FARMERS & MERCHANTS BANCORP INC - Annual Report: 2010 (Form 10-K)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

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

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

Commission File Number 0-14492

FARMERS & MERCHANTS BANCORP, INC.

OHIO		34-1469491
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)
307 North Defiance Street Archbold, Ohio		43502
(Address of principal Executive offices)		(Zip Code)

Registrant’s telephone number, including area code (419) 446-2501

Securities registered pursuant to Section 12(b) of the Act:

Title of each class None		Name of each exchange on which registered None

Securities registered pursuant to Section 12(g) of the Act:

Common shares without par value
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or Section 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 þ No o

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes o No þ

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

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

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

As of June 30, 2010, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $86,373,431.65

As of February 25, 2011, the Registrant had 5,200,000 shares of common stock issued of which 4,693,969 shares are outstanding.

Part III of Form 10-K — Portions of the definitive Proxy Statement for the 2010 Annual Meeting of Shareholders of Farmers & Merchants Bancorp, Inc.

 

 

FARMERS & MERCHANTS BANCORP, INC.
TABLE OF CONTENTS

Form 10-K Items		PAGE
Item 1. Business			3-11
Item 1a. Risk Factors			11-12
Item 1b. Unresolved Staff Comments			13
Item 2. Properties			13-14
Item 3. Legal Proceedings			14
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters			14-17
Item 6. Selected Financial Data			17
Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations			18-39
Item 7a. Quantitative and Qualitative Disclosures About Market Risk			39-40
Item 8. Financial Statements and Supplementary Data			40
Item 9. Disagreements on Accounting and Financial Disclosure			75
Item 9a. Controls and Procedures			76
Item 9b. Other Information			76
Item 10. Directors and Executive Officers of the Registrant			77-79
Item 11. Executive Compensation			79
Item 12. Security Ownership of Certain Beneficial Owners and Management			79
Item 13. Certain Relationships and Related Transactions			79
Item 14. Principal Accountant Fees and Services			79
Item 15. Exhibits, Financial Schedules and Reports on Form 8-K			80-81
Signatures & Certifications			82-87
Total Pages:			87
EX-21
EX-31.1
EX-31.2
EX-32.1
EX-32.2

Statements contained in this portion of the Company’s annual report may be forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of such words as “intend,” “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential.” Such forward-looking statements are based on current expectations, but may differ materially from

those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in documents filed by the Company with the Securities and Exchange Commission from time to time. Other factors which could have a material adverse effect on the operations of the Company and its subsidiaries which include, but are not limited to, changes in interest rates, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Bank’s market area, changes in relevant accounting principles and guidelines and other factors over which management has no control. The forward-looking statements are made as of the date of this report, and the Company assumes no obligation to update the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements.

PART 1.

ITEM 1. BUSINESS

General

Farmers & Merchants Bancorp, Inc. (Company) is a bank holding company incorporated under the laws of Ohio in 1985. Our primary subsidiary, The Farmers & Merchants State Bank (Bank) is a community bank operating in Northwest Ohio since 1897. We report our financial condition and net income on a consolidated basis and we report only one segment.

Our executive offices are located at 307 North Defiance Street, Archbold, Ohio 43502, and our telephone number is (419) 446-2501.

For a discussion of the general development of the Company’s business throughout 2010, please see the portion of Management’s Discussion and Analysis of Financial Condition and Results of Operations captioned “2010 in Review”.

Nature Of Activities

The Bank’s primary service area, Ohio, continued to experience high but declining unemployment. After reaching a high of 11% unemployment in March, 2010, the unemployment rate decreased in each of the ensuing months and closed the year at 9.6%. The agricultural industry continued its strong performance in 2010. Steel and trucking showed renewed strength early in the year and provided a portent of an improving economy. 1-4 family residential and construction remain weak. The Consumer Confidence increased from an average of 45% in 2009 to 53% in 2010 and January, 2011 topped 60%.

The Farmers & Merchants State Bank engages in general commercial banking business. Their activities include commercial, agricultural and residential mortgage, consumer and credit card lending activities. Because the Bank’s offices are located in Northwest Ohio and Northeast Indiana, a substantial amount of the loan portfolio is comprised of loans made to customers in the farming industry for such things as farm land, farm equipment, livestock and operating loans for seed, fertilizer, and feed. Other types of lending activities include loans for home improvements, and loans for such items as autos, trucks, recreational vehicles, motorcycles, etc.

The Bank also provides checking account services, as well as savings and time deposit services such as certificates of deposits. In addition ATM’s (automated teller machines) are provided at most branch locations along with other independent locations such as major employers and hospitals in the market area. The Bank has custodial services for IRA’s (Individual Retirement Accounts) and HSA’s (Health Savings Accounts). The Bank provides on-line banking access for consumer and business customers. For consumers, this includes bill-pay and on-line statement opportunities. For business customers, it provides the option of electronic transaction origination such as wire and ACH file transmittal. In addition the Bank offers remote deposit capture or electronic deposit processing.

The Bank’s underwriting policies, exercised through established procedures, facilitate operating in a safe and sound manner in accordance with supervisory and regulatory guidance. Within this sphere of safety and soundness, the Bank’s practice has been not to promote innovative, unproven credit products which may not be in the best

interest of the Bank or its customers. The Bank does offer a hybrid loan. Hybrid loans are loans that start as a fixed rate mortgage but after a set number of years automatically adjust to an adjustable rate mortgage. The Bank offers a three year fixed rate mortgage after which the interest rate will adjust annually. The majority of the Bank’s adjustable rate mortgages are of this type. In order to offer longer term fixed rate mortgages, the Bank does participate in the Freddie Mac, Farmer Mac and Small Business Lending programs. The Bank also retains the servicing on these partially or 100% sold loans. In order for the customer to participate in these programs they must meet the requirements established by these agencies.

The Bank does not fund sub-prime loans. Sub-prime loans are characterized as a lending program or strategy that target borrowers who pose a significantly higher risk of default than traditional retail banking customers.

Following are the characteristics and underwriting criteria for each major type of loan the Bank offers:

Commercial Real Estate: Construction, purchase, and refinance of business purpose real estate. Risks include loan amount in relation to construction delays and overruns, vacancies, collateral value subject to market value fluctuations, interest rate, market demands, borrower’s ability to repay in orderly fashion, and others. The Bank does employ stress testing on higher balance loans to mitigate risk by ensuring the customer’s ability to repay in a changing rate environment before granting loan approval.

Agricultural Real Estate: Purchase of farm real estate or for permanent improvements to the farm real estate. Cash flow from the farm operation is the primary repayment source and is therefore subject to the financial success of the farm operation.

Consumer Real Estate: Purchase, refinance, or equity financing of one to four family owner occupied dwelling. Success in repayment is subject to borrower’s income, debt level, character in fulfilling payment obligations, employment, and other factors.

Commercial/Industrial: Loans to proprietorships, partnerships, or corporations to provide temporary working capital and seasonal loans as well as long term loans for capital asset acquisition. Risks include adequacy of cash flow, reasonableness of profit projections, financial leverage, economic trends, management ability, and others. The Bank does employ stress testing on higher balance loans to mitigate risk by ensuring the customer’s ability to repay in a changing rate environment before granting loan approval.

Agricultural: Loans for the production and housing of crops, fruits, vegetables, and livestock or to fund the purchase or re-finance of capital assets such as machinery and equipment, and livestock. The production of crops and livestock is especially vulnerable to commodity prices and weather. The vulnerability to commodity prices is offset by the farmer’s ability to hedge their position by using future contracts. The risk related to weather is often mitigated by requiring federal crop insurance.

Consumer: Funding for individual and family purposes. Success in repayment is subject to borrower’s income, debt level, character in fulfilling payment obligations, employment, and others.

Industrial Development Bonds: Funds for public improvements in the Bank’s service area. Repayment ability is based on the continuance of the taxation revenue as the source of repayment.

All loan requests are reviewed as to credit worthiness and are subject to the Bank’s underwriting guidelines as to secured versus unsecured credit. Secured loans are in turn subject to loan to value (LTV) requirements based on collateral types as set forth in the Bank’s Loan Policy. In addition, credit scores of principal borrowers are reviewed and an approved exception from an additional officer is required should a credit score not meet the Bank’s Loan Policy guidelines.

Consumer Loans:

Maximum loan to value (LTV) for cars, trucks and light trucks vary from 90% to 110% depending on whether direct or indirect. Loans above 100% are generally due to additional charges for extended warranties and/or insurance coverage periods of lost wages or death.

Boats, campers, motorcycles, RV’s and Motor Coaches range from 80%-90% based on age of vehicle. 1^st or 2^nd mortgages on 1-4 family homes range from 75%-90% with “in-house” first real estate mortgages requiring private mortgage insurance on those exceeding 80% LTV.
Raw land LTV maximum ranges from 65%-75% depending on whether or not the property has been improved.

Commercial/Agriculture:
Real Estate:
Maximum LTVs range from 70%-80% depending on type.
Accounts Receivable:
Up 80% LTV

Inventory:

Agriculture:
Livestock and grain up to 80% LTV, crops (insured) up to 75% and Warehouse Receipts up to 87%
Commercial:
Maximum LTV of 50% on raw and finished goods
Used vehicles, new recreational vehicles and manufactured homes not to exceed (NTE) 80% LTV

Equipment:

New not to exceed 80% of invoice, used NTE 50% of listed book or 75% of appraised value
Restaurant equipment up to 35% of market value
Heavy trucks, titled trailers and NTE 75% LTV and aircraft up to 75% of appraised value

We also provide checking account services, as well as savings and time deposit services such as certificates of deposits. In addition, ATM’s (automated teller machines) are also provided at our Ohio offices in Archbold, Wauseon, Stryker, West Unity, Bryan, Delta, Napoleon, Montpelier, Swanton, Defiance, and Perrysburg, along with ones at our Auburn and Angola, Indiana offices. Two ATM’s are located at Sauder Woodworking Co., Inc., a major employer in Archbold. Additional locations in Ohio are at Northwest State Community College, Archbold; Community Hospitals of Williams County, Bryan; Fairlawn Haven Wyse Commons, Archbold; R&H Restaurant, Fayette; Delta Eagles, Bryan Eagles; Sauder Village, Archbold; Fulton County Health Center, Wauseon; downtown Defiance; and a mobile trailer ATM. In Indiana, four additional ATM’s are located at St. Joe; at Kaiser’s Supermarket and Therma-Tru in Butler; and at DeKalb Memorial Hospital in Auburn.

F&M Investment Services, the brokerage department of the Bank, opened for business in April, 1999. Securities are offered through Raymond James Financial Services, Inc.

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956. Our subsidiary bank is in turn regulated and examined by the Ohio Division of Financial Institutions, and the Federal Deposit Insurance Corporation. The activities of our bank subsidiary are also subject to other federal and state laws and regulations.

The Bank’s primary market includes communities located in the Ohio counties of Defiance, Fulton, Henry, Williams, and Wood. The commercial banking business in this market is highly competitive, with approximately 17 other depository institutions currently doing business in the Bank’s primary market. In our banking activities, we compete directly with other commercial banks, credit unions, farm credit services, and savings and loan institutions in each of our operating localities. In a number of our locations, we compete against entities which are much larger than us. The primary factors in competing for loans and deposits are the rates charged as well as location and quality of the services provided. On December 31, 2007, the Bank acquired the Knisely Bank of Indiana, expanding its market with the addition of offices in Butler and Auburn, Indiana, both located in DeKalb County. An additional office was opened in the summer of 2008 in Angola, Indiana, located in Steuben County. On July 9, 2010 the Bank purchased a branch office in Hicksville, Ohio shortening the distance between our Ohio and Indiana office.

At December 31, 2010, we had 248 full time equivalent employees. The employees are not represented by a collective bargaining unit. We provide our employees with a comprehensive benefit program, some of which are contributory. We consider our employee relations to be excellent.

