financial condition of the underlying issues and the level of subordination below the A-3 tranches.  The Company also utilizes a multi-scenario model which assumes varying levels of additional defaults and deferrals and the effects of such adverse developments on the contractual cash flows for the A-3 tranches.  In each of the adverse scenarios, there was no indication of a break to the A-3 contractual cash flows.

In one of the pooled trust preferred securities, 64% of the principal balance is subordinate to the Company’s class of ownership, and it is estimated that a break in contractual cash flow would occur if $178 million of the remaining $231 million, or 77% of the performing collateral defaulted or deferred payment.  In the other pooled trust preferred security, 62% of the principal balance is subordinate to the Company’s class of ownership, and it is estimated that a break in contractual cash flow would occur if $155 million of the remaining $219 million, or 71% of the performing collateral defaulted or deferred payment. Significant judgment is involved in the evaluation of other-than-temporary impairment.  The Company does not intend to sell nor does the Company believe it is probable that it will be required to sell these pooled trust preferred securities prior to the recovery of its investment.

No other-than-temporary impairment has been recognized on the securities in the Company’s investment portfolio for the three and nine months ended September 30, 2014.

19

Note 7

Loans Receivable and Allowance for Loan Losses

The loan portfolio at September 30, 2014 and December 31, 2013 consist of the following:

	2014									2013
(In thousands)	Originated			Acquired			Total			Total
Commercial and industrial	$	291,044		$	30,216		$	321,260		$	219,156
Real estate - commercial	1,115,979			108,992			1,224,971			1,048,579
Real estate - construction	411,615			17,003			428,618			363,063
Real estate - residential	376,893			10,390			387,283			299,484
Home equity lines	121,866			4,167			126,033			109,481
Consumer	4,299			847			5,146			4,159
	2,321,696			171,615			2,493,311			2,043,922
Net deferred fees	(4,018		)	—			(4,018		)	(3,754		)
Loans receivable, net of fees	2,317,678			171,615			2,489,293			2,040,168
Allowance for loan losses	(29,392		)	(145		)	(29,537		)	(27,864		)
Loans receivable, net	$	2,288,286		$	171,470		$	2,459,756		$	2,012,304

During 2014, as a result of the Company’s acquisition of UFBC, the loan portfolio was segregated between loans initially accounted for under the amortized cost method (referred to as “originated” loans) and loans acquired (referred to as “acquired” loans).

The loans segregated to the acquired loan portfolio were initially measured at fair value and subsequently accounted for under either Accounting Standards Codification (“ASC”) Topic 310-30 or ASC 310-20.  The outstanding principal balance and related carrying amount of acquired loans included in the consolidated statement of condition are as follows:

(in thousands)	September 30, 2014
Credit impaired acquired loans evaluated individually for future credit losses
Outstanding principal balance	$	18,356
Carrying amount	14,167
Other acquired loans
Outstanding principal balance	158,026
Carrying amount	157,448
Total acquired loans
Outstanding principal balance	176,382
Carrying amount	171,615

The following table presents changes in the accretable discount, which includes income recognized from contractual interest cash flows.

(in thousands)
Balance at January 1, 2014	$	—
Recorded discount at acquisition date	(3,872		)
Accretion	(896		)
Balance at September 30, 2014	$	(4,768	)

The Company’s allowance for loan losses is based first on a segmentation of its loan portfolio by general loan type, or portfolio segments, as presented in the preceding table.  For originated loans, certain portfolio segments are further disaggregated and evaluated collectively for impairment based on class segments, which are largely based on thetype of collateral underlying each loan.  The Company also maintains an allowance for loan losses for acquired loans when: (i) for loans accounted for under ASC 310-30, there is deterioration in credit quality subsequent to acquisition, and (ii) for loans accounted for under ASC 310-20, the inherent losses in the loans exceed the remaining credit discount recorded at the time of acquisition.

20

Activity in the Company’s allowance for loan losses for the three and nine months ended September 30, 2014 and 2013 is shown below.

	Three months ended September 30,					Nine months ended September 30,
	2014			2013		2014			2013
Balance, beginning of period	$	29,566		$	26,934	$	27,864		$	27,400
Provision for loan losses	—			157		2,541			(432		)
Loans charged off:
Commercial and industrial	—			—		(1,346		)	(42		)
Residential	(78		)	—		(78		)	(185		)
Consumer	(5		)	—		(7		)	(1		)
Total loans charged off	(83		)	—		(1,431		)	(228		)
Recoveries:
Commercial and industrial	10			290		339			609
Residential	44			11		136			41
Consumer	—			—		88			2
Total recoveries	54			301		563			652
Net recoveries (charge offs)	(29		)	301		(868		)	424
Ending balance, September 30, 2014	$	29,537		$	27,392	$	29,537		$	27,392

For the three and nine months ended September 30, 2014, the Company recorded an allowance for loan losses for the acquired loan portfolio of $0 and $145,000 respectively.  This amount represents credit deterioration post acquisition related to acquired loans.  There were no impairments recorded in the purchase credit impaired portfolio as of September 30, 2014.

An analysis of the allowance for loan losses based on loan type, or segment, and the Company’s loan portfolio, which identifies certain loans that are evaluated for individual or collective impairment, as of September 30, 2014 and December 31, 2013, are below:

21

Allowance for Loan Losses

At and for the Three Months Ended September 30, 2014

(In thousands)

	Commercial and		Real Estate -			Real Estate -			Real Estate -			Home Equity
	Industrial		Commercial			Construction			Residential			Lines		Consumer			Total
Allowance for loan losses:
Beginning Balance, July 1	$	3,494	$	17,199		$	5,985		$	2,397		$	400	$	91		$	29,566
Charge-offs	—		—			—			(78		)	—		(5		)	(83		)
Recoveries	3		—			7			44			—		—			54
Provision for loan losses	610		(422		)	(184		)	(52		)	38		10			—
Ending balance, September 30, 2014	$	4,107	$	16,777		$	5,808		$	2,311		$	438	$	96		$	29,537

Allowance for Loan Losses

At and for the Nine Months Ended September 30, 2014

(In thousands)

	Commercial and			Real Estate -			Real Estate -		Real Estate -			Home Equity
	Industrial			Commercial			Construction		Residential			Lines			Consumer			Total
Allowance for loan losses:
Beginning Balance, January 1	$	3,329		$	16,076		$	5,336	$	2,421		$	609		$	93		$	27,864
Charge-offs	(301		)	(1,045		)	—		(78		)	—			(7		)	(1,431		)
Recoveries	7			316			16		136			—			88			563
Provision for loan losses	1,072			1,430			456		(168		)	(171		)	(78		)	2,541
Ending balance, September 30, 2014	$	4,107		$	16,777		$	5,808	$	2,311		$	438		$	96		$	29,537
Ending balance, September 30, 2014
Individually evaluated for impairment	$	574		$	—		$	—	$	—		$	—		$	—		$	574
Collectively evaluated for impairment	3,533			16,777			5,808		2,311			438			96			28,963

22

Loans Receivable

At September 30, 2014

(In thousands)

	Commercial and		Real Estate -		Real Estate -		Real Estate -		Home Equity
	Industrial		Commercial		Construction		Residential		Lines		Consumer		Total
Loans Receivable:
Ending balance, September 30, 2014	$	321,260	$	1,224,971	$	428,618	$	387,283	$	126,033	$	5,146	$	2,493,311
Ending balance, September 30, 2014
Individually evaluated for impairment	$	1,882	$	1,070	$	250	$	146	$	347	$	1	$	3,696
Purchased Credit Impaired Loans	2,965		8,786		1,617		336		458		5		14,167
Collectively evaluated for impairment	316,413		1,215,115		426,751		386,801		125,228		5,140		2,475,448

Allowance for Loan Losses

At and for the Three Months Ended September 30, 2013

(In thousands)

	Commercial and		Real Estate -			Real Estate -			Real Estate -		Home Equity
	Industrial		Commercial			Construction			Residential		Lines		Consumer		Total
Allowance for loan losses:
Beginning Balance, July 1	$	31	$	19,909		$	6,700		$	133	$	112	$	49	$	26,934
Charge-offs	—		—			—					—		—		—
Recoveries	—		289			1			11		—		—		301
Provision for loan losses	669		(552		)	(234		)	229		29		16		157
Ending balance, September 30, 2013	$	700	$	19,646		$	6,467		$	373	$	141	$	65	$	27,392

23

Allowance for Loan Losses

At and for the Nine Months Ended September 30, 2013

(In thousands)

	Commercial and			Real Estate -		Real Estate -			Real Estate -			Home Equity
	Industrial			Commercial		Construction			Residential			Lines			Consumer			Total
Allowance for loan losses:
Beginning Balance, January 1	$	525		$	17,990	$	7,675		$	857		$	266		$	87		$	27,400
Charge-offs	(42		)	—		—			(185		)	—			(1		)	(228		)
Recoveries	306			293		10			41			—			2			652
Provision for loan losses	(89		)	1,363		(1,218		)	(340		)	(125		)	(23		)	(432		)
Ending balance, September 30, 2013	$	700		$	19,646	$	6,467		$	373		$	141		$	65		$	27,392
Ending balance, September 30, 2013
Individually evaluated for impairment	$	—		$	—	$	—		$	—		$	—		$	—		$	—
Collectively evaluated for impairment	700			$	19,646	$	6,467		$	373		$	141		$	65		$	27,392

Loans Receivable

At September 30, 2013

(In thousands)

	Commercial and		Real Estate -		Real Estate -		Real Estate -		Home Equity
	Industrial		Commercial		Construction		Residential		Lines		Consumer		Total
Loans Receivable:
Ending balance, September 30, 2013	$	207,729	$	999,128	$	353,241	$	294,105	$	109,125	$	3,818	$	1,967,146
Ending balance, September 30, 2013
Individually evaluated for impairment	$	—	$	1,738	$	1,022	$	—	$	—	$	—	$	2,760
Collectively evaluated for impairment	207,729		997,390		352,219		294,105		109,125		3,818		1,964,386

The accounting policy related to the allowance for loan losses is considered a critical accounting policy given the level of estimation, judgment and uncertainty in evaluating the levels of the allowance required for the inherent probable losses in the loan portfolio and the material effect such estimation, judgment and uncertainty can be on the consolidated financial results.

The Company’s ongoing credit quality management process relies on a system of activities to assess and evaluate various factors that impact the estimation of the allowance for loan losses.  These factors include, but are not limited to; current economic conditions; loan concentrations, collateral adequacy and value; past loss experience for particular types of loans, size, composition and nature of loans; migration of loans through our loan rating methodology; trends in charge-offs and recoveries.  This process also contemplates a disciplined approach to managing and monitoring credit exposures to ensure that the structure and pricing of credit is always consistent with the Company’s assessment of risk.  The loan officer has frequent contact with the borrower and is a key player in the credit management process and must develop and diligently practice sound credit management skills and habits to ensure effectiveness.  Under the direction of the Company’s loan committee and the chief credit officer, the credit risk management function works with the loan officers and other groups within the Company to monitor the loan portfolio, maintain the watch list, and compile the analysis necessary to determine the allowance for loan losses.

24

Loans are added to the watch list when circumstances appear to warrant the inclusion of the relationship.  As a general rule, loans are added to the watch list when they are deemed to be problem assets.  Problem assets are defined as those that have been risk rated special mention or lower.   Successful problem asset management requires early recognition of deteriorating credits and timely corrective or risk management actions.  Generally, risk ratings are either approved or amended by the loan committee accordingly.  Problem loans are maintained on the watch list until the loan is either paid off or circumstances around the borrower’s situation improve to the point that the risk rating on the loan is adjusted upward.

In addition to internal activities, the Company also engages an external consultant on a quarterly basis to review the Company’s loan portfolio.  This external loan review function helps to ensure the soundness of the loan portfolio through a third party review of existing exposures in the portfolio, supporting the commercial loan officers in the execution of its credit management responsibilities, and monitoring the adherence to the Company’s credit risk management standards.

The following tables report the Company’s nonaccrual and past due loans at September 30, 2014 and December 31, 2013.  In addition, the credit quality of the loan portfolio is provided as of September 30, 2014 and December 31, 2013.

25

Nonaccrual and Past Due Loans - Originated Loan Portfolio

At September 30, 2014

(In thousands)

					90 Days or
	30-		60-		More Past Due								90 Days Past
	59 Days		89 Days		(includes								Due and Still		Nonaccrual
	Past Due		Past Due		nonaccrual)		Total Past Due		Current		Total Loans		Accruing		Loans
Commercial and industrial	$	69	$	380	$	1,495	$	1,944	$	289,100	291,044		$	—	$	1,495
Real estate - commercial
Owner occupied	—		—		—		—		285,416		285,416		—		—
Non-owner occupied	76		—		1,070		1,146		829,417		830,563		—		1,070
Real estate - construction
Residential	—		—		—		—		147,216		147,216		—		—
Commercial	—		—		—		—		264,399		264,399		—		—
Real estate - residential
Single family	—		—		146		146		271,204		271,350		—		146
Multi-family	—		—		—		—		105,543		105,543		—		—
Home equity lines	50		119		228		397		121,469		121,866		—		228
Consumer
Installment	—		1		—		1		3,824		3,825		—		—
Credit cards	—		—		—		—		474		474		—		—
	$	195	$	500	$	2,939	$	3,634	$	2,318,062	$	2,321,696	$	—	$	2,939

26

Nonaccrual and Past Due Loans - Acquired Loan Portfolio

At September 30, 2014

(In thousands)

					90 Days or
	30-		60-		More Past Due								90 Days Past
	59 Days		89 Days		(includes								Due and Still		Nonaccrual
	Past Due		Past Due		nonaccrual)		Total Past Due		Current		Total Loans		Accruing		Loans
Commercial and industrial	$	—	$	—	$	724	$	724	$	29,492	30,216		$	—	$	724
Real estate - commercial
Owner occupied	—		—		—		—		51,906		51,906		—		—
Non-owner occupied	146		—		969		1,115		55,971		57,086		—		348
Real estate - construction
Residential	—		—		—		—		12,978		12,978		—		—
Commercial	—		—		—		—		4,025		4,025		—		—
Real estate - residential
Single family	—		—		312		312		10,078		10,390		—		312
Multi-family	—		—		—		—		—		—		—		—
Home equity lines	—		—		—		—		4,167		4,167		—		—
Consumer
Installment	—		—		—		—		847		847		—		—
Credit cards	—		—		—		—		—		—		—		—
	$	146	$	—	$	2,005	$	2,151	$	169,464	$	171,615	$	—	$	1,384

27

Nonaccrual and Past Due Loans - Originated Loan Portfolio

At December 31, 2013

(In thousands)

					90 Days or
	30-		60-		More Past Due								90 Days Past
	59 Days		89 Days		(includes								Due and Still		Nonaccrual
	Past Due		Past Due		nonaccrual)		Total Past Due		Current		Total Loans		Accruing		Loans
Commercial and industrial	$	101	$	316	$	—	$	417	$	218,739	219,156		$	—	$	—
Real estate - commercial
Owner occupied	—		—		—		—		279,631		279,631		—		—
Non-owner occupied	82		—		1,738		1,820		767,128		768,948		—		1,738
Real estate - construction
Residential	—		—		—		—		120,144		120,144		—		—
Commercial	—		—		525		525		242,394		242,919		—		525
Real estate - residential
Single family	8		—		—		8		213,537		213,545		—		—
Multi-family	—		—		—		—		85,939		85,939		—		—
Home equity lines	—		—		51		51		109,430		109,481		—		51
Consumer
Installment	—		—		—		—		3,912		3,912		—		—
Credit cards	—		—		—		—		247		247		—		—
	$	191	$	316	$	2,314	$	2,821	$	2,041,101	$	2,043,922	$	—	$	2,314

The Company had no acquired loans as of December 31, 2013.

Additional information on the Company’s impaired loans that were evaluated for specific reserves as of September 30, 2014 and December 31, 2013, including the recorded investment on the statement of condition and the unpaid principal balance, is shown below:

28

Impaired Loans - Originated Loan Portfolio

At September 30, 2014

(In thousands)

	Recorded		Unpaid Principal		Related		Interest Income
	Investment		Balance		Allowance		Recognized
With no related allowance:
Commercial and industrial	$	239	$	239	$	—	$	—
Real estate - commercial
Owner occupied	—		—		—		—
Non-owner occupied	1,070		3,206		—		—
Real estate - construction
Residential	—		—		—		—
Commercial	250		250		—		—
Real estate - residential
Single family	146		146		—		3
Multi-family	—				—		—
Home equity lines	347		347		—		5
Consumer	1		1		—		—
With related allowance:
Commercial and industrial	$	1,495	$	1,495	$	428	$	—
Real estate - commercial							—
Owner occupied	—		—		—		—
Non-owner occupied	—		—		—		—
Real estate - construction							—
Residential	—		—		—		—
Commercial	—		—		—		—
Real estate - residential							—
Single family	—		—		—		—
Multi-family	—		—		—		—
Home equity lines	—		—		—		—
Consumer	—		—		—		—
By segment total:
Commercial and industrial	$	1,734	$	1,734	$	428	$	—
Real estate - commercial	1,070		3,206		—		—
Real estate - construction	250		250		—		—
Real estate - residential	146		146		—		3
Home equity lines	347		347		—		5
Consumer	1		1		—		—
Total	$	3,548	$	5,684	$	428	$	8

29

Impaired Loans - Acquired Loan Portfolio

At September 30, 2014

(In thousands)

	Recorded		Unpaid Principal		Related		Interest Income
	Investment		Balance		Allowance		Recognized
With no related allowance:
Commercial and industrial	$	574	$	1,227	$	—	$	6
Real estate - commercial
Owner occupied	—		—		—		—
Non-owner occupied	543		1,428		—		38
Real estate - construction
Residential	—		—		—		—
Commercial	841		943		—		5
Real estate - residential
Single family	312		455		—		2
Multi-family	—		—		—		—
Home equity lines	—		—		—		—
Consumer	—		—		—		—
With related allowance:
Commercial and industrial	$	147	$	147	$	145	$	—
Real estate - commercial							—
Owner occupied	—		—		—		—
Non-owner occupied	—		—		—		—
Real estate - construction
Residential	—		—		—		—
Commercial	—		—		—		—
Real estate - residential
Single family	—		—		—		—
Multi-family	—		—		—		—
Home equity lines	—		—		—		—
Consumer	—		—		—		—
By segment total:
Commercial and industrial	$	721	$	1,374	$	145	$	6
Real estate - commercial	543		1,428		—		38
Real estate - construction	841		943		—		5
Real estate - residential	312		455		—		2
Home equity lines	—		—		—		—
Consumer	—		—		—		—
Total	$	2,417	$	4,200	$	145	$	51

30

Impaired Loans

At December 31, 2013

(In thousands)

	Recorded		Unpaid Principal		Related		Interest Income
	Investment		Balance		Allowance		Recognized
With no related allowance:
Commercial and industrial	$	814	$	814	$	—	$	23
Real estate - commercial
Owner occupied	—		—		—		—
Non-owner occupied	1,738		3,872		—		—
Real estate - construction
Residential	—		—		—		—
Commercial	775		2,928		—		—
Real estate - residential
Single family	—		—		—		—
Multi-family	—		—		—		—
Home equity lines	51		51		—		—
With related allowance:
Commercial and industrial	$	—	$	—	$	—	$	—
Real estate - commercial							—
Owner occupied	—		—		—		—
Non-owner occupied	—		—		—		—
Real estate - construction							—
Residential	—		—		—		—
Commercial	—		—		—		—
Real estate - residential							—
Single family	—		—		—		—
Multi-family	—		—		—		—
Home equity lines	—		—		—		—
By segment total:
Commercial and industrial	$	814	$	814	$	—	$	23
Real estate - commercial	1,738		3,872		—		—
Real estate - construction	775		2,928		—		—
Real estate - residential	—		—		—		—
Home equity lines	51		51		—		—
Total	$	3,378	$	7,665	$	—	$	23

In order to maximize the collection of certain loans, the Company will attempt to work with borrowers when necessary to extend or modify loan terms to better align with the borrower’s ability to repay.  Extensions and modifications to loans are made in accordance with the Company’s policy and conform to regulatory guidance.  Each occurrence is unique to the borrower and is evaluated separately.  The Company considers regulatory guidelines when restructuring a loan to ensure that prudent lending practices are followed.  As such, qualification criteria and payment terms consider the borrower’s current and prospective ability to comply with the modified terms of the loan.

