LIMESTONE BANCORP, INC. - Quarter Report: 2012 June (Form 10-Q)

a50360323.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2012

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

For the transition period from to

Commission file number: 001-33033

PORTER BANCORP, INC.

(Exact name of registrant as specified in its charter)


Kentucky		61-1142247
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

2500 Eastpoint Parkway, Louisville, Kentucky		40223
(Address of principal executive offices)		(Zip Code)

(502) 499-4800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 x No ¨

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

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

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o	Smaller reporting company x

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

Indicate the number of shares outstanding of each of the issuer’s class of common stock, as of the latest practicable date.

11,934,872 shares of Common Stock, no par value, were outstanding at July 27, 2012.

INDEX


		Page
PART I –	FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS	1
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
	CONDITION AND RESULTS OF OPERATIONS	34
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	49
ITEM 4.	CONTROLS AND PROCEDURES	49

PART II –	OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	51
ITEM 1A.	RISK FACTORS	51
ITEM 2.	UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS	51
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	51
ITEM 4.	MINE SAFETY DISCLOSURES	51
ITEM 5.	OTHER INFORMATION	51
ITEM 6.	EXHIBITS	51

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

The following consolidated financial statements of Porter Bancorp Inc. and subsidiary, PBI Bank, Inc. are submitted:

Unaudited Consolidated Balance Sheets for June 30, 2012 and December 31, 2011

Unaudited Consolidated Statements of Operations for the three and six months ended June 30, 2012 and 2011

Unaudited Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2012 and 2011

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the six months ended June 30, 2012

Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011

Notes to Unaudited Consolidated Financial Statements

PORTER BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

	June 30, 2012			December 31, 2011
Assets Cash and due from financial institutions	$	33,653		$	104,680
Federal funds sold		2,708			1,282
Cash and cash equivalents		36,361			105,962
Securities available for sale		194,091			158,833
M ortgage loans held for sale		383			694
Loans, net of allowance of $51,594 and $52,579, respectively		989,315			1,083,444
Premises and equipment		21,223			21,541
Other real estate owned		54,365			41,449
Federal Home Loan Bank stock		10,072			10,072
Bank owned life insurance		8,254			8,106
Accrued interest receivable and other assets		20,788			25,323
Total assets	$	1,334,852		$	1,455,424
Liabilities and Stockholders’ Equity Deposits Non-interest bearing	$	112,797		$	111,118
Interest bearing		1,091,925			1,212,645
Total deposits		1,204,722			1,323,763
Repurchase agreements		2,501			1,738
Federal Home Loan Bank advances		6,398			7,116
Accrued interest payable and other liabilities		7,526			7,628
Subordinated capital note		7,200			7,650
Junior subordinated debentures		25,000			25,000
Total liabilities		1,253,347			1,372,895
Stockholders’ equity Preferred stock, no par, 1,000,000 shares authorized, Series A – 35,000 issued and outstanding; Liquidation preference of $35 million at June 30, 2012		34,751			34,661
Series C – 317,042 issued and outstanding; Liquidation preference of $3.6 million at June 30, 2012		3,283			3,283
Common stock, no par, 86,000,000 shares authorized, 11,934,872 and 11,824,472 shares issued and outstanding, respectively		112,236			112,236
Additional paid-in capital		20,056			19,841
Retained deficit		(90,968	)		(91 ,656	)
Accumulated other comprehensive income		2,147			4,164
Total stockholders' equity		81 ,505			82,529
Total liabilities and stockholders’ equity	$	1,334,852		$	1,455,424

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Operations

(dollars in thousands, except per share data)

	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012		2011
Interest income Loans, including fees	$	13,689		$	17,589		$	28,201	$	35,699
Taxable securities		797			1,139			1,638		2,181
Tax exempt securities		196			268			446		528
Fed funds sold and other		130			202			282		406
		14,812			19,198			30,567		38,814
Interest expense Deposits		3,726			5,272			7,726		10,632
Federal Home Loan Bank advances		54			139			111		281
Subordinated capital note		67			71			138		144
Junior subordinated debentures		168			157			339		312
Federal funds purchased and other		2			118			4		236
		4,017			5,757			8,318		11,605
Net interest income		10,795			13,441			22,249		27,209
Provision for loan losses		4,000			13,700			7,750		18,800
Net interest income after provision for loan losses		6,795			(259	)		14,499		8,409
Non-interest income Service charges on deposit accounts		556			659			1,110		1,289
Income from fiduciary activities		291			246			542		501
Secondary market brokerage fees		31			76			48		152
Title insurance commissions		11			22			33		53
Net gain on sales of loans originated for sale		77			320			122		541
Net gain on sales of securities		1,511			1,025			3,530		1,108
Other		541			517			1,078		1,008
		3,018			2,865			6,463		4,652
Non-interest expense Salaries and employee benefits		3,982			4,180			8,294		8,304
Occupancy and equipment		969			981			1,855		1,953
Goodwill impairment		—			23,794			—		23,794
Other real estate owned expense		1,205			22,109			2,462		23,476
FDIC Insurance		832			855			1,705		1,710
State franchise tax		592			582			1,184		1,164
Loan collection expense		586			925			946		1,187
Professional fees		567			354			923		634
Comm unications		168			165			348		333
Postage and delivery		109			128			231		251
Advertising		28			87			61		189
Other		624			599			1,300		1,159
		9,662			54,759			19,309		64,154
Income (loss) before income taxes		151			(52,153	)		1,653		(51,093	)
Income tax expense (benef it)		—			(12,164	)		—		(11,903	)
Net income (loss)		151			(39,989	)		1,653		(39,190	)
Less: Dividends on preferred stock		438			437			875		875
Accretion on Series A preferred stock		45			44			90		88
Earnings (losses) allocated to participating securities		(13	)		(1,510	)		27		(1,552	)
Net income (loss) available to common shareholders	$	(319	)	$	(38,960	)	$	661	$	(38,601	)
Basic earnings (loss) per common share	$	(0.03	)	$	(3.33	)	$	0.06	$	(3.30	)
Diluted earnings (loss) per common share	$	(0.03	)	$	(3.33	)	$	0.06	$	(3.30	)

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

	Three Months Ended June 30,						Six Month Ended June 30,
	2012			2011			2012			2011
Net income (loss)	$	151		$	(39,989	)	$	1,653		$	(39,190	)

Other comprehensive income (loss), net of tax: Unrealized gain (loss) on securities: Unrealized gain (loss) arising in period (net of tax of $68, $980, $149, and $1,005, respectively)		(127	)		1,819			278			1,865
Reclassification of amount realized through sales (net of tax of $529, $359, $1,236 and $388, respectively)		(982	)		(666	)		(2,295	)		(720	)
Net unrealized gain (loss) on securities		(1,109	)		1,153			(2,017	)		1,145

Comprehensive income (loss)	$	(958	)	$	(38,836	)	$	(364	)	$	(38,045	)

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC.

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

For Six Months Ended June 30, 2012

(dollars in thousands, except share and per share data)

	Shares							Amount						Additional					Accumulated Other
	Common			Series A Preferred		Series C Preferred		Common		Series A Preferred		Series C Preferred		Paid-In Capital		Retained Deficit			Comprehensive Income			Total
Balances, January 1, 2012		11,824,472			35,000		317,042	$	112,236	$	34,661	$	3,283	$	19,841	$	(91,656	)	$	4,164		$	82,529
Issuance of unvested stock		115,095			–		–		–		–		–		–		–			–			–
Forfeited unvested stock		(4,695	)		–		–		–		–		–		–		–			–			–
Stock-based compensation expense		–			–		–		–		–		–		215		–			–			215
Net income		–			–		–		–		–		–		–		1,653			–			1,653
Net change in accumulated other comprehensive income, net of taxes		–			–		–		–		–		–		–		–			(2,017	)		(2,017	)
Dividends 5% on Series A preferred stock		–			–		–		–		–		–		–		(875	)		–			(875	)
Accretion of Series A preferred stock discount		–			–		–		–		90		–		–		(90	)		–			–

Balances, June 30, 2012		11,934,872			35,000		317,042	$	112,236	$	34,751	$	3,283	$	20,056	$	(90,968	)	$	2,147		$	81,505

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Six Months Ended June 30, 2012 and 2011

(dollars in thousands)

	2012			2011
Cash flows from operating activities Net income (loss)	$	1,653		$	(39,190	)
Adjustments to reconcile net income to net cash from operating activities Depreciation and amortization		1,127			1,214
Provision for loan losses		7,750			18,800
Net amortization on securities		1,566			597
Goodwill impairment charge		—			23,794
Stock-based compensation expense		215			234
Deferred income taxes (benefit)		—			(7,915	)
Net gain on loans originated for sale		(122	)		(541	)
Loans originated for sale		(5,721	)		(17,609	)
Proceeds from sales of loans originated for sale		6,133			17,798
Net gain on sales of investment securities		(3,530	)		(1,108	)
Net loss on sales of other real estate owned		948			6,876
Net write-down of other real estate owned		830			15,437
Earnings on bank owned life insurance		(148	)		(140	)
Net change in accrued interest receivable and other assets		4,282			(3,339	)
Net change in accrued interest payable and other liabilities		(977	)		(46	)
Net cash from operating activities		14,006			14,862
Cash flows from investing activities Purchases of available-for-sale securities		(121,854	)		(108,647	)
Sales and calls of available-for-sale securities		65,695			49,653
Maturities and prepayments of available-for-sale securities		20,848			10,050
Proceeds from sale of other real estate owned		13,072			5,047
Improvements to other real estate owned		(1	)		(1,420	)
Loan originations and payments, net		58,397			30,418
Purchases of premises and equipment, net		(318	)		(89	)
Net cash from investing activities		35,839			(14,988	)
Cash flows from financing activities Net change in deposits		(119,041	)		(32,171	)
Net change in repurchase agreements		763			(616	)
Repayment of Federal Home Loan Bank advances		(718	)		(1,085	)
Advances from Federal Home Loan Bank		—			25,000
Repayment of subordinated capital note		(450	)		(225	)
Cash dividends paid on preferred stock		—			(882	)
Cash dividends paid on common stock		—			(237	)
Net cash from financing activities		(119,446	)		(10,216	)
Net change in cash and cash equivalents		(69,601	)		(10,342	)
Beginning cash and cash equivalents		105,962			185,435
Ending cash and cash equivalents	$	36,361		$	175,093
Supplemental cash flow information: Interest paid	$	8,159		$	11,602
Income taxes paid		—			2,000
Supplemental non-cash disclosure: Transfer from loans to other real estate	$	28,126		$	15,261
Financed sales of other real estate owned		361			7,043

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements include Porter Bancorp, Inc. (Company or PBI) and its subsidiary, PBI Bank (Bank). The Company owns a 100% interest in the Bank. All significant inter-company transactions and accounts have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2011 included in the Company’s Annual Report on Form 10-K.

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, fair values of financial instruments, stock compensation, deferred tax assets, other intangibles, and fair values of other real estate owned are particularly subject to change.

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications did not impact net income or stockholders’ equity.

Note 2 – Recent Developments and Future Plans

During the first six months of 2012, we reported net income available to common shareholders of $661,000. This was an improvement from our 2011 results. During the year ended December 31, 2011, we recorded a net loss to common shareholders of $105.2 million. This loss was primarily attributable to a $23.8 million goodwill impairment charge, the establishment of a $31.7 million valuation allowance on our deferred tax assets, OREO expense of $47.5 million related to valuation adjustments for our change in strategy related to certain properties, fair value write-downs related to new appraisals received for properties in the portfolio during 2011, net loss on the sale of OREO properties, and increase in carrying costs associated with carrying these higher levels of assets, as well as provision for loan losses expense of $62.6 million due to the continued decline in credit trends within our portfolio.

In June 2011, the Bank agreed to a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Consent Order was included in our Current Report on 8-K filed on June 30, 2011. As of June 30, 2012, these capital ratios were not met.

In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate strategies including the following:

●	Continuing to operate the Company and Bank in a safe and sound manner. This strategy will require us to continue to reduce the size of our balance sheet, reduce our lending concentrations, consider selling loans, and reduce other noninterest expense through the disposition of OREO.

●

Continuing with succession planning and add resources to management team. On March 29, 2012, the Board of Directors announced that it had formed a search committee comprised of its five independent directors to identify and hire a President and CEO for PBI Bank. On July 19, 2012, we reported that the Company had successfully filled this key position.

●	Addressing other real estate owned.

In 2011, management determined, with the concurrence of the Board of Directors, that certain properties held in OREO were not likely to be successfully disposed of in an acceptable time-frame using routine marketing efforts. It became apparent due to weakness in the economy and softness in demand for housing that certain land development and residential condominium projects would require extended holding periods to sell the properties at recent appraised values. Accordingly, management determined to market these properties more aggressively to retail and bulk buyers. In June 2011, the Company sold, in a single transaction, 54 finished condominium property units from condominium developments held in our OREO portfolio with a carrying value of approximately $11.0 million, for $5.2 million, resulting in a pre-tax loss of $5.8 million.

Although we were carrying our OREO at fair market value less estimated cost to sell, we subsequently adjusted our valuations for land development and residential development properties held in OREO similar to the properties we sold earlier in 2011. Our 2011 fair value adjustments totaled approximately $25.6 million to reflect our intent to market these properties more aggressively to retail and bulk buyers. Additionally, we recorded approximately $9.3 million of fair value adjustments related to new appraisals received for properties in the portfolio during 2011.

