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POTOMAC BANCSHARES INC - Quarter Report: 2012 March (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
____________________
 
FORM 10-Q
 
(Mark one)
 
XXX       QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
    For the quarterly period ended March 31, 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 0-24958
 
POTOMAC BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)
 
West Virginia   55-0732247
(State or Other Jurisdiction of   (I.R.S. Employer  
Incorporation or Organization)   Identification No.)

111 East Washington Street    
PO Box 906, Charles Town WV   25414-0906
(Address of Principal Executive Offices)   (Zip Code)
     
Registrant's telephone number, including area code 304-725-8431

Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
                         
Yes      XX          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      XX          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 definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated Filer 
           
Accelerated Filer 
           
Non-Accelerated Filer 
           
Smaller Reporting Company 
XX 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
                         
Yes                  No      XX   
 
APPLICABLE ONLY TO CORPORATE REGISTRANTS
 
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
3,390,178 as of May 14, 2012



POTOMAC BANCSHARES, INC. AND SUBSIDIARY
FORM 10-Q
March 31, 2012

INDEX

PART I.       FINANCIAL INFORMATION PAGE
 
Item 1. Financial Statements.
 
  Consolidated Balance Sheets as of March 31, 2012 (Unaudited) and December 31, 2011 (Audited) 3
 
Consolidated Statements of Operations (Unaudited) for the Three Months Ended March 31, 2012 and 2011 4
 
Consolidated Statements of Comprehensive Income (Unaudited) for the Three Months Ended
       March 31, 2012 and 2011 5
 
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Three Months Ended
       March 31, 2012 and 2011 6
 
Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2012 and 2011 7
 
Notes to Consolidated Financial Statements (Unaudited) 8 - 26
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 26 - 31
 
Item 4. Controls and Procedures. 32
 
Part II. OTHER INFORMATION
 
Item 1. Legal Proceedings. 32
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 32
 
Item 4. Mine Safety Disclosures. 32
 
Item 5. Other Information. 32
 
Item 6. Exhibits. 33
 
Signatures 34

FORWARD-LOOKING STATEMENTS

     The Private Securities Litigation Reform Act of 1995 evidences Congress’ determination that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by corporate management. This Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve risk and uncertainty. “Forward-looking statements” are easily identified by the use of words such as “could,” “anticipate,” “estimate,” “believe,” “confident,” and similar words that refer to a future outlook. To comply with the terms of the safe harbor, the company notes that a variety of factors could cause the company’s actual results and experiences to differ materially from the anticipated results or other expectations expressed in the company’s forward-looking statements.

     The risks and uncertainties that may affect the operations, performance, development and results of the company’s business include, but are not limited to, the growth of the economy, unemployment, pricing in the real estate market, interest rate movements, the impact of competitive products, services and pricing, customer business requirements, the current economic environment posing significant challenges and affecting our financial condition and results of operations, the possibility of future FDIC assessments, Congressional legislation and similar matters (including changes as a result of rules and regulations adopted under the Dodd-Frank Wall Street Reform and Consumer Protection Act). The downgrade of U.S. government securities by one of the credit rating agencies could have a material adverse effect on the company’s operations, earnings and financial condition. We caution readers of this report not to place undue reliance on forward-looking statements which are subject to influence by unanticipated future events. Actual results, accordingly, may differ materially from management expectations.

2



PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
($ in thousands, except per share data)
(Unaudited)

       March 31,        December 31,
2012 2011
Assets:
       Cash and due from banks $      1 571 $      1 485
       Interest-bearing deposits in other financial institutions 26 770 11 445
       Federal funds sold 740 794
       Securities available for sale, at fair value 39 201 42 331
       Loans held for sale 672 198
       Loans, net of allowance for loan losses of $4,401 and
              $4,484, respectively 200 845 202 761
       Premises and equipment, net 7 834 7 923
       Other real estate owned, net of valuation allowance of
              $2,023 and $2,197, respectively 6 782 6 393
       Accrued interest receivable 819 832
       Bank owned life insurance 6 990 6 932
       Federal Home Loan Bank of Pittsburgh stock 789 808
       Other assets 5 282   5 491
 
                     Total Assets $ 298 295 $ 287 393
 
Liabilities and Stockholders’ Equity:
Liabilities:
       Deposits    
              Noninterest-bearing $ 43 313 $ 37 050
              Interest-bearing   221 715 216 067
                     Total Deposits 265 028 253 117
       Securities sold under agreements to repurchase 4 333 3 415
       Federal Home Loan Bank advances 1 221 1 523
       Accrued interest payable 168 204
       Other liabilities 1 680 3 669
                     Total Liabilities $ 272 430 $ 261 928
 
