General

Monroe Bancorp is a one-bank holding company formed under Indiana law in 1984. The Company holds all of the outstanding stock of Monroe Bank, which was formed in 1892. Banking is the primary business activity of the Company.

The Bank, with its primary offices located in Bloomington, Indiana, conducts business from eighteen locations in Monroe, Jackson, Lawrence, Hendricks and Hamilton counties in Indiana. Approximately 75 percent of the Bank's deposits are in Monroe County and is concentrated in and around the city of Bloomington.

The Bank is a traditional community bank which provides a variety of financial services to its customers, including:

o accepting deposits;
o making commercial, mortgage and personal loans;
o originating fixed and variable rate residential mortgage loans for sale into the secondary market;
o providing personal and corporate trust services;
o providing investment advisory and brokerage services; and
o providing annuities and other investment products.

The majority of the Bank's revenue is derived from interest and fees on loans and investments, and the majority of its expense is interest paid on deposits and general and administrative expenses related to its business.

Critical Accounting Policies

The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements on pages 37 to 38 of the 2008 Annual Report to Shareholders. Certain of these policies are important to the portrayal of the Company's financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management has identified these policies in the Critical Accounting Policies section of the Management's Discussion and Analysis on pages 22 to 23 of the 2008 Annual Report to Shareholders. There have been no changes in these critical accounting policies to date.

Non-GAAP Financial Measures

In January 2003, the United States Securities and Exchange Commission ("SEC") issued Regulation G, "Conditions for Use of Non-GAAP Financial Measures." A non-GAAP financial measure is a numerical measure of a company's historical or future performance, financial position, or cash flow that excludes (includes) amounts or adjustments that are included (excluded) in the most directly comparable measure calculated in accordance with generally accepted accounting principles ("GAAP"). Regulation G requires companies that present non-GAAP financial measures to disclose a numerical reconciliation to the most directly comparable measurement using GAAP as well as the reason why the non-GAAP measure is an important measure.

Management has used the following non-GAAP financial measures throughout this quarterly report on Form 10-Q.

o In the "Net Interest Income / Net Interest Margin" section, the discussion is focused on tax-equivalent rates and margin. Municipal bond and municipal loan interest has been converted to a tax-equivalent rate using a federal tax rate of 34 percent. Management believes a discussion of the changes in tax-equivalent rates and margin is more relevant because it better explains changes in after-tax net income.
o In the "Noninterest Income / Noninterest Expense" section of this document, we report noninterest income and noninterest expense without the effect of unrealized gains and losses on securities in a grantor trust ("rabbi trust") which is a non-GAAP financial measure. Other income includes realized and unrealized securities gains and losses and capital gain dividends on trading securities (mutual funds) held in a rabbi trust in connection with the Company's Directors' and Executives' Deferred Compensation Plans. These securities are held as trading securities, and hence, unrealized gains and losses are recognized on the income statement. Any unrealized or realized loss on securities held in the rabbi trust net of any dividend, interest and capital gain dividend income earned on the securities in the rabbi trust (included in net interest income) are directly offset by a decrease to directors' fee/deferred executive compensation expense (included in other expense), and conversely, any net realized or unrealized gain combined with interest, dividends and capital gain dividends earned on the securities in the trust are directly offset by an increase to directors' fee/deferred executive compensation expense. These offsets are included in the line item identified on page 4 of the consolidated financial statements as "Depreciation in directors' and executives' deferred compensation plans." The activity in the rabbi trust has no effect on the Company's net income, therefore, management believes a more accurate comparison of current and prior year noninterest income and noninterest expense can be made if the rabbi trust realized and unrealized gains, losses, capital gain dividends and offsetting appreciation (depreciation) on the deferred compensation plans and trustee fees are removed.

Results of Operations

Overview

Net income for the first quarter of 2009 was $1,107,000, a 30.5 percent decrease from net income of $1,593,000 for the same quarter last year. Basic and diluted earnings per share for the first quarter of 2009 were $0.178, down 30.5 percent from $0.256 per basic and diluted share for the first quarter of 2008. Annualized return on average equity (ROAE) for the first quarter of 2009 decreased to 8.00 percent compared to 11.62 percent for the first quarter of 2008. The annualized return on average assets (ROAA) was 0.54 percent for the first quarter of 2009 compared to 0.82 percent for the same period of 2008.