Supervision and Regulation

General

The Company is a corporation organized under the laws of the State of Ohio. The business in which the Company and its subsidiary are engaged is subject to extensive supervision, regulation and examination by various bank regulatory authorities. The supervision, regulation and examination to which the Company and its subsidiary are subject are intended primarily for the protection of depositors and the deposit insurance funds that insure the deposits of banks, rather than for the protection of shareholders.

Several of the more significant regulatory provisions applicable to banks and bank holding companies to which the Company and its subsidiary are subject are discussed below, along with certain regulatory matters concerning the Company and its subsidiary. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory provisions. Any change in applicable law or regulation may have a material effect on the business and prospects of the Company and its subsidiary.

Regulatory Agencies

The Company is a registered bank holding company and is subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) pursuant to the Bank Holding Company Act of 1956, as amended.

The Bank is an Ohio chartered commercial bank. It is subject to regulation and examination by both the Ohio Division of Financial Institutions (ODFI) and the Federal Deposit Insurance Corporation (FDIC).

Holding Company Activities

As a bank holding company incorporated and doing business within the State of Ohio, the Company is subject to regulation and supervision under the Bank Holding Act of 1956, as amended (the “Act”). The Company is required to file with the Federal Reserve Board on quarterly basis information pursuant to the Act. The Federal Reserve Board may conduct examinations or inspections of the Company and its subsidiary.

The Company is required to obtain prior approval from the Federal Reserve Board for the acquisition of more than five percent of the voting shares or substantially all of the assets of any bank or bank holding company. In addition, the Company is generally prohibited by the Act from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. The Company may, however, subject to the prior approval of the Federal Reserve Board, engage in, or acquire shares of companies engaged in activities which are deemed by the Federal Reserve Board by order or by regulation to be so closely related to banking or managing and controlling a bank as to be a proper activity.

On November 12, 1999, the Gramm-Leach-Bliley Act (the “GLB Act”) was enacted into law. The GLB Act made sweeping changes with respect to the permissible financial services which various types of financial institutions may now provide. The Glass-Steagall Act, which had generally prevented banks from affiliation with securities and insurance firms, was repealed. Pursuant to the GLB Act, bank holding companies may elect to become a “financial holding company,” provided that all of the depository institution subsidiaries of the bank holding company are “well capitalized” and “well managed” under applicable regulatory standards.

Under the GLB Act, a bank holding company that has elected to become a financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. Activities that are “financial in nature” include securities underwriting, dealing and market-making, sponsoring mutual funds and investment companies, insurance underwriting and agency, merchant banking, and activities that the Federal Reserve Board has determined to be closely related to banking. No Federal Reserve Board approval is required for the Company to acquire a company, other than a bank holding company, bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve

Board. Prior Federal Reserve Board approval is required before the Company may acquire the beneficial ownership or control of more than 5% of the voting shares, or substantially all of the assets, of a bank holding company, bank or savings association. If any subsidiary bank of the Company ceases to be “well capitalized” or “well managed” under applicable regulatory standards, the Federal Reserve Board may, among other actions, order the Company to divest the subsidiary bank. Alternatively, the Company may elect to conform its activities to those permissible for a bank holding company that is not also a financial holding company. If any subsidiary bank of the Company receives a rating under the Community Reinvestment Act of 1977 of less than satisfactory, the Company will be prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations. The Company has not elected to become a financial holding company and has no current intention of making such an election.

Affiliate Transactions

Various governmental requirements, including Sections 23A and 23B of the Federal Reserve Act, limit borrowings by holding companies and non-bank subsidiaries from affiliated insured depository institutions, and also limit various other transactions between holding companies and their non-bank subsidiaries, on the one hand, and their affiliated insured depository institutions on the other. Section 23A of the Federal Reserve Act also generally requires that an insured depository institution’s loan to its non-bank affiliates be secured, and Section 23B of the Federal Reserve Act generally requires that an insured depository institution’s transactions with its non-bank affiliates be on arms-length terms.

Interstate Banking and Branching

Under the Riegle-Neal Interstate Banking and Branching Efficiency Act (“Riegle-Neal”), subject to certain concentration limits and other requirements, adequately capitalized bank holding companies such as the Company are permitted to acquire banks and bank holding companies located in any state. Any bank that is a subsidiary of a bank holding company is permitted to receive deposits, renew time deposits, close loans, service loans and receive loan payments as an agent for any other bank subsidiary of that bank holding company. Banks are permitted to acquire branch offices outside their home states by merging with out-of-state banks, purchasing branches in other states and establishing de novo branch offices in other states. The ability of banks to acquire branch offices is contingent, however, on the host state having adopted legislation “opting in” to those provisions of Riegle-Neal. In addition, the ability of a bank to merge with a bank located in another state is contingent on the host state not having adopted legislation “opting out” of that provision of Riegle-Neal. The Company could from time to time use Riegle-Neal to acquire banks in additional states.

Control Acquisitions

The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank holding company, unless the Federal Reserve Board has been notified and has not objected to the transaction. Under the rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, such as the Company, would, under the circumstances set forth in the presumption, constitute acquisition of control of the bank holding company. In addition, a company is required to obtain the approval of the Federal Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of outstanding voting stock of a bank holding company, or otherwise obtaining control or a “controlling influence” over that bank holding company.

Liability for Banking Subsidiaries

Under the current Federal Reserve Board policy, a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to maintain resources adequate to support each subsidiary bank. This support may be required at times when the bank holding company may not have the resources to provide it. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a U.S. federal bank regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and entitled to priority of payment. Any depository institution insured by the FDIC can be held liable for any

loss incurred, or reasonably expected to be incurred, by the FDIC in connection with (1) the “default” of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to both a commonly controlled FDIC-insured depository institution “in danger of default.” The Company’s subsidiary bank is an FDIC-insured depository institution. If a default occurred with respect to the Bank, any capital loans to the Bank from its parent holding company would be subordinate in right of payment to payment of the Bank’s depositors and certain of its other obligations.

Regulatory Capital Requirements

The Company is required by the various regulatory authorities to maintain certain capital levels. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve Board capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses. The required capital levels and the Company’s capital position at December 31, 2010 are summarized in the table included in Note 14 to the consolidated financial statements.

FDICIA

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), and the regulations promulgated under FDICIA, among other things, established five capital categories for insured depository institutions-well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized-and requires U.S. federal bank regulatory agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements based on these categories. Unless a bank is well capitalized, it is subject to restrictions on its ability to offer brokered deposits and on certain other aspects of its operations. An undercapitalized bank must develop a capital restoration plan and its parent bank holding company must guarantee the bank’s compliance with the plan up to the lesser of 5% of the banks or thrift’s assets at the time it became undercapitalized and the amount needed to comply with the plan. As of December 31, 2010, the Company’s banking subsidiary was well capitalized pursuant to these prompt corrective action guidelines.

Dividend Restrictions

The ability of the Company to obtain funds for the payment of dividends and for other cash requirements will be largely dependent on the amount of dividends which may be declared by its banking subsidiary. Various U.S. federal statutory provisions limit the amount of dividends the Company’s banking subsidiary can pay to the Company without regulatory approval. Dividend payments by the Bank are limited to its retained earnings during the current year and its prior two years. See Note 15 to the consolidated financial statements for the actual amount.

Deposit Insurance Assessments

The deposits of the Company’s banking subsidiary are insured up to regulatory limits set by the FDIC, and, accordingly in 2010, were subject to deposit insurance assessments based on the Federal Deposit Insurance Reform Act of 2005, as adopted and effective on April 21, 2006. The FDIC maintains the Deposit Insurance Fund (“DIF”) by assessing depository institutions an insurance premium (assessment). The amount assessed to each institution is based on statutory factors that include the balance of insured deposits as well as the degree of risk the institution poses to the DIF. The FDIC assesses higher rates to those institutions that pose greater risks to the insurance fund.

In order to recapitalize and restore the DIF, the FDIC initially established a Restoration Plan in October 2008 to return the DIF to the statutorily mandated minimum reserve ratio of 1.15 percent within five years. Since 2008 and due to the extraordinary circumstances facing the banking industry, the FDIC imposed an emergency special assessment in 2009 and has continued to make further amendments to its Restoration Plan by extending the restoration period for the DIF, increasing the premium assessments, and changing how regular deposit insurance premiums are assessed. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) revised the statutory authorities governing the FDIC’s management of the DIF. Key requirements from the Dodd-Frank Act have resulted in the FDIC’s adoption of the following proposed amendments: (1) redefined the assessment base used to calculate deposit insurance assessments to “average consolidated total assets minus average

tangible equity” (2) raised the DIF’s minimum reserve ratio to 1.35 percent and removed the upper limit on the reserve ratio; (3) revised adjustments to the assessment rates by eliminating one adjustment and adding another; and (4) revised the deposit insurance assessment rate schedules due to changes to the assessment base. Revised rate schedules and other revisions to the deposit insurance assessment rules would become effective April 1, 2011 and would be used to calculate the June 30, 2011 assessments which are due September 30, 2011. Though deposit insurance assessments maintain a risk-based approach, the FDIC’s proposed changes effective April 1, 2011, impose a more extensive risk-based assessment system on large insured depository institutions with at least $10 billion in total assets since they are more complex in nature and could pose greater risk. Due to the changes to the assessment base and assessment rates, as well as the DIF restoration time frame, the impact on the Company’s future deposit insurance assessments will likely result in increased premiums in future years.

The Emergency Economic Stabilization Act of 2008 provided a temporary increase in deposit insurance coverage from $100,000 to $250,000 per depositor. This legislation was effective immediately upon the President’s signature on October 3, 2008. The basic deposit insurance limit was set to return to $100,000 on January 1, 2010; however, on May 20, 2009 the temporary increase was extended through December 31, 2013.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) permanently raised the standard maximum deposit insurance coverage amount to $250,000 and made the increase retroactive to January 1, 2008. This was effective immediately upon the President’s signature on July 21, 2010. The FDIC deposit insurance coverage limit applies per depositor, per insurance depository institution for each account ownership category.

The FDIC Board of Directors issued a final rule on November 9, 2010 implementing a provision of the Dodd-Frank Act which temporarily provided for separate deposit insurance coverage for noninterest-bearing transaction accounts. Funds held in noninterest-bearing transaction accounts are fully insured, without limit, and the temporary unlimited coverage is separate from, and in addition to, the deposit insurance coverage provided to depositors with respect to other accounts held at an insured depository institution. This temporary deposit insurance coverage became effective on December 31, 2010 and will terminate on December 31, 2012. A noninterest-bearing transaction account is a deposit account in which (1) interest is neither accrued nor paid, (2) depositors are permitted to make an unlimited number of transfers and withdrawals, and (3) the insured depository institution does not reserve the right to require advance notice of an intended withdrawal. As of January 1, 2013, noninterest-bearing transaction accounts will then be insured under the FDIC’s general deposit insurance coverage rules. The Dodd-Frank Act provision did not include low-interest NOW (Negotiable Order of Withdrawal) Accounts or Interest on Lawyer Trust Accounts (“IOLTAs”) within the definition of noninterest-bearing transaction accounts. On December 29, 2010, the FDIC Board of Directors issued a final rule amending the Federal Deposit Insurance Act (FDI Act) to include IOLTAs within the definition of a noninterest-bearing transaction account thereby providing such accounts with temporary, unlimited deposit insurance coverage.

Depositor Preference Statute

In the “liquidation or other resolution” of an institution by any receiver, U.S. federal legislation provides that deposits and certain claims for administrative expenses and employee compensation against the insured depository institution would be afforded a priority over general unsecured claims against that institution, including federal funds and letters of credit.

Government Monetary Policy

The earnings of the Company are affected primarily by general economic conditions and to a lesser extent by the fiscal and monetary policies of the federal government and its agencies, particularly the Federal Reserve. Its policies influence, to some degree, the volume of bank loans and deposits, and interest rates charged and paid thereon, and thus have an effect on the earnings of the Company’s subsidiary Bank.