Stockholders’ Equity:
       Common stock, $1 per share par value; 5,000,000 shares
              authorized; 3,671,691 shares issued and outstanding $ 3 672 $ 3 672
       Surplus 3 944 3 943
       Undivided profits 22 968 22 648
       Accumulated other comprehensive (loss), net (1 853 ) (1 932 )
  $ 28 731 $ 28 331
 
                     Less cost of shares acquired for the treasury, 281,513 shares 2 866 2 866
                     Total Stockholders’ Equity $ 25 865 $ 25 465
                     Total Liabilities and Stockholders’ Equity $ 298 295 $ 287 393

See Notes to Consolidated Financial Statements.

3



POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
($ in thousands, except per share data)
(Unaudited)

For the Three Months
Ended March 31
      2012       2011
Interest and Dividend Income:
       Interest and fees on loans $      2 753 $      2 993
       Interest on securities available for sale - taxable 117 168
       Interest on securities available for sale - nontaxable 60 54
       Interest on federal funds sold - - 1
       Other interest and dividends 12 8
              Total Interest and Dividend Income 2 942 3 224
 
Interest Expense:
       Interest on deposits 450 895
       Interest on securities sold under agreements to repurchase 3 19
       Federal Home Loan Bank advances 6 11
              Total Interest Expense 459 925
 
              Net Interest Income 2 483 2 299
 
Provision for Loan Losses 309   423
             
              Net Interest Income after Provision for Loan Losses 2 174 1 876
 
Noninterest Income:
       Trust and financial services   246   221
       Service charges on deposit accounts 418 429
       Visa/MC fees   198 174
       Cash surrender value of life insurance 58 57
       Other operating income 118 94
              Total Noninterest Income 1 038 975
 
Noninterest Expenses:
       Salaries and employee benefits 1 220 1 236
       Net occupancy expense of premises 156 171
       Furniture and equipment expenses 242 200
       Loss on sale of other real estate 54 27
       Accounting, audit and compliance 41 40
       Computer services and online banking 105 69
       FDIC assessment 98 153
       Other professional fees 45 31
       Printing, stationary and supplies 42 41
       Communications 53 47
       Foreclosed property expense 134 117
       Write down of other real estate 142 - -
       ATM and check card expenses 93 71
       Other operating expenses 338 349
              Total Noninterest Expenses 2 763 2 552
              Income before Income Tax Expense 449 299
Income Tax Expense 129 42
 
              Net Income $ 320 $ 257
 
Earnings Per Share, basic and diluted $ .09 $ .08

See Notes to Consolidated Financial Statements.

4



POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
($ in thousands)
(Unaudited)

For the three months
      Ended March 31
2012       2011
Net Income $         320 $         257
Other comprehensive income, net of tax  
       Unrealized holding (losses) gains on securities,
              net of tax of $22 and $61, respectively (38 ) 119
       Deferred tax adjustment   117       - -
Other comprehensive income, net of tax 79 119
Comprehensive income $ 399 $ 376

See Notes to Consolidated Financial Statements.

5



POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2012 AND 2011
($ in thousands, except share and per share data)
(Unaudited)

Accumulated
Other
Common Undivided Treasury Comprehensive
      Stock       Surplus       Profits       Stock       (Loss)       Total
Balances, December 31, 2010 $      3 672 $      3 932 $      23 725 $      (2 866 ) $      (1 687 ) $      26 776
                                             
       Net income - - - - 257 - - - - 257
       Other comprehensive income   - - - - - -   - -   119 119
       Stock-based compensation expense - - 4 - - - - - -   4
       Cash dividends ($.01 per share)   - - - - (34 )   - - - - (34 )
 
Balances, March 31, 2011 $ 3 672   $ 3 936 $ 23 948 $ (2 866 )   $ (1 568 ) $ 27 122
 
Balances, December 31, 2011 $ 3 672 $ 3 943 $ 22 648 $ (2 866 ) $ (1 932 ) $ 25 465
 
       Net income - -   - - 320 - - - - 320
       Other comprehensive income - - - - - - - - 79 79
       Stock-based compensation expense - - 1 - - - - - - 1
 
Balances, March 31, 2012 $ 3 672 $ 3 944   $ 22 968 $ (2 866 ) $ (1 853 ) $ 25 865

See Notes to Consolidated Financial Statements.