The decline in net income resulted primarily from an increase in the provision for loan losses. The provision for loan losses totaled $2,600,000 for the first quarter of 2009 compared to $880,000 for the same period of 2008. Net interest income for the first quarter of 2009, after the provision for loan losses, decreased $1,654,000, or 33.1 percent from the first quarter of 2008.

The following items affected first quarter results:

o General Economic Conditions in the Real Estate Markets - Among the primary areas of management focus during 2008 and 2009 were managing the deterioration of asset quality resulting from slowing economic activity and stresses in the multi-family residential housing markets. Nonperforming assets and 90-day past due loans totaled $17,289,000 (2.10 percent of total assets) at March 31, 2009 compared to $18,780,000 (2.29 percent of total assets) at December 31, 2008 and $8,355,000 (1.08 percent of total assets) at March 31, 2008. The provision for loan losses for the three months ended March 31, 2009 totaled $2,600,000, a $1,720,000 increase over the $880,000 provision made during the same period of 2008 due to management's assessment of potential losses in the Bank's loan portfolio.
o Securities Gains - Securities gains of $1,028,000 were realized from sales of securities during the first three months of 2009 compared to $140,000 in the same period of 2008.
o Compensation Expenses - Total compensation expenses (salaries, incentive compensation and benefits) decreased by $301,000 or 9.2 percent to $2,964,000 for the first three months of 2009 compared to $3,265,000 for the first three months of 2008 due primarily to a reduction in staff levels and the reduction and elimination of certain incentive plans.
o Gains on Loan Sales - Gains on the sale of loans totaled $290,000 for the first quarter of 2009, a 46.5 percent increase over the $198,000 in the first quarter of 2008 due to strong residential mortgage loan refinancing activity.
o Federal Deposit Insurance Corporation (FDIC) Assessment Expense - The Company experienced a $235,000 or 489.6 percent increase in deposit insurance expense in the first three months of 2009 compared to the same period in 2008 related to the new insurance assessment methodology set forth in the Federal Deposit Insurance Reform Act of 2005 ("FDIC Act"). The FDIC Act allocated credits to the Bank that could be applied toward quarterly FDIC assessments. The Bank's credits were depleted in the first quarter of 2008 which contributed to the increased 2009 expense. In addition, the FDIC assessment rate increased substantially in 2009 compared to 2008.

In February 2009, the Board of Directors of the Federal Deposit Insurance Corporation voted to amend the restoration plan for the Deposit Insurance Fund (DIF). The amended restoration plan extended the period of time to raise the DIF reserve ratio to 1.15 percent from five to seven years. The amended restoration plan also includes a final rule that sets assessment rates. Under this final rule, beginning on April 1, 2009 the Company expects the FDIC premium assessed to the Company to increase.

The Board of the FDIC also adopted an interim rule imposing a 20 basis point special assessment on insured institutions as of June 30, 2009 which will be payable on September 30, 2009. The interim rule would also allow the assessment of additional special assessments of up to 10 basis points after June 30, 2009 as deemed necessary. Comments on the interim rule were due within 30 days of publication in the Federal Register. On May 6, 2009, the U.S. Senate approved deposit insurance legislation (S. 896) that would extend the FDIC's borrowing authority with the U.S. Treasury from $30 billion to $100 billion, with emergency funding up to $500 billion. The FDIC previously indicated the expanded borrowing authority is needed to cut its planned 20 basis point special assessment in half. While aspects of the FDIC's assessment plan remain unresolved, it is anticipated the impact of 2009 FDIC assessments will be material to the 2009 results of operations.

