UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

	☑		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2013

	☐		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 000-25141

MetroCorp Bancshares, Inc.

(Exact name of registrant as specified in its charter)

Texas

(State or other jurisdiction of

incorporation or organization)

76-0579161

(I.R.S. Employer

Identification No.)

9600 Bellaire Boulevard, Suite 252

Houston, Texas 77036

(Address of principal executive offices including zip code)

(713) 776-3876

(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 ☑ No ☐

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 ☑ No ☐

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 definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ☐	Accelerated Filer ☑

Non-accelerated Filer ☐ (Do not check if a smaller reporting company)	Smaller Reporting Company ☐

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

As of November 1, 2013, the number of outstanding shares of Common Stock was 18,699,121

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

METROCORP BANCSHARES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

(Unaudited)

	September 30, 2013			December 31, 2012
ASSETS
Cash and due from banks	$	29,963		$	31,203
Federal funds sold and other short-term investments		137,527			128,246
Total cash and cash equivalents		167,490			159,449
Interest-bearing time deposits in banks		15,616			15,321

Securities available-for-sale, at fair value		145,344			119,422
Securities available-for-sale pledged with creditors’ right to repledge, at fair value		38,313			44,626
Total securities available-for-sale		183,657			164,048
Securities held-to-maturity (fair value $8,108 and $4,757 at September 30, 2013 and December 31, 2012, respectively)		7,788			4,046
Other investments		5,702			5,592
Loans, net of allowance for loan losses of $20,800 and $24,592 at September 30, 2013 and December 31, 2012, respectively		1,163,864			1,075,745


Loans held-for-sale		160			—
Accrued interest receivable		3,753			4,120
Premises and equipment, net		3,788			4,046
Goodwill		14,327			14,327
Deferred tax asset, net		15,327			13,110
Customers' liability on acceptances		5,828			7,045
Foreclosed assets, net		9,373			12,555
Cash value of bank owned life insurance		33,721			32,794
Prepaid FDIC assessment		—			3,439
Other assets		4,055			4,175
Total assets	$	1,634,449		$	1,519,812

LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing	$	330,067		$	309,696
Interest-bearing		1,022,401			957,334
Total deposits		1,352,468			1,267,030
Junior subordinated debentures		36,083			36,083
Other borrowings		46,000			25,000
Accrued interest payable		280			233
Acceptances outstanding		5,828			7,045
Other liabilities		13,672			7,390
Total liabilities		1,454,331			1,342,781
Commitments and contingencies		—			—

Shareholders' equity:
Common stock, $1.00 par value, 50,000,000 shares authorized; 18,776,765 and 18,766,765 shares issued and 18,699,638 and 18,746,385 shares outstanding at September 30, 2013 and December 31, 2012, respectively		18,777			18,767
Additional paid-in-capital		75,164			74,998
Retained earnings		91,403			82,881
Accumulated other comprehensive (loss) income		(4,466	)		567
Treasury stock, at cost, 77,127 and 20,380 shares at September 30, 2013 and December 31, 2012, respectively		(760	)		(182	)
Total shareholders' equity		180,118			177,031
Total liabilities and shareholders' equity	$	1,634,449		$	1,519,812

See accompanying notes to condensed consolidated financial statements.

METROCORP BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

(Unaudited)

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2013			2012			2013			2012
Interest income:
Loans	$	14,695		$	14,593		$	42,530		$	44,346
Securities:
Taxable		892			1,020			2,530			3,051
Tax-exempt		186			145			499			407
Other investments		70			42			184			129
Federal funds sold and other short-term investments (1)		218			229			610			675
Total interest income		16,061			16,029			46,353			48,608

Interest expense:
Time deposits		1,361			1,288			3,896			4,194
Demand and savings deposits		376			508			1,192			1,729
Junior subordinated debentures		328			338			973			1,007
Other borrowings		305			247			798			741
Total interest expense		2,370			2,381			6,859			7,671

Net interest income		13,691			13,648			39,494			40,937
(Reduction in) provision for loan losses		(655	)		(300	)		(1,130	)		300
Net interest income after provision for loan losses		14,346			13,948			40,624			40,637

Noninterest income:
Service fees		1,002			1,099			2,913			3,347
Loan-related fees		125			139			424			326
Letters of credit commissions and fees		166			197			540			584
(Loss) gain on securities, net		(4	)		24			33			108
Total other-than-temporary impairments (“OTTI”) on securities		(36	)		(14	)		(129	)		(101	)
Less: Noncredit portion of OTTI		(27	)		(7	)		(54	)		(17	)

Net impairment on securities		(9	)		(7	)		(75	)		(84	)
Gain on sale of loans		487		–				558		–
Other noninterest income		322			420			1,290			1,154
Total noninterest income		2,089			1,872			5,683			5,435

Noninterest expense:
Salaries and employee benefits		6,017			6,016			18,242			17,934
Occupancy and equipment		1,649			1,792			4,977			5,224
Foreclosed assets, net		309			552			(450	)		1,915
FDIC assessment		486			480			1,463			1,362
Other noninterest expense		3,017			2,689			8,256			7,339
Total noninterest expense		11,478			11,529			32,488			33,774

Income before provision for income taxes		4,957			4,291			13,819			12,298
Provision for income taxes		1,509			1,410			4,548			4,023
Net income	$	3,448		$	2,881		$	9,271		$	8,275

Dividends and discount – preferred stock	–				(20	)	–				(1,429	)
One-time adjustment from repurchase of preferred stock	–				(149	)	–				557
Net income available to common shareholders	$	3,448		$	2,712		$	9,271		$	7,403

Earnings per common share:
Basic	$	0.19		$	0.15		$	0.50		$	0.47
Diluted	$	0.18		$	0.15		$	0.49		$	0.47
Weighted average shares outstanding:
Basic		18,417			18,307			18,372			15,666
Diluted		18,814			18,648			18,757			15,876

Dividends per common share	$	0.02		$	–		$	0.04		$	–

(1)

Includes interest-bearing time deposits in banks

See accompanying notes to condensed consolidated financial statements.