6



POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in thousands)
(Unaudited)

For the Three Months Ended  
March March
      2012       2011
CASH FLOWS FROM OPERATING ACTIVITIES
       Net income $         320 $         257
       Adjustments to reconcile net income to net cash (used in) provided by
              operating activities:
                     Provision for loan losses 309 423
                     Depreciation 110 125
                     Discount accretion and premium amortization on securities, net 56 75
                     Write down of other real estate 142 - -
                     Loss on sale of other real estate 54 27
                     Stock compensation expense 1 4
                     Proceeds from sale of loans 626 314
                     Origination of loans for sale (1 100 ) (238 )
                     Change in cash surrender value of
                            bank owned life insurance (58 ) (57 )
                     Changes in assets and liabilities:
                            Decrease (increase) in accrued interest receivable 13 (52 )
                            Decrease in other assets 367 274
                            Decrease in accrued interest payable (36 ) (1 )
                            Decrease in other liabilities (1 989 ) (100 )
                                   Net cash (used in) provided by operating activities $ (1 185 ) $ 1 051
 
CASH FLOWS FROM INVESTING ACTIVITIES
       Proceeds from maturity of securities available for sale $ - - $ 2 000
       Proceeds from call of securities available for sale 8 000 3 000
       Purchase of securities available for sale (4 986 ) (15 000 )
       Net (increase) decrease in loans (204 ) 5 230
       Purchases of premises and equipment (21 ) (12 )
       Proceeds from sale of other real estate 1 226 470
                                   Net cash provided by (used in) investing activities $ 4 015 $ (4 312 )
 
CASH FLOWS FROM FINANCING ACTIVITIES
       Net increase in noninterest-bearing deposits $ 6 263 $ 246
       Net increase in interest-bearing deposits 5 648 14 808
       Net proceeds (repayment) of securities sold under agreements to repurchase 918 (367 )
       Net repayment of Federal Home Loan Bank advances (302 ) (296 )
       Cash dividends - - (34 )
                                   Net cash provided by financing activities $ 12 527 $ 14 357  
                 
                                   Increase in cash and cash equivalents $ 15 357 $ 11 096
                 
CASH AND CASH EQUIVALENTS
       Beginning 13 724 12 905
                 
       Ending $ 29 081 $ 24 001
   
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION  
       Cash payments for:  
              Interest $ 495   $ 926
   
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING  
       AND FINANCING ACTIVITIES
       Unrealized loss on securities available for sale $ (60 ) $ (180 )
       Loans transferred to other real estate owned $ 1 812 $ 914
       Loans made on sale of other real estate owned $ 419 $ 20

See Notes to Consolidated Financial Statements.

7



POTOMAC BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1.           In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of March 31, 2012 and December 31, 2011, and the results of operations and comprehensive income for the three months ended March 31, 2012 and 2011, and cash flows and statements of changes in stockholders’ equity for the three months ended March 31, 2012 and 2011. The statements should be read in conjunction with Notes to Consolidated Financial Statements included in the Potomac Bancshares, Inc. annual report for the year ended December 31, 2011. The results of operations for the three month period ended March 31, 2012 are not necessarily indicative of the results to be expected for the full year.
 
The consolidated financial statements of Potomac Bancshares, Inc. (the “company”) and its wholly-owned subsidiary, Bank of Charles Town (the “bank”), include the accounts of both companies. All material inter-company balances and transactions have been eliminated in consolidation.
 
Certain reclassifications have been made to prior period amounts to conform to the current year presentation.
 
In preparing these financial statements, the company has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.
 
2. Stock-Based Compensation
 
The 2003 Stock Incentive Plan was approved by stockholders on May 13, 2003, which authorized up to 183,600 shares of common stock to be used in the granting of incentive options to employees and directors. On April 24, 2007, the stockholders approved an additional 250,000 shares of common stock to be used in the granting of incentive options to employees and directors. This is the first and only stock incentive plan adopted by the company. Under the plan, the option price cannot be less than the fair market value of the stock on the date granted. An option’s maximum term is ten years from the date of grant. Employee options granted under the plan are subject to a five year vesting schedule. Director options immediately vest.
 
Incremental stock-based compensation expense recognized for the three month periods ending March 31, 2012 and 2011 was $1 thousand and $4 thousand, respectively.
 
Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for each separately vesting portion of the award. Fair value is estimated using the Black-Scholes option-pricing model. There were no options granted during the first quarter of 2012 and 2011.
 