In summary, for the years ended December 31, 2011 and 2010 respectively, we recorded net construction and development OREO fair value adjustments and loss on sale of OREO totaling $38.7 million and $10.4 million. This represents approximately 89% and 71% of our total OREO fair value adjustments and loss on sale in 2011 and 2010, respectively.

For the first six months of 2012, we recorded net construction and development OREO fair value adjustments and loss on sale of construction and development OREO of $280,000. This represents approximately 16% of our total OREO fair value adjustments and loss on sale of OREO in the first six months of 2012.

●	We are committed to reducing loan concentrations and balance sheet risk.

We recorded net construction and development loan charge-offs totaling $1.3 million during the first six months of 2012. This represented approximately 15% of our total net loan charge-offs for the first six months of 2012. We recorded net construction and development loan charge-offs totaling $11.0 million and $11.4 million for the years ended December 31, 2011 and 2010, respectively. This represented approximately 27% and 51% of our total net loan charge-offs in 2011 and 2010, respectively.

Our Consent Order calls for us to reduce our construction and development loans to not more than 75% of total risk-based capital. We were in compliance at June 30, 2012 with construction and development loans representing 68% of total risk-based capital. These loans totaled $81.8 million, or 68% of total risk-based capital, at June 30, 2012 and $101.5 million, or 85% of total risk-based capital, at December 31, 2011.

Our Consent Order also requires us to reduce non-owner occupied commercial real estate loans, construction and development loans, and multifamily residential real estate loans as a group, to not more than 250% of total risk-based capital. We were not in compliance at June 30, 2012 with non-owner occupied commercial real estate loans, construction and development loans, and multifamily residential real estate loans as a group representing 313% of total risk-based capital. These loans totaled $376.6 million, or 313% of total risk-based capital, at June 30, 2012 and $414.6 million, or 349% of total risk-based capital, at December 31, 2011.

We are working to reduce these loans by curtailing new construction and development lending and new non-owner occupied commercial real estate lending. We are also receiving principal reductions from amortizing credits and pay-downs from our customers who sell properties built for resale. We have reduced the construction loan portfolio from $199.5 million at December 31, 2010 to $81.8 million at June 30, 2012. Our non-owner occupied commercial real estate loans declined from $293.3 million at December 31, 2010 to $234.9 million at June 30, 2012.

●	Raising capital by selling common stock through a public offering or private placement to existing and new investors.

●	Evaluating other strategic alternatives, such as the sale of assets or branches.

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions.

Note 3 - Securities

The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
June 30, 2012
U.S. Government and federal agency	$	5,695	$	550	$	—		$	6,245
Agency mortgage-backed: residential		125,017		1,342		(255	)		126,104
State and municipal		49,791		1,898		(233	)		51,456
Corporate bonds		7,267		545		(34	)		7,778
Other		572		34		—			606
Total debt securities		188,342		4,369		(522	)		192,189
Equity		1,359		543		—			1,902
Total	$	189,701	$	4,912	$	(522	)	$	194,091
December 31, 2011
U.S. Government and federal agency	$	10,494	$	1,149	$	—		$	11,643
Agency mortgage-backed: residential		97,286		2,211		(22	)		99,475
State and municipal		35,456		2,610		(4	)		38,062
Corporate bonds		7,259		315		(242	)		7,332
Other		572		34		—			606
Total debt securities		151,067		6,319		(268	)		157,118
Equity		1,359		356		—			1,715
Total	$	152,426	$	6,675	$	(268	)	$	158,833

Sales and calls of available for sale securities were as follows:

		Three Months Ended June 30,				Six Months Ended June 30,
		2012		2011		2012		2011
		(in thousands)
Proceeds	$	44,310	$	46,759	$	65,695	$	49,653
Gross gains		1,511		1,025		3,530		1,108
Gross losses		—		—		—		—

The amortized cost and fair value of the debt investment securities portfolio are shown by contractual maturity. Contractual maturities may differ from actual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are detailed separately.

	June 30, 2012
	Amortized Cost		Fair Value
	(in thousands)
Maturity Available-for-sale Within one year	$	215	$	217
One to five years		11,120		11,890
Five to ten years		42,183		43,863
Beyond ten years		9,807		10,115
Agency mortgage-backed: residential		125,017		126,104
Total	$	188,342	$	192,189

Securities pledged at June 30, 2012 and December 31, 2011 had carrying values of approximately $57.3 million and $57.7 million, respectively, and were pledged to secure public deposits and repurchase agreements.

The Company evaluates securities for other than temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. Management currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity.

At June 30, 2012, the Company held 40 equity securities. Of these securities, one security had an unrealized loss less than $1,000 and had been in an unrealized loss position for less than twelve months. All other equity securities were in an unrealized gain position at June 30, 2012. Management monitors the underlying financial condition of the issuers and current market pricing for these equity securities monthly. As of June 30, 2012, management does not believe any securities in our portfolio with unrealized losses should be classified as other than temporarily impaired. Management currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity.

Securities with unrealized losses at June 30, 2012 and December 31, 2011, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
	(in thousands)
June 30, 2012
State and municipal	$	16,286	$	(233	)	$	—	$	—		$	16,286	$	(233	)
Agency mortgage-backed: residential		40,037		(255	)		—		—			40,037		(255	)
Corporate bonds		—		—			989		(34	)		989		(34	)
Equity		2		—			—		—			2		—
Total temporarily impaired	$	56,325	$	(488	)	$	989	$	(34	)	$	57,314	$	(522	)


December 31, 2011
State and municipal	$	508	$	(4	)	$	—	$	—		$	508	$	(4	)
Agency mortgage-backed: residential		2,159		(22	)		—		—			2,159		(22	)
Corporate bonds		2,805		(242	)		—		—			2,805		(242	)
Total temporarily impaired	$	5,472	$	(268	)	$	—	$	—		$	5,472	$	(268	)

Note 4 – Loans

Loans were as follows:

	June 30,			December 31,
	2012			2011
	(in thousands)
Commercial	$	68,084		$	71,216
Commercial Real Estate: Construction		81,815			101,471
Farmland		85,634			90,958
Other		384,718			423,844
Residential Real Estate: Multi-family		59,867			60,410
1-4 Family		310,626			337,350
Consumer		22,898			26,011
Agriculture		26,251			23,770
Other		1,016			993
Subtotal		1,040,909			1,136,023
Less: Allowance for loan losses		(51,594	)		(52,579	)
Loans, net	$	989,315		$	1,083,444

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended June 30, 2012 and 2011:

	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Agriculture			Other		Total
	(in thousands)
June 30, 2012:
Beginning balance	$	4,082		$	32,982		$	15,720		$	812		$	345		$	12	$	53,953
Provision for loan losses		(78	)		1,003			2,696			97			282			–		4,000
Loans charged off		(210	)		(2,944	)		(2,862	)		(135	)		(287	)		–		(6,438	)
Recoveries		17			8			33			18			3			–		79
Ending balance	$	3,811		$	31,049		$	15,587		$	792		$	343		$	12	$	51,594


June 30, 2011:
Beginning balance	$	1,974		$	23,396		$	7,451		$	631		$	139		$	8	$	33,599
Provision for loan losses		2,538			7,964			3,089			96			12			1		13,700
Loans charged off		(1,856	)		(5,353	)		(1,259	)		(120	)		(8	)		–		(8,596	)
Recoveries		12			14			(21	)		9			–			–		14
Ending balance	$	2,668		$	26,021		$	9,260		$	616		$	143		$	9	$	38,717

The following table presents the activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2012 and 2011:

	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Agriculture			Other			Total
	(in thousands)
June 30, 2012:
Beginning balance	$	4,207		$	33,024		$	14,217		$	792		$	325		$	14		$	52,579
Provision for loan losses		11			1,775			5,202			321			443			(2	)		7,750
Loans charged off		(466	)		(3,863	)		(3,891	)		(372	)		(428	)		–			(9,020	)
Recoveries		59			113			59			51			3			–			285
Ending balance	$	3,811		$	31,049		$	15,587		$	792		$	343		$	12		$	51,594


June 30, 2011:
Beginning balance	$	2,147		$	24,075		$	7,224		$	701		$	134		$	4		$	34,285
Provision for loan losses		2,432			11,421			4,707			218			17			5			18,800
Loans charged off		(1,935	)		(9,494	)		(2,693	)		(333	)		(8	)		–			(14,463	)
Recoveries		24			19			22			30			–			–			95
Ending balance	$	2,668		$	26,021		$	9,260		$	616		$	143		$	9		$	38,717

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of June 30, 2012:

	Commercial		Commercial Real Estate		Residential Real Estate		Consumer		Agriculture		Other		Total
	(in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	4,626	$	994	$	—	$	—	$	—	$	5,620
Collectively evaluated for impairment		3,811		26,423		14,593		792		343		12		45,974
Total ending allowance balance	$	3,811	$	31,049	$	15,587	$	792	$	343	$	12	$	51,594


Loans:
Loans individually evaluated for impairment	$	6,779	$	115,045	$	52,376	$	331	$	586	$	533	$	175,650
Loans collectively evaluated for impairment		61,305		437,122		318,117		22,567		25,665		483		865,259
Total ending loans balance	$	68,084	$	552,167	$	370,493	$	22,898	$	26,251	$	1,016	$	1,040,909

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2011:

	Commercial		Commercial Real Estate		Residential Real Estate		Consumer		Agriculture		Other		Total
	(in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	237	$	5,281	$	1,055	$	—	$	—	$	—	$	6,573
Collectively evaluated for impairment		3,970		27,743		13,162		792		325		14		46,006
Total ending allowance balance	$	4,207	$	33,024	$	14,217	$	792	$	325	$	14	$	52,579

Loans:
Loans individually evaluated for impairment	$	5,032	$	116,676	$	27,848	$	—	$	631	$	540	$	150,727
Loans collectively evaluated for impairment		66,184		499,598		369,911		26,011		23,139		453		985,296
Total ending loans balance	$	71,216	$	616,274	$	397,759	$	26,011	$	23,770	$	993	$	1,136,023

Impaired Loans

Impaired loans include restructured loans and commercial, commercial real estate, construction, residential real estate, and agriculture loans on non-accrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss had been provided.

The following table presents information related to loans individually evaluated for impairment by class of loans as of and for the three and six months ended June 30, 2012:

							Three Months Ended June 30, 2012				Six Months Ended June 30, 2012
	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Cash Basis Income Recognized
	(in thousands)
With No Related Allowance Recorded:
Commercial	$	6,899	$	6,779	$	—	$	7,004	$	52	$	6,346	$	87	$	19
Commercial real estate:
Construction		8,882		8,580		—		8,633		59		8,998		122		2
Farmland		6,477		6,477		—		6,039		10		5,408		24		7
Other		35,192		34,460		—		30,299		124		28,408		370		3
Residential real estate:
Multi-family		10,756		10,756		—		11,759		55		8,807		141		—
1-4 Family		32,029		31,412		—		31,487		206		24,586		379		27
Consumer		338		331		—		365		2		243		3		1
Agriculture		701		586		—		548		—		576		—		—
Other		533		533		—		535		5		536		9		—
With An Allowance Recorded:
Commercial real estate:
Construction		14,561		11,812		1,212		13,397		28		13,291		75		—
Farmland		4,394		4,193		831		4,188		—		4,770		—		—
Other		52,387		49,523		2,583		57,347		95		57,952		491		76
Residential real estate:
Multi-family		—		—		—		706		—		942		—		—
1-4 Family		11,946		10,208		994		11,698		25		12,048		50		—
Consumer		—		—		—		—		—		—		—		—
Agriculture		—		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—		—
Total	$	185,095	$	175,650	$	5,620	$	184,005	$	661	$	172,911	$	1,751	$	135

The following table presents loans individually evaluated for impairment by class of loan as of December 31, 2011:

	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized		Cash Basis Income Recognized
	(in thousands)
With No Related Allowance Recorded:
Commercial	$	3,997	$	3,954	$	—	$	3,489	$	146	$	48
Commercial real estate:
Construction		8,381		8,288		—		9,635		57		4
Farmland		4,230		4,146		—		2,403		36		36
Other		26,590		26,068		—		19,606		459		99
Residential real estate:
Multi-family		2,904		2,904		—		1,029		35		—
1-4 Family		10,883		10,784		—		6,805		296		3
Consumer		—		—		—		—		—		—
Agriculture		637		631		—		253		5		5
Other		540		540		—		108		—		—
With An Allowance Recorded:
Commercial		1,078		1,078		237		1,125		69		69
Commercial real estate:
Construction		15,915		13,079		1,941		4,039		93		—
Farmland		6,375		5,934		532		6,302		322		—
Other		64,984		59,431		2,808		29,091		609		148
Residential real estate:
Multi-family		1,891		1,412		487		1,795		115		—
1-4 Family		15,342		12,478		568		9,651		352		—
Consumer		—		—		—		—		—		—
Agriculture		—		—		—		—		—		—
Other		—		—		—		—		—		—
Total	$	163,747	$	150,727	$	6,573	$	95,331	$	2,594	$	412

Troubled Debt Restructuring

A troubled debt restructuring (TDR) is where the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the customer.