METROCORP BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2013			2012			2013			2012

Net income	$	3,448		$	2,881		$	9,271		$	8,275

Other comprehensive income, net of taxes:

Change in accumulated gain (loss) on effective cash flow hedging derivatives		56			8			287			42

Unrealized loss on investment securities, net:
Securities with OTTI charges during the period		(23	)		(9	)		(82	)		(65	)
Less: OTTI charges recognized in net income		(7	)		(4	)		(48	)		(54	)
Net unrealized losses on investment securities with OTTI		(16	)		(5	)		(34	)		(11	)

Unrealized holding (loss) gain on investment securities arising during the period		(594	)		623			(5,265	)		1,126
Less: reclassification adjustment for (loss) gain included in net income		(3	)		15			21			69
Net unrealized (losses) gains on investment securities		(591	)		608			(5,286	)		1,057
Other comprehensive (loss) income, net of taxes		(551	)		611			(5,033	)		1,088
Total comprehensive income	$	2,897		$	3,492		$	4,238		$	9,363

See accompanying notes to condensed consolidated financial statements.

METROCORP BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2013

(In thousands)

(Unaudited)

	Common Stock				Additional paid-in		Retained			Accumulated other comprehensive income			Treasury Stock at
	Shares		At par		capital		earnings			(loss)			cost			Total
Balance at December 31, 2012		18,767	$	18,767	$	74,998	$	82,881		$	567		$	(182	)	$	177,031
Issuance of common stock		10		10		94	–			–			–				104
Repurchase of common stock	–		–		–		–			–				(578	)		(578	)
Stock-based compensation expense related to stock options recognized in earnings	–		–			72	–			–			–				72
Net income	–		–		–			9,271		–			–				9,271
Other comprehensive loss	–		–		–		–				(5,033	)	–				(5,033	)
Dividends – common stock ($0.04 per share)		–		–		–		(749	)		–			–			(749	)
Balance at September 30, 2013		18,777	$	18,777	$	75,164	$	91,403		$	(4,466	)	$	(760	)	$	180,118

See accompanying notes to condensed consolidated financial statements.

METROCORP BANCSHARES, INC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	For the Nine Months Ended September 30,
	2013			2012
Cash flows from operating activities:
Net income	$	9,271		$	8,275
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		687			792
(Reduction in) provision for loan losses		(1,130	)		300
Impairment on securities		75			84
Gain on securities transactions, net		(33	)		(108	)
(Gain) loss on writedown and sale of foreclosed assets		(912	)		944
Loss on sale of premises and equipment		6			—
Gain on sale of loans		(558	)		—
Amortization of premiums and discounts on securities, net		535			330
Amortization of deferred loan fees and discounts		(889	)		(858	)
Amortization of core deposit intangibles		28			42
Stock-based compensation		72			60
Changes in:
Accrued interest receivable		367			389
Other assets		3,499			(1,781	)
Accrued interest payable		47			(52	)
Other liabilities		6,194			8,214
Net cash provided by operating activities		17,259			16,631

Cash flows from investing activities:
Net change in interest-bearing deposits in banks		(295	)		—
Purchases of securities available-for-sale		(53,026	)		(105,708	)
Purchases of securities held-to-maturity		(3,746	)		—
Purchases of other investments		(649	)		(2	)
Proceeds from maturities, calls, and principal paydowns of securities available-for-sale		24,695			101,146
Proceeds from sales and maturities of other investments		360			711
Net change in loans		(92,640	)		(60,259	)
Proceeds from sale of foreclosed assets		11,032			15,958
Purchases of premises and equipment		(435	)		(290	)
Net cash used in investing activities		(114,704	)		(48,444	)

Cash flows from financing activities:
Net change in:
Deposits		85,438			13,482
Other borrowings		21,000			(315	)
Proceeds from issuance of common stock		—			45,969
Repurchase of common stock		(578	)		(145	)
Repurchase of preferred stock		—			(44,443	)
Cash dividends paid on preferred stock		—			(1,433	)
Cash dividends paid on common stock		(374	)		—
Net cash provided by financing activities		105,486			13,115

Net increase (decrease) in cash and cash equivalents		8,041			(18,698	)
Cash and cash equivalents at beginning of period		159,449			193,609
Cash and cash equivalents at end of period	$	167,490		$	174,911


Supplemental information:
Interest paid	$	6,812		$	7,723
Income taxes paid		2,450			3,482
Noncash investing and financing activities:
Issuance of common stock – restricted shares		104			3,024
Foreclosed assets acquired		6,938			5,799
Loans originated to finance foreclosed assets		6,120			6,501

See accompanying notes to condensed consolidated financial statements.

METROCORP BANCSHARES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements include the accounts of MetroCorp Bancshares, Inc. (the “Company”) and wholly-owned subsidiaries, MetroBank, National Association (“MetroBank”) and Metro United Bank (“Metro United”), in Texas and California, respectively (collectively, the “Banks”). MetroBank is engaged in commercial banking activities through its thirteen branches in the greater Houston and Dallas, Texas metropolitan areas, and Metro United is engaged in commercial banking activities through its six branches in the San Diego, Los Angeles and San Francisco, California metropolitan areas. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain principles which significantly affect the determination of financial position, results of operations and cash flows are summarized below.