Capital Purchase Program

In response to the financial crisis affecting the banking system and financial markets, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law on October 3, 2008 creating the Troubled Assets Relief Program (“TARP”). As part of TARP, the U.S. Treasury established the Capital Purchase Program to provide up to

$700 billion of funding to eligible financial institutions through the purchase of capital stock and other financial institutions for the purpose of stabilizing and providing liquidity to the United States financial markets. The Company did not participate in the TARP Capital Purchase Program. In connection with the EESA, there have been numerous actions by the Federal Reserve Board, the United States Congress, the U.S. Treasury, the FDIC, the SEC and others to further the economic and banking industry stabilization efforts under the EESA. It remains unclear at this time what further legislative and regulatory measures will be implemented under the EESA that affect the Company.

Additional Regulation

The Bank is also subject to federal regulation as to such matters as required reserves, limitation as to the nature and amount of its loans and investments, regulatory approval of any merger or consolidation, issuance or retirement of their own securities, limitations upon the payment of dividends and other aspects of banking operations. In addition, the activities and operations of the Bank are subject to a number of additional detailed, complex and sometimes overlapping laws and regulations. These include state usury and consumer credit laws, state laws relating to fiduciaries, the federal Truth-in-Lending Act and Regulation Z, the federal Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the federal Home Mortgage Disclosure Act and Regulation C, the federal Electronic Funds Transfer Act and Regulation E, the federal Truth in Lending Act and Regulation Z, the federal Truth in Savings Act and Regulation DD, the Bank Secrecy Act, the federal Community Reinvestment Act, HUD’s Real Estate Settlement Act (RESPA) regulations, anti-discrimination laws and legislation, and antitrust laws.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) signed by the President on July 21, 2010 posed a significant impact on financial regulations. Certain provisions such as the permanent increase in deposit insurance coverage had an immediate effective date. Provisions regarding rules for interchanges fees on electronic debit transactions must be effective by July 21, 2011. Other provisions which, though intended to provide regulatory relief to community banks, may require time and further analysis to evaluate the actual consequences. Implementation of the Dodd-Frank Act provisions, which are conservatively estimated at more than 5,000 pages of new or expanded regulations for banks, will result in new rulemaking by the federal regulatory agencies over the next several years. Fully implementing the new and expanded regulation will involve ensuring compliance with extensive new disclosure and reporting requirements. The Dodd-Frank Act created an independent regulatory body, the Bureau of Consumer Financial Protection (“Bureau”), with authority and responsibility to set rules and regulations for most consumer protection laws applicable to all banks — large and small — adds another regulator to scrutinize and police financial activities. Transfer to the Bureau of all consumer financial protection functions for designated laws by the other federal agencies must be completed no later than July 21, 2011. The Bureau has responsibility for mortgage reform and enforcement, as well as broad new powers over consumer financial activities which could impact what consumer financial services would be available and how they are provided. The following consumer protection laws are the designated laws that will fall under the Bureau’s rulemaking authority: the Alternative Mortgage Transactions Parity Act of 1928, the Consumer Leasing Act of 1976, the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, the Fair Credit Billing Act, the Fair Credit Reporting Act subject to certain exclusions, the Fair Debt Collection Practices Act, the Home Owners Protection Act, certain privacy provisions of the Gramm-Leach-Bliley Act, the Home Mortgage Disclosure Act (HMDA), the Home Ownership and Equity Protection Act of 1994, the Real Estate Settlement Procedures Act (RESPA), the S.A.F.E. Mortgage Licensing Act of 2008 (SAFE Act), and the Truth in Lending Act. Review and revision of current financial regulations in conjunction with added new financial service regulations will heighten the regulatory compliance burden and increase litigation risk for the banking industry.

Future Legislation

Changes to the laws and regulations, both at the federal and state levels, can affect the operating environment of the Company and its subsidiary in substantial and unpredictable ways. The Company cannot accurately predict whether those changes in laws and regulations will occur, and, if those changes occur, the ultimate effect they would have upon the financial condition or results of operations of the Company or its subsidiary.

****Available Information:

The Company maintains an Internet web site at the following internet address: www.fm-bank.com. The Company files reports with the Securities and Exchange Commission (SEC). Copies of all filings made with the SEC may be read and

copied at the SEC’s Public Reference Room, 450 Fifth Street, Washington, DC, 20549. You may obtain information about the SEC’s Public Reference Room by calling (800/SEC-0330). Because the Company makes its filing with the SEC electronically, you may access such reports at the SEC’s website, www.sec.gov. The Company makes available, free of charge through its internet address, copies of its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports as soon as reasonable practicable after such materials have been filed with or furnished to the SEC. Copies of these documents may also be obtained, either in electronic or paper form, by contacting Barbara J. Britenriker, Chief Financial Officer of the Company at (419) 446-2501.

Please see the Consolidated Financial Statements provided under Part II, Item 8 of this Form 10-K for information regarding the Company’s revenues from external customers, profits, and total assets for and as of, respectively, the fiscal year ended December 31, 2010.

ITEM 1a. RISK FACTORS

Significant Competition from an Array of Financial Service Providers

Our ability to achieve strong financial performance and a satisfactory return on investment to shareholders will depend in part on our ability to expand our available financial services. In addition to the challenge of attracting and retaining customers for traditional banking services, our competitors now include securities dealers, brokers, mortgage bankers, investment advisors and finance and insurance companies who seek to offer one-stop financial services to their customers that may include services that banks have not been able or allowed to offer to their customers in the past. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems and the accelerating pace of consolidation among financial services providers. If we fail to adequately address each of the competitive pressures in the banking industry, our financial condition and results of operations could be adversely affected.

Credit Risk

The risk of nonpayment of loans is inherent in commercial banking. Such nonpayment could have an adverse effect on the Company’s earnings and our overall financial condition as well as the value of our common stock. Management attempts to reduce the Bank’s credit exposure by carefully monitoring the concentration of its loans within specific industries and through the loan approval process. However, there can be no assurance that such monitoring and procedures will totally mitigate the risks. Credit losses can cause insolvency and failure of a financial institution and, in such event, its shareholders could lose their entire investment. For more information on the exposure of the Company and the Bank to credit risk, see the section under Part II, Item 7 of this Form 10-K captioned “Loan Portfolio.”

Susceptibility to Changes in Regulation

Any changes to state and federal banking laws and regulations may negatively impact our ability to expand services and to increase the value of our business. We are subject to extensive state and federal regulation, supervision, and legislation that govern almost all aspects of our operations. These laws may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds. In addition, the Company’s earnings are affected by the monetary policies of the Board of Governors of the Federal Reserve. These policies, which include regulating the national supply of bank reserves and bank credit, can have a major effect upon the source and cost of funds and the rates of return earned on loans and investments. The Federal Reserve influences the size and distribution of bank reserves through its open market operations and changes in cash reserve requirements against member bank deposits. The Gramm-Leach-Bliley Act regarding financial modernization that became effective in November, 1999 removed many of the barriers to the integration of the banking, securities and insurance industries and is likely to increase the competitive pressures upon the Bank. We cannot predict what effect such Act and any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, but such changes could be materially adverse to our financial performance. For more information on this subject, see the section under Part I, Item 1 of this Form 10-K captioned “Supervision and Regulation.”

Interest Rate Risk

Changes in interest rates affect our operating performance and financial condition in diverse ways. Our profitability depends in substantial part on our “net interest spread,” which is the difference between the rates we receive on loans and investments and the rates we pay for deposits and other sources of funds. Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal economic, monetary and fiscal policies, and economic conditions generally. Historically, net interest spreads for other financial institutions have widened and narrowed in response to these and other factors, which are often collectively referred to as “interest rate risk.” Over the last few years, the Bank, along with most other financial institutions, has experienced a “margin squeeze” as drastic interest rate fluctuations have made it difficult to maintain a more favorable net interest spread. During 2010, the Bank’s margin and spread tightened slightly as the rate environment remained low and flat. Maturities of higher rate deposits aided the decrease in cost of funds.

The Bank manages interest rate risk within an overall asset/liability framework. The principal objectives of asset/liability management are to manage sensitivity of net interest spreads and net income to potential changes in interest rates. Funding positions are kept within predetermined limits designed to ensure that risk-taking is not excessive and that liquidity is properly managed. In the event that our asset/liabilities management strategies are unsuccessful, our profitability may be adversely affected. For more information regarding the Company’s exposure to interest rate risk, see Part II, Item 7A of this Form 10-K.

Attraction and Retention of Key Personnel

Our success depends upon the continued service of our senior management team and upon our ability to attract and retain qualified financial services personnel. Competition for qualified employees is intense. In our experience, it can take a significant period of time to identify and hire personnel with the combination of skills and attributes required in carrying out our strategy. If we lose the services of our key personnel, or are unable to attract additional qualified personnel, our business, financial condition, results of operations and cash flows could be materially adversely affected.

A key component of employee retention is providing a fair compensation base combined with the opportunity for additional compensation for above average performance. In this regard, the Company and the Bank use two incentive programs. The Company uses a stock award program to recognize and incent officers of the Bank. Under the long-term incentive compensation plan, restricted stock awards may be granted to officers. The amount of shares to be granted each year is determined by the Board Compensation Committee and may vary each year in its amount of shares and the number of recipients. The Compensation Committee determines the number of shares to be awarded overall and to the Chief Executive Officer (“CEO”). The CEO then makes recommendations to the committee as to the recipients of the remaining shares. The full Board of Directors approves the action of the Committee. Since the plan’s inception in 2005, all granted stock awards have utilized a three year cliff vesting feature. This is viewed as a retention aid as the awards may be forfeited should an officer leave employment during the vesting period.

A second incentive program of the Bank is based on cash compensation of which almost all employees participate (excluding commission based employees and other employees paid for specific higher paid positions, such as peak time.) A discussion of executive officer pay is incorporated within the proxy and as such, this discussion will pertain to all other employees. Non-officer employees are paid a cash incentive based on the projected overall performance of the Bank in terms of Return of Average Assets (“ROA”). The Compensation Committee determines the target performance levels on which the percentage of pay will be based. The Committee takes into account the five and ten year trend of ROA along with budget forecasted for the next year and the Bank’s past year performance. The Committee also considers the predicted banking environment under which the Bank will be operating. Non-officers receive incentive pay in December of the same year based on the year-to-date base compensation through the last pay received in November.

Officers, other than executive, receive incentive pay based on additional criterion. The officers are rewarded based on overall ROA of the Bank along with individual pre-established goals. Officers, therefore, have incentive pay at risk for individual performance. The individualized goals are recommended by each officer’s supervisor and are approved by an incentive committee of the Bank. The goals are designed to improve the performance of the Bank while also

limiting the risk of a short-term performance focus. For example, a lending officer may be given two goals of which one is to grow loans within specific targets and another is tied to a specific level of past dues and charge-offs. The second goal limits the ability to be rewarded for growth at all costs along with the specific target levels within the growth goal itself. Officers in a support department may be given goals which create efficiencies, ensure compliance with procedures, or generate new fee or product opportunities. An average of four goals were given to each officer in 2010. Officers are paid cash incentives based on the year end ROA of the Bank and receive it within the first quarter of the following year. Should the ROA be forecasted to be positive but below the base target set by the Board, the officers are paid an incentive under the same basis and timing as non-officers disclosed above.

The percentages of base pay on which the incentive is calculated graduates higher as does the responsibility level of the employee and their ability to impact the financial performance of the Bank. These percentages are recommended by management to the Compensation Committee and Board for approval. The cash incentive plan along with its targets and goals are subject to modification at the Compensation Committee and Board’s discretion throughout each year.

Dividend Payout Restrictions

We currently pay a quarterly dividend on our common shares. However, there is no assurance that we will be able to pay dividends in the future. Dividends are subject to determination and declaration by our board of directors, which takes into account many factors. The declaration of dividends by us on our common stock is subject to the discretion of our board and to applicable state and federal regulatory limitations. The Company’s ability to pay dividends on its common stock depends on its receipt of dividends from the Bank. The Bank is subject to restrictions and limitations in the amount and timing of the dividends it may pay to the Company.