The following table presents the types of TDR loan modifications by portfolio segment outstanding as of June 30, 2012 and December 31, 2011:

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
June 30, 2012
Commercial
Rate reduction	$	1,217	$	—	$	1,217
Principal deferral		891		—		891
Interest only payments		—		1,019		1,019
Commercial Real Estate:
Construction
Rate reduction		10,787		3,600		14,387
Interest only payments		152		—		152
Farmland
Rate reduction		—		135		135
Principal deferral		738		3,893		4,631
Other
Rate reduction		37,056		21,452		58,508
Principal deferral		1,196		—		1,196
Interest only payments		2,463		2,174		4,637
Residential Real Estate:
Multi-family
Rate reduction		8,672		—		8,672
Interest only payments		656		—		656
1-4 Family
Rate reduction		20,707		4,676		25,383
Principal deferral		—		799		799
Other
Rate reduction		533		—		533
Total TDRs	$	85,068	$	37,748	$	122,816

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
December 31, 2011
Commercial
Rate reduction	$	1,231	$	—	$	1,231
Principal deferral		898		—		898
Commercial Real Estate:
Construction
Rate reduction		11,155		3,767		14,922
Interest only payments		—		1,404		1,404
Farmland
Rate reduction		182		—		182
Principal deferral		746		5,101		5,847
Other
Rate reduction		42,946		20,446		63,392
Interest only payments		1,288		—		1,288
Residential Real Estate:
Multi-family
Rate reduction		2,247		1,413		3,660
Interest only payments		656		—		656
1-4 Family
Rate reduction		12,255		7,176		19,431
Principal deferral		—		247		247
Other
Rate reduction		540		—		540
Total TDRs	$	74,144	$	39,554	$	113,698

At June 30, 2012, and December 31, 2011, 69% and 65%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated $11.2 million and $10.6 million in reserves to customers whose loan terms have been modified in TDRs as of June 30, 2012, and December 31, 2011, respectively. The Company has committed to lend additional amounts totaling $349,000 and $317,000 as of June 30, 2012, and December 31, 2011, respectively, to customers with outstanding loans that are classified as TDRs.

The following table presents a summary of the types of TDR loan modifications by portfolio type that occurred during the three months ended June 30, 2012:

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
June 30, 2012
Commercial Real Estate:
Construction
Interest only payments	$	152	$	—	$	152
Other
Rate reduction		8,152		—		8,152
Principal deferral		1,196		—		1,196
Interest only payments		2,462		—		2,462
Residential Real Estate:
1-4 Family
Rate reduction		3,086		—		3,086
Principal deferral		—		573		573
Total TDRs	$	15,048	$	573	$	15,621

As of June 30, 2012, 96% of the Company’s TDRs that occurred during the three months ended June 30, 2012, were performing in accordance with their modified terms. The Company has allocated $1.3 million in reserves to customers whose loan terms have been modified during the three months ended June 30, 2012. For modifications occurring during the three month period ended June 30, 2012, the post- modification balances approximate the pre-modification balances.

The following table presents a summary of the types of TDR loan modifications by portfolio type that occurred during the six months ended June 30, 2012:

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
June 30, 2012
Commercial
Interest only payments	$	—	$	1,019	$	1,019
Commercial Real Estate:
Construction
Interest only payments		152		—		152
Other
Rate reduction		11,302		—		11,302
Principal deferral		1,196		—		1,196
Interest only payments		2,462		2,174		4,636
Residential Real Estate:
Multi-family
Rate reduction		8,386		—		8,386
1-4 Family
Rate reduction		8,470		—		8,470
Principal deferral		—		573		573
Total TDRs	$	31,968	$	3,766	$	35,734

As of June 30, 2012, 89% of the Company’s TDRs that occurred during the first six months of 2012 were performing in accordance with their modified terms. The Company has allocated $2.6 million in reserves to customers whose loan terms have been modified during the first six months of 2012. For modifications occurring during the six month period ended June 30, 2012, the post- modification balances approximate the pre-modification balances.

During the first six months of 2012, approximately $7.9 million TDRs defaulted on their restructured loan and the default occurred within the 12 month period following the loan modification. These defaults consisted of $6.3 million in commercial real estate loans, $1.0 million in commercial loans, and $622,000 in 1-4 family residential real estate loans. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.

Nonperforming Loans

Nonperforming loans include impaired loans not on accrual and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.

The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of June 30, 2012, and December 31, 2011:

	Nonaccrual				Loans Past Due 90 Days And Over Still Accruing
	June 30, 2012		December 31, 2011		June 30, 2012		December 31, 2011
	(in thousands)

Commercial	$	2,663	$	2,903	$	48	$	109
Commercial Real Estate:
Construction		9,454		13,564		—		—
Farmland		9,932		9,152		—		26
Other		36,409		35,154		—		918
Residential Real Estate:
Multi-family		1,428		2,921		—		—
1-4 Family		20,913		27,375		39		265
Consumer		268		320		1		—
Agriculture		586		631		—		32
Other		—		—		—		—
Total	$	81,653	$	92,020	$	88	$	1,350

The following table presents the aging of the recorded investment in past due loans as of June 30, 2012 and December 31, 2011:

	30 – 59 Days Past Due		60 – 89 Days Past Due		90 Days And Over Past Due		Nonaccrual		Total Past Due And Nonaccrual
	(in thousands)
June 30, 2012
Commercial	$	97	$	545	$	48	$	2,663	$	3,353
Commercial Real Estate:
Construction		76		176		—		9,454		9,706
Farmland		1,263		1,068		—		9,932		12,263
Other		1,596		44		—		36,409		38,049
Residential Real Estate:
Multi-family		—		442		—		1,428		1,870
1-4 Family		3,227		1,912		39		20,913		26,091
Consumer		369		154		1		268		792
Agriculture		75		67		—		586		728
Other		—		—		—		—		—
Total	$	6,703	$	4,408	$	88	$	81,653	$	92,852

	30 – 59 Days Past Due		60 – 89 Days Past Due		90 Days And Over Past Due		Nonaccrual		Total Past Due And Nonaccrual
	(in thousands)
December 31, 2011
Commercial	$	2,792	$	91	$	109	$	2,903	$	5,895
Commercial Real Estate:
Construction		20		—		—		13,564		13,584
Farmland		1,353		305		26		9,152		10,836
Other		4,555		756		918		35,154		41,383
Residential Real Estate:
Multi-family		442		135		—		2,921		3,498
1-4 Family		7,568		2,511		265		27,375		37,719
Consumer		593		149		—		320		1,062
Agriculture		23		—		32		631		686
Other		—		—		—		—		—
Total	$	17,346	$	3,947	$	1,350	$	92,020	$	114,663

Credit Quality Indicators – We categorize loans into risk categories at origination based upon original underwriting. Subsequent to origination, we categorized loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. Loans are analyzed individually by classifying the loans as to credit risk. This analysis includes loans with an outstanding balance greater than $500,000 and non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a quarterly basis. We do not have any non-rated loans. The following definitions are used for risk ratings:

Watch – Loans classified as watch are those loans which have experienced a potentially adverse development which necessitates increased monitoring.

Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility that we will sustain some losses if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans. As of June 30, 2012, and December 31, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

	Pass		Watch		Special Mention		Substandard		Doubtful		Total
	(in thousands)
June 30, 2012
Commercial	$	46,405	$	11,008	$	3,620	$	6,976	$	75	$	68,084
Commercial Real Estate:
Construction		32,185		15,750		11,177		22,703		—		81,815
Farmland		55,035		11,534		2,233		16,832		—		85,634
Other		166,343		72,802		48,629		96,310		634		384,718
Residential Real Estate:
Multi-family		32,969		7,600		1,640		17,658		—		59,867
1-4 Family		198,371		43,058		6,243		62,795		159		310,626
Consumer		20,463		1,235		87		1,050		63		22,898
Agriculture		23,128		1,122		1,277		724		—		26,251
Other		483		533		—		—		—		1,016
Total	$	575,382	$	164,642	$	74,906	$	225,048	$	931	$	1,040,909

	Pass		Watch		Special Mention		Substandard		Doubtful		Total
	(in thousands)
December 31, 2011
Commercial	$	53,223	$	9,357	$	3,237	$	5,300	$	99	$	71,216
Commercial Real Estate:
Construction		45,407		13,132		7,777		35,155		—		101,471
Farmland		69,881		4,955		2,688		13,236		199		90,959
Other		213,406		80,149		30,787		99,502		—		423,844
Residential Real Estate:
Multi-family		37,807		4,619		2,100		15,884		—		60,410
1-4 Family		247,422		28,734		2,276		58,891		26		337,349
Consumer		23,721		1,418		43		762		67		26,011
Agriculture		22,502		343		14		911		—		23,770
Other		453		540		—		—		—		993
Total	$	713,822	$	143,247	$	48,922	$	229,641	$	391	$	1,136,023

Note 5 – Other Real Estate Owned

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent reductions in fair value are recorded as non-interest expense. To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are taken.

For larger dollar residential and commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to other real estate owned. We obtain updated appraisals each year on the anniversary date of ownership unless a sale is imminent. We continue to explore opportunities to bulk sell OREO. While the ultimate outcome of a transaction is uncertain, we determined in 2011 that we would be willing to sell certain OREO properties at an amount below their individual appraised values. Accordingly, we adjusted our valuations for these properties downward through additional provision of a valuation allowance to reflect a more aggressive disposition strategy. These properties are primarily single and multi-family residential land development properties. The following table presents the major categories of OREO at the period-ends indicated:

	June 30, 2012			December 31, 2011
	(in thousands)
Commercial Real Estate:
Construction	$	27,760		$	32,538
Farmland		285			744
Other		18,741			6,620
Residential Real Estate:
1-4 Family		9,303			3,214
		56,089			43,116
Valuation allowance		(1,724	)		(1,667	)
	$	54,365		$	41,449

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2012			2011			2012			2011
		(in thousands)
OREO Valuation Allowance Activity:
Beginning balance	$	1,682		$	700		$	1,667		$	700
Provision to allowance		350			14,951			830			15,437
Write-downs		(308	)		(5,008	)		(773	)		(5,494	)
Ending balance	$	1,724		$	10,643		$	1,724		$	10,643

Net activity relating to other real estate owned during the six months ended June 30, 2012 and 2011 is as follows:

	2012			2011
	(in thousands)
OREO Activity
OREO as of January 1	$	41,449		$	67,635
Real estate acquired		28,126			15,261
Valuation adjustments		(830	)		(15,437	)
Improvements		1			1,420
Loss on sale		(948	)		(6,876	)
Proceeds from sale of properties		(13,433	)		(12,090	)
OREO as of June 30	$	54,365		$	49,913

Expenses related to other real estate owned include:

	Three Months Ended				Six Months Ended
	June 30, 2012		June 30, 2011		June 30, 2012		June 30, 2011
	(in thousands)
Net loss on sales	$	546	$	6,485	$	948	$	6,876
Provision to allowance		350		14,951		830		15,437
Operating expense		309		673		684		1,163
Total	$	1,205	$	22,109	$	2,462	$	23,476

Note 6 – Advance from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank were as follows:

		June 30, 2012		December 31, 2011
		(in thousands)
Monthly amortizing advances with fixed rates from 0.00% to 5.25% and maturities ranging from 2012 through 2033, averaging 3.27% for 2012	$	6,398	$	7,116

Each advance is payable per terms on agreement, with a prepayment penalty. The advances were collateralized by first mortgage loans. The borrowing capacity is based on the market value of the underlying pledged loans. At June 30, 2012, our additional borrowing capacity with the FHLB was $45.9 million. The availability of our borrowing capacity could be affected by our financial position and the FHLB could require additional collateral or, amount other things exercise its right to deny a funding request, at its discretion.

Note 7 – Fair Values Measurement

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We use various valuation techniques to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability to access as of the measurement date, or observable inputs.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, we classify the fair value hierarchy on the lowest level of input that is significant to the fair value measurement. We used the following methods and significant assumptions to estimate fair value.

Securities: The fair values of securities are determined by market quoted prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where the date of the appraisal of the collateral predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be for unique use. This is in addition to estimated discounts for cost to sell of six to ten percent.

Impaired loans are evaluated quarterly for additional impairment. We obtain updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and our assessment of deterioration of real estate values in the market in which the property is located. The first stage of our assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market makers to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal market evaluation less cost to sell. Our quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. Based on these consultations, we determine asking prices for OREO properties we are marketing for sale. If the internally evaluated fair value is below our recorded investment in the property, appropriate write-downs are taken.

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end, and we must make our best estimate of fair value based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We obtain updated appraisals on the anniversary date of ownership unless a sale is imminent.

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our OREO. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate to 25% for real estate that is determined (1) to have a thin trading market or (2) to be for unique use. This is in addition to estimated discounts for cost to sell of six to ten percent.

In 2011, management, with concurrence of the Board of Directors, determined that certain properties held in other real estate were not likely to be successfully disposed of in an acceptable time-frame using routine marketing efforts. It became apparent that certain properties were going to require extended holding periods to sell the properties at recent appraised values. These properties are primarily single and multi-family residential loan development properties. Given our change in strategy to reduce non-performing assets in an accelerated manner, management adjusted downward the valuations for these properties in our OREO portfolio to amounts below their individual appraised values.