A legal entity is referred to as a Variable Interest Entity (“VIE”) if any of the following conditions exist: (1) the total equity at risk is insufficient to permit the legal entity to finance its activities without additional subordinated financial support from other parties, or (2) the entity has equity investors that cannot make significant decisions about the entity’s operations or that do not absorb their proportionate share of the expected losses or receive the expected returns of the entity. In addition, as specified in VIE accounting guidance, a VIE must be consolidated by the Company if it is deemed to be the primary beneficiary of the VIE. The primary beneficiary is the party that has both (1) the power to direct the activities of an entity that most significantly impact the VIE’s economic performance, and (2) through its interests in the VIE, the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. All facts and circumstances are taken into consideration when determining whether the Company has variable interest that would deem it the primary beneficiary and, therefore, require consolidation of the related VIE or otherwise rise to the level where disclosure would provide useful information to the users of the Company’s financial statements. In the case of the Company’s sole VIE, MCBI Statutory Trust I, it is qualitatively clear based on the extent of the Company’s involvement that the Company is not the primary beneficiary of the VIE. Accordingly, the accounts of this entity are not consolidated in the Company’s financial statements.

The accompanying unaudited condensed consolidated financial statements were prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal and recurring adjustments, necessary for a fair statement of the Company’s financial position at September 30, 2013, results of operations for the three and nine months ended September 30, 2013 and 2012, and cash flows for the nine months ended September 30, 2013 and 2012. Interim period results are not necessarily indicative of results for a full year period. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. generally accepted accounting principles.

Certain items in prior financial statements have been reclassified to conform to the 2013 presentation, with no impact on the balance sheet, net income, shareholders’ equity or cash flows.

These unaudited financial statements and the notes thereto should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

2. SECURITIES

The amortized cost and approximate fair value of securities is as follows:

	As of September 30, 2013
	Amortized		Unrealized								Fair
	Cost		Gains		Losses			OTTI			Value
	(Dollars in thousands)
Securities available-for-sale
Debt securities
U.S. Treasury and other U.S. government sponsored enterprises and agencies	$	86,395	$	-	$	(4,649	)	$	-		$	81,746
Obligations of state and political subdivisions		17,899		156		(912	)		-			17,143
Corporate		6,063		216		-			-			6,279
Mortgage-backed securities and collateralized mortgage obligations
Government issued or guaranteed		63,874		782		(929	)		-			63,727
Privately issued residential		588		379		-			(299	)		668
Asset backed securities		152		143		-			(152	)		143
Equity Securities
Community Reinvestment Act (“CRA”) funds		14,352		-		(401	)		-			13,951
Total available-for-sale securities	$	189,323	$	1,676	$	(6,891	)	$	(451	)	$	183,657

Securities held-to-maturity
Obligations of state and political subdivisions	$	7,788	$	372	$	(52	)	$	-		$	8,108
Total held-to-maturity securities	$	7,788	$	372	$	(52	)	$	-		$	8,108

Other investments
Federal Home Loan Bank (“FHLB”)(1)/Federal Reserve Bank stock (2)	$	4,619	$	-	$	-		$	-		$	4,619
Investment in subsidiary trust (3)		1,083		-		-			-			1,083
Total other investments	$	5,702	$	-	$	-		$	-		$	5,702

	As of December 31, 2012
	Amortized		Unrealized								Fair
	Cost		Gains		Losses			OTTI			Value
Securities available-for-sale
Debt securities
U.S. Treasury and other U.S. government sponsored enterprises and agencies	$	70,892	$	362	$	(73	)	$	—		$	71,181
Obligations of state and political subdivisions		12,810		579		—			—			13,389
Corporate		6,080		270		—			—			6,350
Mortgage-backed securities and collateralized mortgage obligations:
Government issued or guaranteed		56,572		1,369		—			—			57,941
Privately issued residential		718		330		—			(365	)		683
Asset backed securities		187		129		—			(173	)		143
Equity securities
Investment in CRA funds		14,128		233		—			—			14,361

Total available-for-sale securities	$	161,387	$	3,272	$	(73	)	$	(538	)	$	164,048

Securities held-to-maturity
Obligations of state and political subdivisions	$	4,046	$	711	$	—		$	—		$	4,757

Total held-to-maturity securities	$	4,046	$	711	$	—		$	—		$	4,757

Other investments
FHLB (1)/Federal Reserve Bank (2) stock		4,509		—		—			—			4,509
Investment in subsidiary trust (3)		1,083		—		—			—			1,083

Total other investments	$	5,592	$	—	$	—		$	—		$	5,592

(1)	FHLB stock held by the Banks is subject to certain restrictions under the membership requirements of the FHLB. Redemption of FHLB stock is dependent upon repayment of borrowings, if any, from the FHLB.
(2)	Federal Reserve Bank stock held by MetroBank is subject to certain restrictions under Federal Reserve Bank Policy.
(3)	The Company’s ownership of common securities of MCBI Trust I is carried at cost.

The following table displays the fair value and gross unrealized losses on securities available-for-sale as of September 30, 2013 and December 31, 2012 for which other-than-temporary impairments (“OTTI”) has not been recognized, that were in a continuous unrealized loss position for the periods indicated. There were no securities held-to-maturity in a continuous unrealized loss position as of December 31, 2012.