Anti-Takeover Provisions

Provisions of our Articles of Incorporation and Ohio law could have the effect of discouraging takeover attempts which certain stockholders might deem to be in their interest. These anti-takeover provisions may make us a less attractive target for a takeover bid or merger, potentially depriving shareholders of an opportunity to sell their shares of common stock at a premium over prevailing market prices as a result of a takeover bid or merger.

Operational Risks

We are subject to certain operational risks, including, but not limited to, data processing system failures and errors, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. We maintain a system of internal controls to mitigate against such occurrences and maintain insurance coverage for such risks that are insurable, but should such an event occur that is not prevented or detected by our internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on our business, financial condition or results of operations.

Limited Trading Market

Our common stock is not listed on any exchange or The NASDAQ Stock Market. Our stock is currently quoted in the over-the-counter markets.

ITEM 1b. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Our principal office is located in Archbold, Ohio.

The Bank operates from the facilities at 307 North Defiance Street. In addition, the Bank owns the property from 200 to 208 Ditto Street, Archbold, Ohio, which it uses for Bank parking and a community mini-park area. The Bank owns

real estate at two locations, 207 Ditto Street and 209 Ditto Street in Archbold, Ohio upon which the bank built a commercial building to be used for storage, and a parking lot for company vehicles and employee parking. The Bank also owns real estate across from the main facilities to provide for parking.

The Bank occupies an Operations Center at 622 Clydes Way in Archbold, Ohio to accommodate our growth over the years. The bank owns a parking lot in downtown Montpelier which had been provided for customer use. The bank owns a property at 204 Washington Street, St Joe, Indiana at which an ATM is located.

The Bank owns all of its office locations, with the exception of Angola, Indiana. The Angola office location is leased. Current locations of retail banking services are:

Office				Location
Archbold, Ohio				1313 S Defiance Street
Wauseon, Ohio				1130 N Shoop Avenue 119 N Fulton Street
Stryker, Ohio				300 S Defiance Street
West Unity, Ohio				200 W Jackson Street
Bryan, Ohio				929 E High Street
				1000 S Main Street
Delta, Ohio				101 Main Street
Montpelier, Ohio				1150 E Main Street
Napoleon, Ohio				2255 Scott Street
Swanton, Ohio				7 Turtle Creek Circle
Defiance, Ohio				1175 Hotel Drive
Perrysburg, Ohio				7001 Lighthouse Way
Butler, Indiana				200 S Broadway
Auburn, Indiana				403 Erie Pass
Angola, Indiana				2310 N Wayne Street
Hicksville, Ohio				100 N. Main Street

All but one of the above locations have drive-up service facilities and an ATM.

ITEM 3. LEGAL PROCEEDINGS

There are no material pending legal proceedings, other than ordinary routine proceedings incidental to the business of the Bank or the Company, to which we are a party or of which any of our properties are the subject.

ITEM 4. No longer applicable.

PART II.

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is not listed on the NASDAQ stock market or any other stock exchange. While there is no established public trading market for our common stock, our shares are currently dually-quoted by various market makers on the Pink Sheets and the Over the Counter Bulletin Board, which are both over-the-counter quotation services for participant broker-dealers.

There are market makers that set a price for our stock; however, private sales continue to occur. The high and low sale prices were from sales of which we have been made aware by researching daily on Bloomberg.com. The high and low sale prices known to our management are as follows:

		Stock Prices 2010
Quarter		Low				High
1st		$	16.00			$	19.00
2nd			17.00				20.00
3rd			17.95				19.45
4th			16.95				18.75

		Stock Prices 2009
Quarter		Low				High
1st		$	17.60			$	20.00
2nd			17.55				20.50
3rd			19.25				20.99
4th			15.20				19.00

The Company utilizes Registrar and Transfer Company as its transfer agent.

As of February 7, 2011 there were 2,052 record holders of our common stock.

Below is a line-graph presentation comparing the cumulative total shareholder returns for the Corporation, an index for NASDAQ Stock Market (U.S. Companies) comprised of all domestic common shares traded on the NASDAQ National Market System and the NASDAQ Bank Index for the five-year period ended December 31, 2010. The chart compares the value of $100 invested in the Corporation and each of the indices and assumes investment on December 31, 2005 with all dividends reinvested.

The Board of Directors recognizes that the market price of stock is influenced by many factors, only one of which is performance. The stock price performance shown on the graph is not necessarily indicative of future performance.

I. Year 2005 as the Base

		2005				2006				2007				2008				2009				2010
FMSB			100.00				102.11				95.40				97.31				84.16				94.87
NASDAQ — COMPOSITE			100.00				110.33				121.98				74.11				106.34				124.87
NASDAQ-BANK INDEX			100.00				113.65				91.88				73.53				62.73				70.25

Dividends are declared and paid quarterly. Per share dividends declared for the years ended 2010 and 2009 are as follows:

		1st Quarter		2nd Quarter		3rd Quarter		4th Quarter		Total
2010		0.18		0.18		0.18		0.19		0.73
2009		0.18		0.18		0.18		0.18		0.72

The ability of the Company to pay dividends is limited by the dividend that the Company receives from the Bank. The Bank may pay as dividends to the Company its retained earnings during the current year and its prior two years. Currently, such limitation on the payment of dividends from the Bank to the Company does not materially restrict the Company’s ability to pay dividends to its shareholders.

Dividends declared during 2010 were $0.73 per share totaling $3.44 million, 1.39% higher than 2009 declared dividends of $0.72 per share. During 2010, the Company purchased 48,130 shares and awarded 10,150 shares to 53 employees and 1,575 shares were forfeited under its long term incentive plan. At year end, 2010, the Company held 477,106 shares in Treasury stock and 28,925 in unearned stock awards.

Dividends declared during 2009 were $0.72 per share totaling $3.41 million, 5.88% higher than 2008 declared dividends of $0.68 per share. During 2009, the Company purchased 28,907 shares and awarded 10,000 restricted shares to 49 employees under its long term incentive plan. 350 shares were forfeited during 2009. At year end 2009, the Company held 437,551 shares in Treasury stock and 27,775 in unearned stock awards.

The Company continues to have a strong capital base and to maintain regulatory capital ratios that are significantly above the defined regulatory capital ratios. On January 21, 2011, the Company announced the authorization by its Board of Directors for the Company’s repurchase, either on the open market, or in privately negotiated transactions, of up to 200,000 shares of its outstanding common stock commencing January 1, 2011 and ending December 31, 2011.

ISSUER PURCHASES OF EQUITY SECURITIES

										Total Number of
										Shares Purchased as				Remaining Share
		Total Number of				Average Price Paid				Part of Publicly				Repurchase
Period		Shares Purchased				per Share				Announced Programs				Authorization
10/1/2010 to 10/31/2010			—				—				—				172,275
11/1/2010 to 11/30/2010			5,000			$	18.00				5,000				167,275
12/1/2010 to 12/31/2010			15,405			$	17.61				15,405				151,870
Total (I)			20,405			$	17.70				20,405				151,870

Reclassification

Certain amounts in the 2009 and 2008 consolidated financial statements have been reclassified to conform with the 2010 presentation.

ITEM 6. SELECTED FINANCIAL DATA

SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA

Summary of Consolidated Statement of Income — UNAUDITED

		(In Thousands, except share data)
		2010				2009				2008				2007				2006
Summary of Income:
Interest income		$	39,893			$	41,114			$	43,824			$	45,424			$	42,269
Interest expense			10,863				13,220				18,101				21,722				18,535
Net Interest Income			29,030				27,894				25,723				23,702				23,734
Provision for loan loss			5,325				3,558				1,787				871				525
Net interest income after provision for loan loss			23,705				24,336				23,936				22,831				23,209
Other income (expense), net			(14,342	)			(15,256	)			(14,763	)			(12,269	)			(11,966	)
Net income before income taxes			9,363				9,080				9,173				10,562				11,243
Income taxes			2,382				2,475				2,450				2,828				3,107
Net income		$	6,981			$	6,605			$	6,723			$	7,734			$	8,136
Per Share of Common Stock:
Earnings per common share outstanding *
Net income		$	1.48			$	1.39			$	1.39			$	1.52			$	1.57
Dividends		$	0.730			$	0.720			$	0.680			$	0.640			$	0.575
Weighted average number of shares outstanding			4,721,235				4,741,392				4,846,310				5,097,636				5,186,329

Summary of Consolidated Balance Sheet — UNAUDITED

		(In Thousands)
		2010				2009				2008				2007				2006
Total assets		$	906,363			$	853,860			$	805,729			$	803,974			$	737,096
Loans, net			521,883				563,911				562,336				523,474				498,580
Total Deposits			724,513				676,444				615,732				634,593				585,409
Stockholders’ equity			94,403				93,584				90,547				89,375				87,732
Key Ratios
Return on average equity			7.38	%			7.19	%			7.51	%			8.71	%			9.64	%
Return on average assets			0.80	%			0.80	%			0.84	%			1.06	%			1.14	%
Loans to deposits			72.03	%			83.36	%			91.33	%			82.49	%			85.17	%
Capital to assets			10.42	%			10.96	%			11.24	%			11.12	%			11.90	%
Dividend payout			49.33	%			51.66	%			48.77	%			42.00	%			36.63	%

ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Critical Accounting Policy and Estimates

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, and the Company follows general practices within the financial services industry in which it operates. At times the application of these principles requires Management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements and accompanying notes. These assumptions, estimates and judgments are based on information available as of the date of the financial statements. As this information changes, the financial statements could reflect different assumptions, estimates and judgments. Certain policies inherently have a greater reliance on assumptions, estimates and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Examples of critical assumptions, estimates and judgments are when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not required to be recorded at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability must be recorded contingent upon a future event.

All significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the notes to the consolidated financial statements and in the management discussion and analysis of financial condition and results of operations, provide information on how significant assets and liabilities are valued and how those values are determined for the financial statements. Based on the valuation techniques used and the sensitivity of financial statement amounts to assumptions, estimates and judgments underlying those amounts, management has identified the determination of the Allowance for Loan and Lease Losses (ALLL) and the valuation of its Mortgage Servicing Rights and Other Real Estate Owned (OREO) as the accounting areas that requires the most subjective or complex judgments, and as such could be the most subject to revision as new information becomes available.

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of fair value or the loan carrying amount at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by Management and the assets are carried at the lower of carrying amount or fair value less cost to sell.

The ALLL represents management’s estimate of credit losses inherent in the Bank’s loan portfolio at the report date. The estimate is a composite of a variety of factors including experience, collateral value, and the general economy. ALLL includes a specific portion, a formula driven portion, and a general nonspecific portion. The collection and ultimate recovery of the book value of the collateral, in most cases, is beyond our control.

The Company is also required to estimate the value of its Mortgage Servicing Rights. The Company recognizes as separate assets rights to service fixed rate single-family mortgage loans that it has sold without recourse but services for others for a fee. Mortgage servicing assets are initially recorded at cost, based upon pricing multiples as determined by the purchaser, when the loans are sold. Mortgage servicing assets are carried at the lower of the initial carrying value, adjusted for amortization, or estimated fair value. Amortization is determined in proportion to and over the period of estimated net servicing income using the level yield method. For purposes of determining impairment, the mortgage servicing assets are stratified into like groups based on loan type, term, new versus seasoned and interest rate. The valuation is completed by an independent third party.

The expected and actual rates of mortgage loan prepayments are the most significant factors driving the potential for the impairment of the value of mortgage servicing assets. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced.