Financial assets measured at fair value on a recurring basis at June 30, 2012 are summarized below:

			Fair Value Measurements at June 30, 2012 Using
			(in thousands)
Description	Carrying Value		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities
U.S. Government and federal agency	$	6,245	$	—	$	6,245	$	—
Agency mortgage-backed: residential		126,104		—		126,104		—
State and municipal		51,456		—		51,456		—
Corporate bonds		7,778				7,778		—
Other debt securities		606						606
Equity securities		1,902		1,902				—
Total	$	194,091	$	1,902	$	191,583	$	606

There were no transfers between Level 1 and Level 2 during 2012 or 2011.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended June 30, 2012 and 2011:

	State and Municipal Securities					Other Debt Securities
	2012			2011		2012		2011
	(in thousands)
Balances of recurring Level 3 assets at January 1	$	1,173		$	—	$	606	$	572
Total gains for the period:
Included in other comprehensive income		—			—		—		22
Sales		(1,173	)		—		—		—
Balance of recurring Level 3 assets at June 30	$	—		$	—	$	606	$	594

Our level 3 state and municipal securities valuations are supported by analysis prepared by an independent third party. Their approach to determining fair value involves using recently executed transactions for similar securities and market quotations for similar securities. As these securities are not rated by the rating agencies and trading volumes are thin, it was determined that these were valued using Level 3 inputs.

Our other debt security valuation is determined internally by calculating discounted cash flows using the security’s coupon rate of 6.5% and an estimated current market rate of 10.5% based upon the current yield curve plus spreads that adjust for volatility, credit risk, and optionality. We also consider the issuer(s) publicly filed financial information as well as assumptions regarding the likelihood of deferrals and defaults.

Financial assets measured at fair value on a non-recurring basis June 30, 2012 are summarized below:

			Fair Value Measurements at June 30, 2012 Using
			(in thousands)
Description	Carrying Value		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans:
Commercial	$	3,027	$	—	$	—	$	3,027
Commercial real estate:
Construction		10,600		—		—		10,600
Farmland		3,362		—		—		3,362
Other		46,940		—		—		46,940
Residential Real Estate
1-4 Family		9,214		—		—		9,214
Other real estate owned, net:
Commercial real estate:
Construction		26,907		—		—		26,907
Farmland		276		—		—		276
Other		18,165		—		—		18,165
Residential real estate:
Multi-family		34		—		—		34
1-4 Family		8,983		—		—		8,983

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $78.8 million, with a valuation allowance of $5.6 million, at June 30, 2012, resulting in an additional provision for loan losses of $689,000 for the six months ended June 30, 2012.

Other real estate owned, which is measured at the lower of carrying or fair value less estimated costs to sell, had a net carrying amount of $54.4 million as of June 30, 2012, compared with $49.9 million at June 30, 2011. Write-downs of $830,000 and $15.4 million were recorded on other real estate owned for the first six months of 2012 and 2011, respectively.

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2012:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
	(in thousands)

Impaired loans – Commercial	$	3,027	Income approach	Capitalization rate		14% - 37% (26%)

Impaired loans – Commercial real estate	$	60,902	Sales comparison approach	Adjustment for differences between the comparable sales		0% - 62% (17%)

Impaired loans – Residential real estate	$	9,214	Sales comparison approach	Adjustment for differences between the comparable sales		3% - 38% (19%)

Other real estate owned – Commercial real estate	$	45,348	Sales comparison approach	Adjustment for differences between the comparable sales		3% - 38% (18%)
			Income approach	Discount or capitalization rate		9% - 16% (11%)
				Accelerated sales strategy		33% - 50% (45%)

Other real estate owned – Residential real estate	$	9,017	Sales comparison approach	Adjustment for differences between the comparable sales		0% - 32% (9%)

Financial assets measured at fair value on a recurring basis at December 31, 2011 are summarized below:

			Fair Value Measurements at December 31, 2011 Using
			(in thousands)
Description	Carrying Value			Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities
U.S. Government and federal agency	$	11,643		$	—	$	11,643	$	—
Agency mortgage-backed		99,475			—		99,475		—
State and municipal		38,062			—		36,889		1,173
Corporate bonds		7,332			—		7,332		—
Other debt securities		606			—		—		606
Equity securities		1,715			1,715		—		—
Total	$	158,833		$	1,715	$	155,339	$	1,779

Financial assets measured at fair value on a non-recurring basis at December 31, 2011 are summarized below:

			Fair Value Measurements at December 31, 2011 Using
			(in thousands)
Description	Carrying Value		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans:
Commercial	$	841	$	—	$	—	$	841
Commercial real estate:
Construction		11,138		—		—		11,138
Farmland		5,402		—		—		5,402
Other		56,623		—		—		56,623
Residential real estate:
Multi-family		925		—		—		925
1-4 Family		11,910		—		—		11,190
Other real estate owned, net:
Commercial real estate:
Construction		31,280		—		—		31,280
Farmland		715		—		—		715
Other		6,364		—		—		6,364
Residential real estate:
1-4 Family		3,090		—		—		3,090

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $73.9 million with a valuation allowance of $5.6 million.

Other real estate owned, which is measured at the lower of carrying or fair value less estimated costs to sell, had a net carrying amount of $41.4 million as of December 31, 2011.

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

			Fair Value Measurements at June 30, 2012 Using
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and cash equivalents	$	36,361	$	31,724	$	4,637	$	—	$	36,361
Securities available for sale		194,091		1,902		191,583		606		194,091
Federal Home Loan Bank stock		10,072		N/A		N/A		N/A		N/A
Mortgage loans held for sale		383		—		383		—		383
Loans, net		989,315		—		—		992,105		992,105
Accrued interest receivable		5,573		—		1,179		4,394		5,573
Financial liabilities
Deposits	$	1,204,722	$	112,797	$	1,098,688	$	—	$	1,211,485
Securities sold under agreements to repurchase		2,501		—		2,501		—		2,501
Federal Home Loan Bank advances		6,398		—		6,402		—		6,402
Subordinated capital notes		7,200		—		—		6,713		6,713
Junior subordinated debentures		25,000		—		—		19,628		19,628
Accrued interest payable		1,890		—		1,352		538		1,890

	Fair Value Measurements at December 31, 2011
	Carrying Amount		Fair Value

Financial assets
Cash and cash equivalents	$	105,962	$	105,962
Securities available for sale		158,833		158,833
Federal Home Loan Bank stock		10,072		N/A
Mortgage loans held for sale		694		694
Loans, net		1,083,444		1,093,456
Accrued interest receivable		6,682		6,682
Financial liabilities
Deposits	$	1,323,763	$	1,332,133
Securities sold under agreements to repurchase		1,738		1,738
Federal Home Loan Bank advances		7,116		7,015
Subordinated capital notes		7,650		7,110
Junior subordinated debentures		25,000		19,765
Accrued interest payable		1,732		1,732

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Noninterest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(d) Mortgage Loans Held for Sale

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

(e) Deposits

The fair values disclosed for non-interest bearing deposits are, by definition, equal to the amount payable on demand at the reporting date resulting in either a Level 1 classification. The carrying amounts of variable rate interest bearing deposits approximate their fair values at the reporting date resulting in either a Level 1 classification. Fair values for fixed rate interest bearing deposits are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(f) Securities Sold Under Agreements to Repurchase

The carrying amounts of borrowings under repurchase agreements approximate their fair values resulting in a Level 2 classification.

(g) Other Borrowings

The fair values of the Company’s FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Level 2 classification.

The fair values of the Company’s subordinated capital notes and junior subordinated debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(h) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.

Note 8 – Income Taxes

Deferred tax assets and liabilities were due to the following as of:

	June 30,			December 31,
	2012			2011
	(in thousands)
Deferred tax assets:
Allowance for loan losses	$	18,058		$	18,403
Other real estate owned write-down		8,984			12,905
Net operating loss carry-forward		6,285			2,470
New market tax credit carry-forward		243			208
Alternative minimum tax credit carry-forward		692			685
Net assets from acquisitions		568			543
Other than temporary impairment on securities		374			374
Amortization of non-compete agreements		23			27
Other		669			827
		35,896			36,442
Deferred tax liabilities:
Fixed assets		399			445
Net unrealized gain on securities available for sale		1,537			2,242
FHLB stock dividends		1,276			1,276
Originated mortgage servicing rights		97			103
Other		613			659
		3,922			4,725
Net deferred tax assets before valuation allowance		31,974			31,717
Valuation allowance		(31,974	)		(31,717	)
Net deferred tax asset	$	—		$	—

Our estimate of the realizability of the deferred tax asset depends on our estimate of projected future levels of taxable income as all carryback ability was fully absorbed by our estimated tax loss of approximately $40 million for 2011. In analyzing future taxable income levels, we considered all evidence currently available, both positive and negative. Based on our analysis, we established a valuation allowance for all deferred tax assets as of December 31, 2011. Our deferred tax assets and the related valuation allowance are analyzed and adjusted on a quarterly basis.

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the six months ended June 30, 2012 or the year ended December 31, 2011 related to unrecognized tax benefits.

The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the state of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2009.

Note 9 – Stock Plans and Stock Based Compensation

The Company has a stock option plan and a stock incentive plan. On February 23, 2006, the Company adopted the Porter Bancorp, Inc. 2006 Stock Incentive Plan. The 2006 Plan permits the issuance of up to 400,000 shares of the Company’s common stock upon the exercise of stock options or upon the grant of stock awards. As of June 30, 2012, the Company had granted 85,767 unvested shares net of forfeitures and vesting under the stock incentive plan. Shares issued under the plan vest annually on the anniversary date of the grant over five to ten years. The Company has 210,212 shares remaining available for issue under the plan. All shares issued under the above mentioned plans came from authorized and unissued shares.

On May 15, 2006, the board of directors approved the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan, which was approved by holders of the Company’s voting common stock on June 8, 2006. On May 22, 2008, shareholders voted to amend the plan to change the form of incentive award from stock options to unvested shares. Under the terms of the plan, 100,000 shares are reserved for issuance to non-employee directors upon the exercise of stock options or upon the grant of unvested stock awards granted under the plan. Prior to the amendment, options were granted automatically under the plan at fair market value on the date of grant. The options vest over a three-year period and have a five year term. Unvested shares are granted automatically under the plan at fair market value on the date of grant and vest semi-annually on the anniversary date of the grant over three years.

On May 16, 2012, holders of the Company’s voting common stock voted to further amend the 2006 Non-Employee Directors Stock Ownership Incentive Plan to award restricted shares having a fair market value of $25,000 annually to each non-employee director, and to increase the number of shares issuable under the Directors’ Plan from 100,000 shares to 400,000 shares. Shares issued under the amended plan vest semi-annually on the anniversary date of the grant over three years.

To date, the Company has issued 96,610 unvested shares to non-employee directors. At June 30, 2012, 295,712 shares remain available for issue under this plan.

The fair value of the 2012 unvested shares issued to certain employees was $38,000, or $1.78 per weighted-average share. The fair value of the 2012 unvested shares issued to non-employee directors was $155,000, or $1.65 per share. The Company recorded $215,000 and $234,000 of stock-based compensation during the first six months of 2012 and 2011, respectively, to salaries and employee benefits. There was no significant impact on compensation expense resulting from forfeited or expiring shares. We expect substantially all of the unvested shares outstanding at the end of the period will vest according to the vesting schedule. A deferred tax benefit of $0 and $82,000, respectively, was recognized related to this expense.

The following table summarizes unvested share activity as of and for the periods indicated:

	Six Months Ended June 30, 2012					Twelve Months Ended December 31, 2011
	Shares			Weighted Average Grant Price		Shares			Weighted Average Grant Price
Outstanding, beginning		100,226		$	13.21		157,697		$	13.43
Granted		115,095			1.67		2,800			5.36
Vested		(28,249	)		12.91		(35,836	)		13.00
Forfeited		(4,695	)		15.71		(24,435	)		14.04
Outstanding, ending		182,377		$	5.91		100,226		$	13.21

As of June 30, 2012, all stock options issued to non-employee directors had expired and none were exercised during their grant term. When granted, stock options have an exercise price that is equal to or greater than the fair market value of the Company’s stock on the date the options were granted. Options granted generally become fully exercisable at the end of three years of continued employment. Options have a life of five years.

The following table summarizes stock option activity:

	Six Months Ended June 30, 2012					Twelve Months Ended December 31, 2011
	Options			Weighted Average Exercise Price		Options			Weighted Average Exercise Price
Outstanding, beginning		29,530		$	19.88		86,469		$	20.72
Forfeited		—			—		(9,557	)		19.49
Expired		(29,530	)	$	19.88		(47,382	)		21.49
Outstanding, ending		—			—		29,530		$	19.88

No options were exercised during the first six months of 2012. The Company recorded no stock option compensation expense during the six months ended June 30, 2012. No options were modified during the period. As of June 30, 2012, no stock options issued by the Company had been exercised, and all granted options had expired.