	As of September 30, 2013
	Less Than 12 Months					Greater Than 12 Months				Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)
Securities available-for-sale
U.S. Treasury and other U.S. government sponsored enterprises and agencies	$	81,747	$	(4,649	)	$	—	$	—	$	81,747	$	(4,649	)
Obligations of state and political subdivisions		14,161		(912	)		—		—		14,161		(912	)
Mortgage-backed securities and collateralized mortgage obligations
Government issued or guaranteed		35,108		(929	)		—		—		35,108		(929	)
Privately issued residential		17		—			—		—		17		—
CRA funds		13,951		(401	)						13,951		(401	)
Total available-for-sale securities	$	144,984	$	(6,891	)	$	—	$	—	$	144,984	$	(6,891	)


Securities held-to-maturity
Obligations of state and political subdivisions	$	2,158	$	(52	)	$	—	$	—	$	2,158	$	(52	)
Total held-to-maturity securities	$	2,158	$	(52	)	$	—	$	—	$	2,158	$	(52	)

	As of December 31, 2012
	Less Than 12 Months					Greater Than 12 Months				Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)
Securities available-for-sale
U.S. Treasury and other U.S. government sponsored enterprises and agencies	$	9,921	$	(73	)	$	—	$	—	$	9,921	$	(73	)
Mortgage-backed securities and collateralized mortgage obligations
Privately issued residential		—		—			72		—		72		—
Total securities	$	9,921	$	(73	)	$	72	$	—	$	9,993	$	(73	)

As of September 30, 2013, management did not have the intent to sell any of the securities classified as available-for-sale in unrealized loss positions and believes it is not more likely than not that the Company will have to sell any such securities before a recovery of the cost. However, if strategic opportunities arise, the Company may consider selling selected securities. Any unrealized losses on such selected securities would be charged to earnings.

The unrealized losses are largely due to increases in the market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such securities decline. Management does not believe any of the unrealized losses above are due to credit quality. Accordingly, management believes the $6.9 million of unrealized losses of available-for-sale securities and the $52,000 of unrealized losses of held-to-maturity securities as of September 30, 2013 is temporary and the remaining $451,000 of OTTI as of September 30, 2013 represents unrealized losses for which an impairment has been recognized in other comprehensive loss.

Other-Than-Temporary Impairments (OTTI)

The following table presents a rollforward for the three and nine months ended September 30, 2013, of the credit loss component of OTTI losses that have been recognized in earnings related to debt securities that the Company does not intend to sell.

	Impairment related to credit losses
	Three months ended September 30, 2013		Nine months ended September 30, 2013
	(In thousands)
Credit losses at beginning of period	$	1,748	$	1,716
Additions to OTTI that were not previously recognized		3		3
Additions to OTTI that was previously recognized when there is no intent to sell and no requirement to sell before recovery of the amortized cost basis		4		4
Transfers from accumulated other comprehensive income (loss) to OTTI related to credit losses		3		35
Credit losses at end of period	$	1,758	$	1,758

For the nine months ended September 30, 2013, credit-related losses of $30,000 on five non-agency residential mortgage-backed securities and $11,000 on one asset-backed security were recognized. There were no credit-related impairments included in accumulated other comprehensive income (loss) for the three or nine months ended September 30, 2013.

To measure credit losses, external credit ratings and other relevant collateral details and performance statistics on a security-by-security basis were considered. Securities exhibiting significant deterioration are subjected to further analysis. Assumptions were developed for prepayment speed, default rate, and loss severity for each security using third party sources and based on the collateral history. The resulting projections of future cash flows of the underlying collateral were then discounted by the underlying yield before any write-downs were considered to determine the net present value of the cash flows (“NPV”). The difference between the cost basis and the NPV was taken as a credit loss in the current period to the extent that these losses have not been previously recognized. The difference between the NPV and the quoted market price is considered a noncredit related loss and was included in other comprehensive income (loss).

Other Securities Information

There were no sales of available-for-sale securities or sales or transfers of held-to-maturity securities for the nine months ended September 30, 2013 or 2012.

At September 30, 2013, future contractual maturities of debt securities were as follows (in thousands):

	Securities Available-for-sale				Securities Held-to-maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Within one year	$	—	$	—	$	—	$	—
Within two to five years		20,053		20,088		—		—
Within six to ten years		73,188		68,785		—		—
After ten years		17,268		16,438		7,788		8,108
Mortgage-backed securities and collateralized mortgage obligations		64,462		64,395		—		—
Total debt securities	$	174,971	$	169,706	$	7,788	$	8,108

The Company holds mortgage-backed securities which may mature at an earlier date than the contractual maturity due to prepayments. The Company also holds certain securities which may be called by the issuer at an earlier date than the contractual maturity date.

3. LOANS

The loan portfolio is classified by major type as follows:

	As of September 30, 2013						As of December 31, 2012
	Amount			Percent			Amount			Percent
	(Dollars in thousands)

Commercial and industrial	$	439,420			37.00	%	$	383,641			34.78	%
Real estate mortgage
Residential		39,998			3.37			36,807			3.34
Commercial		694,980			58.52			665,244			60.32
		734,978			61.89			702,051			63.66
Real estate construction
Residential		4,936			0.42			2,420			0.22
Commercial		3,747			0.31			7,284			0.66
		8,683			0.73			9,704			0.88
Consumer and other		4,483			0.38			7,531			0.68
Gross loans		1,187,564			100.00	%		1,102,927			100.00	%
Unearned discounts, interest and deferred fees		(2,740	)					(2,590	)
Total loans		1,184,824						1,100,337
Allowance for loan losses		(20,800	)					(24,592	)
Loans, net (1)	$	1,164,024					$	1,075,745

(1)

Includes loans held-for-sale.

The recorded investment in loans is the face amount increased or decreased by applicable accrued interest and unamortized premium, discount, or finance charges, and may also reflect a previous direct write-down of the loan.

