If the Company determines that a decline in fair value is other-than-temporary and that it is more likely than not that the Company will not sell or be required to sell the security before recovery of its amortized cost, the credit portion of the impairment loss is recognized in earnings and the noncredit portion is recognized in accumulated comprehensive income. The credit portion of the other-than-temporary impairment represents the difference between the amortized cost and the present value of the expected future cash flows of the security. If the Company determines that a decline in fair value is other-than-temporary and it will more likely than not sell or be required to sell the security before recovery of its amortized cost, the entire difference between the amortized cost and the fair value of the security will be recognized in earnings. Continued adverse economic and market conditions could result in losses from other-than-temporary impairment. Overview
The primary drivers of the Company's operating income are net interest income, which is strongly affected by the net yield on interest-earning assets and liabilities ("net interest margin"), and the quality of the Company's assets. The Company's net interest income represents the difference between interest income and its cost of funds. Interest income depends on the amount of interest-earning assets outstanding during the year and the interest rates earned thereon. Cost of funds is a function of the average amount of deposits and borrowed money outstanding during the year and the interest rates paid thereon. The net interest margin is calculated by dividing net interest income by average interest-earning assets. Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. Net interest margin generally exceeds the net interest spread as a portion of interest-earning assets is funded by various noninterest-bearing sources (primarily noninterest-bearing deposits and shareholders' equity). The increases (decreases) in the components of interest income and interest expense, expressed in terms of fluctuation in average volume and rate, are summarized under "Rate/Volume Analysis" on page 39. Information as to the components of interest income and interest expense and average rates is provided under "Average Balances, Yields and Costs" on page 38. Because the Company's assets are not identical in duration and in repricing dates to its liabilities, the spread between the two is vulnerable to changes in market interest rates as well as the overall shape of the yield curve. These vulnerabilities are inherent to the business of banking and are commonly referred to as "interest rate risk." How to measure interest rate risk and, once measured, how much risk to take are based on numerous assumptions and other subjective judgments. See also discussion under "Interest Rate Risk" on page 48. The quality of the Company's assets also influences its earnings. Loans and leases that are not paid on a timely basis and exhibit other weaknesses can result in the loss of principal and/or interest income. Additionally, the Company must make timely provisions to the allowance for loan and lease losses based on estimates of probable losses inherent in the loan and lease portfolio; these additions, which are charged against earnings, are necessarily greater when greater probable losses are expected. Further, the Company incurs expenses as a result of resolving troubled assets. All of these reflect the "credit risk" that the Company takes on in the ordinary course of business and are further discussed under "Financial Condition - Asset Quality" on pages 32 to 34. The Company's business strategy has been to concentrate its asset generation efforts on commercial and consumer loans and its deposit generation efforts on checking and savings accounts. These deposit accounts are commonly referred to as "core deposits." This strategy is based on the Company's belief that it can distinguish itself from its larger competitors, and indeed attract customers from them, through a higher level of service and through its ability to set policies and procedures, as well as make decisions locally. The loan and deposit products referenced also tend to be geared more toward customers who are relationship oriented than those who are seeking stand-alone or single transaction products. The Company believes that its service-oriented approach enables it to compete successfully for relationship-oriented customers. Additionally, the Company is predominantly an urban franchise with a high concentration of businesses, which makes deployment of funds in the commercial lending area practicable. Commercial loans are attractive to the Company, among other reasons, because of their higher yields. Similarly, core deposits are attractive to the Company because of their generally lower interest cost and potential for fee income.

The deposit market in Rhode Island is highly concentrated. The State's three largest banks have an aggregate market share of approximately 84% (based upon June 2009 FDIC statistics, excluding one bank that draws its deposits primarily from the internet) in Providence and Kent Counties, the Bank's primary marketplace. Competition for loans and deposits remains intense. This competition has resulted in considerable advertising and promotional product offerings by competitors, including print, radio and television media as well as web-based advertising and promotions.
The Company also seeks to leverage business opportunities presented by its customer base, franchise footprint and resources. In 2005, the Bank completed the acquisition of an equipment leasing company located in Long Island, New York ("Macrolease") and formed a private banking division. The Bank is using the Macrolease platform to increase the Bank's loan and lease portfolio, as well as to generate additional income by originating equipment leases for third parties. For the nine months ended September 30, 2009, approximately 84% of the Company's revenues (defined as net interest income plus noninterest income) were derived from its net interest income. In a continuing effort to diversify its sources of revenue, the Company has sought to expand its sources of noninterest income (primarily fees and charges for products and services the Bank offers). Service charges on deposit accounts remain the largest component of noninterest income. The future operating results of the Company will depend upon on the ability to maintain its net interest margin, while minimizing its exposure to credit risk, along with increasing sources of noninterest income, while controlling the growth of noninterest or operating expenses.