Unrecognized stock based compensation expense related to unvested shares for the remainder of 2012 and beyond are estimated as follows (in thousands):

July 2012 – December 2012	$	241
2013		400
2014		290
2015		135
2016 & thereafter		32

Note 10 – Earnings per Share

The factors used in the basic and diluted earnings per share computations follow:

		Three Months Ended June 30,						Six Months Ended June 30,
		2012			2011			2012		2011
		(in thousands, except share and per share data)

Net income (loss)	$	151		$	(39,989	)	$	1,653	$	(39,190	)
Less: Preferred stock dividends		438			437			875		875
Accretion of Series A preferred stock discount		45			44			90		88
Earnings (loss) allocated to unvested shares		(4	)		(403	)		8		(454	)
Earnings (loss) allocated to Series C preferred		(9	)		(1,107	)		19		(1,098	)
Net income (loss) allocated to common shareholders, basic and diluted	$	(319	)	$	(38,960	)	$	661	$	(38,601	)
Basic
Weighted average common shares including unvested common shares outstanding		12,195,232			12,172,864			12,175,850		12,175,852
Less: Weighted average unvested common shares		129,182			121,314			141,301		137,712
Less: Weighted average Series C preferred		332,894			332,894			332,894		332,893
Weighted average common shares outstanding		11,733,156			11,718,656			11,701,655		11,705,247
Weighted average common shares outstanding
Basic earnings (loss) per common share	$	(0.03	)	$	(3.33	)	$	0.06	$	(3.30	)

Diluted
Add: Dilutive effects of assumed exercises of common and Preferred Series C stock warrants	—			—			—		—
Weighted average common shares and potential common shares		11,733,156			11,718,656			11,701,655		11,705,247
Diluted earnings (loss) per common share	$	(0.03	)	$	(3.33	)	$	0.06	$	(3.30	)

Stock options for 56,161 shares of common stock for 2011 were not considered in computing diluted earnings per common share because they were anti-dilutive. The Company had no outstanding stock options at June 30, 2012. Additionally, a warrant for the purchase of 330,561 shares of the Company’s common stock at an exercise price of $15.88 was outstanding at June 30, 2012 and 2011 but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. Finally, warrants for the purchase of 1,380,437 shares of non-voting common stock at an exercise price of $11.50 per share were outstanding at June 30, 2012 and 2011, but were not included in the diluted EPS computation as inclusion would have been anti-dilutive.

Note 11 – Capital Requirements and Restrictions on Retained Earnings

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

On June 24, 2011, PBI Bank entered into a Consent Order with the FDIC and the Kentucky Department of Financial Institutions. The consent order required the Bank to complete a management study, to maintain Tier 1 capital as a percentage of total assets of at least 9% and a total risk based capital ratio of at least 12%, to develop a plan to reduce our risk position in each substandard asset in excess of $1 million, to complete board review of the adequacy of the allowance for loan losses prior to quarterly Call Report submissions, to adopt procedures which strengthen the loan review function and ensure timely and accurate grading of credit relationships, to charge-off all assets classified as loss, to develop a plan to reduce concentrations of construction and development loans to not more than 75% of total risk based capital and non-owner occupied commercial real estate loans to not more than 250% of total risk based capital, to limit asset growth to no more than 5% in any quarter or 10% annually, to not extend additional credit to any borrower classified substandard unless the board of directors adopts prior to the extension a detailed statement giving reasons why the extension is in the best interest of the bank, and to not declare or pay any dividend without the prior consent of our regulators. We are also restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators.

On September 21, 2011, we entered into a Written Agreement with the Federal Reserve Bank of St. Louis. Pursuant to the Agreement, we made formal commitments to use our financial and management resources to serve as a source of strength for the Bank and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or principal on subordinated debentures or trust preferred securities without prior written approval, and to submit an acceptable plan to maintain sufficient capital

The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and PBI Bank at the dates indicated:

										June 30, 2012						December 31, 2011
	Regulatory Minimums			Well-Capitalized Minimums			Minimum Capital Ratios Under Consent Order			Porter Bancorp			PBI Bank			Porter Bancorp			PBI Bank

Tier 1 Capital		4.0	%		6.0	%		N/A			9.95	%		9.72	%		9.23	%		8.86	%
Total risk-based capital		8.0			10.0			12.0	%		11.94			11.71			11.22			10.86
Tier 1 leverage ratio		4.0			5.0			9.0			7.56			7.38			6.53			6.23

At June 30, 2012, PBI Bank’s Tier 1 leverage ratio was 7.38% which is below the 9% minimum capital ratio required by the Consent Order and its total risk-based capital ratio was 11.71% which is below the 12% minimum capital ratio required by the Consent Order. Failure to meet minimum capital requirements can result in additional discretionary actions by regulators that, if undertaken, could have a materially adverse effect on our financial condition.

Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. PBI Bank has agreed with its primary regulators to obtain their written consent prior to declaring or paying any future dividends. As a practical matter, PBI Bank cannot pay dividends for the foreseeable future.

Note 12 – Contingencies

In 2010, the Company sold common shares, convertible preferred shares and warrants to purchase common shares to accredited investors for $32 million in a private placement. In the placement, an affiliate of Clinton Group, Inc. (“CGI”) purchased 456,524 common shares and warrants to purchase 228,262 common shares for $10.93 per share for $5,000,016. The numbers of shares and the warrant exercise price have been adjusted to reflect the Company’s 5% stock dividend in November 2010.

On July 11, 2011, CGI sent a letter to the Company, which was also attached as an exhibit to a Schedule 13D CGI filed with the Securities and Exchange Commission on the same date. In its letter CGI set forth concerns about the Company’s executive leadership team and its ability to properly manage the Bank's operations, compliance with GAAP, financial disclosures and relationships with regulators, referencing the consent order PBI Bank entered into with the Federal Deposit Insurance Corporation and the Commonwealth of Kentucky Department of Financial Institutions on June 24, 2011. CGI listed a number of steps it believed the Company must take to maximize shareholder value and comply with the consent order. In addition, CGI stated its belief “that it is likely that a number of representations and warranties made when the CGI affiliate entered into an agreement to purchase shares were false,” and demanded that the Company take immediate steps to “redress such breaches and make CGI and the other purchasers whole.”

On July 20, 2011, the Company’s board of directors established a new Risk Policy and Oversight Committee comprised of independent directors, to lead the Board’s oversight of the assessment and management of the risks of Porter Bancorp and PBI Bank. During the third quarter, the Oversight Committee undertook an investigation of the allegations raised in the CGI 13D to evaluate their merit and to ascertain the reasonableness of the Bank’s allowance for loan losses and OREO valuations at the time of Clinton’s investment.

The Oversight Committee reported its conclusions to the Company’s board of directors in October 2011. While recognizing opportunities for procedural improvements existed in the Bank’s lending and non-performing asset administration, the Oversight Committee concluded that this did not rise to a level that would result in the financial statements, or representations and warranties with respect to the financial statements, being misleading to investors in the 2010 private placement offering of the Company’s stock. The Oversight Committee further concluded that investors were afforded ample opportunity and access to information for their due diligence, including documentation involving asset valuation estimates, on-site management discussions and additional inquiries during visits to the Company headquarters, and access to loan files of their choosing and the appraisals contained therein, and that the Company’s disclosures were adequate in all material respects.

In a letter dated November 28, 2011, that was filed as an exhibit to its 13D amendment, CGI was critical of the Oversight Committee’s investigation and restated its belief the Company’s balance sheet was overstated. CGI called upon the independent directors to correct the balance sheet, replace the management team and raise capital. On January 30, 2012, CGI delivered a demand to inspect the Company’s records pursuant to the Kentucky Business Corporation Act. The Company is providing records to CGI in accordance with Kentucky law.

Item 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations

This item analyzes our financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited condensed consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

Cautionary Note Regarding Forward-Looking Statements

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of our control. Factors that could contribute to differences in our results include, but are not limited to the factors listed in Part 2, Item 1A – Risk Factors in this report and the more detailed risks identified, and the cautionary statements included in our December 31, 2011 Annual Report on Form 10-K.

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. We caution you however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. The forward-looking statements included in this report speak only as of the date of the report. We have no duty, and do not intend to, update these statements unless applicable laws require us to do so.

Overview

Porter Bancorp, Inc. (NASDAQ: PBIB) is a Louisville, Kentucky-based bank holding company which operates 18 full-service banking offices in twelve counties through its wholly-owned subsidiary, PBI Bank. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt, and extend south along the Interstate 65 corridor to Tennessee. We serve south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio and Daviess Counties. We also have an office in Lexington, the second largest city in Kentucky. The Bank is both a traditional community bank with a wide range of commercial and personal banking products, including wealth management and trust services, and an online banking division which delivers competitive deposit products and services under the separate brand of Ascencia.

The Company reported net income of $151,000 and $1.7 million, respectively, for the three and six months ended June 30, 2012, compared with net loss of $40.0 million and $39.2 million, respectively, for the same periods of 2011. After deductions for dividends on preferred stock, accretion on preferred stock, and earnings/loss allocated to participating securities, net loss to common shareholders was $319,000 for the three months ended June 30, 2012, and net income to common shareholders was $661,000 for the six months ended June 30, 2012, compared with net loss to common shareholders of $39.0 million and $38.6 million, respectively, for the three and six months ended June 30, 2011. The 2011 results were negatively impacted by a non-recurring 100% goodwill impairment charge of $23.8 million, and higher provision for loan losses and OREO expense.

Basic and diluted income (loss) per common share were ($0.03) and $0.06 for the three and six months ended June 30, 2012, respectively, compared with basic and diluted loss per common share of ($3.33) and ($3.30) for the three and six months ended June 30, 2011, respectively.

Significant developments during the quarter and six months ended June 30, 2012 consist of the following:

●

Net interest margin decreased 10 basis points to 3.40% in the first six months of 2012 compared with 3.50% in the first six months of 2011. The decrease in margin between periods was primarily due to lower interest earning assets coupled with lower rates on those assets and elevated non-accrual loan levels. Average loans decreased 14.1% to $1.1 billion in the first six months of 2012 compared with $1.3 billion in the first six months of 2011. Net loans decreased 18.3% to $989 million at June 30 2012, compared with $1.21 billion at June 30, 2011.


●	We continue to execute on our strategy to reduce our commercial real estate and construction and development loans. Construction and development loans totaled $81.8 million, or 68% of total risk-based capital, at June 30, 2012 compared to $101.5 million, or 85% of total risk-based capital, at December 31, 2011. Non-owner occupied commercial real estate loans, construction and development loans, and multifamily residential real estate loans as a group totaled $376.6 million, or 313% of total risk-based capital, at June 30, 2012 and $414.6 million, or 349% of total risk-based capital, at December 31, 2011.

●	Loan proceeds received from the reduction of our commercial real estate and construction and development loans were used primarily to redeem maturing certificates of deposit during the quarter. Deposits decreased 16.1% to $1.20 billion compared with $1.44 billion at June 30, 2011. Certificate of deposit balances declined $114.8 million during the first six months of 2012 to $909.5 million at June 30, 2012, from $1.02 billion at December 31, 2011. Demand deposits increased 1.5% during the first six months of 2012 compared with the fourth quarter of 2011, and increased 9.7% compared with the first six months of 2011.

●	Non-performing loans decreased $11.6 million during the first six months of 2012 to $81.7 million at June 30, 2012, compared with $93.4 million at December 31, 2011. The decrease was primarily in the commercial and residential real estate segments of our portfolio.

●	Loans past due 30-59 days decreased from $17.3 million at December 31, 2011 to $6.7 million at June 30, 2012. Loans past due 60-89 days increased from $3.9 million at December 31, 2011 to $4.4 million at June 30, 2012. The net decrease in loan past dues 30-89 days was primarily in the 1-4 family residential real estate, commercial real estate, and commercial segments of the portfolio.

●	Foreclosed properties at June 30, 2012 increased to $54.4 million compared with $35.6 million at March 31, 2012, and $49.9 million at June 30, 2011. The Company acquired $23.9 million of OREO and sold $4.8 million of OREO during the second quarter of 2012. Our ratio of non-performing assets to total assets increased to 10.2% at June 30, 2012, compared with 6.65% at June 30, 2011.

These items are discussed in further detail throughout this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” Section. For a discussion of our accounting policies, please see “Application of Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operation in our Annual Report on Form 10-K for the calendar year ended December 31, 2011.

Recent Developments and Future Plans

In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate strategies including the following:

●	Continuing to operate the Company and Bank in a safe and sound manner. This strategy will require us to continue to reduce the size of our balance sheet, reduce our lending concentrations, consider selling loans, and reduce other noninterest expense through the disposition of OREO.

●	Continuing with succession planning and add resources to management team. On March 29, 2012, the Board of Directors announced that it had formed a search committee comprised of its five independent directors to identify and hire a President and CEO for PBI Bank. On July 19, 2012, we reported that the Company had successfully filled this key position.

●	Addressing other real estate owned.
	o	In 2011, management determined, with the concurrence of the Board of Directors, that certain properties held in OREO were not likely to be successfully disposed of in an acceptable time-frame using routine marketing efforts. It became apparent due to weakness in the economy and softness in demand for housing that certain land development and residential condominium projects would require extended holding periods to sell the properties at recent appraised values. Accordingly, management determined to market these properties more aggressively to retail and bulk buyers. In June 2011, the Company sold, in a single transaction, 54 finished condominium property units from condominium developments held in our OREO portfolio with a carrying value of approximately $11.0 million, for $5.2 million, resulting in a pre-tax loss of $5.8 million.
	o	Although we were carrying our OREO at fair market value less estimated cost to sell, we subsequently adjusted our valuations for land development and residential development properties held in OREO similar to the properties we sold earlier in 2011. Our 2011 fair value adjustments totaled approximately $25.6 million to reflect our intent to market these properties more aggressively to retail and bulk buyers. Additionally, we recorded approximately $9.3 million of fair value adjustments related to new appraisals received for properties in the portfolio during 2011.
	o	In summary, for the years ended December 31, 2011 and 2010 respectively, we recorded net construction and development OREO fair value adjustments and loss on sale of OREO totaling $38.7 million and $10.4 million. This represents approximately 89% and 71% of our total OREO fair value adjustments and loss on sale in 2011 and 2010, respectively.
	o	For the first six months of 2012, we recorded net construction and development OREO fair value adjustments and loss on sale of construction and development OREO of $280,000. This represents approximately 16% of our total OREO fair value adjustments and loss on sale of OREO in the first six months of 2012.

