The purpose of this discussion is to focus on important factors affecting our financial condition and results of operations. The discussion and analysis should be read in conjunction with the Consolidated Financial Statements and supplemental financial data.

We generate a significant amount of our income from the net interest income earned by Monarch Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates thereon. Monarch Bank's cost of money is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on non-accrual loans and the amount of additions to the allowance for loan losses.

We also generate income from non-interest sources. Non-interest income sources include bank related service charges, fee income from residential and commercial mortgage sales, fee income from the sale of investment and insurance services, income from bank owned life insurance ("BOLI") policies, as well as gains or losses from the sale of investment securities.

This report contains forward-looking statements with respect to our financial condition, results of operations and business. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of our management and on information available at the time these statements and disclosures were prepared. Factors that may cause actual results to differ materially from those expected include the following:

• General economic conditions may deteriorate and negatively impact the ability of borrowers to repay loans and depositors to maintain balances.

• Changes in interest rates could reduce income.

• Competitive pressures among financial institutions may increase.

• The businesses that we are engaged in may be adversely affected by legislative or regulatory changes, including changes in accounting standards.

• New products developed or new methods of delivering products could result in a reduction in our business and income.

• Adverse changes may occur in the securities market.

A summary of our significant risk factors is set forth in Note 1A to the consolidated financial statements in our 2008 Form 10-K.

Net Income

Net income for the third quarter of 2009 was $1,153 thousand, compared to $772 thousand for the same period in 2008. This represents a $380 thousand, or 49.3% increase, quarter over quarter. Basic and diluted earnings per share for the third quarter of 2009 were $0.17 compared to $0.14 for the third quarter of 2008.

We reported year-to-date net income of $3.6 million for the first nine months of 2009 compared to $2.7 million for the same period in 2008, an increase of 36.2% or $965 thousand. Basic earnings per share were $0.54 compared to $0.52 and diluted earnings per share were $0.53 compared to $0.51, respectively.

Two important and commonly used measures of profitability are return on assets (net income as a percentage of average total assets) and return on equity (net income as a percentage of average shareholders' equity). Our annualized return on assets was 0.74% compared to 0.53%, and 0.75% compared to 0.65%, for the three months and nine months periods ended September 30, 2009 and 2008, respectively. Our annualized return on equity for the third quarter of 2009 was 7.25% compared to 6.67% in 2008 and 7.84% for the first nine month of 2009 compared to 8.79% in 2008.

The improvements, quarter over quarter and year over year, in net income were due to growth in both net interest income and non-interest income. The impact of this growth was partially offset by slower growth in non-interest expense and a greater provision for loan losses expense.

Net interest income increased $1.2 million and non-interest income increased $3.9 million in the third quarter of 2009, compared to 2008. For the first nine months of 2009 compared to 2008, net interest income increased $3.5 million and non-interest income increased $11.9 million. Lower interest costs associated with our deposits is a primary contributor to the improvement in net interest income and increased production from our mortgage division is the source of the increase in non-interest income.

Non-interest expense increased $3.5 million for the quarter and $11.2 million for the first nine months of 2009 compare to the same periods in 2008. The areas of greatest non-interest expense growth were salaries and benefits, loan origination expense, and FDIC insurance expense. Our provision for loan losses increased $1.1 million for the quarter and $2.8 million for the nine month period ended September 30, 2009 compared to 2008. This growth was due to higher loss experience and an increase in watch-list loans.

Net Interest Income

Net interest income, a significant source of our revenue, is the excess of interest income over interest expense. Net interest income is influenced by a number of factors, including the volume of interest-earning assets and interest bearing liabilities, the mix of interest-earning assets and interest bearing liabilities, the interest rates earned on earning assets, and the interest rates paid to obtain funding to support the assets. For analytical purposes, net interest income is adjusted to a taxable equivalent basis to recognize the income tax savings on tax-exempt assets, such as bank owned life insurance ("BOLI") and state and municipal securities. A tax rate of 34% was used in adjusting interest on BOLI, tax-exempt securities and loans to a fully taxable equivalent basis. The difference between rates earned on interest-earning assets (with an adjustment made to tax-exempt income to provide comparability with taxable income, i.e. the "FTE" adjustment) and the cost of the supporting funds is measured by net interest margin.