Stock option plan activity for the three months ended March 31, 2012 is summarized below:
 
               Weighted
Average
Weighted Remaining
Average Contractual Aggregate
Exercise Life Intrinsic
       Shares        Price        (in years)        Value
  Options outstanding, January 1, 2012   119 908 $       14.76
Granted - -     - -    
Exercised - -   - -    
Canceled or expired (8 180 ) 14.54  
Options outstanding, March 31, 2012 111 728 14.77 3 $ - -
Options exercisable, March 31, 2012        111 728 14.77        3 $       - -

              The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on March 31, 2012. The aggregate intrinsic values change based on changes in the market value of the company’s stock.
 
As of March 31, 2012 there was $0 of total unrecognized compensation expense related to nonvested stock options.

8



3.           Securities
 
The amortized cost and fair value of securities available for sale as of March 31, 2012 and December 31, 2011 (in thousands) are as follows:
 
March 31, 2012
            Gross       Gross      
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
Obligations of U.S. Government
       sponsored agencies $ 31 409 $ 278 $ (29 ) $ 31 658
State and municipal obligations 6 446 245 - - 6 691
Equity securities 1 099 - - (247 ) 852
$ 38 954 $ 523 $ (276 ) $ 39 201
 
December 31, 2011
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses)   Value
Obligations of U.S. Government    
       sponsored agencies $       34 475 $       357 $       (9 ) $       34 823
State and municipal obligations   6 450   265 - -     6 715
Equity securities 1 099 - - (306 ) 793
$ 42 024 $ 622 $ (315 ) $ 42 331

             The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the company through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The company monitors the portfolio, which is subject to liquidity needs, market rate changes and credit risk changes, to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business behind the instrument. There are five debt securities in the consolidated portfolio that has a loss at March 31, 2012. The primary cause of the temporary impairments in the company’s investments in debt securities was fluctuations in interest rates. Because the company intends to hold these investments in debt securities to maturity and it is more likely than not that the company will not be required to sell these investments before a recovery of unrealized losses, the company does not consider these investments to be other-than-temporarily impaired at March 31, 2012 and no impairment has been recognized.
 
There are three equity security investments in the company’s portfolio with losses at March 31, 2012. The company considers these investments to be temporarily impaired at March 31, 2012 and is recognizing no impairment. These are community bank stock related holdings that the company has the ability and intent to hold until recovery.
 
U.S. Government sponsored agencies include the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation debt securities with a fair value of $19.3 million as of March 31, 2012 and $25.3 million as of December 31, 2011.
 
The following table summarizes the fair value and gross unrealized losses for securities aggregated by investment category and length of time that individual securities have been in a continuous gross unrealized loss position as of March 31, 2012 and December 31, 2011 (in thousands).

March 31, 2012
Less than 12 months More than 12 months Total
Gross Gross Gross
Unrealized Unrealized Unrealized
      Fair Value       Losses       Fair Value       Losses       Fair Value       Losses
Obligations of U.S. Government    
       sponsored agencies $       7 957   $       (29 ) $       - - $        - -     $       7 957 $       (29 )
Equity securities     - -   - -     852   (247 )   852   (247 )
              Total $ 7 957 $ (29 ) $ 852 $ (247 ) $ 8 809 $ (276 )

9



3. Securities (Continued)
          
December 31, 2011  
Less than 12 months   More than 12 months   Total  
Gross   Gross   Gross  
Unrealized   Unrealized   Unrealized  
Fair Value Losses   Fair Value Losses   Fair Value Losses  
Obligations of U.S. Government
       sponsored agencies $ 5 023 $ (9 ) $ - - $ - - $ 5 023 $ (9 )
Equity securities - - - - 793 (306 ) 793 (306 )
              Total       $      5 023       $      (9 )       $      793       $      (306 )       $      5 816       $      (315 )

The company’s investment in Federal Home Loan Bank (FHLB) stock totaled $789 thousand at March 31, 2012. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The company does not consider this investment to be other-than-temporarily impaired at March 31, 2012 and no impairment has been recognized. FHLB stock is shown as a separate line item on the balance sheet and is not a part of the available for sale securities portfolio.
 
At March 31, 2012 and December 31, 2011, securities with carrying values of approximately $12.7 million and $12.8 million, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, other borrowings, and for other purposes as required or permitted by law.
 