●	We are committed to reducing loan concentrations and balance sheet risk.
	o	We recorded net construction and development loan charge-offs totaling $1.3 million during the first six months of 2012. This represented approximately 15% of our total net loan charge-offs for the first six months of 2012. We recorded net construction and development loan charge-offs totaling $11.0 million and $11.4 million in for the years ended December 31, 2011 and 2010, respectively. This represented approximately 27% and 51% of our total net loan charge-offs in 2011 and 2010, respectively.

	o	Our Consent Order calls for us to reduce our construction and development loans to not more than 75% of total risk-based capital. We were in compliance at June 30, 2012 with construction and development loans representing 68% of total risk-based capital. These loans totaled $81.8 million, or 68% of total risk-based capital, at June 30, 2012 and $101.5 million, or 85% of total risk-based capital, at December 31, 2011.

	o	Our Consent Order also requires us to reduce non-owner occupied commercial real estate loans, construction and development loans, and multifamily residential real estate loans as a group, to not more than 250% of total risk-based capital. We were not in compliance at June 30, 2012 with non-owner occupied commercial real estate loans, construction and development loans, and multifamily residential real estate loans as a group representing 313% of total risk-based capital. These loans totaled $376.6 million, or 313% of total risk-based capital, at June 30, 2012 and $414.6 million, or 349% of total risk-based capital, at December 31, 2011.


	o	We are working to reduce these loans by curtailing new construction and development lending and new non-owner occupied commercial real estate lending. We are also receiving principal reductions from amortizing credits and pay-downs from our customers who sell properties built for resale. We have reduced the construction loan portfolio from $199.5 million at December 31, 2010 to $81.8 million at June 30, 2012. Our non-owner occupied commercial real estate loans declined from $293.3 million at December 31, 2010 to $234.9 million at June 30, 2012.

●	Raising capital by selling common stock through a public offering or private placement to existing and new investors.

●	Evaluating other strategic alternatives, such as the sale of assets or branches.

Results of Operations

The following table summarizes components of income and expense and the change in those components for the three months ended June 30, 2012, compared with the same period of 2011:

	For the Three Months					Change from
	Ended June 30,					Prior Period
	2012		2011			Amount			Percent
	(dollars in thousands)

Gross interest income	$	14,812	$	19,198		$	(4,386	)		(22.8	)%
Gross interest expense		4,017		5,757			(1,740	)		(30.2	)
Net interest income		10,795		13,441			(2,646	)		(19.7	)
Provision for loan losses		4,000		13,700			(9,700	)		(70.8	)
Non-interest income		3,018		2,865			153			5.3
Non-interest expense		9,662		54,759			(45,097	)		(82.4	)
Net income (loss) before taxes		151		(52,153	)		52,304			(100.3	)
Income tax expense (benefit)		—		(12,164	)		12,164			(100.0	)
Net income (loss)		151		(39,989	)		40,140			(100.4	)

Net income for the three months ended June 30, 2012 increased $40.1 million to $151,000 compared with net loss of $40.0 million for the comparable period of 2011. Second quarter 2011 results were negatively impacted by a non-recurring 100% goodwill impairment charge of $23.8 million. OREO expense decreased $20.9 million from the 2011 second quarter due to lower loss on sales of OREO, lower valuation write-downs, and lower property maintenance expense. Provision for loan losses expense decreased $9.7 million in the second quarter of 2012 compared with the same period in 2011 primarily as the result of lower net charge-offs and a decrease of $208.9 million in outstanding loan balances between periods. These decreases were partially off-set by a $55.3 million increase in internal loan downgrades between periods. Additionally, gain on sales of investment securities was $1.5 million for the second quarter of 2012 compared with $1.0 million in the second quarter of 2011. These improvements were partially offset by a decrease of $2.6 million in net interest income from the 2011 second quarter due to a 10 basis point decline in net interest margin.

The following table summarizes components of income and expense and the change in those components for the six months ended June 30, 2012 compared with the same period of 2011:

	For the Six Months					Change from
	Ended June 30,					Prior Period
	2012		2011			Amount			Percent
	(dollars in thousands)

Gross interest income	$	30,567	$	38,814		$	(8,247	)		(21.2	)%
Gross interest expense		8,318		11,605			(3,287	)		(28.3	)
Net interest income		22,249		27,209			(4,960	)		(18.2	)
Provision for credit losses		7,750		18,800			(11,050	)		(58.8	)
Non-interest income		6,463		4,652			1,811			38.9
Non-interest expense		19,309		64,154			(44,845	)		(69.9	)
Net income (loss) before taxes		1,653		(51,093	)		52,746			(103.2	)
Income tax expense (benefit)		—		(11,903	)		11,903			(100.0	)
Net income (loss)		1,653		(39,190	)		40,843			(104.2	)

Net income of $1.7 million for the six months ended June 30, 2012, was an increase in earnings of $40.8 million from net loss of $39.2 million for the comparable period of 2011. A non-recurring 100% goodwill impairment charge of $23.8 million was recorded during the first half of 2011. OREO expense decreased $21.0 million from the first half of 2011 due to lower loss on sales of OREO, lower valuation write-downs, and lower property maintenance expense. Provision for loan losses expense decreased $11.1 million in the first six months of 2012 compared with the same period in 2011 primarily as the result of lower net charge-offs and a decrease of $208.9 million in outstanding loan balances between periods. These decreases were partially off-set by a $55.3 million increase in internal loan downgrades between periods. Additionally, gain on sales of investment securities was $3.5 million for the first six months of 2012 compared with $1.1 million for the first six months of 2011. These improvements were partially offset by a decrease of $5.0 million in net interest income from the first six months of 2011 due to a 10 basis point decline in net interest margin.

Net Interest Income – Our net interest income was $10.8 million for the three months ended June 30, 2012, a decrease of $2.6 million, or 19.7%, compared with $13.4 million for the same period in 2011. Net interest spread and margin were 3.20% and 3.35%, respectively, for the second quarter of 2012, compared with 3.30% and 3.45%, respectively, for the second quarter of 2011. Net interest income was $22.2 million for the six months ended June 30, 2012, a decrease of $5.0 million, or 18.2%, compared with $27.2 million for the same period of 2011. Net interest spread and margin were 3.25% and 3.40%, respectively, for the first six months of 2012, compared with 3.34% and 3.50%, respectively, for the first six months of 2011. Net average non-accrual loans were $90.9 million and $63.9 million in the first six months of 2012 and 2011, respectively.

Average loans receivable declined approximately $189.7 million for the quarter ended June 30, 2012 compared with the second quarter of 2011. This resulted in a decline in interest revenue of approximately $3.9 million for the quarter ended June 30, 2012 compared with the prior year period. Average loans receivable declined approximately $180.6 million for the six months ended June 30, 2012 compared with the first six months of 2011. This resulted in a decline in interest revenue of approximately $7.5 million for the six months ended June 30, 2012 compared with the prior year period. This decline in loan volume is attributable to soft loan demand in our markets as well as our efforts to reduce concentrations in our construction and development loan portfolio and our non-owner occupied commercial real estate loan portfolio.

Net interest margin decreased 10 basis points from our margin of 3.45% in the prior year second quarter. The yield on earning assets declined 32 basis points from the second quarter of 2011, compared with a 22 basis point decline in rates paid on interest-bearing liabilities. Net interest margin for the first six months of 2012 decreased 10 basis points from our margin of 3.50% in the first half of 2011 due primarily to lower average earning assets relative to average interest bearing liabilities. The yield on earning assets declined 31 basis points from the first six months of 2011, compared with a 22 basis point decline in rates paid on interest-bearing liabilities.

Net interest margin for the second quarter of 2012 decreased 10 basis points from our margin of 3.45% in the first quarter of 2012 due primarily to lower average loan receivables and lower yield on loans, coupled with lower yield on investment securities. Average loan receivables declined $40.7 million from the first quarter of 2012 due to our efforts to reduce concentrations in our construction and development loan portfolio and our non-owner occupied commercial real estate loan portfolio and increased foreclosures. Yield on loans was adversely affected by an increase in interest foregone on non-accrual loans. Interest foregone on non-accrual loans totaled $1.3 million in the second quarter of 2012, compared with $790,000 in the first quarter of 2012. The decrease in yield on investment securities was the result of reinvestment of scheduled principal and interest payment proceeds and securities sales proceeds at lower rates. Yield on average earning assets for the second quarter of 2012 decreased 14 basis points from 4.73% in the first quarter of 2012, compared with a 4 basis points decrease in rates paid on interest-bearing liabilities from 1.43% in the first quarter of 2012.

Average Balance Sheets

The following table presents the average balance sheets for the three month periods ended June 30, 2012 and 2011, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

	Three Months Ended June 30,
	2012								2011
	Average Balance			Interest Earned/Paid		Average Yield/Cost			Average Balance			Interest Earned/Paid		Average Yield/Cost
	(dollars in thousands)
ASSETS
Interest-earning assets:
Loan receivables (1)(2)	$	1,078,497		$	13,689		5.10	%	$	1,268,196		$	17,589		5.56	%
Securities
Taxable		149,482			783		2.11			120,738			1,126		3.74
Tax-exempt (3)		22,977			196		5.28			27,722			268		5.97
FHLB stock		10,072			107		4.27			10,072			112		4.46
Other equity securities		1,359			14		4.14			1,400			13		3.72
Federal funds sold and other		45,133			23		0.20			152,057			90		0.24

Total interest-earning assets		1,307,520			14,812		4.59	%		1,580,185			19,198		4.91	%

Less: Allowance for loan losses		(53,546	)							(34,287	)
Non-interest earning assets		109,366								162,655

Total assets	$	1,363,340							$	1,708,553

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Certificates of deposit and other time deposits	$	930,012		$	3,517		1.52	%	$	1,159,610		$	4,802		1.66	%
NOW and money market deposits		149,174			169		0.46			172,300			408		0.95
Savings accounts		39,181			40		0.41			37,338			62		0.67
Repurchase agreements		2,121			2		0.38			11,169			118		4.24
FHLB advances		6,538			54		3.32			18,015			139		3.09
Junior subordinated debentures		32,421			235		2.92			33,325			228		2.74

Total interest-bearing liabilities		1,159,447			4,017		1.39	%		1,431,757			5,757		1.61	%

Non-interest-bearing liabilities:
Non-interest-bearing deposits		112,914								104,211
Other liabilities		6,992								5,983

Total liabilities		1,279,353								1,541,951
Stockholders’ equity		83,987								166,602

Total liabilities and stockholders’ equity	$	1,363,340							$	1,708,553

Net interest income				$	10,795							$	13,441

Net interest spread							3.20	%							3.30	%

Net interest margin							3.35	%							3.45	%

(1)	Includes loan fees in both interest income and the calculation of yield on loans.

(2)	Calculations include non-accruing loans in average loan amounts outstanding.

(3)	Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

Average Balance Sheets

The following table presents the average balance sheets for the six month periods ended June 30, 2012 and 2011, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

	Six Months Ended June 30,
	2012								2011
	Average Balance			Interest Earned/Paid		Average Yield/Cost			Average Balance			Interest Earned/Paid		Average Yield/Cost
	(dollars in thousands)
ASSETS
Interest-earning assets:
Loan receivables (1)(2)	$	1,098,839		$	28,201		5.16	%	$	1,279,461		$	35,699		5.63	%
Securities
Taxable		137,492			1,609		2.35			116,340			2,155		3.74
Tax-exempt (3)		25,040			446		5.51			27,373			528		5.98
FHLB stock		10,072			221		4.41			10,072			226		4.52
Other equity securities		1,359			29		4.29			1,400			26		3.75
Federal funds sold and other		56,397			61		0.22			151,196			180		0.24

Total interest-earning assets		1,329,199			30,567		4.66	%		1,585,842			38,814		4.97	%

Less: Allowance for loan losses		(53,220	)							(34,260	)
Non-interest earning assets		111,994								171,739

Total assets	$	1,387,973							$	1,723,321

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Certificates of deposit and other time deposits	$	953,230		$	7,289		1.54	%	$	1,163,201		$	9,677		1.68	%
NOW and money market deposits		151,136			355		0.47			172,189			832		0.97
Savings accounts		38,133			82		0.43			36,766			123		0.67
Repurchase agreements		1,897			4		0.42			11,257			236		4.23
FHLB advances		6,722			111		3.32			16,379			281		3.46
Junior subordinated debentures		32,533			477		2.95			33,437			456		2.75

Total interest-bearing liabilities		1,183,651			8,318		1.41	%		1,433,229			11,605		1.63	%

Non-interest-bearing liabilities:
Non-interest-bearing deposits		112,785								105,148
Other liabilities		7,214								6,417

Total liabilities		1,303,650								1,544,794
Stockholders’ equity		84,323								178,527

Total liabilities and stockholders’ equity	$	1,387,973							$	1,723,321

Net interest income				$	22,249							$	27,209

Net interest spread							3.25	%							3.34	%

Net interest margin							3.40	%							3.50	%

(1)	Includes loan fees in both interest income and the calculation of yield on loans.

(2)	Calculations include non-accruing loans in average loan amounts outstanding.