Net interest income showed marked improvement in both the third quarter and the first nine months of 2009 due to repricing opportunities of both assets and liabilities in a low, but stable, rate environment. Interest rates have remained at a record low since December 2008, which has allowed us to realign our longer term liability costs with that of our assets. Historically, we are an asset sensitive company with the majority of our loan portfolio indexed to the Wall Street Journal Prime Rate and set to re-price quickly. Our net interest income is negatively impacted when rates decline because repricing of our liabilities lags behind that of our assets. Over the past year, we have renegotiated the majority of our commercial and mortgage loans to include rate "floors" which limits how low a rate can go, despite of how a loan is indexed. In addition, we have repriced deposits as they mature to lower market rates.

The federal funds rate that is set by the Federal Reserve Bank's Federal Open Market Committee was 0.25% in the third quarter of 2009 compared to 2.00% for the same period in 2008. For comparable periods, the Wall Street Journal Prime Rate ("WSJ"), which generally moves with the federal funds rate, was 3.25% compared to 5.00%. A stable, though lower, rate environment has allowed us to renegotiate the pricing of our interest bearing liabilities and assets to terms which should be more favorable to us in the future when rates begin to rise.

Net interest income was $5.5 million for the third quarter and $15.8 million for the first nine months of 2009. Prior year's net interest income was $4.4 million and $12.3 million, respectively, for the third quarter and first nine months of 2008. Despite a 300bp decline in our primary pricing index, interest income increased $194 thousand for the quarter and $611 thousand for the first nine months of 2009 compared to 2008. Growth in loan volume coupled with the addition of rate floors have kept interest income level with prior periods, while falling rates have resulted in lower interest expense for an overall improvement in net interest income.

Establishing rate floors, which are the contractually defined minimum rate that can be charged on variable rate loans, is one of the ways a traditionally asset sensitive lender can neutralize that sensitivity and buffer the impact of falling rates. Interest and fees on loans are the largest component of our interest income. At September 30, 2009, $214.4 million, or 89% of our commercial and real estate loans had average floors of 5.68% compared to 37%, or $104.7 million, at an average rate of 5.21% at September 30, 2008. The addition of floors coupled with loan growth have kept interest earnings level in spite of steep rate declines in an $86 million segment of our consumer loan portfolio, home equity loans, that cannot have floors and carry rates on or near WSJ prime.

Concurrent with the addition of loan floors, we have replaced the majority of our longer term, higher cost, liabilities with lower cost liabilities. At September 2009, the blended cost on our time deposits had declined 108 basis points when compared to the first nine months of 2008. Total interest expense declined $983 thousand in the third quarter of 2009 and $2.9 million in the first nine months when compared to 2008.

Our net interest rate spread on a tax-equivalent basis increased 45 basis points to 3.12% for first nine months of 2009 when compared to 2.67% for the same period in 2008. Yield on earning assets decreased 75 basis points to 5.31% in 2009 compared to 6.06% for the first nine months of 2008, while the cost of interest bearing liabilities decreased 120 basis points to 2.19% from 3.39%, respectively, for the same period.

Bank Owned Life Insurance (BOLI) has been included in interest earning assets. We purchased $6,000,000 in BOLI during the fourth quarter of 2005. The income on BOLI is not subject to Federal Income tax, giving it a tax-effective yield of 5.68% for the first nine months of 2009 compared to 5.51% for the same period in 2008.

In July, 2006, we added additional capital through the issuance of $10,000,000 in trust preferred securities. These securities are treated as subordinated debt and have been included in other borrowings. The cost on trust preferred securities decreased to an average of 2.95% from 5.36% in the first half of 2009 compared to 2008.

The following table sets forth average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders' equity and the related income, expense and corresponding weighted average yields and costs.

                          NET INTEREST INCOME ANALYSIS

The following is an analysis of net interest income, on a taxable equivalent
basis.