Financial Condition - Executive Summary
Selected balance sheet data is presented in the table below as of the dates indicated:

                              September 30,        June 30,         March 31,        December 31,        September 30,
(In thousands)                    2009               2009             2009               2008                2008

Total assets                 $     1,569,880      $ 1,584,482      $ 1,548,863      $    1,528,974      $     1,489,980
Loans and leases
receivable                         1,116,627        1,117,655        1,105,298           1,077,742            1,060,739
Available for sale
securities                           365,706          376,026          356,681             326,406              333,431
Goodwill                              12,051           12,051           12,051              12,019               12,019
Core deposits (1)                    685,104          681,834          636,240             618,749              615,085
Certificates of deposit              406,827          402,839          419,621             423,443              407,069
Borrowings                           340,081          336,244          320,517             320,015              338,862
Common shareholders'
equity                               122,476          120,471          122,306             121,010              114,226
Book value per common
share                                  26.57            26.18            26.57               26.45                24.97
Tangible book value per
common share                           23.96            23.56            23.95               23.82                22.34
Tangible common equity
ratio (2) (3)                           7.09 %           6.90 %           7.17 %              7.18 %               6.92 %
Core deposits to total
deposits(1) (3)                         62.7 %           62.9 %           60.3 %              59.4 %               60.2 %

(1) Core deposits consist of demand deposit, NOW, money market and savings accounts.

(2) Calculated by dividing Common Shareholders' Equity less Goodwill by Total Assets less Goodwill.

(3) Non-GAAP performance measure.

Total assets increased by $40.9 million since December 31, 2008. Total loans and leases increased by $38.9 million during the first nine months of 2009, with increases in commercial loans and leases of $66.0 million, or 10.0%, and consumer and other loans of $3.2 million, or 1.6%, respectively. The residential mortgage loan portfolio decreased by $30.4 million, or 14.3%. Available for sale securities increased $39.3 million, or 12.0%, since year-end. The Bank's core deposits increased by $66.4 million, or 10.7%, since year-end. Within this increase, demand deposit accounts increased by $30.0 million, or 17.0%, money market accounts increased by $45.9 million, or 1033.4%, due to a new product offering, NOW accounts increased by $5.6 million, or 9.9%, and savings accounts decreased by $15.2 million, or 4.0%. Certificate of deposit accounts decreased by $16.6 million, or 3.9%, and borrowings increased by $20.1 million, or 6.3%, since year-end. Shareholders' equity as a percentage of total assets was 7.8% at September 30, 2009 and 9.8% at December 31, 2008.
The Company's financial position at September 30, 2009 as compared to September 30, 2008 reflects net growth of $55.9 million in total loans and leases. This increase reflects the continuing conversion of the balance sheet to a more commercial profile with increases in commercial loans and leases of $84.8 million, or 13.3%. Consumer loans increased $3.9 million, or 1.9%, from the prior year quarter-end. The residential mortgage portfolio declined $32.8 million, or 15.3%, from September 30, 2008. Also, available for sale securities at September 30, 2009 increased by $32.3 million, or 9.7%, from the same period in 2008. Core deposits have increased $70.0 million, or 11.4%, since the prior year quarter-end, with growth centered in money market accounts of $46.4 million, demand deposit accounts of $25.2 million and NOW accounts of $6.1 million. These increases were offset by a decrease in savings accounts of $7.7 million and certificate of deposit accounts of $242,000 since September 30, 2008. Borrowings have increased by $1.2 million from the same period in 2008.