The recorded investment in loans at the dates indicated is determined as follows (in thousands):

September 30, 2013	Gross Loan Balance		Deferred Loan Fees			Accrued Interest Receivable		Recorded Investment in Loans

Commercial and industrial	$	439,420	$	(956	)	$	1,137	$	439,601
Real estate mortgage		734,978		(1,549	)		1,851		735,280
Real estate construction		8,683		(101	)		25		8,607
Consumer and other		4,483		(134	)		13		4,362

Total	$	1,187,564	$	(2,740	)	$	3,026	$	1,187,850

December 31, 2012	Gross Loan Balance		Deferred Loan Fees			Accrued Interest Receivable		Recorded Investment in Loans

Commercial and industrial	$	383,641	$	(814	)	$	1,078	$	383,905
Real estate mortgage		702,051		(1,595	)		2,024		702,480
Real estate construction		9,704		(30	)		18		9,692
Consumer and other		7,531		(151	)		21		7,401

Total	$	1,102,927	$	(2,590	)	$	3,141	$	1,103,478

Loan Origination/Risk Management

The Company selectively extends credit for the purpose of establishing long-term relationships with its customers. The Company mitigates the risks inherent in lending by focusing on businesses and individuals with demonstrated payment history, historically favorable profitability trends and stable cash flows. In addition to these primary sources of repayment, the Company looks to tangible collateral and personal guarantees as secondary sources of repayment. Lending officers are provided with detailed underwriting policies covering all lending activities in which the Company is engaged and that require all lenders to obtain appropriate approvals for the extension of credit. The Company also maintains documentation requirements and extensive credit quality assurance practices in order to identify credit portfolio weaknesses as early as possible so any exposures that are discovered may be reduced.

The Company has certain lending procedures in place that are designed to maximize loan income within an acceptable level of risk. These procedures include the approval of lending policies and underwriting guidelines by the Board of Directors of each Bank, and separate policy, administrative and approval oversight by the Directors’ Loan Committee of MetroBank, and by the Directors’ Credit Committee of Metro United. Additionally, MetroBank’s loan portfolio is reviewed by its internal loan review department, and Metro United's loan portfolio is reviewed by an external third-party company. These procedures also serve to timely identify changes in asset quality and to ensure proper recording and reporting of nonperforming assets.

Inherent in all lending is the risk of nonpayment. The types of collateral required, the terms of the loans and the underwriting practices discussed under each loan category below are all designed to minimize the risk of nonpayment. In addition, as further risk protection, the Banks rarely make loans at their respective legal lending limit. MetroBank generally does not make loans larger than $13 million to one borrower and Metro United generally does not make loans larger than $8 million to one borrower. Loans greater than the Banks’ lending limits are subject to participation with other financial institutions, including with each other. Loans originated by MetroBank are approved by the Chief Lending Officer, Chief Credit Officer, the Loan Committee or the Director’s Loan Committee based on the size of the loan relationship and its risk rating. Loans originated by Metro United are approved by the Management Credit Committee or Director’s Credit Committee except for certain consumer loans, which are approved under individual authority. Control systems and procedures are in place to ensure all loans are approved in accordance with credit policies.

Commercial and Industrial Loans. Generally, the Company’s commercial loans are underwritten on the basis of the borrower’s ability to service such debt as reflected by cash flow projections. Commercial loans are generally collateralized by business assets, which may include real estate, accounts receivable and inventory, certificates of deposit, securities, guarantees or other collateral. The Company also generally obtains personal guarantees from the principals of the business. Working capital loans are primarily collateralized by short-term assets, whereas term loans are primarily collateralized by long-term assets. As a result, commercial loans involve additional complexities, variables and risks and require more thorough underwriting and servicing than other types of loans. Indigenous to individuals in the Asian business community is the desire to own the building and land which house their businesses. Accordingly, while a loan may be principally driven and classified by the type of business operated, real estate is frequently the primary source of collateral.

Real Estate Mortgage - Commercial and Residential Mortgage Loans. The Company makes commercial mortgage loans to finance the purchase of real property, which generally consists of developed real estate. The Company’s commercial mortgage loans are collateralized by first liens on real estate. For MetroBank, these loans typically have variable rates and amortize over a 15 to 20 year period, with balloon payments due at the end of five to seven years. For Metro United, these loans have both variable and fixed rates and amortize over a 25 to 30 year period, with balloon payments due at the end of five to ten years. Payments on loans collateralized by such properties are dependent on the successful operation or management of the properties. Accordingly, repayment of these loans may be subject to adverse conditions in the real estate market or the economy to a greater extent than other types of loans. In underwriting commercial mortgage loans, consideration is given to the property’s historical cash flow, current and projected occupancy, location and physical condition. The underwriting analysis also includes credit checks, appraisals, environmental impact reports and a review of the financial condition of the borrower. The Company also originates two to seven year balloon residential mortgage loans with a 15 to 30-year amortization primarily collateralized by owner occupied residential properties, which are retained in the Company’s residential mortgage portfolio.

Real Estate Construction Loans. The Company makes loans to finance the construction of residential and non-residential properties. The majority of the Company’s residential construction loans in Texas are for single-family dwellings that are pre-sold or are under earnest money contracts. The Company also originates loans to finance the construction of commercial properties such as multi-family, office, industrial, warehouse and retail centers. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of a project under construction, and the project is of uncertain value prior to its completion. Because of uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation on real property, it can be difficult to accurately evaluate the total funds required to complete a project and the related loan to value ratio. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If the Company is forced to foreclose on a project prior to completion, there is no assurance that the Company will be able to recover the entire unpaid portion of the loan. In addition, the Company may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminable period of time. While the Company has underwriting procedures designed to identify what it believes to be acceptable levels of risks in construction lending, no assurance can be given that these procedures will prevent losses from the risks described above.