The Company’s mortgage servicing rights relating to loans serviced for others represent an asset of the Company. This asset is initially capitalized and included in other assets on the Company’s consolidated balance sheet. The mortgage servicing rights are then amortized against noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying mortgage servicing rights. There are a number of factors, however, that can affect the ultimate value of the mortgage servicing rights to the Company, including the estimated prepayment speed of the loan and the discount rate used to present value the servicing right. For

example, if the mortgage loan is prepaid, the Company will receive fewer servicing fees, meaning that the present value of the mortgage servicing rights is less than the carrying value of those rights on the Company’s balance sheet. Therefore, in an attempt to reflect an accurate expected value to the Company of the mortgage servicing rights, the Company receives a valuation of its mortgage servicing rights from an independent third party. The independent third party’s valuation of the mortgage servicing rights is based on relevant characteristics of the Company’s loan servicing portfolio, such as loan terms, interest rates and recent national prepayment experience, as well as current national market interest rate levels, market forecasts and other economic conditions. Management, with the advice from its third party valuation firm, review the assumptions related to prepayment speeds, discount rates, and capitalized mortgage servicing income on a quarterly basis. Changes are reflected in the following quarter’s analysis related to the mortgage servicing asset. In addition, based upon the independent third party’s valuation of the Company’s mortgage servicing rights, management then establishes a valuation allowance by each strata, if necessary, to quantify the likely impairment of the value of the mortgage servicing rights to the Company. The estimates of prepayment speeds and discount rates are inherently uncertain, and different estimates could have a material impact on the Company’s net income and results of operations. The valuation allowance is evaluated and adjusted quarterly by management to reflect changes in the fair value of the underlying mortgage servicing rights based on market conditions. The accuracy of these estimates and assumptions by management and its third party can be directly tied back to the fact that management has not been required to record a valuation allowance through its income statement based upon the valuation of each stratum of serving rights.

For more information regarding the estimates and calculations used to establish the ALLL and the value of Mortgage Servicing Rights, please see Note 1 to the consolidated financial statements provided herewith.

2010 in Review

During 2010 the Company proved it was up to the challenges presented by another tough year. One of the first indications of decreased revenue caused by regulatory changes was felt in the overdraft fee arena. The impact of regulatory reform on fees in banking remains a concern for the Company in the coming years. Economic challenges were also faced by the Company, our shareholders, employees and customers. Unemployment remained high in the markets we serve, though slight improvements began towards the second half of the year. The economic outlook appears to favor the economic recovery, though recognition of its fragility exists.

Continued difficult economic stresses caused the Company to experience significant expenses to improve its loan quality and to seek additional sources of revenue to offset these costs. Loan costs included increased collection, loss provision, and legal expenses. The benefits of those costs were an $8.2 million decrease in nonaccrual loans, $7.8 million decrease in loans classified as impaired, and an overall $8.7 million decrease in the Bank’s watch list loans, as of December 31, 2010 as compared to 2009, all of which; positions the Company for better earnings in the year to come.

The improvement in asset quality also correlates to a $42 million decrease in the net loan balances when comparing December 31, 2010 to the same date in 2009. This smaller loans balance in turn explains a somewhat hidden cost — a decline in the interest income from loans for 2010 as compared to 2009. This is discussed in greater detail in the net interest income section.

Offsetting the additional expenses in the loan portfolio was the $956 thousand gain on sale of investments and an increase in noninterest income during 2010. A decrease in long-term rates during the fourth quarter spurred activity in the consumer real estate market and the addition of the Hicksville office in July 2010 contributed to the increase in noninterest income.

The Company is proud of the strides that were achieved in improving asset quality while increasing 2010’s net income over 2009. Earnings per share were $0.09 higher than the previous two years. The Company is well positioned to face the challenges of 2011.

Material Changes in Results of Operations

The discussion now turns to more financial based results and trends as a result of 2010 operations. In comparing line items of the consolidated statement of income for years ended 2008 through 2010, it is easily seen where the Company has been spending its time and the impact of the recession. Decreasing interest income and expense are obvious large factors on the profitability of the Company for 2010; however, that discussion can be found in the net interest income section. This discussion will focus on the significant noninterest items that impacted the operations of the Company.

Looking at the positive items first; overall, non-interest income shows a trend of improvement. A nice improvement of $1.1 million in 2010 over 2009 was preceded by a more significant gain of over $1.3 million in 2009 as compared to 2008. Accounting for over $1 million of the gain in 2009 was the revenue generated from mortgage loan activity through establishing mortgage servicing rights and gain on the sale of loans into the secondary market. As mentioned earlier, the fourth quarter of 2010 was also a busy time handling refinance activity for mortgages; however the volume was below 2009. In terms of dollars, 2010 was $381 thousand lower than 2009’s noninterest income from mortgage activities. It did make up almost $1.4 million of noninterest income in 2010. It was a much needed, but unexpected source of increased revenue.

The largest difference in noninterest income for 2010 compared to the previous years was the gain on sale of securities. For 2010, it accounted for $956 thousand compared to $230 and $15 thousand for 2009 and 2008 respectively. The Bank was able to take advantage of the ability to book some gains on the sale of securities. This opportunity presented itself in the first and last quarter of 2009 and the first three quarters of 2010. The Bank did not sacrifice long term profitability for short term gains as the yields of the portfolio were not negatively impacted by the sales. The discussion on causes for changes to yields follows in the interest section. The Bank did recognize a loss of just over $50 thousand on an equity security of a Banker’s Bank in 2009. The entity had been taken over by the FDIC with its assets and deposits being bought by another financial institution.

Another increase to non-interest income was derived from increased debit card usage. As the Bank receives interchange revenue from each “swipe” of the card, usage increased thereby increasing revenue over $232 thousand in 2010 as compared to 2009 and over $126.5 thousand in 2009 over 2008. Both increases are attributed to the growth and popularity of the Bank’s Reward checking product which migrated to KASASA in 2010. One of the criteria for the payment of high interest on the account is utilizing the debit card at least twelve times per statement cycle. The Bank’s Reward & KASASA Checking customers averaged 25 transactions per statement during 2009 and 2010, surpassing the 9 transactions average of our Free Checking customers. The additional revenue from debit card usage offsets the interest expense, creating a win-win situation for the customers and the Bank. In 2011, this revenue stream may be reduced by the Federal Reserve regulating the interchange fee. All of the KASASA products have a debit card usage qualification; however, interest income is not the customer benefit for all accounts. As an alternative to receiving interest on their deposits, customers may choose to receive credit towards iTunes downloads or donate earnings to charity.

One additional noninterest income item to mention is overdraft and return check fee income. This revenue source increased $37.7 thousand or 1.6% in 2010 over 2009 supported by a 9% increase in the number of accounts and a $20 million increase in year-end balances. Hicksville accounted for 44% of the increase in the number of accounts and only 19% in the balances. During 2009, this revenue stream decreased 6.5%, or $176 thousand, during 2009 even though the number of checking accounts increased 4.16% and the portfolio yearend balance was $23.6 million higher in 2009 than 2008. Over the last three years, the average revenue per account continued to decrease due to regulatory changes. This revenue source remains under intense regulatory review and additional changes are required in 2011 that may negatively impact revenue.

Service charge income remained virtually unchanged from 2008 even with the increase in accounts. Most of the new accounts added either don’t have service fee charges and/or the balances are high enough to offset any charges. The largest increase was in the Health Savings Account portfolio where the volume of accounts has increased steadily the last two years. Both the OD and return check and service charge income from checking accounts are included in the customer service fees line item on the income statement.

Switching to the expense side, overall, non-interest expense increased less than 1% in 2010 over 2009 while an increase of 8.6% or $1.8 million occurred in 2009 over 2008. The largest factor behind the 2009 increase was FDIC assessment, which was broken out as its own line item on the statement of income due to its significance. Of the $1.8 million increase in 2009 noninterest expense, $1.2 million is attributed to the cost of FDIC insurance. FDIC insurance, while still costly at $1.1 million, decreased in 2010 as compared to 2009 by $253 thousand.

The largest increase in 2010 over 2009 in noninterest expense, aside from provision expense, was the summation line of “Other general and administrative” expenses on the income statement. Within this summation line, the larger increases correspond to the asset quality issues and included an increase in loan collection expenses, cost of appraisals, and insurance cost for other real estate owned totaling $403 thousand. This was the second year of increased cost due to collection as 2009 had an increase of $251 thousand as compared to 2008. These costs were necessary to improve the asset quality and position the Bank for higher profitability in the future.

Also mentioned previously was the mortgage refinancing activity of the last two years. A correlating expense to that activity is the amortization of mortgage servicing rights. The income was discussed previously; the amortization is the offset to the income recognized. These remain large line items on both sides of the income statement. Income is recorded when the mortgage loan is first sold with servicing retained and is therefore recognized within one year. The amortization, however, is calculated over the life of the loan and accelerated when paid off early. An increase in this expense can be driven by two activities: an increase in the number of sold loans and/or by the acceleration of the expense from payoff and refinance activity. The best picture of the bottom line impact is achieved by netting the income with the expense each year. 2008 had net income of $77 thousand, 2009 had net income of $225 thousand and 2010 had net income of only $1.1 thousand. Of course, the value (or income) of the mortgage servicing right when sold also impacts the net position. The reason for 2009’s larger net position is due to the increase in the number of loans being serviced; thereby new rights are being established without having been offset by accelerated expense. This is evidenced by the year end number of loans and balances being up significantly. In 2010, the income barely offset the amortization expense. As of December 31, 2010 there were 3,647 loans serviced with outstanding balances of $275.7 million, there were 3,571 loans serviced with outstanding balances of $267.8 million for 2009, and 3,472 loans with balances of $277.5 million for 2008. Returning to the expense only portion, expense for 2010 was $250 thousand lower than 2009, 2009 was $563 thousand higher than the expense for 2008.

The impact of mortgage servicing rights to both noninterest income and expense is shown in the following table:

		December 31				December 31				December 31
		2010				2009				2008
				(In thousands)
Capitalized Additions (Noninterest income)		$	685			$	1,158			$	447
Amortizations (Noninterest expense)			(684	)			(933	)			(370	)
Net Noninterest income		$	1			$	225			$	77

Salaries and wages increased $172 thousand in 2010 over 2009. Three main components flow into salaries and wages: base salary, deferred costs from loans and incentive pay. Base salaries decreased during 2010 even with the addition of the Hicksville office by $338 thousand. The deferred costs component actually decreased by $318 thousand which in effect increases salary expense and incentive pay increased $192 thousand. (For further discussion on incentive pay, see note 11 of the consolidated financial statements). During the first part of 2009, some of the Bank’s lending officers were also very busy in auto loan financing. This activity was spurred by government and auto manufacturer incentives along with large banks exiting the market in the first half of the year. The consumer loan portfolio grew by 26%, or almost $6 million. This increased activity offset the increased salary expense as deferred costs from these loans are recorded as a deduction to the salary expense when the loans are made. While salaries and wages decreased in 2009

as compared to 2008, it was this component that made it possible. Base salary expense increased just over $400 thousand with the deferred costs offsetting with a $50 thousand increase for 2009. The increases in base salary have been driven by additional offices being opened and increase in revenue generating positions, such as additional staff in the Bank’s financial planning division.

Employee benefits decreased $109 thousand in 2010 as compared to 2009 and 2009 ended at $185 less than (or basically even) 2008’s. The Bank is partially self-insured and fluctuations to costs are therefore caused by fluctuations in claims made by employees. Employee’s group insurance costs were lower in 2010 than 2009 by $139 thousand and were up $224 for 2009 over 2008. In 2009, the Bank offered a traditional medical plan along with a Health Savings Account (HSA) option. Both options were available in 2009 and the decision was made to implement the HSA plan only bank-wide for 2010. The increase in medical expense in 2009 was offset by a decrease of $201.5 thousand in miscellaneous personnel expense and in the BOLI retirement expense for 2009 as compared to 2008. Miscellaneous personnel expense includes such items as employee outings and the use of employment and executive search agencies. Bank Owned Life Insurance (BOLI) retirement expense represents the yearly cost to fund the liability of post retirement officers upon which the Bank has an insurance policy of which the Bank is the beneficiary. The total of these two expenses increased $47 thousand in 2010 as compared to 2009 and as stated previously was opposite of the movement in 2009 as compared to 2008.