A modification is classified as a troubled debt restructuring (“TDR”) if both of the following exist: (1) the borrower is experiencing financial difficulty and (2) the Company has granted a concession to the borrower.  The Company determines that a borrower may be experiencing financial difficulty if the borrower is currently in default on any of its debt, or if the Company is concerned that the borrower may not be able to perform in accordance with the current terms of the loan agreement in the foreseeable future.  Many aspects of the borrower’s financial situation are assessed when determining whether they are experiencing financial difficulty, particularly as it relates to commercial borrowers due to the complex nature of the loan structure, business/industry risk, and borrower/guarantor structures. Concessions may include the reduction of an interest rate at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, or principal forgiveness.  When evaluating whether a concession has been granted, the Company also considers whether the borrower has provided additional collateral or guarantors and whether such additions adequately compensate the Company for the restructured terms, or if the revised terms are consistent with those currently being offered to new loan customers.  The assessments of whether a borrower is experiencing (or is likely to experience) financial difficulty and whether a concession has been granted is subjective in nature and management’s judgment is required when determining whether a modification is a TDR.

31

Although each occurrence is unique to the borrower and is evaluated separately, for all portfolio segments, TDRs are typically modified through reductions in interest rates, reductions in payments, changing the payment terms from principal and interest to interest only, and/or extensions in term maturity.

Nonaccruing loans that are modified can be placed back on accrual status when both the principal and interest are current and it is probable that the Company will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.

At September 30, 2014 and December 31, 2013, the Company had TDRs totaling $1.1 million and $2.3 million, respectively, all of which were on nonaccrual.  Nonaccrual TDRs that are reasonably assured of repayment according to their modified terms may be returned to accrual status by the Company upon a detailed credit evaluation of the borrower’s financial condition and prospects for repayment under the revised terms.  Consistent with regulatory guidance, upon sustained performance and classification as a TDR over the Company’s year-end, the loan will be removed from TDR status as long as the modified terms were market-based at the time of the modification.  The following table reconciles the beginning and ending balances on TDRs as of September 30, 2014 and 2013, respectively:

Troubled Debt Restructurings

At and For the Nine Months Ended September 30, 2014

(In thousands)

	Commercial and		Real Estate -			Real Estate -			Real Estate -
	Industrial		Commercial			Construction			Residential		Home Equity Lines		Consumer		Total
Beginning Balance, January 1, 2014	$	—	$	1,738		$	525		$	—	$	—	$	—	$	2,263
New TDRs	—		—			—			—		—		—		—
Increases to existing TDRs	—		—			—			—		—		—		—
Charge-Offs Post Modification	—		—			—			—		—		—		—
Sales, paydowns, or other decreases	—		(668		)	(525		)	—		—		—		(1,193		)
Ending balance, September 30, 2014	$	—	$	1,070		$	—		$	—	$	—	$	—	$	1,070

32

Troubled Debt Restructurings

At and For the Nine Months Ended September 30, 2013

(In thousands)

	Commercial and			Real Estate -			Real Estate -			Real Estate -		Home Equity
	Industrial			Commercial			Construction			Residential		Lines		Consumer		Total
Beginning Balance, January 1, 2013	$	1,776		$	3,800		$	1,762		$	—	$	—	$	—	$	7,338
New TDRs	—			570			—			—		—		—		570
Increases to existing TDRs	—			—			—			—		—		—		—
Charge-Offs Post Modification	—			—			—			—		—		—		—
Sales, paydowns, or other decreases	(1,776		)	(2,632		)	(990		)	—		—		—		(5,398		)
Ending balance, September 30, 2013	$	—		$	1,738		$	772		$	—	$	—	$	—	$	2,510

At September 30, 2014, TDRs make up one relationship with the Bank.  These loans are performing as expected post-modification. There are no acquired loans classified as TDRs.  For restructured loans in the portfolio, the Company had no loan loss reserves as of September 30, 2014 and December 31, 2013, respectively.

Loans modified as TDRs within the previous 12 months and for which there was a payment default during the period are calculated by first identifying TDRs that defaulted during the period and then determining whether they were modified within the 12 months prior to the default.  For the period ended September 30, 2014, one loan identified as a TDR had a payment default within the last twelve months.  For the period ended December 31, 2013, one loan identified as a TDR had a payment default within the last twelve months.

One of the most significant factors in assessing the credit quality of the Company’s loan portfolio is the risk rating.  The Company uses the following risk ratings to manage the credit quality of its loan portfolio: pass, substandard, doubtful and loss.  During 2011, the Company added an additional risk rating, other loans especially mentioned (“OLEM”), for the monitoring of credit quality.  Other loans especially mentioned are those loans in which the borrower exhibits potential weakness that may, if not corrected or reversed, weaken the bank’s credit position at some future date.  These loans may not show problems as yet due to the borrower’s apparent ability to service the debt, but special circumstances surround the loans of which the Bank’s management should be aware.  Substandard risk rated loans are those loans whose full final collectability may not appear to be a matter for serious doubt, but which nevertheless have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and require close supervision by management.  Loans that have a risk rating of doubtful have all the weakness inherent in one graded substandard with the added provision that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and value, highly questionable.  A loss loan is one that is considered uncollectible and will be charged-off immediately.  All other loans not rated other loans especially mentioned, substandard, doubtful or loss are considered to have a pass risk rating.  Substandard and doubtful risk rated loans are evaluated for impairment.  The following table presents a summary of the risk ratings by portfolio segment and class segment at September 30, 2014 and December 31, 2013.

33

Internal Risk Rating Grades - Originated Loan Portfolio

At September 30, 2014

(In thousands)

	Pass		OLEM		Substandard		Doubtful		Loss
Commercial and industrial	$	288,902	$	408	$	1,734	$	—	$	—
Real estate - commercial
Owner occupied	285,416		—		—		—		—
Non-owner occupied	827,037		2,456		1,070		—		—
Real estate - construction
Residential	147,216		—		—		—		—
Commercial	264,149		—		250		—		—
Real estate - residential
Single family	271,204		—		146		—		—
Multi-family	105,543		—		—		—		—
Home equity lines	121,469		50		347		—		—
Consumer
Installment	3,824		—		1		—		—
Credit cards	474		—		—		—		—
	$	2,315,234	$	2,914	$	3,548	$	—	$	—

Internal Risk Rating Grades - Acquired Loan Portfolio

At September 30, 2014

(In thousands)

	Pass		OLEM		Substandard		Doubtful		Loss
Commercial and industrial	$	29,490	$	5	$	721	$	—	$	—
Real estate - commercial
Owner occupied	51,906		—		—		—		—
Non-owner occupied	53,213		3,330		543		—		—
Real estate - construction
Residential	12,978		—		—		—		—
Commercial	3,184		—		841		—		—
Real estate - residential
Single family	10,078		—		312		—		—
Multi-family	—		—		—		—		—
Home equity lines	4,167		—		—		—		—
Consumer
Installment	847		—		—		—		—
Credit cards	—		—		—		—		—
	$	165,863	$	3,335	$	2,417	$	—	$	—

34

Internal Risk Rating Grades

At December 31, 2013

(In thousands)

	Pass		OLEM		Substandard		Doubtful		Loss
Commercial and industrial	$	217,755	$	587	$	814	$	—	$	—
Real estate - commercial
Owner occupied	279,631		—		—		—		—
Non-owner occupied	753,872		13,338		1,738		—		—
Real estate - construction
Residential	120,144		—		—		—		—
Commercial	242,144		—		775		—		—
Real estate - residential
Single family	213,537		8		—		—		—
Multi-family	85,939		—		—		—		—
Home equity lines	109,430		—		51		—		—
Consumer
Installment	3,912		—		—		—		—
Credit cards	247		—		—		—		—
	$	2,026,611	$	13,933	$	3,378	$	—	$	—

Note 8

Derivative Instruments and Hedging Activities

The Company enters into rate lock commitments with its mortgage customers.  The Company is also a party to forward mortgage loan sales contracts to sell loans servicing released.  The rate lock commitment and forward sale agreement are undesignated derivatives and marked to fair value through earnings.  The fair value of the rate lock derivative includes the servicing premium and the interest spread for the difference between retail and wholesale mortgage rates.  Realized and unrealized gains on mortgage banking activities presents the gain recognized for the period presented and associated with these elements of fair value.  On the date the mortgage loan closes, the loan held for sale is designated as the hedged item in a cash flow hedge relationship and the forward loan sale commitment is designated as the hedging instrument.

At September 30, 2014, accumulated other comprehensive income included an unrealized loss, net of tax, of $438,000 related to forward loan sales contracts designated as the hedging instrument in the cash flow hedge. Loans held for sale are generally sold within sixty days of closing and, therefore, all or substantially all of the amount recorded in accumulated other comprehensive income at September 30, 2014, which is related to the Company’s cash flow hedges, will be recognized in earnings during the fourth quarter of 2014. At September 30, 2014, the Company recognized minimal amounts due to hedge ineffectiveness.

At September 30, 2014, the Company had $265.4 million in residential mortgage rate lock commitments and associated forward sales, and $259.7 million in forward loan sales associated with $313.5 million of loans that had closed and were presented as held for sale.

35

Note 9

Fair Value of Derivative Instruments and Hedging Activities

The following tables disclose the derivative instruments’ location on the Company’s statement of condition and the fair value of those instruments at September 30, 2014 and December 31, 2013.  In addition, the gains and losses related to these derivative instruments is provided for the three and nine months ended September 30, 2014 and 2013.

Derivative Instruments and Hedging Activities

At September 30, 2014

(in thousands)

	Asset Derivatives			Liability Derivatives
	Balance Sheet			Balance Sheet
	Location	Fair Value		Location	Fair Value
Derivatives Designated as Hedging Instruments
Forward Loan Sales Commitments	Accrued Interest Receivable and Other Assets	$	1,667	Accrued Interest Payable and Other Liabilities	$	2,143
Total Derivatives Designated as Hedging Instruments		1,667			2,143
Derivatives Not Designated as Hedging Instruments
Rate Lock and Forward Loan Sales Commitments	Accrued Interest Receivable and Other Assets	14,011		Accrued Interest Payable and Other Liabilities	617
Rate Lock Commitments	Accrued Interest Receivable and Other Assets	617		Accrued Interest Payable and Other Liabilities	277
Total Derivatives Not Designated as Hedging Instruments		14,628			894
Total Derivatives		$	16,295		$	3,037

36

Derivative Instruments and Hedging Activities

At December 31, 2013

(in thousands)

	Asset Derivatives			Liability Derivatives
	Balance Sheet			Balance Sheet
	Location	Fair Value		Location	Fair Value
Derivatives Designated as Hedging Instruments
Forward Loan Sales Commitments	Accrued Interest Receivable and Other Assets	$	5,489	Accrued Interest Payable and Other Liabilities	$	4,043
Total Derivatives Designated as Hedging Instruments		5,489			4,043
Derivatives Not Designated as Hedging Instruments
Rate Lock and Forward Loan Sales Commitments	Accrued Interest Receivable and Other Assets	10,989		Accrued Interest Payable and Other Liabilities	9
Rate Lock Commitments	Accrued Interest Receivable and Other Assets	9		Accrued Interest Payable and Other Liabilities	1,554
Total Derivatives Not Designated as Hedging Instruments		10,998			1,563
Total Derivatives		$	16,487		$	5,606

Impact of Derivative Instruments on the Statement of Income

For the Three Months Ended September 30, 2014

(in thousands)

							Location of Gain	Amount of Gain
							(Loss) Recognized	(Loss) Recognized
	Amount of Gain			Amount of Gain			in Income on	in Income on
	(Loss) Recognized		Location of Gain	(Loss) Reclassified			Derivative	Derivative
	in Other		(Loss) Reclassified	from Accumulated			(Ineffective Portion	(Ineffective
	Comprehensive		from Accumulated	Other			and Amount	Portion and
	Income on		Other Comprehensive	Comprehensive			Excluded from	Amount Excluded
Derivatives in Cash Flow Hedging	Derivative		Income into Income	Income into Income			Effectiveness	from Effectiveness
Relationships	(Effective Portion)		(Effective Portion)	(Effective Portion)			Testing)	Testing)
Forward Loan Sales Commitments	$	254	Other Income	$	(287	)	Other Income	$	—
Total	$	254		$	(287	)		$	—

37

	Amount of Gain
	(Loss) Recognized			Location of Gain
	in Income on			(Loss) Recognized in
	Derivative			Income on Derivative
Derivatives Not Designated as Hedging Instruments
Interest Rate Lock Commitments	$	13,733		Realized and unrealized gains on mortgage banking activities
Forward Loan Sales Commitments	(340		)	Other Income
Rate Lock Commitments	340			Other Income
Total	$	13,733

Impact of Derivative Instruments on the Statement of Income

For the Nine Months Ended September 30, 2014

(in thousands)

								Location of Gain	Amount of Gain
								(Loss) Recognized	(Loss) Recognized
	Amount of Gain				Amount of Gain			in Income on	in Income on
	(Loss) Recognized			Location of Gain	(Loss) Reclassified			Derivative	Derivative
	in Other			(Loss) Reclassified	from Accumulated			(Ineffective Portion	(Ineffective
	Comprehensive			from Accumulated	Other			and Amount	Portion and
	Income on			Other Comprehensive	Comprehensive			Excluded from	Amount Excluded
Derivatives in Cash Flow Hedging	Derivative			Income into Income	Income into Income			Effectiveness	from Effectiveness
Relationships	(Effective Portion)			(Effective Portion)	(Effective Portion)			Testing)	Testing)
Forward Loan Sales Commitments	$	(438	)	Other Income	$	(5,723	)	Other Income	$	—
Total	$	(438	)		$	(5,723	)		$	—

	Amount of Gain
	(Loss) Recognized			Location of Gain
	in Income on			(Loss) Recognized in
	Derivative			Income on Derivative
Derivatives Not Designated as Hedging Instruments
Interest Rate Lock Commitments	$	43,910		Realized and unrealized gains on mortgage banking activities
Forward Loan Sales Commitments	(1,589		)	Other Income
Rate Lock Commitments	1,589			Other Income
Total	$	43,910

Impact of Derivative Instruments on the Statement of Income

For the Three Months Ended September 30, 2013

(in thousands)

	Locations of Gain			Location of Gain	Amount of Gain
	(Loss) Recognized	Amount of Gain		(Loss) Recognized	(Loss) Recognized
Derivatives in Fair Value Hedging	in Income on	(Loss) Recognized in		in Income on	in Income on
Relationships	Derivative	Income on Derivative		Hedged Item	Hedged Item
Interest Rate Swaps	Other Income	$	142	Other Income	$	(142	)
Total		$	142		$	(142	)

38

								Location of Gain	Amount of Gain
								(Loss) Recognized	(Loss) Recognized
	Amount of Gain				Amount of Gain			in Income on	in Income on
	(Loss) Recognized			Location of Gain	(Loss) Reclassified			Derivative	Derivative
	in Other			(Loss) Reclassified	from Accumulated			(Ineffective Portion	(Ineffective
	Comprehensive			from Accumulated	Other			and Amount	Portion and
	Income on			Other Comprehensive	Comprehensive			Excluded from	Amount Excluded
Derivatives in Cash Flow Hedging	Derivative			Income into Income	Income into Income			Effectiveness	from Effectiveness
Relationships	(Effective Portion)			(Effective Portion)	(Effective Portion)			Testing)	Testing)
Interest Rate Swaps	$	(15	)	Other Income	$	—		Other Income	$	—
Forward Loan Sales Commitments	(701		)	Other Income	(37,928		)	Other Income	—
Total	$	(716	)		$	(37,928	)		$	—

	Amount of Gain
	(Loss) Recognized			Location of Gain
	in Income on			(Loss) Recognized in
	Derivative			Income on Derivative
Derivatives Not Designated as Hedging Instruments
Interest Rate Lock Commitments	$	11,722		Realized and unrealized gains on mortgage banking activities
Forward Loan Sales Commitments	(4,730		)	Other Income
Rate Lock Commitments	4,730			Other Income
Total	$	11,722

Impact of Derivative Instruments on the Statement of Income

For the Nine Months Ended September 30, 2013

(in thousands)

	Locations of Gain			Location of Gain	Amount of Gain
	(Loss) Recognized	Amount of Gain		(Loss) Recognized	(Loss) Recognized
Derivatives in Fair Value Hedging	in Income on	(Loss) Recognized in		in Income on	in Income on
Relationships	Derivative	Income on Derivative		Hedged Item	Hedged Item
Interest Rate Swaps	Other Income	$	430	Other Income	$	(430	)
Total		$	430		$	(430	)

							Location of Gain	Amount of Gain
							(Loss) Recognized	(Loss) Recognized
	Amount of Gain				Amount of Gain		in Income on	in Income on
	(Loss) Recognized			Location of Gain	(Loss) Reclassified		Derivative	Derivative
	in Other			(Loss) Reclassified	from Accumulated		(Ineffective Portion	(Ineffective
	Comprehensive			from Accumulated	Other		and Amount	Portion and
	Income on			Other Comprehensive	Comprehensive		Excluded from	Amount Excluded
Derivatives in Cash Flow Hedging	Derivative			Income into Income	Income into Income		Effectiveness	from Effectiveness
Relationships	(Effective Portion)			(Effective Portion)	(Effective Portion)		Testing)	Testing)
Interest Rate Swaps	$	74		Other Income	$	—	Other Income	$	—
Forward Loan Sales Commitments	(651		)	Other Income	4,744		Other Income
Total	$	(577	)		$	4,744		$	—

39

	Amount of Gain
	(Loss) Recognized			Location of Gain
	in Income on			(Loss) Recognized in
	Derivative			Income on Derivative
Derivatives Not Designated as Hedging Instruments
Interest Rate Lock Commitments	$	50,131		Realizedand unrealized gains on mortgage banking activities
Forward Loan Sales Commitments	4,877			Other Income
Rate Lock Commitments	(4,877		)	Other Income
Total	$	50,131

Note 10

Goodwill and Other Intangibles

Information concerning total amortizable other intangible assets at September 30, 2014 is as follows:

	Mortgage Banking
	Gross Carrying		Accumulated
(In thousands)	Amount		Amortization
Balance at December 31, 2013	$	1,781	$	1,781
2014 activity:
Acquisition of UFBC	2,740		578
Balance at September 30, 2014	$	4,521	$	2,359

The aggregate amortization expense was $185,000 and $49,000 for three months ended September 30 2014 and 2013, respectively. For the nine months ended September 30, 2014 and 2013, the aggregate amortization expense was $578,000 and $148,000, respectively. The estimated amortization expense for the next five years and thereafter is as follows:

	(In thousands)
2014 (October — December)	$	178
2015	634
2016	512
2017	391
2018	269
2019 and Thereafter	178

The carrying amount of goodwill at September 30, 2014 was as follows:

	Commercial		Mortgage
(In thousands)	Banking		Banking		Total
Balance at December 31, 2013	$	24	$	10,120	$	10,144
Acquisition of UFBC	24,706		—		24,706
Balance at September 30, 2014	$	24,730	$	10,120	$	34,850

Goodwill is evaluated for impairment on an annual basis or more frequently if events or circumstances warrant.