Consumer Loans. The Company, through its subsidiary Metro United, offers a variety of loan products to retail customers through its branch network. Loans to retail customers include automobile loans, lines of credit and other personal loans. The terms of these loans typically range from 12 to 60 months depending on the nature of the collateral and the size of the loan.

Loan review process. In addition to the Banks’ loan portfolio reviews by by external third-party companies, other ongoing reviews are performed by loan officers and involve the grading of each loan by its respective loan officer. Depending on the grade, a loan will be aggregated with other loans of similar grade and a loss factor is applied to the total loans in each group to establish the required level of allowance for loan losses. For both Banks, grades of 1-10 are applied to each loan, with loans graded 7-10 requiring the most allowance for loan losses. Factors utilized in the grading process include but are not limited to historical performance, payment status, collateral value and financial strength of the borrower. Oversight of the loan review process is the responsibility of the Chief Risk Officer. Differences of opinion are resolved among the Loan Officer, Chief Risk Officer and the Chief Credit Officer. See “Allowance for Loan Losses and Reserve for Unfunded Lending Commitments” for additional discussion on loan grades.

MetroBank’s credit department reports credit risk grade changes on a monthly basis to its management and the Board of Directors. MetroBank performs monthly and quarterly, and Metro United performs monthly concentration analyses based on industries, collateral types and business lines. Findings are reported monthly to the Directors’ Loan Committee of MetroBank and the Directors’ Credit Committee of Metro United and quarterly to the Board of Directors of each respective Bank.

In addition, the Company reviews the real estate values, and when necessary, orders new appraisals on loans collateralized by real estate when loans are renewed, prior to foreclosure and at other times as necessary, particularly in problem loan situations. In instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible charge-offs or appropriate additions to the allowance for loan losses. The Company records other real estate at fair value at the time of acquisition less estimated costs to sell.

The following table presents the recorded investment in loans by credit risk profile, and which were updated as of the date indicated (in thousands):

As of September 30, 2013	Commercial and industrial		Real estate mortgage		Real estate construction		Consumer and other		Total

Grade:
1-6 - “Pass”	$	425,498	$	673,267	$	8,607	$	4,362	$	1,111,734
7 - “Special Mention”/ “Watch”		2,851		17,714		—		—		20,565
8 - “Substandard”		11,252		44,299		—		—		55,551
9 -“Doubtful"		—		—		—		—		—

Total	$	439,601	$	735,280	$	8,607	$	4,362	$	1,187,850

As of December 31, 2012	Commercial and industrial		Real estate mortgage		Real estate construction		Consumer and other		Total

Grade:
1-6 - “Pass”	$	366,571	$	611,159	$	5,163	$	7,401	$	990,294
7 - “Special Mention”/ “Watch”		4,393		14,593		—		—		18,986
8 - “Substandard”		12,941		76,728		4,529		—		94,198
9 -“Doubtful"		—		—		—		—		—

Total	$	383,905	$	702,480	$	9,692	$	7,401	$	1,103,478

There can be no assurance, however, that the Company’s loan portfolio will not become subject to increasing pressures from deteriorating borrowers’ financial condition due to general economic and other factors. While future deterioration in the loan portfolio is possible, management is continuing its risk assessment and resolution program. In addition, management is focusing its attention on minimizing the Company’s credit risk through diversification.

Nonperforming Assets

The Company generally places a loan on nonaccrual status and ceases accruing interest when, in the opinion of management, full payment of loan principal or interest is in doubt. All loans past due 90 days are placed on nonaccrual status unless the loan is both well collateralized and in the process of collection. Cash payments received while a loan is classified as nonaccrual are recorded as a reduction of principal as long as significant doubt exists as to collection of the principal. Loans are restored to accrual status only when interest and principal payments are brought current and, in management’s judgment, future payments are reasonably assured. In addition to nonaccrual loans, the Company evaluates on an ongoing basis other loans which are potential problem loans as to risk exposure in determining the adequacy of the allowance for loan losses.

A loan is considered impaired based on current information and events if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual basis for other loans. The measurement of impaired loans is based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s observable market price or based on the fair value of the collateral if the loan is collateral-dependent.

Loans are classified as a troubled debt restructuring in cases where a borrower is experiencing financial difficulty and the Banks make concessionary modifications to contractual terms. Restructured loans typically involve a modification of terms such as a reduction of the stated interest rate and an extension of the maturity date(s). Generally, a nonaccrual loan that is restructured remains on nonaccrual for a minimum period of six months to demonstrate that the borrower can meet the restructured terms. Once performance has been demonstrated, the loan may be returned to performing status after the calendar year end.

The Company requires that nonperforming assets be monitored by the special assets department or senior lenders for MetroBank, and by the special asset team consisting of internal credit personnel with the assistance of third party consultants and attorneys for Metro United. All nonperforming assets are actively managed pursuant to the Company’s loan policy. Senior management is apprised on a weekly basis of the workout endeavors and provides assistance as necessary to determine the best strategy for problem loan resolution and maximizing repayment on nonperforming assets.

In addition to the Banks’ loan review process described in the preceding paragraphs, the Office of the Comptroller of the Currency (“OCC”) periodically examines and evaluates MetroBank, while the Federal Deposit Insurance Corporation (“FDIC”) and California Department of Business Oversight, Division of Financial Institutions (“CDBO”) periodically examine and evaluate Metro United. Based upon such examinations, the regulators may revalue the assets of the institution and require that it charge-off certain assets, establish specific reserves to compensate for the difference between the regulators-determined value and the book value of such assets or take other regulatory action designed to lessen the risk in the asset portfolio.