The Company announced on April 27, 2009 several actions related to efforts to increase capital. The first action was to withdraw the Company's application to participate in the U. S. Treasury Department's Trouble Asset Relief Program (TARP). As the program evolved over the months since it was announced it became increasingly clear that participation in the program was not in the best interest of the Company or its shareholders. In place of the TARP, the Company announced it would raise capital by reducing its quarterly dividend from $0.13 per share to $0.01 per share and by issuing $10 million of subordinated debentures. These

actions will help ensure that the Bank continues to be well-capitalized during the current economic downturn and allowing the Company to be in a stronger position for growth when the economy improves.

The subordinated debt securities referred to in the April 27, 2009 announcement have not been registered under the Securities Act of 1933, as amended (the "Securities Act"), and, unless so registered, may not be offered or sold in the United States absent registration or an applicable exemption from, or in a transaction not subject to, the registration requirements of the Securities Act and other applicable securities laws. The announcement shall not constitute an offer to sell or the solicitation of an offer to buy any securities described herein, nor shall there be any sales of these securities in any state or jurisdiction in which the offer, solicitation or sale would be unlawful. The announcement is being issued pursuant to and in accordance with Rule 135 and Rule 135c under the Securities Act.

Net Interest Income / Net Interest Margin

The following table presents information to assist in analyzing net interest income. The table of Average Balance Sheets and Interest Rates presents the major components of interest-earning assets and interest-bearing liabilities, related interest income and expense and the resulting yield or cost. Interest income presented in the table has been adjusted to a tax-equivalent basis assuming a 34 percent tax rate. The tax-equivalent adjustment recognizes the income tax savings when comparing taxable and tax-exempt assets.

                                                                         Average Balance Sheets and Interest Rates
                                                           ----------------------------------------------------------------------
                                                           Three Months Ended March 31, 2009    Three Months Ended March 31, 2008
                                                           ---------------------------------    ---------------------------------
                                                           Average              Average Rate    Average              Average Rate
                                                           Balance   Interest   (annualized)    Balance   Interest   (annualized)
                                                           -------   --------   ------------    -------   --------   ------------
                             ASSETS
Interest earning assets
   Securities
      Taxable............................................. $ 77,501  $   596       3.12%        $ 82,697  $   987         4.80%
      Tax-exempt (1)......................................   33,227      383       4.68%          38,456      508         5.31%
                                                           --------  -------                    --------  -------
          Total securities................................  110,728      979       3.59%         121,153    1,495         4.96%

   Loans (2)..............................................  632,877    8,512       5.45%         582,255   10,003         6.91%
   FHLB Stock.............................................    2,312       (4)     -0.70%           2,312       28         4.87%
   Federal funds sold.....................................   16,029        7       0.18%          10,462       87         3.34%
   Interest-earning deposits..............................    7,789       15       0.80%           9,611       65         2.70%
                                                           --------  -------                    --------  -------
           Total interest earning assets..................  769,735    9,509       5.01%         725,793   11,678         6.47%
                                                           --------  -------                    --------  -------

Noninterest earning assets
  Allowance for loan losses...............................  (11,821)                              (6,885)
   Premises and equipment & other assets..................   56,053                               47,276
   Cash and due from banks................................   12,747                               14,272
                                                           --------                             --------
          Total assets.................................... $826,714                             $780,456
                                                           ========                             ========

      LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities
   Total interest-bearing deposits........................ $599,119    3,090       2.09%        $568,013    4,958         3.51%
   Borrowed funds.........................................   83,022      346       1.69%          71,552      649         3.65%
                                                           --------  -------                    --------  -------
      Total interest-bearing liabilities..................  682,141    3,436       2.04%         639,565    5,607         3.52%
                                                           --------  -------                    --------  -------

Noninterest-bearing liabilities
   Noninterest-bearing demand deposits....................   79,257                               75,673
   Other liabilities......................................    9,211                               10,077
   Shareholders' equity...................................   56,105                               55,141
                                                           --------                             --------
           Total liabilities and shareholders' equity..... $826,714                             $780,456
                                                           ========                             ========


Interest margin recap
   Tax-equivalent net interest income and
      interest rate spread................................           $ 6,073       2.97%                  $ 6,071         2.95%
   Tax-equivalent net interest income margin as
      a percent of total average earning assets...........                         3.20%                                  3.36%
Tax-equivalent adjustment (1).............................               131                                  195
                                                                     -------                              -------