40

The Company performs its annual recoverability assessment each September for the mortgage banking business segment.  The Company adopted the provisions of Accounting Standards Update No. 2011-08, Testing Goodwill for Impairment (“ASU No. 2011-08”).  For purposes of performing the recoverability assessment, ASU No. 2011-08 requires an entity to assess all relevant events and circumstances in evaluating whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount.  After evaluating all relevant facts and circumstances, the Company has determined that it is more likely than not that the fair value of the mortgage banking reporting unit exceeds its carrying value and no goodwill impairment is indicated.

Note 11

Commitments and Contingencies

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer so long as there is no violation of any condition established in the contract.  Commitments usually have fixed expiration dates up to one year or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  These instruments represent obligations of the Company to extend credit or guarantee borrowings and are not recorded on the consolidated statements of financial condition.  The rates and terms of these instruments are competitive with others in the market in which the Company operates.

The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.  The Company evaluates each customer’s creditworthiness on a case-by-case basis and requires collateral to support financial instruments when deemed necessary.  The amount of collateral obtained upon extension of credit is based upon management’s evaluation of the counterparty.  Collateral held varies but may include deposits held by the Company, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of the contractual obligations by a customer to a third party.  The majority of these guarantees extend until satisfactory completion of the customer’s contractual obligations.  All standby letters of credit outstanding at September 30, 2014 are collateralized.

Commitments to extend credit of $1.5 billion primarily have floating rates as of September 30, 2014.  At September 30, 2014, standby letters of credit were $25.9 million. Commitments to extend credit of $265.4 million as of September 30, 2014 are related to George Mason’s mortgage loan funding commitments and are of a short term nature.

These off-balance sheet financial instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition.  Credit risk is defined as the possibility of sustaining a loss because the other parties to a financial instrument fail to perform in accordance with the terms of the contract.  The Company’s maximum exposure to credit loss under standby letters of credit and commitments to extend credit is represented by the contractual amounts of those instruments. It is uncertain as to the amount, if any, that the Company will be required to fund on these commitments as many such arrangements expire with no amounts drawn.

George Mason provides for its estimated exposure to repurchase loans previously sold to investors for which borrowers failed to provide full and accurate information on their loan application or for which appraisals have not been acceptable or where the loan was not underwritten in accordance with the loan program specified by the loan investor, and for other exposure to its investors related to loan sales activities.  The Company evaluates the merits of each claim and estimates its reserve based on actual and expected claims received and considers the historical amounts paid to settle such claims. George Mason has a reserve of $150,000 and $261,000 at September 30, 2014 and December 31, 2013, respectively.

41

The Company has derivative counter-party risk that may arise from the possible inability of George Mason’s third party investors to meet the terms of their forward sales contracts.  George Mason works with third-party investors that are generally well-capitalized, are investment grade and exhibit strong financial performance to mitigate this risk.  The Company does not expect any third-party investor to fail to meet its obligation.  In addition, the Company has derivative counterparty risk relating to certain interest rate swaps it has with third parties.  This risk may arise from the inability of the third party to meet the terms of the contracts.  The Company monitors the financial condition of these third parties on an annual basis.  The Company does not expect any of these third parties to fail to meet its obligations.

Note 12

Fair Value Measurements

The fair value framework under U.S. generally accepted accounting principles defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  It also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring the fair value.  There are three levels of inputs that may be used to measure fair value:

Level 1 — Quoted prices in active markets for identical assets or liabilities as of the measurement date.

Level 2 — Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

Level 3 — Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

Recurring Fair Value Measurements

All classes of the Company’s investment securities available-for-sale with the exception of its treasury securities, the Company’s trading investment securities, which include cash equivalents and mutual funds, and bank-owned life insurance are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service and therefore fall into the Level 2 category.  This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information.  Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.  The Company’s treasury securities are recorded at fair value using unadjusted quoted market prices for identical securities and therefore fall under the Level 1 category.

The Company records its interest rate lock commitments and forward loan sales commitments at fair value determined as the amount that would be required to settle each of these derivative financial instruments at the balance sheet date.  In the normal course of business, George Mason enters into contractual interest rate lock commitments to extend credit to borrowers with fixed expiration dates.  The commitments become effective when the borrowers “lock-in” a specified interest rate within the time frames established by the mortgage companies.  All borrowers are evaluated for credit worthiness prior to the extension of the commitment.  Market risk arises if interest rates move adversely between the time of the interest rate lock by the borrower and the sale date of the loan to the investor.  To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, George Mason enters into a best efforts forward sales contracts to sell loans to investors.  The forward sales contracts lock in an interest rate and price for the sale of loans similar to the specific rate lock commitments.  Both the rate lock commitments to the borrowers and the forward sales contracts to the investors through to the date the loan closes are undesignated derivatives and accordingly, are marked to fair value through earnings.  These valuations fall into a Level 2 category.

There were no significant transfers into and out of Level 1, Level 2 and Level 3 measurements in the fair value hierarchy during the three months ended September 30, 2014.  Transfers between levels are recognized at the end of each reporting period.  The valuation technique used for fair value measurements using significant other observable inputs (Level 2) is the market approach for each class of assets and liabilities.

42

Assets and liabilities measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 are shown below:

At September 30, 2014
(In thousands)

	Fair Value Measurements Using
					Significant
			Quoted Prices in		Other		Significant
			Active markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Investment securities available-for-sale:
U.S. government-sponsored agencies	$	59,113	$	—	$	59,113	$	—
Mortgage-backed securities	127,928		—		127,928		—
Municipal securities	140,647		—		140,647		—
Pooled trust preferred & corporate securities	2,727		—		2,727		—
Total investment securities available-for-sale	330,415		—		330,415		—
Investment securities — trading	4,724		—		4,724		—
Bank-owned life insurance	32,418		—		32,418		—
Derivative asset - rate lock and forward loan sales commitments	15,678		—		15,678		—
Derivative asset — interest rate lock commitments	617		—		617		—
Derivative liability - rate lock and forward loan sales commitments	2,760		—		2,760		—
Derivative liability — interest rate lock commitments	277		—		277		—

43

At December 31, 2013

(In thousands)

			Fair Value Measurements Using
					Significant
			Quoted Prices in		Other		Significant
			Active markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Investment securities available-for-sale:
U.S. treasury securities	$	5,029	$	5,029	$	—	$	—
U.S. government-sponsored agencies	76,928				76,928		—
Mortgage-backed securities	147,829		—		147,829		—
Municipal securities	116,738		—		116,738		—
Pooled trust preferred securities	2,795		—		2,795		—
Total investment securities available-for-sale	349,319		5,029		344,290		—
Investment securities — trading	3,890		—		3,890		—
Bank-owned life insurance	32,063		—		32,063		—
Derivative asset - rate lock and forward loan sales commitments	16,478		—		16,478		—
Derivative asset — interest rate lock commitments	9		—		9		—
Derivative liability - rate lock and forward loan sales commitments	4,052		—		4,052		—
Derivative liability — interest rate lock commitments	1,554		—		1,554		—

Nonrecurring Fair Value Measurements

Certain assets and liabilities are measured at fair value on a nonrecurring basis and are not included in the tables above.  These assets include the valuation of the Company’s pooled trust preferred securities held in its held-to-maturity investment securities portfolio, loans receivable — evaluated for impairment and other real estate owned.

At September 30, 2014

(in thousands)

			Fair Value Measurements Using
			Quoted Prices		Significant
			in Active		Other		Significant
			markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Pooled trust preferred securities	$	3,117	$	—	$	—	3,117
Loans receivable — evaluated for impairment	3,696		—		301		3,395

At December 31, 2013

(In thousands)

			Fair Value Measurements Using
			Quoted Prices		Significant
			in Active		Other		Significant
			markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Pooled trust preferred securities	$	2,910	$	—	$	—	$	2,910
Loans receivable — evaluated for impairment	3,378		—		301		3,077

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The Company’s held-to-maturity portfolio includes investments in two pooled trust preferred securities, totaling $4.0 million of par value at September 30, 2014.  The collateral underlying these structured securities are instruments issued by financial institutions.  The Company owns the A-3 tranches in each issuance.  Observable trading activity remains limited for these types of securities.  The Company has estimated the fair value of the securities through the use of internal calculations and through information provided by external pricing services.  Given the level of subordination below the A-3 tranches, and the actual and expected performance of the underlying collateral, the Company expects to receive all contractual interest and principal payments recovering the amortized cost basis of each of the two securities, and concluded that these securities are not other-than-temporarily impaired.  The Company also utilizes a multi-scenario model which assumes varying levels of additional defaults and deferrals and the effects of such adverse developments on the contractual cash flows for the A-3 tranches.  In each of the adverse scenarios, there was no indication of a break to the A-3 contractual cash flows.

The Company’s loans receivable — evaluated for impairment are measured at the present value of its expected future cash flows discounted at the loan’s coupon rate, or at the loan’s observable market price or fair value of the collateral if the loan is collateral dependent.  The Company measures the collateral value on loans receivable — evaluated for impairment by obtaining an updated appraisal of the underlying collateral and may discount further the appraised value, if necessary, to an amount equal to the expected cash proceeds in the event the loan is foreclosed upon and the collateral is sold.  In addition, an estimate of costs to sell the collateral is assumed.  The Company values other real estate owned by obtaining an updated appraisal of the property foreclosed upon, and discounts further the appraised value to an amount equal to the expected cash proceeds upon the sale of the property.  Loans receivable — evaluated for impairment and other real estate owned are valued using third party appraisal data that is based on market comparisons and may be subject to further adjustment for certain non-observable criteria.

Loans receivable — evaluated for impairment that are measured at fair value using Level 3 inputs on a nonrecurring basis total $3.4 million at September 30, 2014.  The total amount for each period presented represents the entire population of loans receivable — evaluated for impairment, and of this amount, $3.4 million was determined to be impaired and recorded at fair value. Collateral is in the form of real estate or business assets including equipment, inventory, and accounts receivable.  The vast majority of the Company’s collateral is real estate.  The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2).  However, in certain instances, the Company applies a discount to the valuation of the collateral if the collateral being evaluated is in process of construction or a residence.  In addition, the Company considers past experience of actual sales of collateral and may further discount the appraisal of the collateral being evaluated.  This is considered a Level 3 valuation.  The value of business equipment is based upon the net book value on the applicable business’s financial statements if not considered significant using observable market data.  Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3).  Fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income.

Although management uses its best judgment in estimating the fair value of financial instruments, there are inherent limitations in any estimation technique.  Because of the wide range of valuation techniques and the numerous estimates and assumptions which must be made, it may be difficult to make reasonable comparisons between the Company’s fair value information and that of other banking institutions.  It is important that the many uncertainties be considered when using the estimated fair value disclosures and that, because of these uncertainties, the aggregate fair value amount should not be construed as representative of the underlying value of the Company.

Fair Value of Financial Instruments

The assumptions used and the estimates disclosed represent management’s best judgment of appropriate valuation methods for estimating the fair value of financial instruments.  These estimates are based on pertinent information available to management at the valuation date.  In certain cases, fair values are not subject to precise quantification or verification and may change as economic and market factors and management’s evaluation of those factors change.

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The following summarizes the significant methodologies and assumptions used in estimating the fair values presented in the following table, and not disclosed elsewhere in this footnote.

Cash and Cash Equivalents

The carrying amount of cash and cash equivalents is used as a reasonable estimate of fair value.

Investment Securities Held-to-Maturity and Other Investments

Fair values for investment securities held-to-maturity are based on quoted market prices or prices quoted for similar financial instruments.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or estimated fair value.  The estimated fair value is based upon the related purchase price commitments from secondary market investors.

Loans Receivable, Net

In order to determine the fair market value for loans receivable, the loan portfolio was segmented based on loan type, credit quality and maturities.  For certain variable rate loans with no significant credit concerns and frequent repricings, estimated fair values are based on current carrying amounts.  The fair values of other loans are estimated using discounted cash flow analyses, at interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  The fair value analysis also included other assumptions to estimate fair value, intended to approximate those a market participant would use in an orderly transaction, with adjustments for discount rates, interest rates, liquidity, as appropriate.  This method of estimating fair value does not incorporate the exit-price concept of fair value which is appropriate for this disclosure.

Deposits

The fair values for demand deposits are equal to the carrying amount since they are payable on demand at the reporting date.  The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit (CDs) approximate their fair value at the reporting date.  Fair values for fixed rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered on CDs to a schedule of aggregated expected monthly maturities on time deposits.

Other Borrowed Funds

The fair value of other borrowed funds is estimated using a discounted cash flow calculation that applies interest rates currently available for loans with similar terms.

Accrued Interest Receivable

The carrying amount of accrued interest receivable approximates its fair value.

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The following summarizes the carrying amount of these financial assets and liabilities that the Company has not recorded at fair value on a recurring basis at September 30, 2014 and December 31, 2013:

	September 30, 2014
	Carrying		Estimated		Fair Value Measurements Using
(In thousands)	Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	47,560	47,560		47,560		$	—	$	—
Investment securities available-for-sale	330,415		330,415		—		330,415		—
Investment securities held-to-maturity and other investments	25,466		24,694		—		21,577		3,117
Loans held for sale	313,525		313,525		—		313,525		—
Loans receivable, net	2,489,293		2,458,149		—		301		2,457,848
Accrued interest receivable	8,093		8,093		8,093		—		—
Financial liabilities:
Demand deposits	$	553,629	$	553,629	$	553,629	$	—	$	—
Interest checking	444,436		444,436		444,436		—		—
Money market and statement savings	592,857		592,857		592,857		—		—
Certificates of deposit	833,883		835,649		—		835,649		—
Other borrowed funds	476,828		489,864		—		489,864		—
Accrued interest payable	978		978		978		—		—

	December 31, 2013
	Carrying		Estimated		Fair Value Measurements Using
(In thousands)	Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	29,209	$	29,209	$	29,209	$	—	$	—
Investment securities available-for-sale	349,319		349,319		5,029		344,290		—
Investment securities held-to-maturity and other investments	25,545		24,595		—		21,685		2,910
Loans held for sale	373,993		373,993		—		373,993		—
Loans receivable, net	2,012,304		2,024,835		—		301		2,024,534
Accrued interest receivable	7,939		7,939		7,939		—		—
Financial liabilities:
Demand deposits	$	433,749	$	433,749	$	433,749	$	—	$	—
Interest checking	398,136		398,136		398,136		—		—
Money market and statement savings	475,707		475,707		475,707		—		—
Certificates of deposit	751,267		756,191		—		756,191		—
Other borrowed funds	475,232		491,236		—		491,236		—
Accrued interest payable	869		869		869		—		—

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Note 13

Subsequent Event

On September 2, 2014, the Company announced that the Bank had signed a definitive agreement with EagleBank to acquire the current Gainesville, Virginia branch office of Virginia Heritage Bank.  With the acquisition, the Bank will take over the operations of the branch and assume approximately $59 million in deposits.  The deposit premium will be $195,000 for the deposits acquired.  The acquisition, subject to regulatory approval and the completion of the Eagle/Virginia Heritage merger, is anticipated to be completed in the fourth quarter of 2014.

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

The following presents management’s discussion and analysis of our consolidated financial condition at September 30, 2014 and December 31, 2013 and the results of our operations for the three and nine months ended September 30, 2014 and 2013. This discussion should be read in conjunction with our unaudited consolidated financial statements and the notes thereto appearing elsewhere in this report and the audited consolidated financial statements and the notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013.

Caution About Forward-Looking Statements

We make certain forward-looking statements in this Form 10-Q that are subject to risks and uncertainties.  These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals.  The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward-looking statements.

These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:

·the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;

·changes in assumptions underlying the establishment of reserves for possible loan losses, reserves for repurchases of mortgage loans sold and other estimates;

·changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and disruption of the capital and credit markets, soundness of other financial institutions we do business with;

·decrease in the volume of loan originations at our mortgage banking subsidiary as a result of the cyclical nature of mortgage banking, changes in interest rates, economic conditions, decreased economic activity, and slowdowns in the housing market which would negatively impact the income recorded on the sales of loans held for sale;

·risks inherent in making loans such as repayment risks and fluctuating collateral values;

·declines in the prices of assets and market illiquidity may cause us to record an other-than-temporary impairment or other losses, specifically in our pooled trust preferred securities portfolio resulting from increases in underlying issuers’ defaulting or deferring payments.