                                                                   For Periods Ended September 30,
                                                         2009                                           2008
                                          Average           Income/       Yield          Average           Income/       Yield
                                          Balance           Expense      Rate(1)       Balance (5)       Expense (5)    Rate(1)
ASSETS
Securities, at amortized cost          $   6,260,901      $    181,539      3.88 %    $  12,290,979      $    367,649      4.00 %
Loans, net                               585,918,470        23,772,474      5.42 %      494,676,533        22,822,737      6.16 %
Federal funds sold                         5,340,746             9,987      0.25 %        1,051,275            17,444      2.22 %
Dividend-earning restricted equity
securities                                 6,112,856            80,553      1.76 %        4,332,645           162,206      5.00 %
Deposits in other banks                    2,470,322             1,902      0.10 %        3,798,859            65,040      2.29 %
Bank owned life insurance (2)              6,879,653           292,230      5.68 %        6,630,381           273,274      5.51 %

Total earning assets                     612,982,948        24,338,685      5.31 %      522,780,672        23,708,350      6.06 %

Less: Allowance for loan losses           (8,560,372 )                                   (4,378,100 )
Nonaccrual loans                           6,767,652                                        600,506
Total nonearning assets                   28,960,333                                     28,475,918

Total assets                           $ 640,150,561                                  $ 547,478,996

LIABILITIES and STOCKHOLDERS' EQUITY
Interest-bearing deposits:
Checking                               $  16,395,957      $     50,504      0.41 %    $  16,710,550      $    121,729      0.97 %
Regular savings                           29,889,357           291,155      1.30 %        6,228,006            29,540      0.63 %
Money market savings                     117,604,995         1,119,478      1.27 %      128,880,070         2,708,259      2.81 %
Certificates of deposit
$100,000 and over                         95,324,826         1,455,647      2.04 %      126,529,066         3,008,377      3.18 %
Under $100,000                           175,835,490         4,232,934      3.22 %      101,206,992         3,603,853      4.76 %

Total interest-bearing deposits          435,050,625         7,149,718      2.20 %      379,554,684         9,471,758      3.33 %
Borrowings                                66,245,972         1,070,214      2.16 %       59,109,988         1,657,240      3.75 %

Total interest-bearing liabilities       501,296,597      $  8,219,932      2.19 %      438,664,672      $ 11,128,998      3.39 %
Noninterest-bearing liabilities
Demand deposits                           71,839,085                                     62,816,450
Other noninterest-bearing
liabilities                                5,047,719                                      5,481,517

Total liabilities                        578,183,401                                    506,962,639
Stockholders' equity                      61,967,160                                     40,516,357

Total liabilities and stockholders'
equity                                 $ 640,150,561                                  $ 547,478,996

Net interest income (2)                                   $ 16,118,753                                   $ 12,579,352

Interest rate spread (2)(3)                                                 3.12 %                                         2.67 %

Net interest margin (2)(4)                                                  3.52 %                                         3.21 %

(1) Yields are annualized and based on average daily balances.

(2) Income and yields are reported on a taxable equivalent basis assuming a federal tax rate of 34%, with a $99,358 adjustment for 2009 and a $92,913 adjustment for 2008.

(3) Represents the differences between the yield on total average earning assets and the cost of total interest-bearing liabilities.

(4) Represents the ratio of net interest-earnings to the average balance of interest-earning assets.

(5) Loans held for sale of $26,815,990 and interim interest income of $1,211,085 have been reclassified from mortgage banking income to interest income and fees on loans for September 30, 2008 to be consistent with the presentation for September 30, 2009.

Rate/Volume Analysis

The goal of a rate/volume analysis is to compare two or more periods to determine whether the difference between those periods is the result of changes in rate, or volume, or some combination of the two. This is achieved through a "what if" analysis. We calculate what the potential income would have been in the new period if the prior period rate would have remained unchanged, and compare that result to what the potential income would have been in the prior period if the current rates were in effect. Through the analysis of these income potentials, we are able to determine how much of the change between periods is the impact of differing rates and how much is volume driven.

For discussion purposes, our "Rate/Volume Analysis" and "Average Balances, Income and Expenses, Yields and Rates" tables include tax equivalent income on bank owned life insurance (BOLI) that is not in compliance with Generally Accepted Accounting Principals (GAAP). The following table is a reconciliation of our income statement presentation to these tables.