          Net interest income.............................           $ 5,942                              $ 5,876
                                                                     =======                              =======

Net Interest Income / Net Interest Margin (continued)
Net interest income is the primary source of the Company's earnings. It is a function of the net interest margin and the volume of average earning assets. The net interest margin as a percent of average earnings assets was 3.13 percent for the first three months of 2009, down from 3.26 percent for the same period in 2008. Adjusting for tax-exempt income and expense, as discussed in the "Non-GAAP Financial Measures" section, the tax-equivalent net interest margin as a percent of average earning assets was 3.20 percent for the first three months of 2009, down from 3.36 percent for the same period last year. The 16 basis point drop in the tax-equivalent net interest margin during the first three months of 2009 compared to the same period in 2008 was primarily the result of higher balances of nonperforming assets and fixed assets during the first quarter of 2009 and significantly higher loan fees during the first quarter of 2008.

Net interest income was $5,942,000 for the three months ended March 31, 2009 compared to $5,876,000 for the same period in 2008, an increase of 1.1 percent. Adjusting for tax-exempt income and expense, as discussed in the "Non-GAAP Financial Measures" section, tax-equivalent net interest income was $6,073,000 for the three months ended March 31, 2009 which was $2,000 more than the $6,071,000 in the same period in 2008.

Noninterest Income / Noninterest Expense

Total noninterest income for the first quarter of 2009 was $3,262,000 compared to $2,364,000 for the same period in 2008. Excluding the effect of the Company's deferred compensation plan, discussed in the "Non-GAAP Financial Measures" section, noninterest income for the first quarter of 2009 was $3,394,000 compared to $2,556,000 for the same period of 2008, an increase of $838,000 or 32.8 percent. The effect of the Company's deferred compensation plan for the first quarter of 2009 was a $132,000 decrease in noninterest income compared to a $192,000 decrease in the same period of 2008.

Significant changes in noninterest income occurred primarily in the following areas:

o Securities gains of $1,028,000 were realized from sales of securities during the first quarter of 2009 compared to $140,000 in the same period of 2008.
o Gains on the sale of loans totaled $290,000 for the first quarter of 2009, a 46.5 percent increase over the $198,000 in the first quarter of 2008 due to strong residential mortgage loan refinancing activity.

Total noninterest expense was $5,223,000 for the first quarter of 2009 compared to $5,391,000 for the same period in 2008. Excluding the effect of the Company's deferred compensation plan, discussed in the "Use of Non-GAAP Financial Measures" section, total noninterest expense for the first quarter of 2009 was $5,337,000, a $214,000 or 3.9 percent decrease from $5,551,000 for the same period in 2008. The effect of the Company's deferred compensation plan for the first quarter of 2009 was a $114,000 decrease in noninterest expense compared to a $160,000 decrease in the same period of 2008.

Significant changes in noninterest expense occurred in the following areas:

o Total compensation expenses (salaries, incentive compensation and benefits) decreased by $301,000 or 9.2 percent to $2,964,000 in the first quarter of 2009 compared to $3,265,000 in the first quarter of 2008.
o The Company experienced a $235,000 or 489.6 percent increase in FDIC insurance assessment expense in the first three months of 2009 compared to the same period in 2008.

Income Taxes

The Company records a provision for income taxes currently payable, along with a provision for those taxes payable in the future. Such deferred taxes arise from differences in timing of certain items for financial statement reporting rather than income tax reporting. The major difference between the effective tax rate applied to the Company's financial statement income and the federal and state statutory rate of approximately 40 percent is interest on tax-exempt securities, tax credits received and the effect of the Company's Delaware based investment holding company and a real estate investment trust (REIT).

The Company's effective tax rate was 19.8 percent for the first quarter of 2009 compared to 19.1 percent for the same period in 2008.