·changes in operations within the wealth management services segment, its customer base and assets under management;

·changes in operations of George Mason Mortgage, LLC as a result of the activity in the residential real estate market and any associated impact on the fair value of goodwill in the future;

·legislative and regulatory changes, including the Dodd Frank Wall Street Reform and Consumer Protection Act (the “Financial Reform Act”) and implementation of the Volcker Rule, and other changes in banking, securities, and tax laws and regulations and their application by our regulators, and changes in the scope and cost of FDIC insurance and other coverages;

·exposure to repurchase loans sold to investors for which borrowers failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;

·the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;

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·the ability to successfully manage our growth or implement our growth strategies as we implement new or change internal operating systems or if we are unable to identify attractive markets, locations or opportunities to expand in the future;

·the effects of future economic, business and market conditions;

·governmental monetary and fiscal policies;

·changes in accounting policies, rules and practices;

·maintaining cost controls and asset quality as we open or acquire new branches;

·maintaining capital levels adequate to support our growth;

·reliance on our management team, including our ability to attract and retain key personnel;

·competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;

·demand, development and acceptance of new products and services;

·problems with technology utilized by us;

·changing trends in customer profiles and behavior; and

·other factors described from time to time in our reports filed with the Securities and Exchange Commission.

Because of these uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.  In addition, our past results of operations do not necessarily indicate our future results.

In addition, this section should be read in conjunction with the description of our “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013.

Overview

We are a financial holding company formed in 1997 and headquartered in Fairfax County, Virginia.  We were formed principally in response to opportunities resulting from the consolidation of several Virginia-based banks.  These bank consolidations were typically accompanied by the dissolution of local boards of directors and relocation or termination of management and customer service professionals and a general deterioration of personalized customer service.

On January 16, 2014, we announced the completion of our acquisition of United Financial Banking Companies, Inc., or UFBC, the holding company of The Business Bank, or TBB, pursuant to a previously announced definitive merger agreement.  The merger of UFBC into Cardinal was effective January 16, 2014.  Under the terms of the merger agreement, UFBC shareholders received $19.13 in cash and 1.154 shares of our common stock in exchange for each share of UFBC common stock they owned immediately prior to the merger. TBB, which was headquartered in Vienna, Virginia, merged into Cardinal Bank effective March 8, 2014 adding eight (8) banking locations in northern Virginia, one of the Company’s target markets.  As a result of the acquisition, we added $329 million in total assets, $238 million in loans, and $295 million in deposits, after purchase accounting adjustments.  The transaction generated $24.7 million in goodwill and $2.7 million in core deposit intangible assets subject to amortization.  During March 2014, we integrated UFBC’s systems into Cardinal with minimal disruption to our customer service and operations allowing us to begin to benefit from this transaction during the remainder of 2014.

We own Cardinal Bank, or the Bank, a Virginia state-chartered community bank with 30 banking offices located in Northern Virginia and the greater Washington D.C. metropolitan area.  The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers.  Our commercial relationship managers focus on attracting small and medium sized businesses as well as government contractors, commercial real estate developers and builders and professionals, such as physicians, accountants and attorneys.

Additionally, we complement our core banking operations by offering a wide range of services through our various subsidiaries, including mortgage banking through George Mason Mortgage, LLC (“George Mason”) and retail securities brokerage through Cardinal Wealth Services, Inc. (“CWS”).

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Prior to June 30, 2013, the Bank had a trust division, Cardinal Trust and Investment Services.  This division merged its remaining operations as of June 30, 2013 into CWS.  In addition, as of June 30, 2013, Wilson/Bennett Capital Management, Inc., formerly the Company’s second nonbank subsidiary, merged its operations into CWS.  During the second quarter of 2013, we exited the third party institutional custody and trustee component of our trust services division due to our limited opportunity to leverage this platform.  As a result of our reorganization of the wealth management business segment, the remaining personal and commercial trust area of this business consolidated into CWS.  In addition, the remaining Wilson/Bennett clients have been serviced on the CWS platform since the third quarter of 2013.  Results for the nine months ended September 30, 2013 include the operations of these subsidiaries.

Net interest income is our primary source of revenue. We define revenue as net interest income plus noninterest income. As discussed further in the interest rate sensitivity section, we manage our balance sheet and interest rate risk exposure to maximize, and concurrently stabilize, net interest income. We do this by monitoring our liquidity position and the spread between the interest rates earned on interest-earning assets and the interest rates paid on interest-bearing liabilities. We attempt to minimize our exposure to interest rate risk, but are unable to eliminate it entirely.  In addition to management of interest rate risk, we analyze our loan portfolio for exposure to credit risk. Loan defaults and foreclosures are inherent risks in the banking industry, and we attempt to limit our exposure to these risks by carefully underwriting and then monitoring our extensions of credit. In addition to net interest income, noninterest income is an important source of revenue for us and includes, among other things, service charges on deposits and loans, investment fee income, gains and losses on sales of investment securities available-for-sale, and gains on sales of mortgage loans.

Critical Accounting Policies

General

U.S. generally accepted accounting principles (“GAAP”) are complex and require management to apply significant judgment to various accounting, reporting, and disclosure matters.  Management must use assumptions, judgments and estimates when applying these principles where precise measurements are not possible or practical.  These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates.  Changes in such judgments, assumptions and estimates may have a significant impact on the consolidated financial statements.  Actual results, in fact, could differ from initial estimates.

The accounting policies we view as critical are those relating to judgments, assumptions and estimates regarding the determination of the allowance for loan losses, accounting for purchased credit-impaired loans, the fair value measurements of certain assets and liabilities, accounting for economic hedging activities, accounting for impairment testing of goodwill, accounting for the impairment of amortizing intangible assets and other long-lived assets, and the valuation of deferred tax assets.

Allowance for Loan Losses

We maintain the allowance for loan losses at a level that represents management’s best estimate of known and inherent losses in our loan portfolio.  Both the amount of the provision expense and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers.  Unusual and infrequently occurring events, such as weather-related disasters, may impact our assessment of possible credit losses.  As a part of our analysis, we use comparative peer group data and qualitative factors such as levels of and trends in delinquencies, nonaccrual loans, charged-off loans, changes in volume and terms of loans, effects of changes in lending policy, experience and ability and depth of management, national and local economic trends and conditions, and concentrations of credit, competition, and loan review results to support our estimates.

For purposes of our analysis, we categorize our loans into one of five categories:  commercial and industrial, commercial real estate (including construction), home equity lines of credit, residential mortgages, and consumer loans. Typically, financial institutions use their historical loss experience and trends in losses for each loan category which are then adjusted for portfolio trends and economical and environmental factors in determining their allowance for loan losses.  Prior to 2008, we experienced minimal loss history within our loan portfolio and it has only been since theeconomic downturn that we have recorded a higher level of loan losses.  Because of this, our allowance model uses the average loss rates of similar institutions (our custom peer group) as a baseline which is then adjusted based on our particular loan portfolio characteristics and environmental factors.  The indicated loss factors resulting from this analysis are applied for each of the five categories of loans.

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Our peer groups are defined by selecting commercial banking institutions of similar size within Virginia, Maryland, and the District of Columbia. This is known as our custom peer group.  The commercial banking institutions comprising the custom peer group can change based on certain factors including but not limited to the characteristics, size, and geographic footprint of the institution. We have identified 20 banks for our custom peer group which are within $500 million to $5 billion in total assets, the majority of whom are geographically concentrated in the Washington metropolitan area in which we operate as this area has seen less of an economic downturn than other areas of the country.  We evaluate the loan quality indicators of our custom peer group to those within our national FDIC peer group, all banks in Virginia, and all banks in Maryland.  These baseline peer group loss rates are then adjusted by an estimated loss emergence factor in order to determine loss coverage for pass-level credits.  Finally, we make adjustments to these loss factors based on an analysis of our loan portfolio characteristics, trends, economic considerations and other conditions that should be considered in assessing our credit risk.  Our peer loss rates are updated on at least an annual basis.

In addition, we individually assign loss factors to all loans that have been identified as having loss attributes, as indicated by deterioration in the financial condition of the borrower or a decline in underlying collateral value if the loan is collateral dependent. In certain cases, we apply, in accordance with regulatory guidelines, a 5% loss factor to loans classified as special mention, a 15% loss factor to loans classified as substandard and a 50% loss factor to loans classified as doubtful. Loans classified as loss loans are fully reserved or charged off.  However, in most instances, we evaluate the impairment of certain loans on a loan by loan basis for those loans that are adversely risk rated.  For these loans, we analyze the fair value of the collateral underlying the loan and consider estimated costs to sell the collateral on a discounted basis.  If the net collateral value is less than the loan balance (including accrued interest and any unamortized premium or discount associated with the loan) we recognize an impairment and establish a specific reserve for the impaired loan.  Because of the limited number of impaired loans in our portfolio, we are able to evaluate each impaired loan individually and therefore our specific reserves for impaired loans are generally less than those recommended by the listed regulatory guidelines above.

Credit losses are an inherent part of our business and, although we believe the methodologies for determining the allowance for loan losses and the current level of the allowance are appropriate, it is possible that there may be unidentified losses in the portfolio at any particular time that may become evident at a future date pursuant to additional internal analysis or regulatory comment. Additional provisions for such losses, if necessary, would be recorded in the commercial banking or mortgage banking segments, as appropriate, and would negatively impact earnings.

Allowance for Loan Losses - Acquired Loans

Acquired loans accounted for under ASC 310-30

For our acquired loans, to the extent that we experience a deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans.

Acquired loans accounted for under ASC 310-20

Subsequent to the acquisition date, we establish our allowance for loan losses through a provision for loan losses based upon an evaluation process that is similar to our evaluation process used for originated loans. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other factors, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, carrying value of the loans, which includes the remaining net purchase discount or premium, and other factors that warrant recognition in determining our allowance for loan losses.

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Purchased Credit-Impaired Loans

Purchased credit-impaired (PCI) loans, which are the loans acquired in our acquisition of UFBC, are loans acquired at a discount (that is due, in part, to credit quality). These loans are initially recorded at fair value (as determined by the present value of expected future cash flows) with no allowance for loan losses. We account for interest income on all loans acquired at a discount (that is due, in part, to credit quality) based on the acquired loans’ expected cash flows. The acquired loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. A pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flow. The difference between the undiscounted cash flows expected at acquisition and the investment in the loans, or the “accretable yield,” is recognized as interest income utilizing the level-yield method over the life of each pool. Increases in expected cash flows subsequent to the acquisition are recognized prospectively through adjustment of the yield on the pool over its remaining life, while decreases in expected cash flows are recognized as impairment through a loss provision and an increase in the allowance for loan losses. Therefore, the allowance for loan losses on these impaired pools reflect only losses incurred after the acquisition (representing the present value of all cash flows that were expected at acquisition but currently are not expected to be received).  At September 30, 2014, the reserve for impairment of PCI loans within our allowance for loan losses was $145,000.

We periodically evaluate the remaining contractual required payments due and estimates of cash flows expected to be collected. These evaluations, performed quarterly, require the continued use of key assumptions and estimates, similar to the initial estimate of fair value. Changes in the contractual required payments due and estimated cash flows expected to be collected may result in changes in the accretable yield and non-accretable difference or reclassifications between accretable yield and the non-accretable difference. On an aggregate basis, if the acquired pools of PCI loans perform better than originally expected, we would expect to receive more future cash flows than originally modeled at the acquisition date. For the pools with better than expected cash flows, the forecasted increase would be recorded as an additional accretable yield that is recognized as a prospective increase to our interest income on loans.

Fair Value Measurements

We determine the fair values of financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value.  Our investment securities available-for-sale are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service.  This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information.  Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.  For certain of our held-to-maturity investment securities where there is minimal observable trading activity, we use a discounted cash flow approach to estimate fair value based on internal calculations and compare our results to information provided by external pricing sources.

We also fair value our interest rate lock commitments and forward loan sales commitments.  The fair value of our interest rate lock commitments considers the expected premium (discount) to par and we apply certain fallout rates for those rate lock commitments for which we do not close a mortgage loan.  In addition, we calculate the effects of the changes in interest rates from the date of the commitment through loan origination, and then period end, using applicable published mortgage-backed investment security prices.  The fair value of the forward sales contracts to investors considers the market price movement of the same type of security between the trade date and the balance sheet date.  At loan closing, the fair value of the interest rate lock commitment is included in the cost basis of loans held for sale, which are carried at the lower of cost or fair value.

Accounting for Economic Hedging Activities

We record all derivative instruments on the statement of condition at their fair values. We do not enter into derivative transactions for speculative purposes. For derivatives designated as hedges, we contemporaneously document the hedging relationship, including the risk management objective and strategy for undertaking the hedge, how effectiveness will be assessed at inception and at each reporting period and the method for measuring ineffectiveness.  We evaluate the effectiveness of these transactions at inception and on an ongoing basis.  Ineffectiveness is recordedthrough earnings.  For derivatives designated as cash flow hedges, the fair value adjustment is recorded as a component of other comprehensive income, except for the ineffective portion which is recorded in earnings.  For derivatives designated as fair value hedges, the fair value adjustments for both the hedged item and the hedging instrument are recorded through the income statement with any difference considered the ineffective portion of the hedge.

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We discontinue hedge accounting prospectively when it is determined that the derivative is no longer highly effective. In situations in which cash flow hedge accounting is discontinued, we continue to carry the derivative at its fair value on the statement of condition and recognize any subsequent changes in fair value in earnings over the term of the forecasted transaction. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, we recognize immediately in earnings any gains and losses that were accumulated in other comprehensive income.

In the normal course of business, we enter into contractual commitments, including rate lock commitments, to finance residential mortgage loans. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the time frame established by us. Interest rate risk arises on these commitments and subsequently closed loans if interest rates change between the time of the interest rate lock and the delivery of the loan to the investor. Loan commitments related to residential mortgage loans intended to be sold are considered derivatives and are marked to market through earnings.

To mitigate the effect of the interest rate risk inherent in providing rate lock commitments, we economically hedge our commitments by entering into best efforts delivery forward loan sales contracts. During the rate lock commitment period, these forward loan sales contracts are marked to market through earnings and are not designated as accounting hedges. Exclusive of the fair value elements of the rate lock commitment related to servicing and the wholesale and retail rate spread, the changes in fair value related to movements in market rates of the rate lock commitments and the forward loan sales contracts generally move in opposite directions, and the net impact of changes in these valuations on net income during the loan commitment period is generally inconsequential. At the closing of the loan, the loan commitment derivative expires and we record a loan held for sale and continue to be obligated under the same forward loan sales contract.  The forward sales contract is then designated as a hedge against the variability in cash to be received from the loan sale.  Loans held for sale are accounted for at the lower of cost or fair value.

Accounting for Impairment Testing of Goodwill

We have adopted ASU 2011-08, Testing Goodwill for Impairment.  This ASU permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If an entity concludes it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it need not perform the two-step impairment test. We perform our annual review of the goodwill related to our mortgage banking segment during the third quarter.  As a result of our acquisition of UFBC, we will perform our annual review of the goodwill associated with the commercial banking segment during the first quarter of 2015.

In the event we are required to perform a Step 1 fair value evaluation of the reporting unit, we make estimates of the discounted cash flows from the expected future operations of the reporting unit. This discounted cash flow analysis involves the use of unobservable inputs including:  estimated future cash flows from operations; an estimate of a terminal value; a discount rate; and other inputs.  Our estimated future cash flows are largely based on our historical actual cash flows.  If the analysis indicates that the fair value of the reporting unit is less than its carrying value, we do an analysis to compare the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. The implied fair value of the goodwill is determined by allocating the fair value of the reporting unit to all its assets and liabilities. If the implied fair value of the goodwill is less than the carrying value, an impairment loss is recognized.

Accounting for the Impairment of Amortizing Intangible Assets and Other Long-Lived Assets

We continually review our long-lived assets for impairment whenever events or changes in circumstances indicate that the remaining estimated useful life of such assets might warrant revision or that the balances may not be recoverable. We evaluate possible impairment by comparing estimated future cash flows, before interest expense and onan undiscounted basis, with the net book value of long-term assets, including amortizable intangible assets. If undiscounted cash flows are insufficient to recover assets, further analysis is performed in order to determine the amount of the impairment.

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An impairment loss is then recorded for the excess of the carrying amount of the assets over their fair values. Fair value is usually determined based on the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved.

Valuation of Deferred Tax Assets

We record a provision for income tax expense based on the amounts of current taxes payable or refundable and the change in net deferred tax assets or liabilities during the year. Deferred tax assets and liabilities are recognized for the tax effects of differing carrying values of assets and liabilities for tax and financial statement purposes that will reverse in future periods. When substantial uncertainty exists concerning the recoverability of a deferred tax asset, the carrying value of the asset is reduced by a valuation allowance. The amount of any valuation allowance established is based upon an estimate of the deferred tax asset that is more likely than not to be recovered. Increases or decreases in the valuation allowance result in increases or decreases to the provision for income taxes.

New Financial Accounting Standards

The Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-04, Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (“ASU No. 2014-04”), which clarifies when an in-substance repossession or foreclosure occurs, and when a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan.  An in-substance repossession or foreclosure occurs upon either the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure, or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, this ASU requires interim and annual disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. ASU No. 2014-04 is effective for annual and interim periods beginning after December 15, 2014. Our adoption of ASU No. 2014-04 is not expected to have a significant impact on our consolidated financial statements.

The FASB issued ASU No. 2014-01, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (“ASU No. 2014-01”), which amends existing guidance to permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense or benefit. For those investments in qualified affordable housing projects not accounted for using the proportional amortization method, the investment should be accounted for as an equity method investment or a cost method investment in accordance with Subtopic 970-323. ASU No. 2014-01 is effective for annual and interim reporting periods beginning after December 15, 2014. Early adoption is permitted. Our adoption of ASU No. 2014-01 is not expected to have a significant impact on our consolidated financial statements.

The FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606).  This ASU provides a framework that replaces the existing revenue recognition guidance and is effective for annual periods and interim periods within that reporting period beginning after December 15, 2016, for public entities.  We are currently assessing the impact of the adoption of this standard on our consolidated financial statements.

The FASB issued ASU No, 2014-11, Transfers and Servicing (Topic 860) Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.  This ASU changes the accounting for repurchase-to-maturity transactions to secured borrowing accounting.  Additionally, for repurchase financing arrangements, the amendments ofthis ASU require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement.  The requirements are effective for public entities for the first interim or annual period beginning after December 15, 2014.  The disclosure of certain transactions accounted for as a sale is required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as securities borrowings is required to be presented for annual periods beginning after December 15, 2014.  Our adoption of ASU No. 2014-01 is not expected to have a significant impact on our consolidated financial statements.

55

2014 Economic Environment

The banking environment and the markets in which we conduct our businesses will continue to be strongly influenced by developments in the U.S. and global economies, as well as the continued implementation of rulemaking from recent financial reforms.  The metropolitan Washington, D.C. area, the region in which we operate, continues to perform relatively well as compared to other geographic regions.  Our credit quality continues to remain strong despite the challenging economic environment.  At September 30, 2014, we had nonaccrual loans totaling $5.5 million, or 0.17% of total assets, and loans contractually past due 90 days or more as to principal or interest and still accruing of $792,000.  We had annualized net charge-offs of 0.05% of our average loans receivable for the nine months ended September 30, 2014.