4. Loans
 
           The loan portfolio, stated at face amount, is composed of the following:

March 31, December 31,
2012 2011
(in thousands)
Commercial – non real estate
       Commercial and industrial $      7 618 $      8 361
Commercial real estate
       Owner occupied 60 758 61 086
       Non-owner occupied 17 274 15 796
Construction
       Residential 2 306 2 492
       Commercial 13 843 16 687
Real Estate
       Farmland 561 598
Residential
       Revolving open end 4 628 5 015
       1 to 4 family – first liens 81 969 80 311
       1 to 4 family – junior liens 7 189 7 530
       5 or more family 3 065 3 088
Consumer loans
       Titled vehicles 2 488 2 650
       Deposit accounts 584 617
       All other consumer loans 2 884 2 898
All other loans 79 116
              Total loans 205 246 207 245
                     Less: allowance for loan losses 4 401 4 484
  
      $ 200 845       $ 202 761

10



4. Loans (Continued)
 
The FHLB of Pittsburgh has a blanket lien on all the company’s loans except those loans specifically pledged to the Federal Reserve and removed from the FHLB lien. Currently, the FHLB lien is securing an advance to the company in the amount of $1.2 million and letters of credit issued on behalf of a customer of the company in the amount of $11 million.
 
5. Allowance for Loan Losses
 
           The following is a summary of transactions (in thousands) in the allowance for loan losses:

March 31,   December 31,   March 31,  
2012   2011   2011  
Balance at beginning of period $ 4 484 $ 5 012 $ 5 012
   
       Provision charged to operating expense 309 3 343 423
       Recoveries added to the allowance 66 183 52
       Loan losses charged to the allowance (458 ) (4 054 ) (642 )
  
Balance at end of period       $      4 401       $      4 484       $      4 845

Allowance for Loan Losses – By Segment
March 31, 2012
(in thousands)

Commercial   All
Farmland   Commercial   Real Estate   Construction   Consumer   Residential Other Unallocated Total  
Beginning balance $ 17 $ 156 $ 882 $ 506 $ 84 $ 2 839 $ - - $ - - $ 4 484
       Charge-offs - - - - - - (354 ) (54 ) (50 ) - - - - (458 )
       Recoveries - - 6 2 2 54 2 - - - - 66
       Provision (1 ) (6 ) (44 ) 325 (19 ) 54 - - - - 309
 
Ending balance $ 16 $ 156 $ 840 $ 479 $ 65 $ 2 845 $ - - $ - - $ 4 401
 
Individually evaluated
       for impairment $ - - $ 159 $ 100 $ 125 $ 33 $ 510 $ - - $ - - $ 927
Collectively evaluated
       for impairment 16 (3 ) 740 354 32 2 335 - - - - 3 474
  $ 16 $ 156 $ 840 $ 479 $ 65 $ 2 845 $ - - $ - - $ 4 401
  
Financing receivables:
Ending balance $ 561 $ 7 618 $ 78 032 $ 16 149 $ 5 956 $ 96 851 $ 79 $ - - $ 205 246
  
Ending balance:
Individually evaluated
       for impairment $ - - $ 159 $ 6 698 $ 3 705 $ 101 $ 6 485 $ - - $ - - $ 17 148
Collectively evaluated
       for impairment 561 7 459 71 334 12 444 5 855 90 366 79 - - 188 098
Total       $      561       $      7 618       $      78 032       $      16 149       $      5 956       $      96 851       $      79       $      - -       $      205 246

11



5. Allowance for Loan Losses (Continued)
          
Allowance for Loan Losses – By Segment
December 31, 2011
(in thousands)
Commercial   All
Farmland   Commercial   Real Estate   Construction   Consumer   Residential   Other   Unallocated   Total  
Beginning balance $ 166 $ 239 $ 859 $ 2 022 $ 20 $ 1 691 $ 1 $ 14 $ 5 012
       Charge-offs - - (20 ) (653 ) (1 673 ) (172 ) (1 536 ) - - - - (4 054 )
       Recoveries - - 30 6 5 131 11 - - - - 183
       Provision (149 ) (93 ) 670 152 105 2 673 (1 ) (14 ) 3 343
  
Ending balance $ 17 $ 156 $ 882 $ 506 $ 84 $ 2 839 $ - - $ - - $ 4 484
 
Individually evaluated
       for impairment $ - - $ 161 $ 122 $ 102 $ 39 $ 349 $ - - $ - - $ 773
Collectively evaluated
       for impairment 17 (5 ) 760 404 45 2 490 - - - - 3 711
$ 17 $ 156 $ 882 $ 506 $ 84 $ 2 839 $ - - $ - - $ 4 484
    