The following table provides an analysis of the age of the recorded investment in loans by portfolio segment at the date indicated (in thousands):

As of September 30, 2013	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Recorded Investment in Loans		Recorded Investment 90 Days and Accruing

Commercial and industrial	$	1,974	$	414	$	1,178	$	3,566	$	436,035	$	439,601	$	—
Real estate mortgage:
Residential		482		—		124		606		39,468		40,074		—
Commercial		16,891		—		8,596		25,487		669,719		695,206		—
Real estate construction:
Residential		—		—		—		—		4,911		4,911		—
Commercial		—		—		—		—		3,696		3,696		—
Consumer and other		8		—		—		8		4,354		4,362		—

Total	$	19,355	$	414	$	9,898	$	29,667	$	1,158,183	$	1,187,850	$	—

As of December 31, 2012	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Recorded Investment in Loans		Recorded Investment 90 Days and Accruing

Commercial and industrial	$	2,233	$	817	$	1,308	$	4,358	$	379,547	$	383,905	$	—
Real estate mortgage:
Residential		—		—		239		239		36,667		36,906		—
Commercial		114		3,817		18,141		22,072		643,502		665,574		—
Real estate construction:
Residential		—		—		1,426		1,426		984		2,410		—
Commercial		150		—		3,103		3,253		4,029		7,282		—
Consumer and other		—		—		—		—		7,401		7,401		—

Total	$	2,497	$	4,634	$	24,217	$	31,348	$	1,072,130	$	1,103,478	$	—

The following table presents the recorded investment in nonaccrual loans, including nonaccruing troubled debt restructurings, by portfolio segment at the dates indicated (in thousands):

Recorded investment in nonaccrual loans	September 30, 2013		December 31, 2012
Commercial and industrial	$	1,441	$	1,308
Real estate mortgage:
Residential		606		239
Commercial		12,969		22,501
Real estate construction:
Residential		—		1,426
Commercial		—		3,103

Total	$	15,016	$	28,577

Information on impaired loans, which includes nonaccrual loans and troubled debt restructurings, and the related specific allowance for loan losses on such loans at September 30, 2013 and December 31, 2012, is presented below (in thousands):

As of September 30, 2013	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment

Impaired loans with no allowance
Commercial and industrial	$	1,441	$	1,441	$	—	$	1,036
Real estate mortgage:
Residential		606		606		—		451
Commercial		12,700		12,713		—		14,204
Real estate construction:
Residential		—		—		—		713
Commercial		—		—		—		1,552

Impaired loans with an allowance
Commercial and industrial	$	—	$	—	$	—	$	216
Real estate mortgage:
Commercial		657		658		174		2,463

Total:
Commercial and industrial	$	1,441	$	1,441	$	—	$	1,252
Real estate mortgage		13,963		13,977		174		17,118
Real estate construction		—		—		—		2,265

As of December 31, 2012	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment

Impaired loans with no allowance
Commercial and industrial	$	1,287	$	1,289	$	—	$	5,162
Real estate mortgage:
Residential		239		239		—		213
Commercial		18,369		18,369		—		19,732
Real estate construction:
Residential		1,426		1,426		—		1,529
Commercial		3,103		3,103		—		3,171

Impaired loans with an allowance
Commercial and industrial	$	21	$	21	$	21	$	1,434
Real estate mortgage:
Commercial		4,533		4,535		503		6,836

Total:
Commercial and industrial	$	1,308	$	1,310	$	21	$	6,596
Real estate mortgage		23,141		23,143		503		26,781
Real estate construction		4,529		4,529		—		4,700

For the nine months ended September 30, 2013 and 2012, interest income of $28,000 and $139,000 was recognized on impaired loans, which consisted of nonaccrual loans that were paid in full and accruing troubled debt restructurings (“TDRs”).

Troubled Debt Restructurings

Loans are classified as a TDR in cases where a borrower is experiencing financial difficulty and the Banks make concessionary modifications to contractual terms. Restructured loans typically involve a modification of terms such as a reduction of the stated interest rate and/or an extension of the maturity date(s). Generally, a nonaccrual loan that is restructured remains on nonaccrual for a minimum period of six months to demonstrate that the borrower can meet the restructured terms. Once performance has been demonstrated the loan may be returned to performing status after the calendar year end.

As of September 30, 2013, there were no commitments to lend additional funds on loans that were modified as TDRs. As of September 30, 2013, there were no defaults on any loans that were modified as TDRs during the preceding twelve months. There were no new TDRs for the three months ended September 30, 2013.

The following table presents the recorded investment in TDRs that occurred for the nine months ended September 30, 2013 (dollars in thousands):

	Nine Months Ended September 30, 2013
Troubled Debt Restructurings	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial and industrial		1	$	229	$	208

Real estate mortgage:
Residential		1		696		482
Commercial		4		3,074		2,636

For the nine months ended September 30, 2013, TDR activity was as follows:

Prior to restructure, one participation purchased by MetroBank and one participation purchased by Metro United secured by a mixed use property containing residential condominium, retail space and subterranean parking were classified as nonaccrual. A 72% principal reduction was received by each Metro Bank and Metro United and the participations were restructured into two loan participations for each Bank with more than sufficient collateral coverage based on the fair value of the collateral. Since the loans were classified and on nonaccrual status both before and after restructuring, the modifications had an insignificant impact on the Company’s determination of the allowance for loan losses. In September 2013, payoffs totaling $211,000 were received by the Banks for one of the restructured loan participations.

Two land loans to the same borrower were restructured as TDRs. The loans, previously on accrual status and paid according to contractual terms, had matured and were renewed without a principal reduction. The loans were classified and on accrual status both before and after restructuring. Prior to restructuring, the Company’s determination of the allowance for loan losses was based on Financial Accounting Standards Board Codification (“FASB Codification”) 450-20; after restructuring, the determination of the allowance for loan losses was based on FASB Codification 310-10-35 and therefore insignificantly reduced the allowance for loan losses.