  RECONCILIATION OF NET INTEREST INCOME TO TAX EQUIVALENT NET INTEREST INCOME



Non-GAAP                                      3 Months Ended September 30,        9 Months Ended September 30,
                                                2009               2008               2009              2008
Interest income:
Total interest income                      $     8,062,871    $     7,869,158   $     24,046,455    $ 23,435,076
Bank owned life insurance                           65,615             61,120            192,872         180,361
Tax equivalent adjustment (34% tax rate)            33,802             31,486             99,358          92,913

Adjusted income on earning assets                8,162,288          7,961,764         24,338,685      23,708,350

Interest expense:
Total interest expense                           2,526,792          3,509,976          8,219,932      11,128,998

Net interest income - adjusted             $     5,635,496    $     4,451,788   $     16,118,753    $ 12,579,352

Adjusted income on earning assets increased $630 thousand in first nine months of 2009 compared to 2008 because our growth earning assets offset reduced yields. Income from loans, which is the largest component of earning assets, increased $949 thousand, in spite of an earnings potential from growth of $3.5 million. During the same period, interest income from securities declined $186 thousand; $168 thousand due to a smaller portfolio and $18 thousand due to lower rates. Interest on federal funds sold declined $8 thousand and BOLI increased $19 thousand in the first nine months of 2009 compared to 2008.

Loans, net of unearned income and loans held for sale grew a combined $56.2 million, to $593.6 million at September 30, 2009 compared to $537.4 million at September 30, 2008. Had interest rates in 2009 remained level with 2008 at this increase in volume, the year over year earnings potential from loans was $3.5 million. Consumer loans, which include home equity products and loans held for sale, had a growth related earnings potential of $2.6 million, or 74.3% of the total category, but only yielded $1.1 million due to the negative impact of much lower rates. Commercial loans had an earnings potential of $645 thousand and mortgage loans, $259 thousand. However, lower yields reduced this potential by $711 and $376 thousand for net losses of $66 thousand in commercial loans and $117 thousand in mortgage loans.

In the third quarter of 2009, adjusted income on earning assets increased $201 thousand when compared to 2008 on a growth related earnings potential of $707 thousand that was reduced due to lower interest rates by $507 thousand. The third quarter 2009 overall earnings potential on loans compared to actual income earned are similar to the nine months' analysis. In spite of quarterly growth in loans, lower yields have reduced earnings potential. However, in the third quarter lower rates on our consumer loans have absorbed $420 thousand of the $470 thousand in earnings adjustment due to rate. Commercial and mortgage earnings have been impacted less by rate in the quarter due to the floors place on a large portion of these loans.

Investment income declined in both the third quarter and first nine months of 2009 compared to 2008. In the third quarter of 2009 investment income declined $87 thousand and for the first nine months of 2009 investment income has decreased $185 thousand due to both volume and rate reductions. A significant portion of our Federal Agency securities have been called in the past year as market rates fell below the rate on these investments. Securities purchased to replace those called have a much lower yield than the original bonds.

Interest on federal funds sold and other bank accounts as well as income on restricted securities decreased a combined total of $9 thousand in the third quarter and $153 thousand for the first nine months of 2009 compared to 2008. Income on restricted equity securities has declined, despite higher average balances, because the Federal Home Loan Bank modified their stock release policy. In addition, they paid zero dividends until August of this year, at which time they declared a much smaller dividend.

Year to date Interest expense through September 30, 2009 has decreased $2.9 million compared to 2008. Interest on deposits has been the primary source, contributing $2.3 million, other borrowings and federal funds purchased added expense savings of $574 and $13 thousand, respectively. Third quarter 2009 interest declined $983 thousand compared to prior year. Deposit interest expense decreased $777 thousand, while other borrowings and federal funds dropped $203 thousand and three thousand, respectively.

On average, interest bearing deposits increased $55.5 million to $435.1 million through September 30, 2009 compared to $379.6 million through September 30, 2008 while the average cost of those deposits has dropped from 3.33% to 2.20%. Comparing quarter end balances, interest bearing deposits were $455.7 million at September 30, 2009, an increase of $30.4 million over $425.3 million at September 30, 2008. Based on period end, our deposit composition has changed along with rates, which should contribute further to cost savings in the future.