Financing receivables:
Ending balance $ 598 $ 8 361 $ 76 882 $ 19 179 $ 6 165 $ 95 944 $ 116 $ - - $ 207 245
  
Ending balance:
Individually evaluated
       for impairment $ - - $ 161 $ 6 995 $ 5 250 $ 109 $ 5 662 $ - - $ - - $ 18 177
Collectively evaluated  
       for impairment 598 8 200 69 887 13 929 6 056 90 282 116 - - 189 068
Total       $      598       $      8 361       $      76 882       $      19 179       $      6 165       $      95 944       $      116       $      - -       $      207 245

Credit Quality Information – By Class
March 31, 2012
(in thousands)

Special Sub-
Internal Risk Rating Grades   Pass Mention Standard Doubtful Loss
Commercial – non real estate
       Commercial and industrial $ 5 566 $ 1 893 $ 159 $  - - $ - -
Commercial real estate
       Owner occupied 39 066 12 405 9 287 - - - -
       Non-owner occupied 16 085 608 581 - - - -
Construction
       Residential 2 077 - - 229 - - - -
       Commercial 8 668 1 861 3 220 94 - -
Real estate
       Farmland 561 - - - - - - - -
Consumer
       Titled vehicles N/A N/A N/A N/A N/A
       Deposit accounts N/A N/A N/A N/A N/A
       All other N/A N/A N/A N/A N/A
Residential
       Revolving open end N/A 1 269 285 N/A N/A
       1-4 family – first liens N/A 1 630 3 214 58 - -
       1-4 family – junior liens N/A - - 265 - - - -
       5 or more family N/A - - - - - - - -
 
Totals       $      72 023       $      19 666       $      17 240       $      152       $      - -

As a matter of practice, we do not risk rate consumer or residential mortgage loans. Any of these loans listed in the risk rating table above are associated with commercial loans that have been risk rated as per our policy. When a loan is designated as a loss, the loss portion is charged off, and if applicable the remaining balance classified as substandard.
          
12



5. Allowance for Loan Losses (Continued)
          
Credit Quality Information – By Class
March 31, 2012
(in thousands)
Non Risk Rated Loans   Performing Nonperforming
Consumer – non real estate
       Titled vehicles $ 2 484 $ 4
       Deposit accounts 584 - -
       All other 2 882 2
Residential
       Revolving open end 3 059 15
       1-4 family – first liens 75 859 1 208
       1-4 Family – junior liens 6 924 - -
       5 or more family 3 065 - -
All other 79 - -
       Totals       $      94 936       $      1 229

Credit Quality Information – By Class
December 31, 2011
(in thousands)

Special Sub-
Internal Risk Rating Grades   Pass Mention Standard Doubtful Loss
Commercial – non real estate
       Commercial and industrial $ 8 094 $ 105 $ 162 $ - - $ - -
Commercial real estate
       Owner occupied 39 405 12 768 8 817 96 - -
       Non-owner occupied 14 824 333 583 56 - -
Construction
       Residential 1 986 - - 506 - - - -
       Commercial 10 077 2 123 4 397 90 - -
Real estate
       Farmland 598 - - - - - - - -
Consumer
       Titled vehicles N/A N/A N/A N/A N/A
       Deposit accounts N/A N/A N/A N/A N/A
       All other N/A 25 N/A N/A N/A
Residential
       Revolving open end N/A 1 276 224 N/A N/A
       1-4 family – first liens N/A 2 894 2 351 N/A N/A
       1-4 family – junior liens N/A 172 94 N/A N/A
       5 or more family N/A N/A N/A N/A N/A
Totals       $      74 984       $      19 696       $      17 134       $      242       $      - -

Credit Quality Information – By Class
December 31, 2011
(in thousands)

Non Risk Rated Loans   Performing Nonperforming
Consumer – non real estate
       Titled vehicles $ 2 645 $ 5
       Deposit accounts 617 - -
       All other 2 870 3
Residential
       Revolving open end 3 498 17
       1-4 family – first liens 74 227 839
       1-4 Family – junior liens 7 264 - -
       5 or more family 3 088 - -
All other 116 - -
Totals       $      94 325       $      864