Occupancy expense decreased by only $14 thousand in 2010 as compared to 2009. In 2009 it increased $84 thousand over 2008 with the largest impact stemming from the costs associated with holding Other Real Estate Owned (OREO). The balance in OREO increased from $426.7 thousand as of December 31, 2008 to $1.4 million as of December 31, 2009. The largest expense increase in occupancy was real estate taxes, which was driven by the additional holding of OREO and had increased $82.9 thousand in 2009 and held steady in 2010. OREO increased to $4.5 million in 2010 which included some rental properties and thereby had rental income of $45 thousand to help offset the cost of holding.

A positive reduction in data processing expense of $183 thousand occurred in 2010. This was preceded by a reduction of $98 thousand in 2009 as compared to 2008. The larger reduction in 2010 was mainly due to the reduction of costs as the Bank switched its core service provider in February. In 2009, the decrease is not attributable to just one vendor, but rather a negotiation with multiple vendors. The Company continues to investigate ways to reduce this expense. The pricing on many services, however, is based on number of accounts and the Bank fully expects those to increase with the KASASA additions and an improving economy.

The largest cost increase to the Bank in 2010 and 2009 was the Provision for Loan Losses. A tough economic environment existed for most businesses in our primary market area during 2007 through 2010. In 2010, the provision expense was $1.8 million higher than 2009 and $3.5 million over 2008. Gross charge-offs were $6.4 million for 2010, $3.3 million for 2009, as compared to 2008’s $2.6 million. Recoveries were $795, $242, and $348 thousand for 2010, 2009, and 2008, respectively. Unfortunately, 2010 had the highest charge-off and lowest recovery amounts, making the net charge-offs the highest at $5.6 million. 2009 had a net charge-off position of $3.0 million and 2008 had a net charge-off position of $2.2 million. 2008 was impacted by mostly agricultural business and 2009 and 2010 activity was mainly commercial driven. Further analysis by loan type is presented in the discussion of the allowance for credit losses.

Net Interest Income

The primary source of the Company’s traditional banking revenue is net interest income. Net interest income is the difference between interest income on interest earning assets, such as loans and securities, and interest expense on liabilities used to fund those assets, such as interest bearing deposits and other borrowings. Net interest income is affected by changes in both interest rates and the amount and composition of earning assets and liabilities. The change in net interest income is most often measured as a result of two statistics — interest spread and net interest margin. The difference between the yields on earning assets and the rates paid for interest bearing liabilities supporting those funds represents the interest spread. Because noninterest bearing sources of funds such as demand deposits and stockholders’ equity also support earning assets, the net interest margin exceeds the interest spread.

Overall, we continue to see pressure in the net interest margin and spread with the risk remaining fairly constant. The net interest margin decreased by 11 basis points and the net interest spread decreased by 5 basis points in comparing 2010 to 2009, with both sides of the equation having lower yields. In connection with interest concerns was the high level of nonaccruals and watch list loans throughout the year. Major improvement occurred in the decrease of nonaccrual and watch list loans to make the future look bright for 2011. Nonaccruals increased during the first part of the year and decreased due to charge-off and payoff during the second half, specifically the fourth quarter. Sustained improvement in the margin will be helped as a large portion of the nonaccruals have been removed from the books. Short term rates remained flat throughout the year and long term rates lowered during the fourth quarter and have since increased in the first two months of 2011.

Earnings assets increased during the year in actual and average balance. The interest collected on the earning assets decreased; the yield decreasing for 2010 as compared to 2009 in all portfolios. The largest decrease in yield occurred in the taxable investment securities and was due to the large amount of calls on government sponsored agencies and the yield on new purchases as the growth in the portfolio was over $30 million in average. It was not unusual for a called security to be replaced with a new security with a yield lower by 100 basis points or more. Overall, this portfolio’s yield was 121 basis points lower in 2010 than in 2009.

Loans which have the highest earning asset yield decreased in average by $8 million when comparing 2010 average to 2009 average balance. The overall change in yield in the loan portfolio for 2010 was due mainly to the change in balance than to the change in rate. Given that the loan portfolio represented only 67% of the earning assets in 2010 as compared to 2009’s 73% and the yield is the highest, it stands to reason that the overall asset yield decreased in 2010 as compared to 2009. Coupling this with the growth in earning assets being invested in securities and Federal Funds Sold and interest bearing bank balances, the overall yield on earning assets decreased 52 basis points as compared to 2009 and 103 basis points lower than 2008.

While the loan portfolio size had remained fairly constant in 2009, the yield, or income, generated had decreased for the second straight year. This was due to the low interest rate environment, with the lending prime rate within 26 basis points of the Company’s net interest spread at that time. Spread is the difference between what the Company earns on its assets and pays on its liabilities. It is on this spread that the Company must fund its operations and generate profit. When the asset yield decreases so must the cost of funds to maintain profitability. It becomes increasingly challenging as the asset yield gets closer to the prime lending rate, or the break-even point, of operations. To mitigate the low rate environment, the Bank placed rate floors on most variable loans during 2009, which were typically 125 basis points over the current prime rate. This protected the Bank during a flat rate environment. The challenge will come when rates start to rise and the Bank will be affected by the index spreads also placed on the loans. The Bank worked to increase the spread on loans during 2010 to minimize the impact of an increased prime rate not directly correlating to an increased yield on loans.

Looking at the other side of the balance sheet and the interest cost of funds, a decrease in the cost is apparent for 2010 as compared to both 2009 and 2008. Fortunately, the cost of funds decreased at a faster rate than the asset yield in 2009 and the net interest margin and spread improved over 2008. Unfortunately, in 2010, the asset yield decreased more than the cost of funds and the net interest margin and spread decreased as compared to 2009.

The impact of the change in the portfolio mix was a factor in the liabilities as it was in the assets. All portfolios decreased in cost of funds with the exception of the one, savings deposits, which represented 94% of the growth in average balances between 2010 and 2009. Savings deposits increased $48 million and the cost increased 4 basis points. The growth in balances was related to the growth in the new KASASA product offerings which rewarded customers by paying a higher interest rate for deposits which was offset by noninterest related Bank earnings and savings. By participating in the KASASA Saver product, a customer may have earned as much as 160 basis points more than the Bank’s basic savings account. Even with the increased interest cost to the Bank for offering these products, the Bank was still able to decrease its cost of funds by 47 basis points. Time deposits, other borrowed money and securities sold under agreement to repurchase all decreased. The Bank borrowed funds from the Federal Home Loan Bank in the first quarter of 2010, to lock in lower rates to replace maturities coming due in the second through fourth quarter of the year. If the Bank does not borrow any additional funds in 2011, the cost of these funds

will again be lower in 2011since the associated expense of the matured advances will be off for a full year. The average balance will also be lower by $7.5 million.

The following tables present net interest income, interest spread and net interest margin for the three years 2008 through 2010, comparing average outstanding balances of earning assets and interest bearing liabilities with the associated interest income and expense. The table also shows their corresponding average rates of interest earned and paid. The tax-exempt asset yields have been tax affected to reflect a marginal corporate tax rate of 34%. Average outstanding loan balances include non-performing loans and mortgage loans held for sale. Average outstanding security balances are computed based on carrying values including unrealized gains and losses on available-for-sale securities.

The percentage of interest earning assets to total assets decreased in 2010 over 2009 and increased slightly in 2009 over 2008 and remained above 90% at a respectable 90.73% and 93.55% for 2010 and 2009, respectively.

As stated previously, the decreased yield on the assets was outpaced by the decreased cost of funds in 2009. The average balances for interest bearing liabilities increased only $17.4 million compared to 2008. While the balance increased, the costs on those funds were significantly lower. The average cost for 2009 was 2.00% compared to 2008’s 2.82%. The balances in noninterest bearing liabilities also increased during the last three years.

As with the yields on assets for 2009, the largest fluctuation in the cost of funds was in the shorter term liabilities, savings deposits. The cost on savings decreased 66% while on time deposits the cost decreased 38%. The Bank has focused on increasing its core deposit base to lessen the dependency on higher cost time deposits. The Bank has also attempted to increase the duration of the time deposits; however, customers have maintained a short-term, twelve month focus.

The yield on Tax-Exempt investments securities shown in the following charts were computed on a tax equivalent basis. The yield on Loans has been tax adjusted for the portion of tax-exempt IDB loans included in the total. Total Interest Earning Assets is therefore also reflecting a tax equivalent yield in both line items, also with the Net Interest Spread and Margin. The adjustments were based on a 34% tax rate.

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						2010
		(In Thousands)
		Average				Interest /
		Balance				Dividends				Yield/Rate
ASSETS
Interest Earning Assets:
Loans (1)		$	550,698			$	32,860				6.00	%
Taxable investment securities			176,885				4,847				2.74	%
Tax-exempt investment securities			59,537				2,091				5.32	%
Federal funds sold & interest bearing deposits			35,195				95				0.27	%
Total Interest Earning Assets			822,315			$	39,893				5.00	%
Non-Interest Earning Assets:
Cash and cash equivalents			14,046
Other assets			42,096
Total Assets		$	878,457
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest Bearing Liabilities:
Savings deposits		$	305,426			$	2,190				0.72	%
Other time deposits			321,018				6,936				2.16	%
Other borrowed money			37,517				1,459				3.89	%
Federal funds purchased and securties sold under agreement to repurchase			46,530				278				0.60	%
Total Interest Bearing Liabilities			710,491			$	10,863				1.53	%
Non-Interest Bearing Liabilities:
Non-interest bearing demand deposits			63,108
Other			10,207
Total Liabilities			783,806
Shareholders’ Equity			94,651
Total Liabilities and Shareholders’ Equity		$	878,457
Interest/Dividend income/yield						$	39,893				5.00	%
Interest Expense / yield						$	10,863				1.53	%
Net Interest Spread						$	29,030				3.47	%
Net Interest Margin											3.68	%

		2009
		(In Thousands)
		Average				Interest/
		Balance				Dividends				Yield/Rate
ASSETS
Interest Earning Assets:
Loans (1)		$	558,869			$	33,585				6.04	%
Taxable investment securities			146,872				5,798				3.95	%
Tax-exempt investment securities			46,736				1,686				5.47	%
Federal funds sold & interest bearing deposits			11,937				45				0.38	%
Total Interest Earning Assets			764,414			$	41,114				5.52	%
Non-Interest Earning Assets:
Cash and cash equivalents			19,209
Other assets			39,007
Total Assets		$	822,630
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest Bearing Liabilities:
Savings deposits		$	257,345			$	1,755				0.68	%
Other time deposits			317,619				9,252				2.91	%
Other borrowed money			38,498				1,727				4.49	%
Federal funds purchased and securities sold under agreement to repurchase			45,920				486				1.06	%
Total Interest Bearing Liabilities			659,382			$	13,220				2.00	%
Non-Interest Bearing Liabilities:
Non-interest bearing demand deposits			57,630
Other			13,778
Total Liabilities			730,790
Shareholders’ Equity			91,840
Total Liabilities and Shareholders’ Equity		$	822,630
Interest/Dividend income/yield						$	41,114				5.52	%
Interest Expense / yield						$	13,220				2.00	%
Net Interest Spread						$	27,894				3.52	%
Net Interest Margin											3.79	%

		2008
		(In Thousands)
		Average				Interest/
		Balance				Dividends				Yield/Rate
ASSETS
Interest Earning Assets:
Loans (1)		$	544,310			$	34,994				6.46	%
Taxable investment securities			146,877				6,963				4.74	%
Tax-exempt investment securities			42,361				1,594				5.70	%
Federal funds sold & interest bearing deposits			9,423				273				2.90	%
Total Interest Earning Assets			742,971			$	43,824				6.03	%
Non-Interest Earning Assets:
Cash and cash equivalents			19,399
Other assets			35,317
Total Assets		$	797,687
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest Bearing Liabilities:
Savings deposits		$	240,880			$	2,760				1.15	%
Other time deposits			314,005				12,467				3.97	%
Other borrowed money			38,110				1,747				4.58	%
Federal funds purchased and securities sold under agreement to repurchase			49,014				1,127				2.30	%
Total Interest Bearing Liabilities			642,009			$	18,101				2.82	%
Non-Interest Bearing Liabilities:
Non-interest bearing demand deposits			53,208
Other			12,928
Total Liabilities			708,145
Shareholders’ Equity			89,542
Total Liabilities and Shareholders’ Equity		$	797,687
Interest/Dividend income/yield						$	43,824				6.03	%
Interest Expense / yield						$	18,101				2.82	%
Net Interest Spread						$	25,723				3.21	%
Net Interest Margin											3.60	%

The following tables show changes in interest income, interest expense and net interest resulting from changes in volume and rate variances for major categories of earnings assets and interest bearing liabilities.