The interest rate environment and the end of the Federal Reserve’s policy of quantitative easing (“QE”) may impact the results of our mortgage banking segment.  Typically, during periods of increasing interest rates, mortgage originations decrease.

We expect challenging economic and operating conditions and an evolving regulatory regime to continue for the foreseeable future.  These conditions could continue to affect the markets in which we do business and could adversely impact our results for the remainder of 2014.

Continued uncertainty and sluggish economic conditions could adversely affect our loan portfolio, including causing increases in delinquencies and default rates, which would adversely impact our charge-offs and provision for loan losses.  Deterioration in real estate values and household incomes may also result in higher credit losses for us.  Also, in the ordinary course of business, we may be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer.  A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our businesses, perhaps materially. The systems by which we set limits and monitor the level of our credit exposure to individual entities and industries also may not function as we have anticipated.

Market illiquidity and concerns over credit risk continue to impact the ratings of our pooled trust preferred securities. We hold investments of $6.4 million in par value of pooled trust preferred securities, which are significantly below book value as of September 30, 2014 due to the lack of liquidity in the market, deferrals and defaults of issuers, and continued investor apprehension for investing in these types of investments.  As a result of the issuance of the final rules to implement Section 619 of the Financial Reform Act, commonly known as the Volcker Rule, which were released by federal banking agencies in late 2013 (the “Final Rule”), two of these investments are considered to be “covered funds” and are now required to be divested by us before July 2015.  These investments have a par value of $2.4 million at September 30, 2014.  During 2013, we recorded an other-than-temporary-impairment of $300,000 as a result of this new regulatory requirement.  Additional impairment on these securities may be recorded in the future if the value of these securities deteriorates further.

Liquidity is essential to our business.  The primary sources of funding for our Bank include customer deposits and wholesale funding.  Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits.  This situation may arise due to circumstances that we may be unable to control, such as general market disruption, negative views about the financial services industry generally, or an operational problem that affects a third party or us.  Our ability to borrow from other financial institutions on favorable terms or atall could be adversely affected by disruptions in the capital markets or other events.  While we believe we have a healthy liquidity position, any of the above factors could materially impact our liquidity position in the future.

56

The U.S. government continues to enact legislation and develop various programs and initiatives designed to regulate the financial services industry, stabilize the housing markets and stimulate the economy.  The banking industry is awaiting many of the regulations resulting from the implementation of the Financial Reform Act.  We remain unsure of the full impact this legislation will have on our business, operations or our financial condition.

Statements of Income

General

For the three months ended September 30, 2014 and 2013, we reported net income of $9.4 million and $3.0 million, respectively, an increase of $6.5 million, or 217%.  Net interest income after the provision for loan losses increased $4.4 million to $27.9 million for the three months ended September 30, 2014 compared to $23.5 million for the three months ended September 30, 2013.  There was no provision for loan losses recorded for the three months ended September 30, 2014, compared to provision expense of $157,000 for the same period of 2013.  Noninterest income for the three months ended September 30, 2014 and 2013 was $8.5 million and $1.7 million, respectively, an increase of $6.8 million.  This increase was primarily due to an increase in gains on mortgage banking activities and other fee income earned at our mortgage banking subsidiary.  For the three months ended September 30, 2014, noninterest expense increased to $22.2 million, compared to $21.0 million for the same period of 2013.  The increase in noninterest expense is primarily attributable to expenses associated with the former UFBC of $850,000 and an increase of $700,000 in the variable component of salary and benefits expense due to improved operating results for the Company.

For the three months ended September 30, 2014, basic and diluted earnings per common share were each $0.29.  Basic and diluted earnings per common share for the three months ended September 30, 2013 were each $0.10.  Weighted average fully diluted shares outstanding for the three months ended September 30, 2014 and 2013 were 32,933,774 and 31,060,572, respectively.

Return on average assets for the three months ended September 30, 2014 and 2013 was 1.16% and 0.43%, respectively. Return on average equity for the three months ended September 30, 2014 and 2013 was 10.20% and 3.73%, respectively.

For the nine months ended September 30, 2014 and 2013, we reported net income of $22.2 million and $20.0 million, respectively, an increase of $2.2 million, or 11%.  Net interest income after the provision for loan losses increased $9.0 million to $78.0 million for the nine months ended September 30, 2014 compared to $69.0 million for the nine months ended September 30, 2013.  Provision for loan losses for the nine months ended September 30, 2014 was $2.5 million, an increase of $3.0 million, compared to a benefit of $432,000 for the same period of 2013, a result of the organic loan growth that occurred during 2014.  Noninterest income for the nine months ended September 30, 2014 and 2013 was $28.8 million and $23.8 million, respectively, an increase of $5.0 million.  This increase was primarily due to an increase in gains on mortgage banking activities and other fee income earned at our mortgage banking subsidiary.  For the nine months ended September 30, 2014, noninterest expense increased to $73.2 million, compared to $63.0 million for the same period of 2013.  The increase in noninterest expense is primarily attributable to our acquisition of UFBC with merger and acquisition expenses of $5.7 million and an additional $3.3 million in expenses associated with the former operations of UFBC.

For the nine months ended September 30, 2014, basic and diluted earnings per common share were $0.69 and $0.68, respectively.  Basic and diluted earnings per common share for the nine months ended September 30, 2013 were $0.65 and $0.64, respectively.  Weighted average fully diluted shares outstanding for the nine months ended September 30, 2014 and 2013 were 32,771,787 and 31,053,448, respectively.

Return on average assets for the nine months ended September 30, 2014 and 2013 was 0.94% and 0.95%, respectively. Return on average equity for the nine months ended September 30, 2014 and 2013 was 8.03% and 8.34%, respectively.

57

General —Business Segments

We operate in three business segments: commercial banking, mortgage banking, and wealth management services.  As of June 30, 2013, we merged operations of our trust division and Wilson/Bennett Capital Management, Inc. into CWS, both of which had been included in the wealth management services segment.  Results for the nine months ended September 30, 2013 include the operations of these subsidiaries.

Net income attributable to the commercial banking segment for the three months ended September 30, 2014 was $10.4 million compared to net income of $8.6 million for the three months ended September 30, 2013.  Net interest income increased $4.2 million to $27.3 million for the three months ended September 30, 2014, compared to $23.1 million for the same period of 2013.  The earning assets and interest-bearing liabilities acquired from UFBC contributed $2.4 million to the increase in net interest income for the three months ended September 30, 2014.  No provision for loan losses was recorded for the three months ended September 30, 2014 compared to a provision of $157,000 for the same period of 2013. We did not record a provision for loan losses for the third quarter of 2014 as our credit quality metrics improved during the quarter.  Noninterest income increased to $1.6 million for the three months ended September 30, 2014 compared to $1.0 million for the three months ended September 30, 2013.  Noninterest expense was $13.4 million for the three months ended September 30, 2014, compared to $11.1 million for the same period of 2013.  The increase is primarily attributable to the UFBC acquisition, as this segment recorded additional operational expenses of $850,000 related to UFBC’s primary subsidiary, The Business Bank.  We recorded $185,000 in core deposit intangible amortization related to the UFBC acquisition.  Branch expansion contributed $370,000 to the increase in noninterest expense for the second quarter of 2014.  The remaining increase in noninterest expense for the three months ended September 30, 2014 was related to several business initiatives, increases in our business development staffing levels, and an increase in the variable component of our salary and benefits expense due to better than expected results at the Bank.

Net income attributable to the commercial banking segment for the nine months ended September 30, 2014 was $23.5 million compared to net income of $26.1 million for the nine months ended September 30, 2013.  Net interest income increased $11.4 million to $78.8 million for the nine months ended September 30, 2014, compared to $67.4 million for the same period of 2013.  The earning assets and interest-bearing liabilities acquired from UFBC contributed $6.8 million to the increase in net interest income for the nine months ended September 30, 2014.  Provision for loan losses increased $3.1 million to $2.5 million for the nine months ended September 30, 2014 compared to a benefit of $517,000 for the same period of 2013. The increase in our provision expense was primarily related to organic growth within our loan portfolio during 2014.  Noninterest income increased to $3.5 million for the nine months ended September 30, 2014 compared to $2.5 million for the nine months ended September 30, 2013.  Noninterest expense was $44.4 million for the nine months ended September 30, 2014, compared to $31.3 million for the same period of 2013.  The increase is primarily attributable to the aforementioned UFBC acquisition, as this segment recorded $5.2 million in merger and acquisition expense and had additional operational expenses of $3.3 million related to UFBC’s primary subsidiary, The Business Bank.  We recorded $578,000 in core deposit intangible amortization related to the UFBC acquisition.  The remaining increase in noninterest expense for the nine months ended September 30, 2014 was related to several business initiatives, branch expansion and increases in our business development staffing levels.

The mortgage banking segment reported a net loss of $76,000 for the three months ended September 30, 2014 compared to a net loss of $4.9 million for the three months ended September 30, 2013.  Realized and unrealized gains associated with the fair value of commitments and loans held for sale increased to $6.6 million for the three months ended September 30, 2014 compared to a net loss of $102,000 for the same period of 2013.  Noninterest expense decreased $1.3 million to $7.5 million for the three months ended September 30, 2014 compared to $8.8 million for the same period of 2013.  The decrease in noninterest expense is a direct result of a 21% reduction in staffing levels which began in September 2013.

For the nine months ended September 30, 2014 and 2013, the mortgage banking segment reported net income of $1.9 million and a net loss of $3.6 million, respectively.  Realized and unrealized gains associated with the fair value of commitments and loans held for sale increased to $28.2 million for the nine months ended September 30, 2014 compared to $17.4 million for the same period of 2013.  Noninterest expense decreased $3.7 million to $23.5 million for the nine months ended September 30, 2014 compared to $27.2 million for the same period of 2013.  The decrease in noninterest expense is a direct result of the previously mentioned reductions in staffing levels that began in September 2013.

58

Loan commitments are accounted for as derivative instruments and are recorded at fair value through earnings.  This causes an unrealized gain to be recognized in income at the time of the commitment.  When the loan actually closes, the unrealized gain is added to the basis of the ensuing loan held for sale (“LHFS”).  At any point in time, the fair value of the locked commitments and the premium to the basis of existing LHFS represent unrealized gains that have been recognized in income, either in the current period or prior periods.  At the time the loan is sold to investors, the “investor buy price” is equal to the basis of the loan held for sale, and there is no gain or loss recognized.  However, this accounting creates a mismatch between the income recognition on loan production and the expense recognition for those same loans.  Direct (e.g. commissions) and indirect loan expenses associated with originating, underwriting and closing loans are deferred and recognized at the time of investor purchase of the loan which often occurs in the quarter subsequent to the original commitment, creating a mismatch in the timing of the revenue and expense as these expenses are “netted” from the gain on sale from mortgage banking activities.

During 2012 and 2013, we expanded the mortgage banking business segment through increases in loan origination officers and number of locations, which contributed to increases in noninterest expense.  As a result of the changes in production levels due to the current economic environment within the markets in which we operate, we have reduced our staffing levels by 21% since September 2013 and are actively monitoring each expense category at the mortgage subsidiary with the goal of returning George Mason to meaningful profitability during 2014.

The wealth management services segment, which includes CWS, recorded net income of $3,000 for the three months ended September 30, 2014, compared to net income of $61,000 for the three months ended September 30, 2013.  For the nine months ended September 30, 2014 and 2013, this segment recorded net income of $106,000 and a net loss of $218,000, respectively.  During 2013, we streamlined the business operations within this business segment, which contributed to the net loss reported.

Net Interest Income

Net interest income is our primary source of revenue, representing the difference between interest and fees earned on interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. For the three months ended September 30, 2014 and 2013, net interest income was $27.9 million and $23.7 million, respectively.  The yields on our loans receivable portfolio decreased 17 basis points for the three months ended September 30, 2014 compared to the same period of 2013 as a result of the low interest rate environment.  The yield on our loans held for sale portfolio decreased 28 basis points, which is due to a decrease in mortgage loan production volumes over the past year.  The yields of our interest-bearing deposits decreased 10 basis points as we have taken efforts to reduce our overall funding costs as a result of the current low interest rate environment.  In addition, our funding costs related to other borrowed funds decreased 81 basis points for the three months ended September 30, 2014 compared to the same three month period of 2013, again as a result of our efforts to reduce funding costs.

Our net interest margin, on a tax-equivalent basis, which is calculated as net interest income divided by average interest earning assets, was 3.66% and 3.65% for the three months ended September 30, 2014 and 2013, respectively.  Our net interest margin was positively impacted through the contribution of earnings assets and interest-bearing liabilities from UFBC; the addition of these assets and liabilities enhanced our yield earned on the loans receivable portfolio by 0.03% and decreased our cost of funds yield by approximately 0.02% for the three months ended September 30, 2014.

Interest income on loans receivable increased $4.7 million to $26.7 million for the three months ended September 30, 2014 compared to $22.0 million for the same three month period of 2013.  The increase in interest income on loans receivable is primarily a result of the increase in the volume of the loans receivable portfolio.  Interest income on loans held for sale was $3.6 million and $4.1 million for the three months ended September 30, 2014 and 2013, respectively, a decrease of $588,000, reflecting a decrease in origination activity within the mortgage banking segment during the past twelve months.

59

Interest income on investment securities increased $50,000 for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. The slight increase in interest income in our investment securities portfolio is attributable to our purchasing over $139 million in investment securities during the third and fourth quarters of 2013 as a result of having excess cash available to invest due to the decrease in the loans held for sale portfolio during these same periods.  The increase in interest income from these bond purchases was offset by a decrease in interest income due to calls, maturities, principal repayments, and sales that have occurred within the investment securities portfolio totaling $68.7 million during 2014.

Total interest expense decreased slightly by $37,000 to $5.3 million for the three months ended September 30, 2014 as compared to $5.4 million for the same period of 2013.

Our net interest margin, on a tax-equivalent basis, was 3.63% and 3.47% for the nine months ended September 30, 2014 and 2013, respectively.  For the nine months ended September 30, 2014 and 2013, net interest income was $80.5 million and $68.5 million, respectively.  The yields on our loans receivable portfolio decreased 26 basis points for the nine months ended September 30, 2014 compared to the same period of 2013.  This decrease in yield was offset by an increase in the yield on our loans held for sale portfolio of 31 basis points, which is due to the increase in mortgage interest rates over the past year.  The yields of our interest-bearing deposits decreased 12 basis points due to our efforts to reduce our overall funding costs as a result of the current low interest rate environment.  In addition, our funding costs related to other borrowed funds decreased 73 basis points for the nine months ended September 30, 2014 compared to the same nine month period of 2013, again as a result of our efforts to reduce funding costs.

Interest income on loans receivable increased $13.5 million to $77.3 million for the nine months ended September 30, 2014 compared to $63.8 million for the same nine month period of 2013.  The increase in interest income on loans receivable is primarily a result of the increase in the volume of the loans receivable portfolio.  Interest income on loans held for sale was $9.3 million and $13.3 million for the nine months ended September 30, 2014 and 2013, respectively, a decrease of $3.9 million, reflecting the significant decrease in origination activity within the mortgage banking segment during the past twelve months.

Interest income on investment securities increased $1.4 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013, a result of our additions to the investment securities portfolio as balances in the loans held for sale portfolio decreased during 2013.

Total interest expense decreased $949,000 for the nine months ended September 30, 2014 as compared to the same period of 2013.  This decrease was primarily related to the decreases in our deposit rates from a year ago due to the low interest rate environment.

The following tables present an analysis of average earning assets and interest-bearing liabilities with related components of interest income and interest expense on a tax equivalent basis.

60

Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities

Three Months Ended September 30, 2014, 2013 and 2012

(In thousands)

	2014							2013							2012
				Interest		Average					Interest		Average					Interest		Average
	Average			Income/		Yield/		Average			Income/		Yield/		Average			Income/		Yield/
	Balance			Expense		Rate		Balance			Expense		Rate		Balance			Expense		Rate
Assets
Interest-earning assets:
Loans (1):
Commercial and industrial	$	301,251		$	3,340	4.44	%	$	214,301		$	2,167	4.04	%	$	218,233		$	2,338	4.27	%
Real estate - commercial	1,185,110			13,438		4.54	%	960,770			11,439		4.65	%	752,653			10,149		5.39	%
Real estate - construction	419,110			5,341		5.09	%	345,072			4,555		5.28	%	364,238			4,828		5.30	%
Real estate - residential	357,502			3,415		3.82	%	259,395			2,800		4.31	%	259,782			3,002		4.62	%
Home equity lines	121,025			1,126		3.69	%	110,297			1,020		3.67	%	119,554			1,104		3.67	%
Consumer	4,921			74		5.88	%	2,601			34		5.18	%	4,089			50		4.86	%
Total loans	2,388,919			26,734		4.48	%	1,892,436			22,015		4.65	%	1,718,549			21,471		5.00	%
Loans held for sale	341,925			3,553		4.16	%	373,318			4,141		4.44	%	571,715			5,544		3.88	%
Investment securities available-for-sale	319,567			3,141		3.93	%	294,445			3,023		4.11	%	270,450			2,889		4.27	%
Investment securities held-to-maturity	6,173			37		2.40	%	10,146			44		1.72	%	11,972			73		2.43	%
Other investments	15,431			132		3.39	%	13,312			84		2.50	%	14,166			60		1.68	%
Federal funds sold	19,229			9		0.19	%	44,788			28		0.25	%	52,519			30		0.23	%
Total interest-earning assets and interest income (2)	3,091,244			33,606		4.35	%	2,628,445			29,335		4.46	%	2,639,371			30,067		4.56	%
Noninterest-earning assets:
Cash and due from banks	19,390							16,876							14,172
Premises and equipment, net	25,806							19,846							19,275
Goodwill and other intangibles, net	37,116							10,168							10,368
Accrued interest and other assets	99,027							120,034							117,522
Allowance for loan losses	(29,865		)					(27,211		)					(27,300		)
Total assets	$	3,242,718						$	2,768,158						$	2,773,408
Liabilities and Shareholders’ Equity
Interest - bearing liabilities:
Interest - bearing deposits:
Interest checking	433,251			550		0.50	%	387,367			518		0.53	%	$	319,617		860		1.07	%
Money markets	336,586			249		0.29	%	300,920			177		0.23	%	380,531			298		0.31	%
Statement savings	257,212			174		0.27	%	219,021			145		0.26	%	221,549			144		0.26	%
Certificates of deposit	828,053			2,081		0.99	%	761,246			2,326		1.21	%	870,470			2,633		1.20	%
Total interest - bearing deposits	1,855,102			3,054		0.65	%	1,668,554			3,166		0.75	%	1,792,167			3,935		0.87	%
Other borrowed funds	415,635			2,269		2.17	%	291,787			2,194		2.98	%	296,515			2,245		3.01	%
Total interest-bearing liabilities and interest expense	2,270,737			5,323		0.93	%	1,960,341			5,360		1.08	%	2,088,682			6,180		1.18	%
Noninterest-bearing liabilities:
Demand deposits	565,650							426,265							347,346
Other liabilities	36,120							62,150							49,567
Common shareholders’ equity	370,211							319,402							287,813
Total liabilities and shareholders’ equity	$	3,242,718						$	2,768,158						$	2,773,408
Net interest income and net interest margin (2)				$	28,283	3.66	%				$	23,975	3.65	%				$	23,887	3.62	%

(1)Non-accrual loans are included in average balances and do not have a material effect on the average yield.  Interest income on non-accruing loans was not material for the periods presented.