13



5. Allowance for Loan Losses (Continued)
          
Impaired Loans – By Class
March 31, 2012
(in thousands)
With no related allowance:
Average Interest
Unpaid Recorded Related Recorded Income
Principal Investment Allowance Investment Recognized
Commercial – non real estate
       Commercial and industrial $ - - $ - - $ N/A $ 48 $ - -
Commercial real estate
       Owner occupied 4 291 4 089 N/A 3 734 39
       Non-owner occupied 584 582 N/A 233 9
Construction
       Residential 110 110 N/A 584 1
       Commercial 3 175 2 810 N/A 3 389 4
Real estate
       Farmland - - - - N/A - - - -
Residential
       Revolving open end 285 285 N/A 217 5
       1 to 4 family –first liens 516 438 N/A 1 096 3
       1 to 4 family – junior liens - - - - N/A 142 - -
       5 or more family - - - - N/A - - - -
Consumer
       Titled vehicles - - - - N/A 4 - -
       Deposit accounts - - - - N/A - - - -
       All other consumer - - - - N/A - - - -
All other - - - - N/A - - - -
$ 8 961 $ 8 314 $ N/A $ 9 447 $ 61
    
With an allowance recorded:
Average Interest
Unpaid Recorded Related Recorded Income
Principal Investment Allowance Investment Recognized
Commercial – non real estate
       Commercial and industrial $ 162 $ 159 $ 159 $ 164 $ 1
Commercial real estate
       Owner occupied 2 042 2 027 100 4 177 30
       Non-owner occupied - - - - - - 162 - -
Construction
       Residential 121 119 29 450 - -
       Commercial 669 666 96 1 596 11
Real estate
       Farmland - - - - - - - - - -
Residential
       Revolving open end 1 272 1 269 33 585 16
       1 to 4 family – first liens 3 612 3 584 435 2 780 33
       1 to 4 family – junior liens 915 909 42 480 18
       5 or more family - - - - - - - - - -
Consumer
       Titled vehicles - - - - - - - - - -
       Deposit accounts - - - - - - - - - -
       All other consumer 102 101 33 57 2
All other - - - - - - - - - -
$ 8 895 $ 8 834 $ 927 $ 10 451 $ 111
  
Totals:
Commercial – non real estate $ 162 $ 159 $ 159 $ 212 $ 1
Commercial real estate 6 917 6 698 100 8 306 78
Construction 4 075 3 705 125 6 019 16
Real estate –farmland - - - - - - - - - -
Residential 6 600 6 485 510 5 300 75
Consumer 102 101 33 61 2
All other - - - - - - - - - -
      $      17 856       $      17 148       $      927       $      19 898       $      172

14



5. Allowance for Loan Losses (Continued)
          
Impaired Loans – By Class
December 31, 2011
(in thousands)
With no related allowance:
Average Interest
Unpaid Recorded Related Recorded Income
Principal Investment Allowance Investment Recognized
Commercial – non real estate
       Commercial and industrial $ - - $ - - $ N/A $ 67 $ - -
Commercial real estate
       Owner occupied 4 622 4 440 N/A 3 752 217
       Non-owner occupied 587 583 N/A 132 11
Construction
       Residential 512 506 N/A 799 14
       Commercial 4 106 3 976 N/A 3 353 168
Real estate
       Farmland - - - - N/A - - - -
Residential
       Revolving open end 225 224 N/A 160 15
       1 to 4 family –first liens 948 870 N/A 1 257 26
       1 to 4 family – junior liens - - - - N/A 177 - -
       5 or more family - - - - N/A - - - -
Consumer
       Titled vehicles - - - - N/A - - - -
       Deposit accounts - - - - N/A - - - -
       All other consumer - - - - N/A 4 - -
All other - - - - N/A - - - -
$ 11 000 $ 10 599 $ N/A $ 9 701 $ 451
   
With an allowance recorded:
Average Interest
Unpaid Recorded Related Recorded Income
Principal Investment Allowance Investment Recognized
Commercial – non real estate
       Commercial and industrial $ 163 $ 161 $ 161 $ 187 $ 8
Commercial real estate
       Owner occupied 1 989 1 972 122 4 800 93
       Non-owner occupied - - - - - - 163 - -
Construction
       Residential - - - - - - 979 - -
       Commercial 771 768 102 2 443 30
Real estate
       Farmland - - - - - - 108 - -
Residential
       Revolving open end 1 277 1 274 31 331 65
       1 to 4 family – first liens 2 550 2 540 299 2 342 102
       1 to 4 family – junior liens 758 754 19 311 28
       5 or more family - - - - - - - - - -
Consumer
       Titled vehicles - - - - - - - - - -
       Deposit accounts - - - - - - - - - -
       All other consumer 109 109 39 37 3
All other - - - - - - - - - -
$ 7 617 $ 7 578 $ 773 $ 11 701 $ 329
  