Financial Condition - Detailed Analysis
Investments
Total investments consist of available for sale securities, stock in the FHLB and overnight investments. Total investments comprised $382.5 million, or 24.4% of total assets at September 30, 2009, compared to $343.2 million, or 22.4% of total assets at December 31, 2008, representing an increase of $39.3 million, or 11.5%. Available for sale securities are recorded at fair value. At September 30, 2009, the fair value of available for sale securities was $365.7 million and carried a total of $4.5 million of net unrealized gain at the end of the quarter, compared to $639,000 at December 31, 2008.
The investment portfolio provides the Company a source of short-term liquidity and acts as a counterbalance to loan and deposit flows. During the first nine months of 2009, the Company purchased $163.6 million of available for sale securities compared to $116.9 million during the same period in 2008. Maturities, calls and principal repayments totaled $126.5 million for the nine months ended September 30, 2009 compared to $91.1 million for the same period in 2008. Additionally, in the first nine months of 2009, the Company sold $1.9 million of available for sale securities generating gains of $61,000 compared to sales of $22.5 million and gains of $410,000 for the same period in 2008.
The Company performs regular analysis on the available for sale securities portfolio to determine whether a decline in fair value indicates that an investment is other-than-temporarily impaired. In making these other-than-temporary determinations, management considers, among other factors, the length of time and extent to which the fair value has been less than amortized cost, projected future cash flows, credit subordination and the creditworthiness, capital adequacy and near-term prospects of the issuers. Management also considers the Company's capital adequacy, interest rate risk, liquidity and business plans in assessing whether it is more likely than not that the Company will sell or be required to sell the securities before recovery.
If the Company determines that a decline in fair value is other-than-temporary and that it is more likely than not that the Company will not sell or be required to sell the security before recovery of its amortized cost, the credit portion of the impairment loss is recognized in earnings and the noncredit portion is recognized in accumulated comprehensive income. The credit portion of the other-than-temporary impairment represents the difference between the amortized cost and the present value of the expected future cash flows of the security. If the Company determines that a decline in fair value is other-than-temporary and it will more likely than not sell or be required to sell the security before recovery of its amortized cost, the entire difference between the amortized cost and the fair value of the security will be recognized in earnings.
In performing the analysis for the two collateralized debt obligations ("CDO A" and "CDO B") held by the Company, which are backed by pools of trust preferred securities, future cash flow scenarios for each security were estimated based on varying levels of severity for assumptions of future delinquencies, recoveries and prepayments. These estimated cash flow scenarios were used to determine whether the Company expects to recover the amortized cost basis of the securities. Projected credit losses were compared to the current level of credit enhancement to assess whether the security is expected to incur losses in any future period and therefore become other-than-temporarily impaired. Upon adoption of FSP No. FAS 115-2 and FAS 124-2 (ASC 320-10) in the second quarter of 2009, management reevaluated the other-than-temporary impairment that was previously recognized on CDO A at September 30, 2008. Management determined that it did not meet the criteria for other-than-temporary impairment as defined by FSP No. FAS 115-2 and FAS 124-2 (ASC 320-10) because the amortized cost basis of the security was expected to be recovered, management had no intent to sell the security before recovery and it was more likely than not that the Company would not be required to sell the security before recovery. As a result, an adjustment of $137,000, representing the previously recognized other-than-temporary impairment charge, net of accretion recognized on impairment and tax effects, has been applied to the opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive income.