(2)Interest income for loans receivable and investment securities available-for-sale is reported on a fully taxable-equivalent basis at a rate of 33% for 2014 and 35% for 2013 and 2012.

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Rate and Volume Analysis

Three Months Ended September 30, 2014, 2013 and 2012

(In thousands)

	2014 Compared to 2013									2013 Compared to 2012
	Change Due to									Change Due to
	Average			Average			Increase			Average			Average			Increase
	Volume (3)			Rate			(Decrease)			Volume (3)			Rate			(Decrease)
Interest income:
Loans (1):
Commercial and industrial	$	875		$	298		$	1,173		$	(53	)	$	(118	)	$	(171	)
Real estate - commercial	2,345			(346		)	1,999			3,070			(1,780		)	1,290
Real estate - construction	987			(201		)	786			(254		)	(19		)	(273		)
Real estate - residential	1,051			(436		)	615			2			(204		)	(202		)
Home equity lines	99			7			106			(83		)	(1		)	(84		)
Consumer	32			8			40			(18		)	2			(16		)
Total loans	5,389			(670		)	4,719			2,664			(2,120		)	544
Loans held for sale	(348		)	(240		)	(588		)	(1,924		)	521			(1,403		)
Investment securities available-for-sale	258			(140		)	118			256			(122		)	134
Investment securities held-to-maturity	(17		)	10			(7		)	(11		)	(18		)	(29		)
Other investments	13			35			48			(3		)	27			24
Federal funds sold	(16		)	(3		)	(19		)	(4		)	2			(2		)
Total interest income (2)	5,279			(1,008		)	4,271			978			(1,710		)	(732		)
Interest expense:
Interest - bearing deposits:
Interest checking	72			(40		)	32			169			(511		)	(342		)
Money markets	22			50			72			(55		)	(66		)	(121		)
Statement savings	25			4			29			(1		)	2			1
Certificates of deposit	219			(464		)	(245		)	(324		)	17			(307		)
Total interest - bearing deposits	338			(450		)	(112		)	(211		)	(558		)	(769		)
Other borrowed funds	899			(824		)	75			(30		)	(21		)	(51		)
Total interest expense	1,237			(1,274		)	(37		)	(241		)	(579		)	(820		)
Net interest income (2)	$	4,042		$	266		$	4,308		$	1,219		$	(1,131	)	$	88

(1)Non-accrual loans are included in average balances and do not have a material effect on the average yield.  Interest income on non-accruing loans was not material for the periods presented.

(2)Interest income for loans receivable and investment securities available-for-sale is reported on a fully taxable-equivalent basis at a rate of 33% for 2014 and 35% for 2013 and 2012.

(3)Changes attributable to rate/volume have been allocated to volume.

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Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities

Nine Months Ended September 30, 2014, 2013 and 2012

(In thousands)

	2014							2013							2012
				Interest		Average					Interest		Average					Interest		Average
	Average			Income/		Yield/		Average			Income/		Yield/		Average			Income/		Yield/
	Balance			Expense		Rate		Balance			Expense		Rate		Balance			Expense		Rate
Assets
Interest-earning assets:
Loans (1):
Commercial and industrial	$	285,329		$	9,504	4.44	%	$	214,232		$	6,499	4.04	%	$	231,389		$	7,260	4.17	%
Real estate - commercial	1,173,169			38,975		4.43	%	881,570			32,118		4.79	%	745,099			30,433		5.45	%
Real estate - construction	411,073			15,488		5.02	%	351,975			13,918		5.27	%	330,372			13,204		5.32	%
Real estate - residential	327,656			9,770		3.97	%	240,380			8,012		4.44	%	245,051			8,880		4.83	%
Home equity lines	117,178			3,244		3.70	%	113,573			3,135		3.69	%	120,284			3,338		3.71	%
Consumer	5,432			414		5.78	%	3,156			127		5.33	%	3,361			130		5.16	%
Total loans	2,319,837			77,395		4.45	%	1,804,886			63,809		4.71	%	1,675,556			63,245		5.03	%
Loans held for sale	291,585			9,326		4.26	%	447,519			13,258		3.95	%	438,898			13,184		4.01	%
Investment securities available-for-sale	330,205			9,821		3.97	%	256,059			8,087		4.21	%	269,037			8,816		4.37	%
Investment securities held-to-maturity	6,877			112		2.17	%	10,647			148		1.85	%	12,373			236		2.55	%
Other investments	15,042			410		3.65	%	13,387			240		2.39	%	15,646			170		1.45	%
Federal funds sold	31,899			50		0.21	%	129,884			244		0.25	%	66,626			118		0.24	%
Total interest-earning assets and interest income (2)	2,995,445			97,114		4.32	%	2,662,382			85,786		4.71	%	2,478,136			85,769		4.61	%
Noninterest-earning assets:
Cash and due from banks	25,270							16,773							15,444
Premises and equipment, net	25,765							19,602							18,738
Goodwill and other intangibles, net	33,548							10,217							10,420
Accrued interest and other assets	105,038							110,004							106,809
Allowance for loan losses	(29,784		)					(27,340		)					(27,085		)
Total assets	$	3,155,282						$	2,791,638						$	2,602,462
Liabilities and Shareholders’ Equity
Interest - bearing liabilities:
Interest - bearing deposits:
Interest checking	428,951			1,630		0.51	%	371,099			1,651		0.59	%	265,287			1,906		0.96	%
Money markets	325,097			742		0.30	%	292,232			624		0.28	%	281,045			737		0.35	%
Statement savings	253,047			517		0.27	%	213,498			425		0.27	%	218,657			507		0.31	%
Certificates of deposit	813,349			5,992		0.98	%	853,174			7,237		1.13	%	883,548			8,159		1.23	%
Total interest - bearing deposits	1,820,444			8,881		0.65	%	1,730,003			9,937		0.77	%	1,648,537			11,309		0.92	%
Other borrowed funds	388,385			6,661		2.29	%	290,509			6,554		3.02	%	318,350			6,943		2.91	%
Total interest-bearing liabilities and interest expense	2,208,829			15,542		0.94	%	2,020,512			16,491		1.09	%	1,966,887			18,252		1.24	%
Noninterest-bearing liabilities:
Demand deposits	544,928							403,881							320,242
Other liabilities	33,702							48,052							39,293
Common shareholders’ equity	367,823							319,193							276,040
Total liabilities and shareholders’ equity	$	3,155,282						$	2,791,638						$	2,602,462
Net interest income and net interest margin (2)				$	81,572	3.63	%				$	69,295	3.47	%				$	67,517	3.63	%

(1)Non-accrual loans are included in average balances and do not have a material effect on the average yield.  Interest income on non-accruing loans was not material for the periods presented.

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(2)Interest income for loans receivable and investment securities available-for-sale is reported on a fully taxable-equivalent basis at a rate of 33% for 2014 and 35% for 2013 and 2012.

Rate and Volume Analysis

Nine Months Ended September 30, 2014, 2013 and 2012

(In thousands)

	2014 Compared to 2013									2013 Compared to 2012
	Change Due to									Change Due to
	Average			Average			Increase			Average			Average			Increase
	Volume (3)			Rate			(Decrease)			Volume (3)			Rate			(Decrease)
Interest income:
Loans (1):
Commercial and industrial	$	2,157		$	848		$	3,005		$	(554	)	$	(207	)	$	(761	)
Real estate - commercial	10,008			(3,151		)	6,857			6,037			(4,352		)	1,685
Real estate - construction	2,337			(767		)	1,570			837			(123		)	714
Real estate - residential	2,934			(1,176		)	1,758			(169		)	(699		)	(868		)
Home equity lines	100			9			109			(186		)	(17		)	(203		)
Consumer	268			19			287			(7		)	4			(3		)
Total loans	17,804			(4,218		)	13,586			5,958			(5,394		)	564
Loans held for sale	(4,620		)	688			(3,932		)	259			(185		)	74
Investment securities available-for-sale	2,342			(608		)	1,734			(425		)	(304		)	(729		)
Investment securities held-to-maturity	(52		)	16			(36		)	(32		)	(56		)	(88		)
Other investments	28			142			170			(25		)	95			70
Federal funds sold	(184		)	(10		)	(194		)	112			14			126
Total interest income (2)	15,318			(3,990		)	11,328			5,847			(5,830		)	17
Interest expense:
Interest - bearing deposits:
Interest checking	257			(278		)	(21		)	760			(1,015		)	(255		)
Money markets	70			48			118			51			(164		)	(113		)
Statement savings	79			13			92			(12		)	(70		)	(82		)
Certificates of deposit	(338		)	(907		)	(1,245		)	(280		)	(642		)	(922		)
Total interest - bearing deposits	68			(1,124		)	(1,056		)	519			(1,891		)	(1,372		)
Other borrowed funds	2,208			(2,101		)	107			(629		)	240			(389		)
Total interest expense	2,276			(3,225		)	(949		)	(110		)	(1,651		)	(1,761		)
Net interest income (2)	$	13,042		$	(765	)	$	12,277		$	5,957		$	(4,179	)	$	1,778

(1)Non-accrual loans are included in average balances and do not have a material effect on the average yield.  Interest income on non-accruing loans was not material for the periods presented.

(2)Interest income for loans receivable and investment securities available-for-sale is reported on a fully taxable-equivalent basis at a rate of 33% for 2014 and 35% for 2013 and 2012.

(3)Changes attributable to rate/volume have been allocated to volume.

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Provision for Loan Losses

The provision for loan losses for the three months ended September 30, 2014 and 2013 was $0 and $157,000, respectively.  For the nine months ended September 30, 2014 and 2013, the provision for loan losses was $2.5 million and a benefit of $432,000, respectively.  The increase in our provision expense during 2014 compared to 2013 is primarily a result of our organic loan growth during 2014.

During 2014, we recorded charge-offs of $1.4 million primarily related to two commercial relationships that deteriorated during the year.  Recoveries from previously charged-off loans totaled $563,000 for the nine months ended September 30, 2014.  During the second quarter of 2014, we received a recovery on a commercial relationship of $316,000.  All other recoveries were primarily related to previously charged off residential real estate loans and home equity loans.  Nonperforming loans at September 30, 2014 and December 31, 2013, were $6.3 million and $2.3 million, respectively. The increase in nonperforming loans is directly related to those loans that were nonperforming at UFBC.  Due to our assessment of the underlying credit related to these loans, we chose to maintain them on a status of nonaccrual post acquisition.

The allowance for loan losses was $29.5 million at September 30, 2014 and $27.9 million at December 31, 2013. Our allowance for loan losses ratio as a percent of total loans was 1.19% and 1.37% at September 30, 2014 and December 31, 2013, respectively.  The decrease in the allowance for loan losses ratio is due to loans we acquired from UFBC during the first quarter of 2014 as these loans do not have an associated allowance.  Our allowance for loans losses ratio on the originated loans receivable portfolio was 1.27% at September 30, 2014.

A sluggish job market could adversely affect our home equity lines of credit, credit card and other loan portfolios, including causing increases in delinquencies and default rates, which we expect could impact our charge-offs and provision for loan losses.  Deterioration in commercial and residential real estate values, employment data and household incomes may also result in higher credit losses in our commercial loan portfolio.  Also, in the ordinary course of business, we may be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer.  At September 30, 2014, our commercial real estate (including construction lending) portfolio was 66% of our total loan portfolio.  A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our businesses, perhaps materially, and the systems by which we set limits and monitor the level of our credit exposure to individual entities and industries may not function as we have anticipated.

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Additional information on the allowance for loan losses, its allocation to the loans receivable portfolio and information on nonperforming loans can be found in the following tables.

Allowance for Loan Losses

Three and Nine Months Ended September 30, 2014 and 2013

(In thousands)

	Three months ended September 30,					Nine months ended September 30,
	2014			2013		2014			2013
Balance, beginning of the period	$	29,566		$	26,934	$	27,864		$	27,400
Provision for loan losses	—			157		2,541			(432		)
Loans charged off:
Commercial and industrial	—			—		(1,346		)	(42		)
Residential	(78		)	—		(78		)	(185		)
Consumer	(5		)	—		(7		)	(1		)
Total loans charged off	(83		)	—		(1,431		)	(228		)
Recoveries:
Commercial and industrial	10			290		339			609
Residential	44			11		136			41
Consumer	—			—		88			2
Total recoveries	54			301		563			652
Net (charge offs) recoveries	(29		)	301		(868		)	424
Ending balance, September 30,	$	29,537		$	27,392	$	29,537		$	27,392

	September 30,			September 30,
	2014			2013
Loans:
Balance at period end	$	2,489,293		$	1,963,519
Allowance for loan losses to loans receivable, net of fees	1.19		%	1.40		%
Annualized net charge-offs to average loans receivable	0.05		%	(0.03		)%

Allocation of the Allowance for Loan Losses

At September 30, 2014 and December 31, 2013

(In thousands)

	September 30,				December 31,
	2014				2013
	Allocation		% of Total*		Allocation		% of Total*
Commercial and industrial	$	4,107	12.89	%	$	3,329	10.72	%
Real estate - commercial	16,777		49.13	%	16,076		51.30	%
Real estate - construction	5,808		17.19	%	5,336		17.77	%
Real estate - residential	2,311		15.53	%	2,421		14.65	%
Home equity lines	438		5.05	%	609		5.36	%
Consumer	96		0.21	%	93		0.20	%
Total allowance for loan losses	$	29,537	100.00	%	$	27,864	100	%

* Percentage of loan type to the total loan portfolio.

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Nonperforming Loans

At September 30, 2014 and December 31, 2013

(In thousands)

	September 30,		December 31,
	2014		2013
Nonaccruing loans (unpaid principal balance)	$	5,472	$	2,314
Loans contractually past-due 90 days or more and still accruing	792		—
Total nonperforming loans	$	6,264	$	2,314

Noninterest Income

Noninterest income includes service charges on deposits and loans, realized and unrealized gains on mortgage banking activities, investment fee income, management fee income, and gains on sales of investment securities available-for-sale, and continues to be an important factor in our operating results.

Noninterest income for the three months ended September 30, 2014 and 2013 was $8.5 million and $1.7 million, respectively.  For the year-to-date September 30, 2014 and 2013, noninterest income was $28.8 million and $23.8 million, respectively.  Realized and unrealized gains (losses) on mortgage banking activities, which are reported net of commission & incentive expense, totaled $6.6 million for the three months ended September 30, 2014 compared to a net loss of $102,000 for the same period of 2013.  For the nine months ended September 30, 2014 and 2013, realized and unrealized gains (losses) on mortgage banking activities was $24.2 million and $17.4 million, respectively.  Noninterest income related to title insurance services and management fees from managed mortgage company affiliates has decreased to $0 and $21,000 for the three and nine months ended September 30, 2014, respectively, compared to $543,000 and $2.4 million for the three and nine month periods of 2013, respectively, as George Mason has exited these lines of business.

The change in net gains from mortgage banking activities is mainly due to changes in the unrealized gains associated with the fair market value of our locked commitments and closed loans held for sale.  For the third quarter of 2014, the unrealized gain increased $3.4 million as compared to the year ago quarter.  For the year-to-date September 30, 2014, the unrealized gain decreased $9.0 million compared to the nine months ended September 30, 2013.  In accordance with GAAP, if a lender enters into a mortgage loan commitment with a customer and intends to sell the mortgage loan after it is funded, the written loan commitment is to be accounted for as a derivative instrument and is to be recorded at fair value through earnings.  George Mason enters into commitments where individual loans are “locked in” at a specified interest rate for a fixed period.  At the time of commitment, George Mason also enters into a “best efforts” forward contract with an investor to sell the loan at an agreed upon price if, and after, the loan is closed. This price represents the fair value of the “interest rate lock commitment” (“IRLC”) and is an unrealized gain that is included in earnings during the period of the IRLC.  This gain is also recognized earlier in earnings than the expenses associated with originating, underwriting and closing the loan, which, under GAAP, are recognized by the Company at the time of loan sale to the investor.  When the loan actually closes, the unrealized gain is added to the basis of the ensuing LHFS.  At any point in time (e.g. quarter end) the fair value of the existing IRLCs (not yet closed) and the premium to the basis of existing LHFS (loans closed but not yet purchased by investors) represent unrealized gains that have been recognized in income, either in the current period or prior periods.  At the time the loan is sold to investors, the “investor buy price” is equal to the basis of the loan held for sale, and there is no gain or loss recognized.  This accounting creates a mismatch between the income recognition on loan production and the expense recognition for those same loans.

As mentioned, direct costs associated with loan origination, such as commission and salaries, are recorded as a reduction to realized and unrealized gains on mortgage banking activities.

67

For the three and nine months ended September 30, 2014, we closed $826.8 million and $2.22 billion in mortgage originations, respectively.  This compares to $927.5 million and $3.40 billion in mortgage originations for the three and nine months ended September 30, 2013, respectively.  The decrease in mortgage originations is primarily a result of an increased interest rate environment compared to the 2013 periods, which has decreased existing home borrowers’ interest in refinancing their current mortgage.  As a result, refinance activity has decreased to only 19% of our total loan origination volume for the year-to-date period of 2014 compared to 35% for the same period of 2013.  Because of the decrease in loan origination volumes, we have reduced our back office staffing by approximately 21% at our mortgage banking segment, which began last year.  We continue to closely monitor each expense category at our mortgage subsidiary in relation to production expectations.

Investment fee income decreased $67,000 to $128,000 for the three months ended September 30, 2014 compared to $195,000 for the same period of 2013.  For the year-to-date September 30, 2014 and 2013, investment fee income was $554,000 and $1.1 million, respectively.  The decrease in investment fee income is a result of the restructuring we completed in our wealth management business segment during 2013.

The increase in the cash surrender value of our bank-owned life insurance for the three months ended September 30, 2014 and 2013 was $111,000 and $124,000, respectively.  For the nine months ended September 30, 2014 and 2013, the increase in the cash surrender value of our bank-owned life insurance was $356,000 and $306,000, respectively.

Noninterest income represented 23% and 7% of our total revenues for the three months ended September 30, 2014 and 2013, respectively.  For each of the nine months ended September 30, 2014 and 2013, noninterest income represented 26% of our total revenues, respectively.