		2010 vs 2009
		(In Thousands)
		Net				Due to change in
		Change				Volume				Rate
Interest Earning Assets:
Loans		$	(725	)		$	(494	)		$	(231	)
Taxable investment securities			(951	)			1,185				(2,136	)
Tax-exempt investment securities			405				700				(295	)
Federal funds sold & interest bearing deposits			50				88				(38	)
Total Interest Earning Assets		$	(1,221	)		$	1,479			$	(2,700	)
Interest Bearing Liabilities:
Savings deposits		$	435			$	328			$	107
Other time deposits			(2,316	)			99				(2,415	)
Other borrowed money			(268	)			(44	)			(224	)
Federal funds purchased and securities sold under agreement to repurchase			(208	)			6				(214	)
Total Interest Bearing Liabilities		$	(2,357	)		$	389			$	(2,746	)

		2009 vs 2008
		(In Thousands)
		Net				Due to change in
		Change				Volume				Rate
Interest Earning Assets:
Loans		$	(1,409	)		$	941			$	(2,350	)
Taxable investment securities			(1,165	)			(0	)			(1,165	)
Tax-exempt investment securities			92				249				(157	)
Federal funds sold & interest bearing deposits			(228	)			73				(301	)
Total Interest Earning Assets		$	(2,710	)		$	1,263			$	(3,973	)
Interest Bearing Liabilities:		$	(1,005	)		$	189			$	(1,194	)
Savings deposits			(3,215	)			143				(3,358	)
Other time deposits			(20	)			18				(38	)
Other borrowed money							—
Federal funds purchased and securities sold under agreement to repurchase			(641	)			(71	)			(570	)
Total Interest Bearing Liabilities		$	(4,881	)		$	279			$	(5,160	)

As mentioned in the discussion earlier, in reviewing the 2010 to 2009 comparison, an impact in change due to volume is evident, where as the 2009 to 2008 comparison shows the impact was due mainly to rate. What did remain the same in the two comparisons is that the change in interest in total is still due mainly to rate change. The strategy during 2010 and currently is to extend the maturities of time deposit “specials” to over 24 months to prepare for rising rates. The other strategy employed during 2009 and 2010 was to increase core deposits by offering innovative products focused on customer needs: higher interest rates. In exchange for a high interest-bearing checking account, customers were asked to utilize services that benefited both the Bank and themselves. Smaller time deposit rate shoppers had an option to perhaps change their behavior of banking or those deposits were allowed to run off. The new core deposit products were indeed embraced by our customers and have helped to reach the deposit portfolio mix the Bank was after.

Allowance for Credit Losses

The Company segregates its Allowance for Loan and Lease Losses (ALLL) into two reserves: The ALLL and the Allowance for Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these reserves constitute the total Allowance for Credit Losses (ACL).

The Bank’s ALLL methodology captures trends in leading, current, and lagging indicators which will directly affect the Bank’s allocation amount. Trends in such leading indicators as delinquency, unemployment changes in the Bank’s service area, experience and ability of staff, regulatory trends, and credit concentrations are referenced. A current indicator such as the total watch list loan amount to Capital, and a lagging indicator such as the charge off amount are referenced as well. A matrix is formed by loan type from these indicators that is responsive in making ALLL adjustments.

The Bank experienced a 7% decrease in Special Mention loan balances as of December 31, 2010 as compared to December 31, 2009. The Bank also experienced a 23% decrease or $8.7 million decrease in Special Mention and Substandard loan balances as of December 31, 2010 as compared to 2009. In response to this decrease, the Bank continued the increase of its ALLL to outstanding loans coverage percentage to 1.08% as of December 31, 2010. As a group, the Special Mention and Substandard loans increased 16.8% or $5.4 million in comparing year-end balances December 31, 2009 to December 31, 2008. In response to this increase, the Bank’s ALLL to outstanding loans coverage percentage increased from .97% as of December 31, 2008 to 1.05% as of December 31, 2009.

The above indicators are reviewed quarterly. Some of the indicators are quantifiable and as such will automatically adjust the ALLL once calculated. These indicators include the ratio of past due loans to total loans, loans past due greater than 30 days, and watch list to capital ratios with the watch list made up of loans graded 5,6 or 7 on a 1 to 7 scale, 1 being the best rating. Other indicators use more subjective data to the extent possible to evaluate the potential for inherent losses in the Bank’s loan portfolio. For example, the economic indicator uses the unemployment statistics from the communities in our market area to help determine whether the ALLL should be adjusted. At the end of 2010, a slight improvement was noted in unemployment figures and several local firms were calling a small number of employees back from layoff. The current recalls do not begin to approximate the number of positions lost.

All aggregate commercial and agricultural credits include real estate loans of $250,000 and over are reviewed annually by both credit committees and internal loan review to look for early signs of deterioration.

To establish the specific reserve allocation in the instance of real estate, a discount to the market value is established to account for liquidation expenses. The discounting percentage used for real estate mirrors the discounting of real estate as provided for in the Bank’s Loan Policy. However, unique or unusual circumstances may be present which will affect the real estate value and, when appropriately identified, can adjust the discounting percentage at the discretion of management.

The ACL decreased $375 thousand during 2010 as compared to 2009. With the decrease in loan balances, the percentage of ACL to the total loan portfolio actually increased from 1.09% as of December 31, 2009 to 1.12% as of December 31, 2010. The ACL increased during 2009 as compared to 2008 as net charge-offs and past due loans had increased during 2009. The increase took into account the high level of nonaccruals and watch list loans and the extended time period it involved for resolution.

Please see Note 4 in the consolidated financial statement for additional tables regarding the composition of the ACL.

Federal Income Taxes

Effective tax rates were 25.44%, 27.26%, and 26.71%, for 2010, 2009, and 2008, respectively. The effect of tax-exempt interest from holding tax-exempt securities and Industrial Development Bonds (IDBs) was $744, $629, and $654 thousand for 2010, 2009, and 2008, respectively.

Financial Condition

Average earning assets increased $57.9 million during 2010 over 2009 and were higher by $79.3 million as compared to 2008. The main cause of fluctuation was the Hicksville acquisition and the repositioning of the balance sheet. Average interest bearing liabilities increased $51.1 million over 2009 and $68.5 million from 2008. The increase in 2009 over 2008 was due to the success of the Reward Checking product to attract funds into the savings deposit bucket. The increase continued into 2010 with the addition of the full line of KASASA products in 2010. It also included an overlapping of $9 million in loan advances from the Federal Home Loan Bank for a couple of quarters.

Securities

The investment portfolio is first used mainly to provide overall liquidity for the Bank. It is also used to provide required collateral for pledging to the Bank’s Ohio public depositors for amounts on deposit over the FDIC coverage limits. It may also be used to pledge for additional borrowings from third parties. Investments are made with the above criteria in mind while still seeking a fair market value of return, and looking for maturities that fall within the projected overall strategy of the Bank. The possible need to fund growth is also a consideration.

All of the Bank’s security portfolio is categorized as available for sale, with the exception of stock, and as such is recorded at market value.

Security balances as of December 31 are summarized below:

		(In Thousands)
		2010				2009				2008
U.S. Treasury		$	32,278			$	5,219			$	—
U.S. Government agency			165,704				104,676				82,675
Mortgage-backed securities			24,531				36,848				51,826
State and local governments			64,804				60,538				43,160
		$	287,317			$	207,281			$	177,661

The following table sets forth the maturities of investment securities as of December 31, 2010 and the weighted average yields of such securities calculated on the basis of cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent adjustments, using a thirty-four percent rate have been made in yields on obligations of state and political subdivisions. Stocks of domestic corporations have not been included.

		Maturities
		(Amounts in Thousands)
										After One Year
		Within One Year								Within Five Years
		Amount				Yield				Amount				Yield
U.S. Treasury			—			$	0.00	%		$	22,726				1.06	%
U.S. Government agency			—				0.00	%			126,890				1.45	%
Mortgage-backed securities			1,169				4.25	%			2,600				4.31	%
State and local governments			2,092				2.21	%			15,928				2.77	%
Taxable state and local governments			—				0.00	%			1,944				3.14	%

		Maturities
		(Amounts in Thousands)
		After Five Years
		Within Ten Years								After Ten Years
		Amount				Yield				Amount				Yield
U.S. Treasury		$	9,552				1.62	%			—			$	0.00	%
U.S. Government agency			38,814				2.26	%			—				0.00	%
Mortgage-backed securities			2,564				4.70	%			18,198				4.63	%
State and local governments			28,795				3.31	%			15,078				4.23	%
Taxable state and local governments			967				3.14	%			—				0.00	%

As of December 31, 2010 the Bank did not hold a large block of any one investment security, except for U.S. Government agencies. The Bank also holds stock in the Federal Home Loan Bank of Cincinnati at a cost of $4.2 million. This is required in order to obtain Federal Home Loan Bank Loans. The Bank also acquired stock in the Federal Home Loan Bank of Indianapolis at a cost of $231.4 thousand and Banker’s Bancorp, Inc at a cost of $50.8 thousand through its acquisition of Knisely Bank. There were no borrowings at the time of acquisition associated with Federal Home Loan Bank of Indianapolis. The Bank had requested Federal Home Loan Bank of Indianapolis to buy back its stock when the acquisition of Knisely was completed in January 2008. A five year waiting period was imposed and the stock will be redeemed in full by January 3, 2013. An early redemption of 42,000 shares occurred in November 2010, decreasing the holdings to a value of $189.4 thousand. The value of the stock in Banker’s Bancorp, Inc was written down to zero at the end of 2009 as the institution was taken over by its regulators. The Bank also owns stock of Farmer Mac with a carrying value of $27.4 thousand which is required to participate loans in the program.

Loan Portfolio

The Bank’s various loan portfolios are subject to varying levels of credit risk. Management mitigates these risks through portfolio diversification and through standardization of lending policies and procedures.

Risks are mitigated through an adherence to Loan Policy with any exception being recorded and approved by Senior Management or committees comprised of Senior Management. Loan Policy defines parameters to essential underwriting guidelines such as loan-to-value ratio, cash flow and debt-to-income ratio, loan requirements and covenants, financial information tracking, collection practice and others. Limitation to any one borrower is defined by the Bank’s legal lending limits and is stated in policy. On a broader basis, the Bank restricts total aggregate funding in comparison to Bank capital to any one business or agricultural sector by an approved sector percentage to capital limitation.