Money market accounts contributed $1.6 million to our interest savings during the first nine months of 2009 compared to 2008. The blended average rate on these deposits has decreased from 2.81% to 1.27%. Based on the Rate/Volume table below, $1.4 million of interest savings is due to rate and $219 thousand is attributable to volume, which is inconsistent with the period end growth noted. For clarification purposes, both the Net Interest Income and the Rate/Volume tables utilize average balances for calculation purposes because an average takes into account both the level and duration of a balance, creating a more accurate picture in most cases. The results then would indicate that money market accounts, on average, had declined over time. Although this has been the case, in mid-September 2009 we opened a $30.0 million brokered money market account which carries a very low interest rate. Given its relative size, this account should provide interest savings benefits going forward.

Interest cost on time deposits ("CDs") declined $923 thousand in the first nine months of 2009 compared to 2008. Interest cost savings of $2.0 million associated with rate were partially offset by $1.1 million in additional interest costs associated with growth. The composition of our CD portfolio has shifted over time to lower cost CDs. On average, Jumbo CDs, time deposits in excess of $100 thousand, represented 55.6% or our total CDs in September 2008 compared to 35.2% in September 2009. Management has focused, through two retail CD campaigns, on our local market. The first of these campaigns was offered in the fall of 2008, with the majority of those CDs maturing from August to October of 2009, when we ran a second campaign. The short duration of the CDs offered has allowed us to manage the decline in rates over time more efficiently.

Interest cost in the third quarter of 2009 has followed the trends of the first nine months, when compared to the same period in 2008. Time deposit cost has declined $427 thousand through rate savings of $774 thousand partially offset by growth cost of $347 thousand. Money market savings of $390 thousand has been achieved through $353 thousand in rate savings and $37 thousand in lower, on average, outstanding balances.

Savings interest cost for the third quarter and first nine months of 2009 increased $60 thousand and $261 thousand, respectively. We introduced a new higher cost savings product in 2008 that has produced average year over year growth of $23.7 million.

Our borrowing costs declined $574 thousand in the first nine months of 2009 due to lower rates, partially offset by higher balances. Quarter over quarter, borrowing costs have declined $203 thousand, $157 thousand of which is attributable to lower rates and $46 thousand attributable to lower borrowings in the quarter.

The following table sets forth an analysis of the impact of changes in rate and volume on our interest bearing assets and liabilities for the third quarter and first nine months of 2009 compared to 2008.

Changes in Net Interest Income (Rate/Volume Analysis)

Net interest income is the product of the volume of average earning assets and the average rates earned, less the volume of average interest-bearing liabilities and the average rates paid. The portion of change relating to both rate and volume is allocated to each of the rate and volume changes based on the relative change in each category. The following table analyzes the changes in both rate and volume components of net interest income on a tax equivalent basis.

                             RATE / VOLUME ANALYSIS

                                 (in thousands)



                                                For the Three Months Ended September 30,                 For the Nine Months Ended September 30,
                                                              2009 vs 2008                                             2009 vs 2008

                                            Interest                       Change                      Interest                     Change
                                            Increase                   Attributable to                 Increase                Attributable to
                                           (Decrease)               Rate               Volume         (Decrease)             Rate             Volume
Interest income
Loans:
Commercial                                $         93         $          (38 )       $    131       $        (66 )      $       (711 )      $    645
Mortgage                                            75                    (12 )             87               (117 )              (376 )           259
Consumer                                           122                   (420 )            542              1,132              (1,424 )         2,556

Total loans                                        290                   (470 )            760                949              (2,511 )         3,460

Securities:
Federal agencies                                   (73 )                   (3 )            (70 )             (182 )               (47 )          (135 )
Mortgage-backed                                     (3 )                   (1 )             (2 )               11                  14              (3 )
Other securities                                   (11 )                    1              (12 )              (14 )                15             (29 )

Total securities                                   (87 )                   (3 )            (84 )             (185 )               (18 )          (167 )
. . .