Noninterest Expense

Noninterest expense includes, among other things, salaries and benefits, occupancy costs, professional fees, depreciation, data processing, telecommunications and miscellaneous expenses. Noninterest expense for the three months ended September 30, 2014 was $22.2 million, compared to $21.0 million for the same period of 2013, an increase of $1.2 million, or 6%.  For the nine months ended September 30, 2014 and 2013, noninterest expense was $73.2 million and $63.0 million, respectively.  Our merger and acquisition expenses related to the UFBC acquisition were $64,000 and $5.7 million for the three and nine months ended September 30, 2014, respectively.  For each of the three and nine months ended September 30, 2013, merger and acquisition expense was $304,000.  We also recognized an additional $850,000 and $3.3 million for the three and nine months ended September 30, 2014, respectively, in noninterest expense related to operating expenses of UFBC, which is contributing to the increase in expenses in 2014 as compared to 2013.  These expenses were related to staffing reductions, branch office consolidations, and back office systems consolidations.

For the quarter ended September 30, 2014, salaries and benefits expense increased to $10.7 million from $10.0 million for the quarter ended September 30, 2013.  For the nine months ended September 30, 2014 and 2013, salaries and benefits expense was $33.6 million and $30.4 million, respectively.  The increase in salaries and benefits expense during 2014 compared to 2013 is primarily a result of the increase in staffing within our commercial banking segment as a result of the UFBC acquisition.  Because the integration of UFBC’s back office systems into Cardinal’s did not occur until March 2014, the staffing levels at UFBC remained near their preacquisition levels.  In addition, we have added business development staffing at the Bank which has contributed to the increase in this expense year over year.

Occupancy expense was $2.6 million for the three months ended September 30, 2014, an increase of $620,000 when compared to the same period of 2013.  For the nine months ended September 30, 2014 and 2013, occupancy expense was $7.8 million and $6.1 million, respectively.  The increase in occupancy expense during 2014 as compared to 2013 is primarily attributable to the eight additional branch office locations of UFBC.  During the second and third quarters of 2014, we closed five branch offices that overlap existing markets as a result of the UFBC acquisition. In addition, we added two branch offices in the last nine months of 2013 which contribute to the increase in occupancy expense for 2014.  The increases in depreciation expense and data processing & communications for 2014 compared to 2013 can also be attributed to the UFBC acquisition.  Our expectation of cost savings associated with the UFBC acquisition is approximately 60% of their total expense base, of which we began to realize during the second quarter of 2014.

68

Professional fees were $783,000 and $786,000 for the three months ended September 30, 2014 and 2013, respectively.  For the nine months ended September 30, 2014 and 2013, professional fees were $2.5 million and $3.2 million, respectively.  Decreases in professional fees were a result of the decrease in temporary staffing we had at George Mason to handle the increase in loan origination volume we experienced during the first quarter of 2013; all due to the increase in refinance activity during that period.  The level of temporary staffing was maintained at George Mason until the beginning of the third quarter of 2013 when we experienced a significant decrease in loan origination volumes as a result of mortgage market conditions.

Income Taxes

For the three months ended September 30, 2014, we recorded a provision for income taxes of $4.7 million, compared to $1.2 million for the same period of 2013.  Our effective tax rate for the three months ended September 30, 2014 and 2013 was 33.3% and 28.2%, respectively.  For the nine months ended September 30, 2014 and 2013, we recorded a provision for income taxes of $11.4 million and $9.8 million, respectively.  Our effective tax rate for the nine months ended September 30, 2014 and 2013 was 34.0% and 32.9%, respectively. Our effective tax rate is less than the statutory rate because of income we receive on tax-exempt investments.  See also “Critical Accounting Policies — Valuation of Deferred Tax Assets.”

Statements of Condition

Total assets were $3.31 billion and $2.89 billion at September 30, 2014 and December 31, 2013, respectively.  In connection with the closing of the UFBC acquisition, we added $329 million in total assets to our balance sheet.  We recorded $24.7 million in goodwill and $2.7 million of core deposit intangibles.  Additional information on the assets acquired and liabilities assumed can be found in the discussion below.

Investment Securities

Our investment securities portfolio is used as a source of income and liquidity.  Investment securities were $341.2 million at September 30, 2014, compared to $359.7 million at December 31, 2013, a decrease of $18.5 million.  The decrease in investment securities was a result of maturities, sales, calls and scheduled principal payments that occurred during 2014.  The investment securities portfolio consists of investment securities available-for-sale, investment securities held-to-maturity and trading securities. Investment securities available-for-sale are those securities that we intend to hold for an indefinite period of time, but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability strategy, liquidity management or regulatory capital management.  Investment securities held-to-maturity are those securities that we have the intent and ability to hold to maturity and are carried at amortized cost. Investment securities-trading are securities we purchase to economically hedge against fair value changes in our nonqualified deferred compensation plan liability.  These securities include cash equivalents, equities and mutual funds.  See the following table for additional information on our investment securities portfolio.

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Investment Securities

At September 30, 2014 and December 31, 2013

(In thousands)

	Amortized		Fair		Average
Available-for-sale at September 30, 2014	Cost		Value		Yield
U.S. government-sponsored agencies
One to five years	$	26,464	$	27,501	2.97	%
Five to ten years	19,996		21,802		3.82	%
After ten years	9,977		9,810		3.42	%
Total U.S. government-sponsored agencies	56,437		59,113		3.35	%
Mortgage-backed securities (1)
One to five years	2,254		2,379		4.20	%
Five to ten years	33,443		34,733		3.39	%
After ten years	86,465		90,816		3.71	%
Total mortgage-backed securities	122,162		127,928		3.63	%
Tax exempt municipal securities (2)
Within one year	4,318		4,400		4.42	%
One to five years	8,703		9,214		3.42	%
Five to ten years	32,106		33,935		3.57	%
After ten years	82,873		86,312		3.44	%
Taxable municipal securities
Within one year	1,006		1,005		1.11	%
Five to ten years	4,262		4,721		4.99	%
After ten years	996		1,060		5.33	%
Total municipal securities	134,264		140,647		3.55	%
Pooled trust preferred & corporate securities
Within one year	503		503		0.35	%
After ten years	2,071		2,224		1.48	%
Total pooled trust preferred & corporate securities	2,574		2,727		1.26	%
Total investment securities available-for-sale	$	315,437	$	330,415	3.53	%

	Amortized		Fair		Average
Held-to-maturity September 30, 2014	Cost		Value		Yield
Mortgage-backed securities (1)
One to five years	$	475	$	500	4.78	%
Five to ten years	78		84		4.45	%
After ten years	1,514		1,599		1.97	%
Total mortgage-backed securities	2,067		2,183		2.71	%
Pooled trust preferred securities
After ten years	4,005		3,117		1.09	%
Total pooled trust preferred securities	4,005		3,117		1.09	%
Total investment securities held-to-maturity	6,072		5,300		1.64	%
Total investment securities	$	321,509	$	335,715	3.49	%

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	Amortized		Fair		Average
Available-for-sale at December 31, 2013	Cost		Value		Yield
U.S. government-sponsored agencies
One to five years	$	25,591	$	26,863	3.07	%
Five to ten years	20,000		21,404		3.82	%
After ten years	29,971		28,661		3.59	%
Total U.S. government-sponsored agencies	75,562		76,928		3.47	%
Mortgage-backed securities (1)
One to five years	99		101		4.66	%
Five to ten years	25,883		26,134		3.57	%
After ten years	118,627		121,594		3.78	%
Total mortgage-backed securities	144,609		147,829		3.74	%
Tax exempt municipal securities (2)
Within one year	3,557		3,661		4.44	%
One to five years	4,529		4,809		3.83	%
Five to ten years	37,392		38,870		3.55	%
After ten years	62,970		63,744		3.61	%
Taxable municipal securities
Five to ten years	4,273		4,602		4.99	%
After ten years	995		1,052		5.33	%
Total municipal securities	113,716		116,738		3.69	%
U. S. treasury securities
Within one year	4,992		5,029		2.36	%
Total U.S. treasury securities	4,992		5,029		2.36	%
Pooled trust preferred securities
After ten years	2,795		2,795		1.49	%
Total pooled trust preferred securities	2,795		2,795		1.49	%
Total investment securities available-for-sale	$	341,674	$	349,319	3.63	%

	Amortized		Fair		Average
Held-to-maturity December 31, 2013	Cost		Value		Yield
Mortgage-backed securities (1)
One to five years	$	663	$	703	4.63	%
Five to ten years	131		137		5.44	%
After ten years	1,678		1,777		2.02	%
Total mortgage-backed securities	2,472		2,617		2.90	%
Pooled trust preferred securities
After ten years	4,005		2,910		1.11	%
Total pooled trust preferred securities	4,005		2,910		1.11	%
Total investment securities held-to-maturity	6,477		5,527		1.79	%
Total investment securities	$	348,151	$	354,846	3.58	%

We complete reviews for other-than-temporary impairment at least quarterly.  As of September 30, 2014, the majority of our investment securities portfolio consisted of securities rated AAA by a leading rating agency.  Investment securities which carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk.  At September 30, 2014, 99% of our mortgage-related investment securities portfolio is guaranteed by the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Government National Mortgage Association (GNMA).

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We have $1.7 million in non-government non-agency mortgage-related securities.  These securities are rated from AAA to AA.  The various protective elements on the non-agency securities may change in the future if market conditions or the financial stability of credit insurers changes, which could impact the ratings of these securities.

At September 30, 2014, certain of our investment grade securities were in an unrealized loss position.  Investment securities with unrealized losses are a result of pricing changes in the current market environment and not as a result of permanent credit impairment. Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government.  Other mortgage-backed securities and municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due.  We do not intend to sell nor do we believe we will be required to sell any of our temporarily impaired securities prior to the recovery of their amortized cost.

We own four pooled trust preferred securities which were all previously classified as held-to-maturity within the investment securities portfolio.  As a result of the issuance of the Final Rule, only two of the four investments were exempt from the covered fund definition.  For the two investments that were not exempt as a result of the Final Rule, we will be required to divest our investment in these particular pooled trust preferred securities prior to the effectiveness of the Final Rule on July 21, 2015.  As a result of this new regulation, these two investments which have a par value of $2.4 million and a carrying value of $2.1 million at September 30, 2014, were reclassified to the available-for-sale investment securities portfolio.  We recorded an other-than-temporary impairment of $300,000 for the year ended December 31, 2013, which was determined based on the market bid price of these investments.  No further impairment was recorded for the three and nine months ended September 30, 2014.

The par value of the two pooled trust preferred securities still classified as held-to-maturity totaled $4.0 million at September 30, 2014.  The collateral underlying these structured securities are instruments issued by financial institutions.  We own the A-3 tranches in each issuance.  Each of the bonds are rated by more than one rating agency.  One security has a composite rating of A-, one security has a composite rating of BBB+.  Observable trading activity remains limited for these types of securities.  We have estimated the fair value of these securities through the use of internal calculations and through information provided by external pricing services.  Given the level of subordination below our A-3 tranches, and the actual and expected performance of the underlying collateral, we expect to receive all contractual interest and principal payments recovering the amortized cost basis of each of the securities, and concluded that these securities are not other-than-temporarily impaired.  We continuously monitor the financial condition of the underlying issues and the level of subordination below the A-3 tranches.  We also utilize a multi-scenario model which assumes varying levels of additional defaults and deferrals and the effects of such adverse developments on the contractual cash flows for the A-3 tranches.  In each of the adverse scenarios, there was no indication of a break to the A-3 contractual cash flows.

In one of the pooled trust preferred securities issues, 64% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $178 million of the remaining $231 million, or 77% of the performing collateral defaulted or deferred payment.  In the other pooled trust preferred security, 62% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $155 million of the remaining $219 million, or 71% of the performing collateral defaulted or deferred payment.  Significant judgment is involved in the evaluation of other-than-temporary impairment.  We do not intend to sell nor do we believe it is probable we will be required to sell these pooled trust preferred securities prior to the recovery of our investment.

No other-than-temporary impairment has been recognized on the securities in our investment portfolio as of September 30, 2014.

We hold $17.1 million in FHLB stock at September 30, 2014, which is included in other investments on the statement of condition.

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Loans Receivable

Total loans receivable, net of deferred fees and costs, were $2.5 billion and $2.0 billion at September 30, 2014 and December 31, 2013, respectively.  See the following table for details on the loans receivable portfolio.  As a result of our acquisition of UFBC, we added $238 million in loans, net of negative $3.9 million fair value adjustments, during 2014.  See further details regarding the acquired loans in Note 7 to the consolidated financial statements.  For the year-to-date ended September 30, 2014, net new organic loan growth was approximately $211 million, representing annualized loan growth of 14%.

Loans held for sale at September 30, 2014 were $313.5 million compared to $374.0 million at December 31, 2013.  Loans closed at our mortgage subsidiary totaled $826.8 million for the three months ended September 30, 2014 compared to $797.3 million for the quarter ended December 31, 2013.  Loans held for sale are valued at the lower of cost or fair value.

Loans Receivable

At September 30, 2014 and December 31, 2013

(In thousands)

	September 30, 2014					December 31, 2013
Commercial and industrial	$	321,260		12.89	%	$	219,156		10.72	%
Real estate - commercial	1,224,971			49.13	%	1,048,579			51.30	%
Real estate - construction	428,618			17.19	%	363,063			17.77	%
Real estate - residential	387,283			15.53	%	299,484			14.65	%
Home equity lines	126,033			5.05	%	109,481			5.36	%
Consumer	5,146			0.21	%	4,159			0.20	%
Gross loans	$	2,493,311		100.00	%	2,043,922			100.00	%
Net deferred (fees) costs	(4,018		)			(3,754		)
Less: allowance for loan losses	(29,537		)			(27,864		)
Loans receivable, net	$	2,459,756				$	2,012,304

Deposits

Total deposits were $2.42 billion at September 30, 2014 compared to $2.06 billion at December 31, 2013.  As a result of our acquisition of UFBC, we added $295 million in deposits, net of positive $1.2 million fair value adjustments to the certificates of deposit portfolio, during 2014.  See the following table for details on certificates of deposit with balances of $100,000 or more.

We are a member of the Certificates of Deposit Account Registry Service (“CDARS”).  CDARS allows our customers to access FDIC insurance protection on multi-million dollar certificates of deposit through our Bank.  When a customer places a large deposit through CDARS, we place their funds into certificates of deposit with other banks in the CDARS network in increments of less than $250,000 so that principal and interest are eligible for FDIC insurance protection.  At September 30, 2014 and December 31, 2013, we had $53.0 million and $72.7 million, respectively, in CDARS deposits, which are considered to be brokered deposits.  The decrease in our CDARS deposits is primarily due to maturities within the portfolio.  Brokered certificates of deposit not in the CDARS network were $246.9 million and $228.5 million at September 30, 2014 and December 31, 2013, respectively. We use this type of funding to lock in low cost term funding to support mortgage loans we originate and intend to sell.

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Certificates of Deposit of $100,000 or More

At September 30, 2014

(In thousands)

Maturities:	Fixed Term		No- Penalty*		Total
Three months or less	$	70,245	$	7,388	$	77,633
Over three months through six months	39,293		6,728		46,021
Over six months through twelve months	68,840		8,933		77,773
Over twelve months	157,510		27,830		185,340
	$	335,888	$	50,879	$	386,767

* No-Penalty certificates of deposit can be redeemed at anytime at the request of the depositor.

Borrowings

Other borrowed funds were $476.8 million at September 30, 2014 compared to $475.2 million at December 31, 2013.  FHLB advances at September 30, 2014 and December 31, 2013 were each $315.0 million.  Customer repurchase agreements increased $2.9 million to $97.5 million at September 30, 2014 compared to $94.6 million at December 31, 2013.  We had federal funds purchased of $40.0 million outstanding at September 30, 2014 compared to $45.0 million at December 31, 2013.  The following table provides information on our borrowings.

In connection with the acquisition, we acquired all of the voting and common shares of UFBC Capital Trust I (the “Trust”), which is a wholly-owned subsidiary established for the sole purpose of issuing $5.0 million of floating rate junior subordinated deferrable interest debentures (“trust preferred securities”).  These trust preferred securities are due in 2035 and have an interest rate of LIBOR (London Interbank Offering Rate) plus 2.10%, which adjusts quarterly.  The Trust is an unconsolidated subsidiary since we are not the primary beneficiary of this entity.  The additional $155,000 that is payable by us to the Trust represents our unfunded capital investment in the Trust.

Short-Term Borrowings and Other Borrowed Funds

At September 30, 2014

(In thousands)

		Maturity or			Amount
Advance Date	Term of Advance	Call Date	Interest Rate		Outstanding
Sep-14	1 month	Oct-14	0.16	%	$	75,000
Total short-term FHLB advances and weighted average rate			0.16	%	$	75,000
Other short-term borrowed funds:
Customer repurchase agreements			0.14	%	$	97,500
Federal Funds Purchased			0.35	%	40,000
Total other short-term borrowed funds and weighted average rate			0.20	%	$	137,500
Other borrowed funds:
Trust preferred			2.78	%	$	24,328
FHLB advances - long term			3.32	%	240,000
Other borrowed funds and weighted average rate			3.27	%	$	264,328
Total other borrowed funds and weighted average rate			1.90	%	$	476,828

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Shareholders’ Equity

Shareholders’ equity at September 30, 2014 was $368.1 million compared to $320.5 million at December 31, 2013, an increase of $47.5 million, or 15%. The increase in shareholders’ equity at September 30, 2014 compared to December 31, 2013 is primarily attributable to shares issued as a result of our acquisition of UFBC.  For each share of UFBC common stock outstanding, the shareholders of UFBC received a fixed exchange ratio of $19.13 in cash and 1.154 shares of our common stock.  We issued 1.6 million shares of our common stock and added $25.2 million in additional paid in capital for a total of $26.8 million in additional capital.  Net income of $22.2 million for the nine months ended September 30, 2014 also contributed to the increase in equity less dividends of $7.7 million that were declared during 2014.  In addition, accumulated other comprehensive income increased $4.3 million for the nine months ended September 30, 2014.

Book value per share at September 30, 2014 was $11.49 compared to $10.57 at December 31, 2013. Tangible book value per share (which is book value per share less goodwill and other intangible assets) at September 30, 2014 was $10.34 compared to $10.23 at December 31, 2013.

Business Segment Operations

We provide banking and non-banking financial services and products through our subsidiaries. We operate in three business segments, commercial banking, mortgage banking and wealth management services.  As of June 30, 2013, we merged operations of our trust division and Wilson/Bennett into CWS, both of which had been included in the wealth management services segment.  Results for the nine months ended September 30, 2013 include the operations of these subsidiaries prior to their closure.

Commercial Banking

The commercial banking segment includes both commercial and consumer lending and provides customers such products as commercial loans, real estate loans, and other business financing and consumer loans. In addition, this segment also provides customers with various deposit products including demand deposit accounts, savings accounts and certificates of deposit.