Financial Condition

Assets and Liabilities

Total assets of the Company at March 31, 2009 were $823,702,000 an increase of 0.5 percent or $3,903,000 compared to $819,799,000 at December 31, 2008. Loans (including loans held for sale) totaled $630,842,000 at

March 31, 2009 compared to $633,091,000 at December 31, 2008, a decrease of 0.4 percent. Deposits increased to $676,557,000 at March 31, 2009 compared to $665,179,000 at December 31, 2008, an increase of $11,378,000 or 1.7 percent. Borrowings decreased to $85,070,000 at March 31, 2009 compared to $93,203,000 at December 31, 2008, an 8.7 percent decrease.

Capital

Shareholders' equity increased by $56,000 at March 31, 2009 compared to December 31, 2008. This increase was a result of quarterly net income of $1,107,000 and option expense of $7,000, offset by ESOP shares forfeited of $3,000, unrealized loss on securities in the Company's available for sale securities portfolio totaling $246,000 (net of tax) and dividends paid of $809,000.

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies and are assigned to a capital category. The assigned capital category is largely determined by three ratios that are calculated according to the regulations: total risk adjusted capital, Tier 1 capital, and Tier 1 leverage ratios. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures of the entity. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios.

There are five capital categories defined in the regulations ranging from well capitalized to critically undercapitalized. Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations. At March 31, 2009 and December 31, 2008, the Company and the Bank were categorized as well capitalized and met all applicable capital adequacy requirements. There are no conditions or events since March 31, 2009 that management believes have changed the Company's or Bank's classification.

The actual and required capital amounts and ratios are as follows:

                                                                             Required for             To Be Well
                                                          Actual         Adequate Capital (1)       Capitalized (1)
                                                      -------------------------------------------------------------
                                                      Amount   Ratio      Amount      Ratio        Amount     Ratio
                                                      -------------------------------------------------------------
As of March 31, 2009
--------------------
Total capital (1) (to risk-weighted assets)
    Consolidated...................................  $ 71,570  11.37 %   $ 50,361       8.00 %         N/A     N/A
    Bank...........................................    70,805  11.29       50,151       8.00      $ 62,689    10.00 %
Tier I capital (1) (to risk-weighted assets)
    Consolidated...................................    63,646  10.11       25,180       4.00           N/A     N/A
    Bank...........................................    62,913  10.04       25,076       4.00        37,613     6.00
Tier I capital (1) (to average assets)
    Consolidated...................................    63,646   7.70       33,069       4.00           N/A     N/A
    Bank...........................................    62,913   7.64       32,946       4.00        41,182     5.00

As of December 31, 2008
-----------------------
Total capital (1) (to risk-weighted assets)
    Consolidated...................................  $ 71,214  11.34 %   $ 50,224       8.00 %         N/A     N/A
    Bank...........................................    70,498  11.28       49,999       8.00      $ 62,499    10.00 %
Tier I capital (1) (to risk-weighted assets)
    Consolidated...................................    63,326  10.09       25,112       4.00           N/A     N/A
    Bank...........................................    62,644  10.02       25,000       4.00        37,499     6.00
Tier I capital (1) (to average assets)
    Consolidated...................................    63,326   7.74       32,734       4.00           N/A     N/A
    Bank...........................................    62,644   7.69       32,600       4.00        40,750     5.00

Classification of Assets, Allowance for Loan Losses, and Nonperforming Loans The Bank currently classifies loans internally to assist management in addressing collection and other risks. The Bank maintains a "watch list" representing credits that require above average attention in order to mitigate the risk of default or loss. Over the periods noted below, the watch list consisted of the following:

-----------------------------------------------------------------------------------------
                                                3/31/2009      12/31/2008       3/31/2008
-----------------------------------------------------------------------------------------
Total Watch List ($)                           79,073,000      59,172,000      25,528,000
-----------------------------------------------------------------------------------------
Number of Watch List Customers                         67              52              52
-----------------------------------------------------------------------------------------
Total Watch List $>30 Days Past Due            22,370,000      14,751,000      10,874,000
-----------------------------------------------------------------------------------------
Total Watch List $ Secured By Real Estate      72,006,000      55,507,000      22,338,000
-----------------------------------------------------------------------------------------
Total Watch List $ Secured by Non R/E           6,878,000       3,268,000       2,891,000
-----------------------------------------------------------------------------------------
. . .