During September 2009, CDO A experienced an additional $10.0 million in defaulting collateral. Projected credit loss severity assumptions were increased in estimated future cash flow scenarios and it was determined that management does not expect to recover $70,000 of the security's amortized cost. As a result, the Company recorded an other-than-temporary impairment totaling $696,000, representing the difference between the security's fair value and book value. The portion deemed to be credit related of $70,000 has been recorded as a reduction to noninterest income, while the non-credit portion of $626,000 has been recorded as a reduction of other comprehensive income. Management will continue to monitor this security for further potential impairment. Management reviewed CDO B and assessed the issuer's ability to continue to make principal and interest payments. The Company did not receive its September interest payment because the security is adding interest to the principal rather than paying out. However, management reviewed various cash flow scenarios driven by varying assumptions (including default rates and recoveries) for this instrument and determined that although current and future deferrals and defaults may cause a temporary break in interest payments, management expects to recover the amortized cost of the security due to the structure of the instrument. The structure is such that payments to all junior subordinated tranches of the instrument (of which there are two) are diverted to senior level tranches until they meet certain over-collateralization tests. Essentially, the senior level tranches will continue to be paid until there are no further funds available from the junior tranches. Because management expects to recover the amortized cost of the security and it is more likely than not that the security will not be sold, no other-than-temporary impairment exists at September 30, 2009.
The decline in fair value of the remaining available for sale securities in an unrealized loss position is due to a substantial widening of interest rate spreads across market sectors related to the continued illiquidity and uncertainty of the securities markets. Management believes that it will recover the amortized cost basis of the securities and that it is more likely than not that it will not be required to sell the securities before recovery. Additionally, management has no intent to sell the securities before recovery. As such, management has determined that the securities are not other-than-temporarily impaired as of September 30, 2009. If market conditions for securities worsen or the creditworthiness of the underlying issuers deteriorates, it is possible that the Company may recognize additional other-than-temporary impairments in future periods.
As of September 30, 2009, the Company's remaining securities in an unrealized loss position were deemed not to be other-than-temporarily impaired after considering the aforementioned factors. The Company does not have the intent to sell the securities with unrealized losses until recovery or maturity and believes it is more likely than not that it will not be required to sell the securities before recovery and that it will recover the amortized cost basis of the securities.
Loans and Leases
Total loans and leases increased by $38.9 million since December 31, 2008 and stood at $1.12 billion at September 30, 2009. As a percentage of total assets, loans and leases increased to 71.1% at September 30, 2009, compared to 70.5% at December 31, 2008. This increase was centered in commercial loans, where the Company concentrates its origination efforts, and was partially offset by decreases in residential mortgage loans, which the Company has historically purchased. Total loans and leases as of September 30, 2009 are comprised of three broad categories: commercial loans and leases that aggregate $724.4 million, or 64.9% of the portfolio; residential mortgages that aggregate $182.3 million, or 16.3% of the portfolio; and consumer and other loans that aggregate $209.9 million, or 18.8% of the portfolio.
Commercial loans and leases - The commercial loan and lease portfolio (consisting of commercial real estate, commercial and industrial, equipment leases, multi-family real estate, construction and small business loans) increased $66.0 million, or 10.0%, during the first nine months of 2009. The primary drivers of this growth occurred in the commercial real estate, commercial and industrial and leasing areas.
The Bank's business lending group originates business loans, also referred to as commercial and industrial loans. In addition, Macrolease-generated equipment loans are included in the commercial and industrial loan portfolio. Total commercial and industrial loans increased $19.3 million, or 11.8%, since year-end.

The Bank's business lending group also originates owner-occupied commercial real estate loans, term loans and revolving lines of credit. Since December 31, 2008, owner-occupied commercial real estate loans decreased by $8.3 million, or 4.7%. The Bank's commercial real estate ("CRE") group originates nonowner-occupied commercial real estate, multi-family residential real estate and construction loans. These real estate secured commercial loans are offered as both fixed and adjustable-rate products. Since December 31, 2008, CRE loans have increased $36.8 million, or 17.6%, on a net basis.
The Bank purchases equipment leases from originators outside of the Bank. The U.S. Government or its agencies are the principal lessees on these purchased leases. These "government" leases generally have maturities of five years or less and are not dependent on residual collateral values. At September 30, 2009, $7.4 million of purchased government leases were included in the commercial loan and lease portfolio representing a decrease of $1.2 million, or 14.4%, since year-end.
With the Macrolease platform, the Bank originates and purchases equipment loans and leases for its own portfolio, as well as originates loans and leases for third parties as a source of noninterest income. Macrolease-generated equipment loans of $43.0 million and $35.2 million were included in the commercial and industrial portfolio at September 30, 2009 and December 31, 2008, respectively. Since December 31, 2008, total Macrolease-generated equipment loans and leases increased $22.7 million, or 26.5%, to $108.4 million.
At September 30, 2009, small business loans (business lending relationships of approximately $500,000 or less) were $55.4 million, or 7.7% of the portfolio, compared to $50.5 million, or 7.7% of the portfolio, at December 31, 2008. These loans reflect those originated by the Bank's business development group, as well as throughout the Bank's branch system. The Bank utilizes credit scoring and streamlined documentation, as well as traditional review standards in originating these credits.
The Bank is a participant in the U.S. Small Business Administration ("SBA") Lender Program in both Rhode Island and Massachusetts. The Bank was named the No. 1 SBA lender in Rhode Island as of the SBA's fiscal year end at September 30, 2009. SBA guaranteed loans exist throughout the portfolios managed by the Bank's various lending groups.
The Company believes it is well positioned for continued commercial growth. The . . .