One commercial retail loan was restructured by extending with no principal reduction at below market terms. The loan was classified and on accrual status before the restructuring and reclassified to nonaccrual status after the restructuring. Prior to restructuring, the Company’s determination of the allowance for loan losses was based on FASB Codification 450-20; after restructuring, the determination of the allowance for loan losses was based on FASB Codification 310-10-35 and therefore insignificantly reduced the allowance for loan losses.

One sufficiently collateralized land loan was previously on nonaccrual status and reported as an impaired loan prior to restructuring. The loan was restructured with no principal reduction at below market terms. Since the loan was classified and on nonaccrual status both before and after restructuring, the modification did not impact the Company’s determination of the allowance for loan losses.

Allowance for Loan Losses and Reserve for Unfunded Lending Commitments

The allowance for loan losses provides for the risk of losses inherent in the lending process and the Company allocates the allowance for loan losses according to management’s assessments of risk inherent in the portfolio. The allowance for loan losses is increased by provisions charged against current earnings and is reduced by net charge-offs. Loans are charged off when they are deemed to be uncollectible in whole or in part. Recoveries are recorded when cash payments are received. In developing the assessment, the Company relies on estimates and exercises judgment regarding matters where the ultimate outcome is uncertain. Circumstances may change and future assessments of credit risk may yield materially different results, resulting in an increase or decrease in the allowance for credit losses.

The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments and is maintained at levels that the Company believes are adequate to absorb probable losses inherent in the loan portfolio and unfunded lending commitments as of the date of the financial statements. The Company employs a systematic methodology for determining the allowance for credit losses that consists of four components: (1) a formula-based general reserve derived from historical average losses by loan grade, (2) specific reserves on larger impaired individual credits that are based on the difference between the current loan balance and the loan’s collateral value, observable market price, or discounted present value, (3) a qualitative component that reflects current market conditions and other factors precedent to losses different from historical averages and (4) a reserve for unfunded lending commitments.

In setting the qualitative reserve portion of the allowance for loan losses, the factors the Company may consider include, but are not limited to, concentrations of credit, common characteristics of known problem loans, potential problem loans and other loans that exhibit weaknesses or deterioration, the general economic environment in the Company’s markets as well as the national economy, particularly the real estate markets, changes in value of the collateral securing loans, results of portfolio stress tests, and changes in lending processes, procedures and personnel. After the aforementioned assessment of the loan portfolio, the general economic environment and other relevant factors, management determines the appropriate allowance for loan loss level and makes the provision necessary to achieve that level. This methodology is consistently followed so that the level of the allowance for loan losses is reevaluated in response to changes in circumstances, economic conditions or other factors on an ongoing basis.

The Company follows a loan review program to evaluate the credit risk in the loan portfolio as discussed under “Nonperforming Assets.” The Company maintains an internally classified loan list which, along with the delinquency list of loans, helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. Loans classified as “substandard” are risk-rated as grade 8, and are those loans with well-defined weaknesses such as a highly-leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition, which may jeopardize recoverability of the debt. Loans classified as “doubtful” are risk-rated as grade 9, and are those loans which have characteristics similar to substandard loans but with an increased risk that a loss may occur, or at least a portion of the loan may require a charge-off if liquidated at present. Although loans classified as substandard do not duplicate loans classified as doubtful, both substandard and doubtful loans include some loans that are delinquent at least 30 days or on nonaccrual status. Loans classified as “loss” are risk-rated as grade 10 and are those loans which are charged off.

In addition to the internally classified loan list and delinquency list of loans, the Company maintains a separate “watch list” for loans risk-rated as grade 7, which further aids the Company in monitoring loan portfolios. Watch list loans show potential weaknesses where the present status portrays one or more deficiencies that require attention in the short-term or where pertinent ratios of the loan account have weakened to a point where more frequent monitoring is warranted. These loans do not have all of the characteristics of a classified loan (substandard or doubtful) but do show weakened elements compared with those of a satisfactory credit. The Company reviews these loans to assist in assessing the adequacy of the allowance for loan losses.

Policies and procedures have been developed to assess the adequacy of the allowance for loan losses and the reserve for unfunded lending commitments that include the monitoring of qualitative and quantitative trends described above. Management of both Banks review and approve their respective allowance for loan losses and the reserve for unfunded lending commitments monthly and perform a comprehensive analysis quarterly, which is also presented for approval by each Bank’s Board of Directors. The allowance for credit losses is also subject to federal and California State banking regulations. The Banks’ primary regulators conduct periodic examinations of the allowance for credit losses and make assessments regarding its adequacy and the methodology used in its determination.

The Company maintains a reserve for unfunded commitments to provide for the risk of loss inherent in its unfunded lending related commitments. The process used in determining the reserve is consistent with the process used for the allowance for loan losses discussed above.

The following table presents the allowance for loan losses and recorded investment in loans by portfolio segment at the dates indicated (in thousands):

As of and for the three months ended September 30, 2013	Commercial and industrial			Real estate- mortgage			Real estate - construction			Consumer and other			Unallocated		Total

Allowance for loan losses at beginning of period	$	7,523		$	13,176		$	75		$	70		$	988	$	21,832
(Reduction in) provision for loan losses		(31	)		(918	)		72			(11	)		233		(655	)
Charge-offs		(450	)		(41	)		(17	)		(9	)		—		(517	)
Recoveries		124			14			—			2			—		140

Allowance for loan losses at end of period	$	7,166		$	12,231		$	130		$	52

MetroCorp Bancshares, Inc. 10-Q