For the three months ended September 30, 2014, the commercial banking segment recorded net income of $10.4 million compared to $8.6 million for the same period of 2013.  For the nine months ended September 30, 2014 and 2013, this segment recorded net income of $23.5 million and $26.1 million, respectively.  See “Statements of Income — General—Business Segments” above for additional information regarding the operating results for the commercial banking segment for the periods presented.  At September 30, 2014, total assets for this segment were $3.26 billion, loans receivable, net of deferred fees and costs, were $2.49 billion and total deposits were $2.42 billion. At September 30, 2013, total assets for this segment were $2.76 billion, loans receivable, net of deferred fees and costs, were $1.96 billion and total deposits were $2.08 billion.

Mortgage Banking

The operations of the mortgage banking segment are conducted through George Mason. George Mason engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis.

For the three months ended September 30, 2014 and 2013, the mortgage banking segment recorded a net loss of $76,000 and $4.9 million, respectively.  For the nine months ended September 30, 2014 and 2013, this segment reported net income of $1.9 million and a net loss of $3.6 million, respectively.  See “Statements of Income — General—Business Segments” above for additional information regarding the operating results for the mortgage banking segment for the periods presented.  At September 30, 2014, total assets for this segment were $352.6 million; loans held for sale were $313.5 million and mortgage funding checks were $15.5 million. At September 30, 2013, total assets for this segment were $335.3 million; loans held for sale were $361.1 million and mortgage funding checks were $10.1 million.

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Wealth Management Services

The wealth management services segment provides investment and financial services to businesses and individuals, including financial planning, retirement/estate planning, and investment management.

For the three months ended September 30, 2014 and 2013, the wealth management services segment recorded net income of $3,000 and $61,000, respectively.  For the nine months ended September 30, 2014 and 2013, this segment recorded net income of $106,000 and a net loss of $218,000, respectively.  See “Statements of Income — General—Business Segments” above for additional information regarding the operating results for this business segment for the periods presented.  At September 30, 2014, total assets were $2.4 million and managed and custodial assets were $265 million. At September 30, 2013, total assets were $2.2 million and managed and custodial assets were $203 million.

Additional information pertaining to our business segments can be found in Note 4 to the notes to consolidated financial statements.

Capital Resources

Capital adequacy is an important measure of our financial stability and performance. Our objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.

Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profile of the financial institution. The guidelines define capital as both Tier 1 (which includes common shareholders’ equity and certain debt obligations) and Tier 2 (which includes certain other debt obligations, a portion of the allowance for loan losses, and 45% of any unrealized gains in equity securities).

At September 30, 2014, our Tier 1 and total (Tier 1 and Tier 2) risk-based capital ratios were 10.95% and 11.91%, respectively. At December 31, 2013, our Tier 1 and total risk-based capital ratios were 11.85% and 12.89%, respectively.  Our regulatory capital levels for the Bank and bank holding company meet those established for well-capitalized institutions.  The decrease in our risk-based capital ratios at September 30, 2014 compared to December 31, 2013 was a primarily a result of the increase in risk weighted assets we acquired from UFBC during 2014.

The following table provides additional information pertaining to our capital ratios.

Capital Components

At September 30, 2014 and December 31, 2013

(In thousands)

										To Be Well
										Capitalized Under
					For Capital					Prompt Corrective
	Actual				Adequacy Purposes					Action Provisions
	Amount		Ratio		Amount			Ratio		Amount			Ratio
Cardinal Financial Corporation (Consolidated):
At September 30, 2014
Total risk-based capital	$	373,020	11.91	%	$	250,470	≥	8.00	%	$	313,087	≥	10.00	%
Tier I risk-based capital	342,897		10.95	%	125,235		≥	4.00	%	187,852		≥	6.00	%
Leverage capital ratio	342,897		10.70	%	128,224		≥	4.00	%	160,280		≥	5.00	%
At December 31, 2013
Total risk-based capital	$	349,894	12.89	%	$	217,111	≥	8.00	%	$	271,389	≥	10.00	%
Tier I risk-based capital	321,513		11.85	%	108,555		≥	4.00	%	162,833		≥	6.00	%
Leverage capital ratio	321,513		11.70	%	109,928		≥	4.00	%	137,410		≥	5.00	%

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										To Be Well
										Capitalized Under
					For Capital					Prompt Corrective
	Actual				Adequacy Purposes					Action Provisions
	Amount		Ratio		Amount			Ratio		Amount			Ratio
Cardinal Bank:
At September 30, 2014
Total risk-based capital	$	368,961	11.85	%	$	249,164	≥	8.00	%	$	311,454	≥	10.00	%
Tier I risk-based capital	338,838		10.88	%	124,582		≥	4.00	%	186,873		≥	6.00	%
Leverage capital ratio	338,838		10.62	%	127,582		≥	4.00	%	159,478		≥	5.00	%
At December 31, 2013
Total risk-based capital	$	343,392	12.73	%	$	215,733	≥	8.00	%	$	269,666	≥	10.00	%
Tier I risk-based capital	315,011		11.68	%	107,867		≥	4.00	%	161,800		≥	6.00	%
Leverage capital ratio	315,011		11.54	%	109,212		≥	4.00	%	136,515		≥	5.00	%

Liquidity

Liquidity in the banking industry is defined as the ability to meet the demand for funds of both depositors and borrowers. We must be able to meet these needs by obtaining funding from depositors or other lenders or by converting non-cash items into cash.  The objective of our liquidity management program is to ensure that we always have sufficient resources to meet the demands of our depositors and borrowers. Stable core deposits and a strong capital position provide the base for our liquidity position. We believe we have demonstrated our ability to attract deposits because of our convenient branch locations, personal service and pricing.

In addition to deposits, we have access to different wholesale funding markets. These markets include the brokered CD market, the repurchase agreement market and the federal funds market. We are a member of the Certificates of Deposit Account Registry Service (“CDARS”).  CDARS allows our customers to access FDIC insurance protection on multi-million dollar certificates of deposit through our Bank.  When a customer places a large deposit through CDARS, we place their funds into certificates of deposit with other banks in the CDARS network in increments of less than $250,000 so that principal and interest are eligible for FDIC insurance protection.  At September 30, 2014 and December 31, 2013, we had $53.0 million and $72.7 million, respectively, in CDARS deposits, which are considered to be brokered deposits.  Brokered certificates of deposit not in the CDARS network were $246.9 million and $228.5 million at September 30, 2014 and December 31, 2013, respectively.

We also maintain secured lines of credit with the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Atlanta. Having diverse funding alternatives reduces our reliance on any one source for funding.

Cash flow from amortizing assets or maturing assets can also provide funding to meet the needs of depositors and borrowers.

We have established a formal liquidity contingency plan which establishes a liquidity management team and provides guidelines for liquidity management. For our liquidity management program, we first determine our current liquidity position and then forecast liquidity based on anticipated changes in the balance sheet. In this forecast, we expect to maintain a liquidity cushion. We also stress test our liquidity position under several different stress scenarios, from moderate to severe. Guidelines for the forecasted liquidity cushion and for liquidity cushions for each stress scenario have been established. We believe that we have sufficient resources to meet our liquidity needs.

Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $378.0 million at September 30, 2014 or 11.4% of total assets. We held investments that are classified as held-to-maturity in the amount of $6.1 million at September 30, 2014. To maintain ready access to the Bank’s secured lines of credit, the Bank has pledged a portion of its investment securities and a portion of its commercial real estate and residential real estate loan portfolios to the Federal Home Loan Bank of Atlanta (“FHLB”) with additional investment securities and certain loans in its commercial & industrial loan portfolio pledged to the Federal Reserve Bank of Richmond. Additional borrowing capacity at the Federal Home Loan Bank of Atlanta at September 30, 2014 was $471.6 million. Borrowing capacity with the Federal Reserve Bank of Richmond was $135.0 million at September 30, 2014. These facilities are subject to the FHLB and the Federal Reserve approving disbursement to us.  In addition, we have unsecured federal funds purchased lines of $315 million available to us.  We anticipate maintaining liquidity at a level sufficient to protect depositors, provide for reasonable growth and fully comply with all regulatory requirements.

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Contractual Obligations

We have entered into a number of long-term contractual obligations to support our ongoing activities. These contractual obligations will be funded through operating revenues and liquidity sources held or available to us and exclude contractual interest costs, where applicable.

The required payments under such obligations are detailed in the following table.

Contractual Obligations

At September 30, 2014

(In thousands)

	Payments Due by Period
			Less than 1						More than 5
	Total		Year		1 - 3 Years		3 - 5 Years		Years
Long-Term Debt Obligations:
Certificates of deposit	$	534,001	$	242,617	$	248,980	$	39,140	$	3,264
Brokered certificates of deposit	299,882		182,178		112,203		5,501		—
Advances from the Federal Home Loan Bank of Atlanta	315,000		85,000		170,000		40,000		20,000
Trust preferred securities	24,328		—		—		—		24,328
Operating lease obligations	35,603		8,097		11,629		8,538		7,339
Total	$	1,208,814	$	517,892	$	542,812	$	93,179	$	54,931

Financial Instruments with Off-Balance-Sheet Risk and Credit Risk

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized on the balance sheet.

The Bank’s maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. We evaluate each customer’s credit worthiness on a case-by-case basis and require collateral to support financial instruments when deemed necessary.  The amount of collateral obtained upon extension of credit is based on management’s credit evaluation of the counterparty.  Collateral held varies but may include deposits held by us, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have expiration dates up to one year or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future funding requirements. These instruments represent obligations to extend credit or guarantee borrowings and are not recorded on the consolidated statements of condition.  The rates and terms of these instruments are competitive with others in the market in which we do business.

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Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers.  Those lines of credit may not be drawn upon to the total extent to which we have committed.

Standby letters of credit are conditional commitments we issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers. We hold certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.

At September 30, 2014 and December 31, 2013, commitments to extend credit were $1.50 billion and $1.49 billion, respectively.  Standby letters of credit were $25.9 million and $28.0 million at September 30, 2014 and December 31, 2013, respectively. Commitments to extend credit of $265.4 million at September 30, 2014 are related to the mortgage banking segment’s mortgage loan funding commitments and are of a short term nature, compared to $210.9 million as of December 31, 2013.  The increase in mortgage loan funding commitments is related to the increased origination production at George Mason during the third quarter of 2014 as compared to the fourth quarter of 2013.

We have counter-party risk which may arise from the possible inability of George Mason’s third-party investors to meet the terms of their forward sales contracts. George Mason works with third-party investors that are generally well-capitalized, are investment grade and exhibit strong financial performance to mitigate this risk.  We do not expect any third-party investor to fail to meet its obligation.  In addition, we have derivative counterparty risk relating to three interest rate swaps we have with third parties.  This risk may arise from the inability of the third party to meet the terms of the contract.  We continuously monitor the financial condition of these third parties.  We do not expect these third parties to fail to meet their obligations.

George Mason provides for its estimated exposure to repurchase loans previously sold to investors for which borrowers failed to provide full and accurate information on their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor, and for other exposure to its investors related to loan sales activities. We evaluate the merits of each claim and estimate the reserve based on actual and expected claims received and consider the historical amounts paid to settle such claims.  We have taken steps to limit our exposure to such loan repurchases through agreements entered into with various investors.  As a result, we receive a limited number of additional claims.  As of September 30, 2014, the reserve for loan repurchases had a balance of $150,000.

Interest Rate Sensitivity

We are exposed to various business risks including interest rate risk. Our goal is to maximize net interest income without incurring excessive interest rate risk. Management of net interest income and interest rate risk must be consistent with the level of capital and liquidity that we maintain. We manage interest rate risk through an asset and liability committee (“ALCO”). ALCO is responsible for managing our interest rate risk in conjunction with liquidity and capital management.

We employ an independent consulting firm to model our interest rate sensitivity.  We use a net interest income simulation model as our primary tool to measure interest rate sensitivity. Many assumptions are developed based on expected activity in the balance sheet. For maturing assets, assumptions are created for the redeployment of these assets. For maturing liabilities, assumptions are developed for the replacement of these funding sources. Assumptions are also developed for assets and liabilities that could reprice during the modeled time period. These assumptions also cover how we expect rates to change on non-maturity deposits such as interest checking, money market checking, and savings accounts as well as certificates of deposit. Based on inputs that include the current balance sheet, the current level of interest rates and the developed assumptions, the model then produces an expected level of net interest income assuming that market rates remain unchanged. This is considered the base case. Next, the model determines what net interest income would be based on specific changes in interest rates. The rate simulations are performed for a two year period and include ramped rate changes of down 100 basis points and up 200 basis points. The down 200 basis point scenario was discontinued given the current level of interest rates.  In the ramped down rate change, the model moves rates gradually down 100 basis points over the first year and then rates remain flat in the second year.

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For the up 200 basis point scenario, rates are gradually moved up 200 basis points in the first year and then rates remain flat in the second year. In both the up and down scenarios, the model assumes a parallel shift in the yield curve. The results of these simulations are then compared to the base case.

At September 30, 2014, our asset/liability position was neutral based on our interest rate sensitivity model.  Our net interest income would decrease by less than 0.50% in a down 100 basis point scenario and would increase by less than 0.50% in an up 200 basis point scenario over a one-year time frame.  In the two-year time horizon, our net interest income would decrease by less than 2.00% in a down 100 basis point scenario and would increase less than 2.20% in an up 200 basis point scenario.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Our Asset/Liability Committee is responsible for reviewing our liquidity requirements and maximizing our net interest income consistent with capital requirements, liquidity, interest rate and economic outlooks, competitive factors and customer needs. Interest rate risk arises because the assets of the Bank and the liabilities of the Bank have different maturities and characteristics. In order to measure this interest rate risk, we use a simulation process that measures the impact of changing interest rates on net interest income. This model is run for the Bank by an independent consulting firm. The simulations incorporate assumptions related to expected activity in the balance sheet. For maturing assets, assumptions are developed for the redeployment of these assets. For maturing liabilities, assumptions are developed for the replacement of these funding sources. Assumptions are also developed for assets and liabilities that reprice during the modeled time period. These assumptions also cover how we expect rates to change on non-maturity deposits such as interest checking, money market checking, and savings accounts as well as certificates of deposit. Based on inputs that include the most recent period end balance sheet, the current level of interest rates and the developed assumptions, the model then produces an expected level of net interest income assuming that interest rates remain unchanged. This becomes the base case. Next, the model determines the impact on net interest income given specified changes in interest rates. The rate simulations are performed for a two year period and include ramped rate changes of down 100 basis points and up 200 basis points. The down 200 basis point scenario was discontinued given the current level of interest rates.  In the ramped down rate change, the model moves rates gradually down 100 basis points over the first year and then rates remain flat in the second year.

For the up 200 basis point scenario, rates are gradually increased by 200 basis points in the first year and remain flat in the second year. In both the up and down scenarios, the model assumes a parallel shift in the yield curve. The results of these simulations are then compared to the base case.

At September 30, 2014, our asset/liability position was neutral based on our interest rate sensitivity model.  Our net interest income would decrease by less than 0.50% in a down 100 basis point scenario and would increase by less than 0.50% in an up 200 basis point scenario over a one-year time frame.  In the two-year time horizon, our net interest income would decrease by less than 2.00% in a down 100 basis point scenario and would increase less than 2.20% in an up 200 basis point scenario.

See also “Interest Rate Sensitivity” in Item 2 above for a discussion of our interest rate risk.

We have counter-party risk that may arise from the possible inability of George Mason’s third party investors to meet the terms of their forward sales contracts.  George Mason works with third-party investors that are generally well-capitalized, are investment grade and exhibit strong financial performance to mitigate this risk.  We do not expect any third-party investor to fail to meet its obligation.  In addition, we have derivative counterparty risk relating to certain interest rate swaps we have with third parties.  This risk may arise from the inability of the third party to meet the terms of the contracts.  We monitor the financial condition of these third parties on an annual basis.  We do not expect these third parties to fail to meet its obligation.

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Item 4.  Controls and Procedures

The Company maintains disclosure controls and procedures (as defined in Rule 13a — 15(e) under the Exchange Act).  As of the end of the period covered by this report, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was carried out under the supervision and with the participation of the Company’s management, including its chief executive officer and chief financial officer. Based on and as of the date of such evaluation, these officers concluded that the Company’s disclosure controls and procedures were effective.

The Company also maintains a system of internal accounting controls that is designed to provide assurance that assets are safeguarded and that transactions are executed in accordance with management’s authorization and are properly recorded. This system is continually reviewed and is augmented by written policies and procedures, the careful selection and training of qualified personnel and an internal audit program to monitor its effectiveness. There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that materially affected, or are likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1.  Legal Proceedings

In the ordinary course of our operations, we become party to various legal proceedings.  Currently, we are not party to any material legal proceedings, and no such proceedings except as noted above are, to management’s knowledge, threatened against us.

Item 1A.  Risk Factors

Our operations are subject to many risks that could adversely affect our future financial condition and performance and, therefore, the market value of our securities, including the risk factors that are outlined in our Annual Report on Form 10-K for the year ended December 31, 2013.  There have been no material changes in our risk factors from those disclosed.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

(a)  None.

(b)  Not applicable.

(c)  For the three months ended September 30, 2014, we did not purchase shares of our common stock.

Item 3.  Defaults Upon Senior Securities

(a)  None.

(b)  None.

Item 4.  Mine Safety Disclosures

None.

Item 5.  Other Information

(a)  None.

(b)  None.

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Item 6.  Exhibits

10.1Amendment to Executive Employment Agreement of Alice P. Frazier, attached as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed July 17, 2014, and incorporated herein by reference.

31.1Rule 13a-14(a) Certification of Chief Executive Officer

31.2Rule 13a-14(a) Certification of Chief Financial Officer

32.1Statement of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350

32.2Statement of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

101The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Condensed Consolidated Statements of Income, (ii) the Condensed Consolidated Balance Sheets, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) related notes (filed herewith).

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

	CARDINAL FINANCIAL CORPORATION
	(Registrant)
Date: November 7, 2014	/s/ Bernard H. Clineburg
	Bernard H. Clineburg
	Chairman and Chief Executive Officer
	(Principal Executive Officer)
Date: November 7, 2014	/s/ Mark A. Wendel
	Mark A. Wendel
	Executive Vice President and Chief Financial Officer
	(Principal Financial Officer)
Date: November 7, 2014	/s/ Jennifer L. Deacon
	Jennifer L. Deacon
	Executive Vice President and Chief Accounting Officer
	(Principal Accounting Officer)

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EXHIBIT INDEX

Exhibit No.	Description
10.1	Amendment to Executive Employment Agreement of Alice P. Frazier, attached as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed July 17, 2014, and incorporated herein by reference.
31.1	Rule 13a-14(a) Certification of Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
32.1	Statement of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
32.2	Statement of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
101	The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Condensed Consolidated Statements of Income, (ii) the Condensed Consolidated Balance Sheets, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) related notes (filed herewith).

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