(3)	Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

Rate/Volume Analysis

The table below sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

	Three Months Ended June 30, 2012 vs. 2011									Six Months Ended June 30, 2012 vs. 2011
	Increase (decrease) due to change in						Net Change			Increase (decrease) due to change in						Net Change
	Rate			Volume			Net Change			Rate			Volume			Net Change
	(in thousands)
Interest-earning assets:

Loan receivables	$	(1,411	)	$	(2,489	)	$	(3,900	)	$	(2,716	)	$	(4,782	)	$	(7,498	)
Securities		(614	)		199			(415	)		(946	)		318			(628	)
FHLB stock		(5	)		—			(5	)		(5	)		—			(5	)
Other equity securities		1			—			1			4			(1	)		3
Federal funds sold and other		(11	)		(56	)		(67	)		(15	)		(104	)		(119	)

Total decrease in interest income		(2,040	)		(2,346	)		(4,386	)		(3,678	)		(4,569	)		(8,247	)

Interest-bearing liabilities:

Certificates of deposit and other time deposits		(392	)		(893	)		(1,285	)		(738	)		(1,650	)		(2,388	)
NOW and money market accounts		(190	)		(49	)		(239	)		(385	)		(92	)		(477	)
Savings accounts		(25	)		3			(22	)		(46	)		5			(41	)
Federal funds purchased and repurchased agreements		(61	)		(55	)		(116	)		(121	)		(111	)		(232	)
FHLB advances		9			(94	)		(85	)		(11	)		(159	)		(170	)
Junior subordinated debentures		13			(6	)		7			33			(12	)		21

Total decrease in interest expense		(646	)		(1,094	)		(1,740	)		(1,268	)		(2,019	)		(3,287	)

Increase (decrease) in net interest income	$	(1,394	)	$	(1,252	)	$	(2,646	)	$	(2,410	)	$	(2,550	)	$	(4,960	)

Non-Interest Income – The following table presents the major categories of non-interest income for the three and six months ended June 30, 2012 and 2011:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2012		2011		2012		2011
	(in thousands)
Service charges on deposit accounts	$	556	$	659	$	1,110	$	1,289
Income from fiduciary activities		291		246		542		501
Secondary market brokerage fees		31		76		48		152
Title insurance commissions		11		22		33		53
Gains on sales of loans originated for sale		77		320		122		541
Gains on sales of investment securities, net		1,511		1,025		3,530		1,108
Other		541		517		1,078		1,008
Total non-interest income	$	3,018	$	2,865	$	6,463	$	4,652

Non-interest income for the second quarter ended June 30, 2012 increased $153,000, or 5.3%, compared with the second quarter of 2011. For the six months ended June 30, 2011, non-interest income increased by $1.8 million to $6.5 million compared with $4.7 million for the same period of 2011. The increase in non-interest income for the second quarter and six months ended June 30, 2012 was primarily due to increased gains on sales of investment securities, partially offset by lower service charges on deposit accounts due to lower transaction volume, and lower gains on sales of loans originated for sale due to fewer loans guaranteed by the USDA or SBA originated for sale.

Non-interest Expense – The following table presents the major categories of non-interest expense for the three and six months ended June 30, 2012 and 2011:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2011		2011		2011		2011
		(in thousands)
Salary and employee benefits	$	3,982	$	4,180	$	8,294	$	8,304
Occupancy and equipment		969		981		1,855		1,953
Goodwill impairment charge		—		23,794		—		23,794
Other real estate owned expense		1,205		22,109		2,462		23,476
FDIC insurance		832		855		1,705		1,710
State franchise tax		592		582		1,184		1,164
Loan collection expense		586		925		946		1,187
Professional fees		567		354		923		634
Communications		168		165		348		333
Postage and delivery		109		128		231		251
Office supplies		68		69		178		180
Advertising		28		87		61		189
Other		556		530		1,122		979
Total non-interest expense	$	9,662	$	54,759	$	19,309	$	64,154

Non-interest expense for the second quarter ended June 30, 2012 decreased $45.1 million, or 82.4%, compared with the second quarter of 2011. For the six months ended June 30, 2012, non-interest expense decreased $44.8 million, or 69.9%, to $19.3 million compared with $64.2 million for the first six months of 2011. The decreases in non-interest expense for the second quarter and six months ended June 30, 2012, were primarily attributable to decreased other real estate owned expense due to lower loss on sales of OREO, lower valuation write-downs, and lower property maintenance expense. Additionally, second quarter 2011 non-interest expense included a non-recurring 100% goodwill impairment charge of $23.8 million. These improvements were partially off-set by higher professional fees due primarily to increased audit and accounting fees, and loan review fees.

Income Tax Expense – Income tax benefit was $12.2 million and $11.9 million, or 23.3% of pre-tax loss, for the three and six months ended June 30, 2011, respectively. No income taxes were recorded for the first six months of 2012. The income tax effect on net income before taxes for the six months ended June 30, 2012, decreased our deferred tax assets and related valuation allowance by $384,000. See Footnote 8, “Income Taxes.”

Effective tax rates differ from the federal statutory rate of 35% applied to income before income taxes due to the following:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2012			2011			2012			2011
	(dollars in thousands)

Federal statutory rate times financial statement income	$	53		$	(18,254	)	$	579		$	(17,883	)
Effect of:
Net operating loss carry-forward		35			—			(384	)		—
Tax-exempt income		(70	)		(94	)		(159	)		(185	)
Goodwill impairment charge		—			6,169			—			6,169
Non-taxable life insurance income		(26	)		(25	)		(52	)		(49	)
Vesting of restricted stock		—			26			—			26
Federal tax credits		—			(12	)		—			(23	)
Other, net		8			26			16			42
Total	$	—		$	(12,164	)	$	—		$	(11,903	)

Analysis of Financial Condition

Total assets decreased $120.6 million, or 8.3%, to $1.33 billion at June 30, 2012, from $1.46 billion at December 31, 2011. This decrease was primarily attributable to decreases of $94.1 million and $69.6 million in net loans and cash and cash equivalents, respectively. These decreases were partially offset by increases of $35.3 million and $12.9 million in securities available for sale and other real estate owned, respectively. The decrease in net loans was due to loan payoffs outpacing loan funding, net loan charge-offs of $8.7 million, and efforts to move impaired loans through the collection, foreclosure, and disposition process. The decrease in cash and cash equivalents was due to cash outflows related to maturing time deposits. The increase in securities available for sale was primarily related to the reinvestment of cash equivalents and loan cash flows into securities available for sale rather than new loans. The increase in other real estate owned was due primarily to additions of $28.1 million to the portfolio from loan receivables, offset by sales of properties with book values of $14.4 million resulting in loss on sales of $948,000.

Loans Receivable – Loans receivable decreased $95.1 million, or 8.4%, during the six months ended June 30, 2012 to $1.04 billion. Our commercial, commercial real estate and real estate construction portfolios decreased by an aggregate of $67.2 million, or 9.8%, during the six months and comprised 59.6% of the total loan portfolio at June 30, 2012. The decline was attributable to net charge-offs of $8.7 million, transfers to OREO of $28.1 million, and loan payoffs outpacing loan funding by approximately $58.4 million.

Loan Portfolio Composition – The following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio. Except for commercial real estate and residential real estate, there is no concentration of loans in any industry exceeding 10% of total loans.

	As of June 30,				As of December 31,
	2012				2011
	Amount		Percent		Amount		Percent
			(dollars in thousands)

Commercial	$	68,084	6.54	%	$	71,216	6.27	%
Commercial Real Estate
Construction		81,815	7.86			101,471	8.93
Farmland		85,634	8.23			90,958	8.01
Other		384,718	36.96			423,844	37.31
Residential Real Estate
Multi-family		59,867	5.75			60,410	5.31
1-4 Family		310,626	29.84			337,350	29.70
Consumer		22,898	2.20			26,011	2.29
Agriculture		26,251	2.52			23,770	2.09
Other		1,016	0.10			993	0.09
Total loans	$	1,040,909	100.00	%	$	1,136,023	100.00	%

Non-Performing Assets – Non-performing assets consist of loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets.

The following table sets forth information with respect to non-performing assets as of June 30, 2012 and December 31, 2011.

	June 30,			December 31,
	2012			2011
	(dollars in thousands)

Loans past due 90 days or more still on accrual	$	88		$	1,350
Non-accrual loans		81,653			92,020
Total non-performing loans		81,741			93,370
Real estate acquired through foreclosure		54,365			41,449
Other repossessed assets		5			5
Total non-performing assets	$	136,111		$	134,824

Non-performing loans to total loans		7.85	%		8.22	%
Non-performing assets to total assets		10.20	%		9.26	%
Allowance for non-performing loans	$	11,784		$	11,382
Allowance for non-performing loans to non-performing loans		14.42	%		12.20	%

Nonperforming loans at June 30, 2012, were $81.7 million, or 7.85% of total loans, compared with $61.5 million, or 4.92% of total loans, at June 30, 2011, and $93.4 million, or 8.22% of total loans at December 31, 2011.

Loans past due 30-59 days decreased from $17.3 million at December 31, 2011 to $6.7 million at June 30, 2012. Loans past due 60-89 days increased from $3.9 million at December 31, 2011 to $4.4 million at June 30, 2012. This represents a $10.2 million decrease from December 31, 2011 to June 30, 2012, in loans past due 30-89 days. These decreases were primarily in the 1-4 family residential real estate, commercial real estate, and commercial segments of the portfolio. We considered this trend in delinquency levels during the evaluation of qualitative trends in the portfolio when establishing the general component of our allowance for loan losses.

Troubled Debt Restructuring – A troubled debt restructuring (TDR) is where the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired, and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the customer. If the loan is considered collateral dependent, it is reported, net, at the fair value of the collateral.

We do not have a formal loan modification program. Rather, we work with individual customers on a case-by-case basis to facilitate the orderly collection of our principal and interest before a loan becomes a non-performing loan. If a customer is unable to make contractual payments, we review the particular circumstances of that customer’s situation and negotiate a revised payment stream. In other words, we identify performing customers experiencing financial difficulties, and through negotiations, we lower their interest rate, most typically on a short-term basis for three to six months. Our goal when restructuring a credit is to afford the customer a reasonable period of time to remedy the issue causing cash flow constraints within their business so that they can return to performing status over time.

Our loan modifications have taken the form of reduction in interest rate and/or curtailment of scheduled principal payments for a short-term period, usually three to six months, but in some cases until maturity of the loan. In some circumstances we restructure real estate secured loans in a bifurcated fashion whereby we have a fully amortizing “A” loan at a market interest rate and an interest-only “B” loan at a reduced interest rate. Our restructured loans are all collateral secured loans. If a customer fails to perform under the modified terms, we place the loan(s) on non-accrual status and begin the process of working with the customer to liquidate the underlying collateral to satisfy the debt.

At June 30, 2012, we had 137 restructured loans totaling $122.8 million with borrowers who experienced deterioration in financial condition compared with 114 loans totaling $113.7 million at December 31, 2011. In general, these loans were granted interest rate reductions to provide cash flow relief to customers experiencing cash flow difficulties. Of these loans, 7 loans totaling approximately $7.5 million were also granted principal payment deferrals until maturity. There were no concessions made to forgive principal relative to these loans, although we have recorded partial charge-offs for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential or commercial real estate properties, or farmland. Restructured loans also include $3.1 million of commercial loans.

In accordance with current guidance, we continue to report restructured loans as restructured until such time as the loan is paid in full, otherwise settled, sold, or charged-off. If the customer fails to perform, we place the loan on non-accrual status and seek to liquidate the underlying collateral for these loans. Our non-accrual policy for restructured loans is identical to our non-accrual policy for all loans. Our policy calls for a loan to be reported as non-accrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest has been in default for a period of 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses.

We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms of the loan to be a troubled debt restructure. Specifically, we consider a concession involving a modification of the loan terms, such as (i) a reduction of the stated interest rate, (ii) reduction or deferral of principal, or (iii) reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings. When a modification of terms is made for a competitive reason, we do not consider that to be a troubled debt restructuring. A primary example of a competitive modification would be an interest rate reduction for a performing customer’s loan to a market rate as the result of a market decline in rates.

See Footnote 4, “Loans,” to the financial statements for additional disclosure related to troubled debt restructuring.

Foreclosed Properties – Foreclosed properties at June 30, 2012 were $54.4 million compared with $49.9 million at June 30, 2011 and $41.4 million at December 31, 2011. See Footnote 5, “Other Real Estate Owned,” to the financial statements. During the first six months of 2012, we acquired $28.1 million of OREO properties, and sold properties totaling approximately $14.4 million. We value foreclosed properties at fair value less estimated costs to sell when acquired and expect to liquidate these properties to recover our investment in the due course of business.

Other real estate owned (OREO) is recorded at fair market value less estimated cost to sell at time of acquisition. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent reductions in fair value are recorded as non-interest expense. To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are recorded.

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We obtain updated appraisals on the anniversary date of ownership unless a sale is imminent.

Net loss on sales, write-downs, and operating expenses for other real estate owned totaled $2.5 million for the six months ended June 30, 2012, compared with $23.5 million for the same period of 2011. The 2011 results were significantly impacted by our determination in the 2011 second quarter that certain properties held in other real estate were not likely to be successfully disposed of in an acceptable time-frame using routine marketing efforts. It became apparent that certain condominium projects were going to require extended holding periods to sell the properties at recent appraised values. Accordingly, during June, the Company sold, in a single transaction, 54 finished condominium property units from several condominium developments in our OREO portfolio, with a carrying value of approximately $11.0 million for $5.2 million, resulting in a pre-tax loss of $5.8 million. In addition, management adjusted its valuations for similar condominium and residential development properties held in other real estate through provision of an allowance of $10.6 million on other real estate held, with the objective of marketing these properties more aggressively.

Allowance for Loan Losses – The allowance for loan losses is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require current recognition in estimating loan losses.

Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss. For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

Our loan loss reserve, as a percentage of total loans at June 30, 2012, increased to 4.96% from 3.10% at June 30, 2011, and from 4.63% at December 31, 2011. Provision for loan losses decreased $9.7 million to $4.0 million for the second quarter of 2012 compared with $13.7 million for the second quarter of 2011. Provision for loan losses decreased $11.1 million to $7.8 million for the six months ended June 30, 2012 compared with $18.8 million for the same six months of 2011. Net loan charge-offs for the second quarter of 2012 were $6.4 million, or 0.59% of average loans, compared with $8.6 million, or 0.68% of average loans, for the second quarter of 2011, and $2.4 million, or 0.21% of average loans, for the first quarter of 2012. Net charge-offs for the six months ended June 30, 2012, were $8.7 million, or 0.79% of average loans, compared with $14.4 million, or 1.12% of average loans, for the first six months of 2011. Our allowance for loan losses to nonperforming loans was 63.12% at June 30, 2012, compared with 56.31% at December 31, 2011, and 62.98% at June 30, 2011. The change in this metric between periods is attributable to the fluctuation in historical loss experience, qualitative factors, non-accrual loans, and provision expense. We have assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses.

The majority of our nonperforming loans are secured by real estate collateral and the underlying collateral coverage for nonperforming loans supports the likelihood of collection of our principal. Our allowance for non-performing loan to non-performing loans was 14.4% at June 30, 2012 compared with 15.4% at June 30, 2011, and 12.2% at December 31, 2011.

An analysis of changes in allowance for loan losses and selected ratios for the three and six month periods ended June 30, 2012 and 2011, and for the year ended December 31, 2011 follows:




	Three Months Ended						Six Months Ended						Year Ended
	June 30,						June 30,						December 31,
	2012			2011			2012			2011			2011
	(dollars in thousands)

Balance at beginning of period	$	53,953		$	33,599		$	52,579		$	34,285		$	34,285
Provision for loan losses		4,000			13,700			7,750			18,800			62,600
Recoveries		79			14			285			95			340
Charge-offs		(6,438	)		(8,596	)		(9,020	)		(14,463	)		(44,646	)
Balance at end of period	$	51,594		$	38,717		$	51,594		$	38,717		$	52,579

Allowance for loan losses to period-end loans		4.96	%		3.10	%		4.96	%		3.10	%		4.63	%
Net charge-offs to average loans		0.59	%		0.68	%		0.79	%		1.12	%		3.56	%
Allowance for loan losses to non-performing loans		63.12	%		62.98	%		63.12	%		62.98	%		56.31	%

Liabilities – Total liabilities at June 30, 2012 were $1.25 billion compared with $1.37 billion at December 31, 2011, a decrease of $119.5 million, or 8.7%. This decrease was primarily attributable to a decrease in deposits of $119.0 million, or 9.0%, to $1.20 billion at June 30, 2012 from $1.32 billion at December 31, 2011. Certificate of deposit balances declined $114.8 million during the first six months of 2012 to $909.5 million at June 30, 2012 from $1.02 billion at December 31, 2011. The decrease in deposits follows management’s strategy to match liability funding levels with lower loan balances.

Federal Home Loan Bank advances decreased by $718,000, or 10.1%, to $6.4 million at June 30, 2012, from $7.1 million at December 31, 2011. These advances are used from time to time to fund asset growth and manage interest rate risk in accordance with our asset/liability management strategies.

Deposits are our primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

	For the Six Months					For the Year
	Ended June 30,					Ended December 31,
	2012					2011
	Average		Average			Average		Average
	Balance		Rate			Balance		Rate
			(dollars in thousands)
Demand	$	112,785		–		$	106,769
Interest checking		87,082		0.44	%		89,103		0.74	%
Money market		64,054		0.52			81,925		0.96
Savings		38,133		0.43			36,511		0.62
Certificates of deposit		953,230		1.54			1,120,154		1.65
Total deposits	$	1,255,284		1.24	%	$	1,434,462		1.40	%

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

	For the Six Months					For the Year
	Ended June 30,					Ended December 31,
	2012					2011
	Average		Average			Average		Average
	Balance		Rate			Balance		Rate
			(dollars in thousands)
Less than $100,000	$	496,953		1.44	%	$	569,667		1.59	%
$100,000 or more		456,277		1.65	%		550,487		1.71	%
Total	$	953,230		1.54	%	$	1,120,154		1.65	%

The following table shows at June 30, 2012 and December 31, 2011 the amount of our time deposits of $100,000 or more by time remaining until maturity:

	As of		As of
	June 30,		December 31,
Maturity Period	2012		2011
	(in thousands)
Three months or less	$	51,690	$	77,118
Three months through six months		94,861		65,359
Six months through twelve months		123,792		167,811
Over twelve months		160,479		183,056
Total	$	430,822	$	493,344

Liquidity

Liquidity risk arises from the possibility we may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that we meet the cash flow requirements of depositors and borrowers, as well as our operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring that we meet our cash flow needs at a reasonable cost. We maintain an investment and funds management policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. Our Asset Liability Committee continually monitors and reviews our liquidity position.

Funds are available from a number of sources, including the sale of securities in the available-for-sale portion of the investment portfolio, principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, brokered deposits and other wholesale funding. Historically, we have utilized brokered and wholesale deposits to supplement our funding strategy. At June 30, 2012, and December 31, 2011, these deposits totaled $106.2 million and $118.4 million, respectively. We are currently restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators. The following table shows at June 30, 2012, the amount of our brokered certificates of deposit by time remaining to maturity (in thousands):

Three months or less	$	2,083
Three months through six months		89,073
Six months through twelve months		15,000

Total	$	106,156

Traditionally, we have borrowed from the FHLB to supplement our funding requirements. The advances are collateralized by first mortgage loans. The borrowing capacity is based on the market value of the underlying pledged loans. At June 30, 2012, our additional borrowing capacity with the FHLB was $45.9 million.

We also secured federal funds borrowing lines from major correspondent banks totaling $5.0 million on an unsecured basis. Management believes our sources of liquidity are adequate to meet expected cash needs for the foreseeable future, however, the availability of these lines could be affected by our financial position and our lenders could exercise their right to deny a funding request at their discretion. We are also subject to FDIC interest rate restrictions for deposits. As such, we are permitted to offer up to the “national rate” plus 75 basis points as published weekly by the FDIC.

We use cash to pay dividends on common stock, if and when declared by the Board of Directors, and to service debt. The main sources of funding include dividends paid by PBI Bank, management fees received from affiliated banks and financing obtained in the capital markets. During 2011, Porter Bancorp contributed $13.1 million to its subsidiary, PBI Bank, which substantially decreased its liquid assets. The contribution was made to strengthen the Bank’s capital in an effort to help it comply with its capital ratio requirements under the consent order. Liquid assets decreased from $20.3 million at December 31, 2010, to $4.1 million at June 30, 2012. Since the Bank is unlikely to be in a position to pay dividends to the parent company for the foreseeable future, cash inflows for the parent are limited to management fees from affiliate banks, earnings on investment securities, sales of investment securities, and interest on deposits with the Bank. These cash inflows along with the liquid assets held at June 30, 2012, totaling $4.1 million, are needed to cover ongoing cash operating expenses of the parent company which have been reduced and are expected to be $1.5 million for 2012. We have elected to defer payments on our Series A preferred stock and on our trust preferred securities. The reduction in expected expenses for 2012 from actual cash expenses for 2011 is primarily the result of deferring payments on our Series A preferred stock issued to the U.S. Treasury and on our trust preferred securities. Parent company liquidity could be improved if a capital raise could be accomplished.

Capital

In the fourth quarter of 2011, we began deferring the payment of regular quarterly cash dividends on our Series A Preferred Stock issued to the U.S. Treasury. At June 30, 2012, cumulative accrued and unpaid dividends on this stock totaled $1.5 million. If we defer dividend payments for six quarters, the holder of our Series A Preferred Stock (currently the U.S. Treasury) would then have the right to appoint representatives to our Board of Directors. We will continue to accrue any deferred dividends, which will be deducted from income to common shareholders for financial statement purposes.

In addition, effective with the fourth quarter of 2011, we began deferring interest payments on our junior subordinated notes which resulted in a deferral of distributions on our trust preferred securities. We have the option to defer interest payments from time-to-time for a period not to exceed 20 consecutive quarters. Thereafter, we must pay all deferred interest and resume quarterly interest payments or we will be in default. Future cash dividends on our common stock are subject to the prior payment of all deferred distributions on our trust preferred securities. At June 30, 2012, cumulative accrued and unpaid interest on our junior subordinated notes totaled $538,000.

Stockholders’ equity decreased $1.0 million to $81.5 million at June 30, 2012, compared with $82.5 million at December 31, 2011. The decrease was due to income earned during the first six months of 2012, reduced by dividends declared on cumulative preferred stock and net reduction in unrealized gain on available for sale securities.

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. See Footnote 11, “Capital Requirements and Restrictions on Retained Earnings,” for detailed regulatory capital ratios. In addition, PBI Bank has agreed with its primary regulators to maintain a ratio of total capital to total risk-weighted assets (“total risk-based capital ratio”) of at least 12.0%, and a ratio of Tier 1 capital to total assets (“leverage ratio”) of 9.0%. The Bank is currently not in compliance with this requirement.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company’s interest sensitivity profile was asset sensitive at June 30, 2012, and December 31, 2011. Given a 100 basis point increase in interest rates, base net interest income would increase by an estimated 4.4% at June 30, 2012, compared with an increase of 5.8% at December 31, 2011, and is within the risk tolerance parameters of our risk management policy. Given a 200 basis point increase in interest rates, base net interest income would increase by an estimated 8.7% at June 30, 2012, compared with an increase of 10.9% at December 31, 2011, and is within the risk tolerance parameters of our risk management policy.

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following June 30, 2012, as calculated using the static shock model approach:

	Change in Future
	Net Interest Income
	Dollar Change		Percentage Change
	(dollars in thousands)
+ 200 basis points	$	4,294		8.72	%
+ 100 basis points		2,158		4.38

We did not run a model simulation for declining interest rates as of June 30, 2012, because the Federal Reserve effectively lowered the federal funds target rate between 0.00% to 0.25% in December 2008. Therefore, no further short-term rate reductions can occur. As we implement strategies to mitigate the risk of rising interest rates in the future, these strategies will lessen our forecasted “base case” net interest income in the event of no interest rate changes.

Item 4. Controls and Procedures

Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of June 30, 2012, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures.

As a result of regulatory examination and audit processes applied to our loan grading activities shortly before and after year end, we determined that our internal process for assigning loan grades did not always establish an accurate grade for credit risk. Our internal control processes surrounding loan grades, which consist of a combination of internal and external loan review activities, identified and corrected grades for the majority of loans that were not initially graded correctly. However, our loan review had not sufficiently covered all loans subject to potential grading error throughout the 2011 fiscal year. In preparing our annual report on Form 10-K, we identified the extent to which our loan review controls did not operate and expanded the scope to cover the remainder of the portfolio and adjusted our allowance for loan losses to take the additional findings into consideration. Accordingly, we determined the controls regarding the determination of loan grades were not operating effectively as of December 31, 2011. Our management, overseen by the Audit Committee, worked throughout the first and second quarters of 2012 and continues to work to implement steps to improve the process for loan grading discovered in the closing process for the year and quarter ended December 31, 2011.

These enhanced procedures include:

●

Completion of additional independent internal and external loan reviews of the portfolio to ensure accurate grading from March 2012 through June 2012.

●

Review of the portfolio by assigned loan officer for proper grading.

●

Analytical review of the portfolio by management based upon payment performance.

These enhanced procedures will include:

●

Implementation of a centralized loan administration and analysis team within the credit department to ensure more timely and regular review of grading, performance metrics, financial information, and collateral.

During the first six months of 2012, we took steps to resolve the material weakness by changing our procedures for loan grading, as discussed above. Notwithstanding the steps taken during this period, the identified material weakness will not be considered remediated until the new procedures have been in operation for a sufficient period of time to be tested and determined by management to be operating effectively. Based on our evaluation and the reasons described above, management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this report. There were no other changes in our internal control over financial reporting that occurred during the six months ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

In the normal course of operations, we are defendants in various legal proceedings. In the opinion of management, there is no known legal proceeding pending which an adverse decision would be expected to result in a material adverse change in our business or consolidated financial position. See Footnote 12, “Contingencies” in the Notes to our consolidated financial statements for additional detail regarding ongoing legal proceedings.

Item 1A. Risk Factors

Information regarding risk factors appears in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 under Item 1A – Risk Factors. There have been no material changes from the risk factors previously discussed in our Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Default Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

(a) Exhibits

The following exhibits are filed or furnished as part of this report:

Exhibit Number	Description of Exhibit

31.1	Certification of Principal Executive Officer, pursuant to Rule 13a – 14(a).

31.2	Certification of Principal Financial Officer, pursuant to Rule 13a – 14(a).

32.1	Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2	Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101*	The following financial statements from the Company’s Quarterly Report on Form 10Q for the quarter ended June, 2012, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.

	* To be filed by amendment within 30 days pursuant to Rule 405(a)(2)(ii) of Regulation S-T.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act if 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	PORTER BANCORP, INC.
	(Registrant)

August 1, 2012		By:	/s/ Maria L. Bouvette
			Maria L. Bouvette
			Chairman & Chief Executive Officer

August 1, 2012		By:	/s/ Phillip W. Barnhouse
			Phillip W. Barnhouse
			Chief Financial Officer and Chief Accounting Officer