The following table shows the Bank’s loan portfolio by category of loan as of December 31^st of each year, including loans held for sale:

		(In Thousands)
Loans:		2010				2009				2008				2007				2006
Commercial real estate		$	185,033			$	214,849			$	226,761			$	181,340			$	162,363
Agricultural real estate			33,650				41,045				48,607				45,518				49,564
Consumer real estate			95,271				98,599				89,773				102,660				86,688
Commercial and industrial			117,344				120,543				112,526				104,188				101,788
Agricultural			65,400				59,813				56,322				58,809				69,301
Consumer			29,008				32,581				26,469				27,796				27,388
Industrial Development Bonds			1,965				2,552				7,572				9,289				7,335
		$	527,671			$	569,982			$	568,030			$	529,600			$	504,427

The following table shows the maturity of loans as of December 31, 2010:

		(In Thousands)
						After One
		Within				Year Within				After
		One Year				Five Years				Five Years				Total
Commercial Real Estate		$	36,523			$	105,168			$	43,342			$	185,033
Agricultural Real Estate			2,738				13,546				17,366				33,650
Consumer Real Estate			8,009				23,094				64,168				95,271
Commercial and industrial loans			83,554				25,387				8,403				117,344
Agricultural			48,038				14,196				3,166				65,400
Consumer, Credit Card and Overdrafts			6,002				20,723				2,283				29,008
Industrial Development Bonds			556				446				963				1,965

The following table presents the total of loans due after one year which has either 1) predetermined interest rates (fixed) or 2) floating or adjustable interest rates (variable):

		(In Thousands)
		Fixed				Variable
		Rate				Rate				Total
Commercial Real Estate		$	57,162			$	91,314			$	148,476
Agricultural Real Estate			18,918				11,682				30,600
Consumer Real Estate			74,095				13,267				87,362
Commercial and industrial loans			26,831				6,324				33,155
Agricultural			17,138				224				17,362
Consumer, Master Card and Overdrafts			23,006				3,664				26,670
Industrial Development Bonds			1,409				—				1,409

The following table summarizes the Company’s nonaccrual and past due loans as of December 31 for each of the last five years:

		(In Thousands)
		2010				2009				2008				2007				2006
Nonaccrual loans		$	5,844			$	14,054			$	13,575				4918				4254
Accruing loans past due 90 days or more			48				69				2,524				—				—
Total		$	5,892			$	14,123			$	16,099			$	4,918			$	4,254

Although loans may be classified as non-performing, some pay on a regular basis, and many continue to pay interest irregularly or at less than original contractual rates. Interest income that would have been recorded under the original terms of these loans was $0.91 million for 2010, $2.0 for 2009, and $1.4 for 2008. Any collections of interest on nonaccrual loans are included in interest income when collected unless it is on an impaired loan with a specific allocation. A collection of interest on an impaired loan with a specific allocation is applied to the loan balance to decrease the allocation needed. Total interest collections amounted to $41 thousand for 2010, $290 thousand for 2009, and $332 thousand for 2008. $3 thousand of interest collected in 2010 was applied to reduce the specific allocation, $6 thousand of interest collected in 2009 and $20 thousand of interest collected in 2008 was applied to reduce the specific allocations.

Loans are placed on nonaccrual status in the event that the loan is in past due status for more than 90 days or payment in full of principal and interest is not expected. The loss of interest due to the high balances in nonaccruals as of the last three years has significantly impacted the yield on loans. A lower balance of $5.8 million in nonaccrual as of December 31, 2010 is an improvement which should help the yield going forward. The balance of December 31, 2010 nonaccrual loans of $5.8 million and the $14.1 million of nonaccrual loans as of December 31, 2009 were secured.

As of December 31, 2010 the Bank had $27.4 million of loans which it considers to be potential problem loans in that the borrowers are experiencing financial difficulties compared to December 31, 2009 when the Bank had $25.6 million of these loans. These loans are subject to constant management attention and are reviewed at least monthly.

The amount of the potential problem loans was considered in management’s review of the loan loss reserve required at December 31, 2010 and 2009.

In extending credit to families, businesses and governments, banks accept a measure of risk against which an allowance for possible loan loss is established by way of expense charges to earnings. This expense, used to enlarge a bank’s allowance for loan losses, is determined by management based on a detailed monthly review of the risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past due loan-loss experience and the financial condition of the bank’s borrowers.

As of December 31, 2010, the Bank had loans outstanding to individuals and firms engaged in the various fields of agriculture in the amount of $65.4 million with an additional $33.7 million in agricultural real estate loans. The ratio of this segment of loans to the total loan portfolio is not considered unusual for a bank engaged in and servicing rural communities.

Modifications granted are typically for seasonality issues where cash flow is decreased. The time period involved is generally quite short in relation to the loan term. For example, a typical modification may consist of interest only payments for 90 days. We consider this treatment of interest only payments for a short time as an insignificant delay in payment. Consequently, we do not consider these occurrences as “troubled debt restructurings”. Interest rate modification to reflect a decrease in market interest rates or maintain a relationship with the debtor, where the debtor is not experiencing financial difficulty and can obtain funding from other sources, is not considered a troubled debt restructuring. As of December 31, 2010, the Bank had almost $3.5 million of its impaired loans that were classified as trouble debt restructurings. The Bank did not have any classified as such as of December 31, 2009. The Bank is occasionally ordered by the courts to give terms to a borrower that are better than what the Bank would like for the risk associated with that credit but not below or beyond rates and terms available for better credits in our market. Therefore, the Bank has not done any modifications that it would classify as “troubled debt restructurings” under those circumstances.

Updated appraisals are required on all collateral dependent loans once they are deemed impaired. The Bank may also require an updated appraisal of a watch list loan which the Bank monitors under their loan policy. On a quarterly basis, Bank management reviews properties supporting asset dependent loans to consider market events that may indicate a change in value has occurred.

To determine observable market price, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months for chattels and titled vehicles and every two years for real estate. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated appraisals are received, the Bank may discount the existing collateral value used.

Performing non-watch list customers secured in whole or in part by real estate do not require an updated appraisal unless the loan is rewritten and additional funds advanced. Watch List customers secured in whole or in part by real estate require updated appraisals every two years. All loans are subject to loan to values as found in Loan Policy no matter what their grade. Our watch list is reviewed on a quarterly basis by management and any questions to value are addressed at that time.

The majority of the Bank’s loans are made in the market by lenders that live and work in the market. Thus, their evaluation of the independent valuation is also valuable and serves as a double check.

On extremely rare occasions, the Bank will make adjustments to the recorded values of collateral securing commercial real estate loans without acquiring an updated appraisal for the subject property. The Bank has no formalized policy for determining when collateral value adjustments between regularly scheduled appraisals are necessary, nor does it use any specific methodology for applying such adjustments. However, on a quarterly basis as part of its normal operations, the Bank’s senior management and the Loan Review Committee will meet to review all commercial credits either deemed to be impaired or on the Bank’s Watch List. In addition to analyzing the recent performance of these loans, management and the Loan Review Committee will also consider any general market conditions that might warrant adjustments to the value of particular real estate collateralizing commercial loans. In addition, management conducts annual reviews of all commercial loans exceeding certain outstanding balance thresholds. In each of these situations, any information available to management regarding market conditions impacting a specific property or other relevant factors is considered, and lenders familiar with a particular commercial real estate loan and the underlying collateral may be present to provide their opinion on such factors. If the available information leads management to conclude a valuation adjustment is warranted, such an adjustment may be applied on the basis of the information available. If management concludes that an adjustment is warranted but lacks the specific information needed to reasonably quantify the adjustment, management will order a new appraisal on the subject property even though one may not be required under the Bank’s general policies for updating appraisal.

Note 4 of the Consolidated Financial Statements may also be reviewed for additional tables dealing with the Bank’s loans and ALLL.

ALLL is evaluated based on an assessment of the losses inherent in the loan portfolio. This assessment results in an allowance consisting of two components, allocated and unallocated.

Management considers several different risk assessments in determining ALLL. The allocated component of ALLL reflects expected losses resulting from an analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan category. For those loans where the internal credit rating is at or below a predetermined classification and management can reasonably estimate the loss that will be sustained based upon collateral, the borrowers operating activity and economic conditions in which the borrower operates, a specific allocation is made. For those borrowers that are not currently behind in their payment, but for which management believes based on economic conditions and operating activities of the borrower, the possibility exists for future collection problems, a reserve is established. The amount of reserve allocated to each loan portfolio is based on past loss experiences and the different levels of risk within each loan portfolio. The historical loan loss portion is determined using a historical loss analysis by loan category.

The unallocated portion of the reserve for loan losses is determined based on management’s assessment of general economic conditions as well as specific economic factors in the Bank’s marketing area. This assessment inherently involves a higher degree of uncertainty. It represents estimated inherent but undetected losses within the portfolio that are probable due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition and other current risk factors that may not have yet manifested themselves in the Bank’s historical loss factors used to determine the allocated component of the allowance.

Actual charge-off of loan balances is based upon periodic evaluations of the loan portfolio by management. These evaluations consider several factors, including, but not limited to, general economic conditions, financial condition of the borrower, and collateral.

As presented below, charge-offs increased to $6.4 million for 2010 preceded by an increase to $3.3 million for 2009. The provision also increased each year for the three years shown. 2010 had provision expense of $5.3 million, 2009 had $3.6 million and 2008 had provision expense of $1.8 million. The Commercial and Industrial portfolio was the only segment in a net recovery for 2008; however it had the largest net charge-off position in 2009 and 2010. The ratio of net charge offs to average loans outstanding is evidence of the recognition of troubled loans and the write down of

collateral values. The improvement in asset quality during the periods shown is reflected in the increased percentage of the allowance for loan loss to nonperforming loans.

With the charge-offs going higher in 2009, it became prudent to increase the ALLL for 2009. The increase provides for the high level of nonaccrual and watch list loans and recognizes the extended time period with which it has taken to achieve resolution and/or collection of these loans. The ALLL for 2010 decreased due to the improvement in the asset quality as the balances in impaired loans and nonaccruals were drastically reduced over the same time periods. A smaller portion of the allowance was needed to fund the impaired loans as collateral remained sufficient to cover the outstanding amounts in most cases.

The following table presents a reconciliation of the allowance for credit losses:

		(In Thousands)
		2010				2009				2008
Loans		$	527,589			$	569,919			$	568,030
Daily average of outstanding loans		$	550,698			$	558,869			$	544,859
Allowance for Loan Losses-Jan 1		$	6,008			$	5,496			$	5,922
Loans Charged off:
Commercial Real Estate			1,147				—				—
Ag Real Estate			—				—				—
Consumer Real Estate			507				452				194
Commercial and Industrial			4,188				2,235				71
Agricultural			136				230				1,912
Consumer & other loans			444				371				384
			6,422				3,288				2,561
Loan Recoveries:
Commercial Real Estate			52				—				—
Ag Real Estate			—				—				—
Consumer Real Estate			55				11				87
Commercial and Industrial			515				72				78
Agricultural			17				6				4
Consumer & other loans			156				153				179
			795				242				348
Net Charge Offs			5,627				3,046				2,213
Provision for loan loss			5,325				3,558				1,787
Acquisition provision for loan loss			—				—				—
Allowance for Loan & Lease Losses — Dec 31		$	5,706			$	6,008			$	5,496
Allowance for Unfunded Loan Commitments & Letters of Credit Dec 31			153				227				226
Total Allowance for Credit Losses — Dec 31		$	5,859			$	6,235			$	5,722
Ratio of net charge-offs to average Loans outstanding			1.02	%			0.55	%			0.41	%
Ratio of the Allowance for Loan Loss to Nonperforming Loans			97.63	%			42.75	%			40.48	%

Allocation of ALLL per Loan Category in terms of dollars and percentage of loans in each category to total loans is as follows:

		2010								2009								2008								2007								2006
		Amount (000’s)				%				Amount (000’s)				%				Amount (000’s)				%				Amount (000’s)				%				Amount (000’s)				%
Balance at End of Period Applicable To:
Commercial Real Estate		$	1,868				35.07			$	1,810				37.69			$	1,810				39.92			$	1,358				34.24			$	1,221				32.19
Ag Real Estate			122				6.38				120				7.20				130				8.56				117				8.59				162				9.83
Consumer Real Estate			258				16.31				439				17.30				386				15.80				381				19.38				288				17.19
Commercial and Industrial			2,354				14.23				2,494				21.15				2,278				19.81				1,859				19.67				2,721				20.18
Agricultural			327				22.24				647				10.49				413				9.92				1,676				11.10				250				13.74
Consumer, Overdrafts and other loans			777				5.77				498				6.16				479				5.99				531				7.00				634				6.88
Unallocated			—								—								—								—								318
Allowance for Loan & Lease Losses			5,706				100.00				6,008				100.00				5,496				100.00				5,922				100.00				5,594				100.00
Off Balance Sheet Commitments			153								227								226								156								168
Total Allowance for Credit Losses		$	5,859							$	6,235							$	5,722							$	6,078							$	5,762