Totals:
Commercial – non real estate $ 163 $ 161 $ 161 $ 254 $ 8
Commercial real estate 7 198 6 995 122 8 847 321
Construction 5 389 5 250 102 7 574 212
Real estate –farmland - - - - - - 108 - -
Residential 5 758 5 662 349 4 578 236
Consumer 109 109 39 41 3
All other - - - - - - - - - -
      $      18 617       $      18 177       $      773       $      21 402       $      780

15



5. Allowance for Loan Losses (Continued)
          
Modifications
(in thousands except number of contracts)

For the Three Months Ended
March 31, 2012

Pre- Post-
Modification Modification
Number Outstanding Outstanding
Of Recorded Recorded
Contracts Investment Investment
           Troubled Debt Restructurings
 
Commercial – non real estate
       Commercial and industrial - - $ - - $ - -
Commercial real estate
       Owner occupied - - - - - -
       Non owner occupied - - - - - -
Construction
       Residential - - - - - -
       Commercial - - - - - -
  Real Estate
       Farmland - - - - - -
Residential
       Revolving open end 1 to 4 family - - - - - -
       1 to 4 family – first liens 1 227 226
       1 to 4 family – junior liens - - - - - -
       5 or more family - - - - - -
Consumer
       Titled vehicles - - - - - -
       Deposit accounts - - - - - -
       All other consumer - - - - - -
All other - - - - - -
   
Totals       1       $      227       $      226

For the Three Months
Ended March 31,2012

Number Outstanding
Of Recorded
Contracts Investment
           Troubled Debt Restructurings
That Subsequently Defaulted
  
Commercial – non real estate
       Commercial and industrial - - $ - -
Commercial real estate
       Owner occupied - - - -
       Non owner occupied - - - -
  Construction
       Residential - - - -
       Commercial - - - -
Real Estate
       Farmland - - - -
Residential
       Revolving open end 1 to 4 family - - - -
       1 to 4 family – first liens 5 715
       1 to 4 family – junior liens 3 110
       5 or more family - - - -
Consumer
       Titled vehicles - - - -
       Deposit accounts - - - -
       All other consumer - - - -
All other - -   - -
Totals       8       $      825

Total Troubled Debt Restructurings as of March 31, 2012 were $12.0 million.
          
16



5. Allowance for Loan Losses (Continued)
          

Nonaccrual and Past Due Loans – By Class
March 31, 2012
(in thousands)

90 Days
30-59 60-89 90 Days Past Due
Days Days or more Total Total Still Non-
      Past Due         Past Due       Past Due       Past Due       Current       Loans       Accruing       Accrual
Commercial – non real estate
       Commercial and industrial $ 79 $ - - $  - - $ 79 $ 7 539 $ 7 618 $ - - $ 91
Commercial real estate
       Owner occupied 224 - - 1 244 1 468 59 290 60 758 - - 1 333
       Non owner occupied - - 330 179 509 16 765 17 274     - -   179
Construction  
       Residential   - - - - - -   - - 2 306 2 306 - - 119
       Commercial 480 231 2 216   2 927 10 916   13 843 - - 2 566
Real Estate          
       Farmland - - - - - - - - 561   561   - - - -
Residential  
       Revolving open end - - - - - - - - 4 628 4 628 - - 16
       1 to 4 family – first liens 301 217   522 1 040 80 929 81 969 - - 1 998
       1 to 4 family – junior liens 167   172 - - 339 6 850 7 189 - - - -
       5 or more family   - -   - -   - - - - 3 065 3 065 - - - -
Consumer
       Titled vehicles 5 - - - - 5 2 483 2 488 - - 4
       Deposit accounts - - - - - - - - 584 584 - - - -
       All other consumer 3 - - 2 5 2 879 2 884 - - 2
All other - - - - - - - - 79 79 - - - -
Totals $        1 259 $        950 $        4 163 $        6 372 $        198 874 $        205 246 $             - - $        6 308
 
Percentage to Total Loans .61% 0.46% 2.03% 3.10% 96.90% 0.00% 3.07%

           Included in the 30 or more days past due loans are non-accrual loans in the amount of $4.9 million. The remaining $1.4 million are in current status.

Nonaccrual and Past Due Loans – By Class
December 31, 2011
(in thousands)

90 Days
30-59 60-89 90 Days Past Due
Days Days or more Total Total Still Non-
      Past Due         Past Due       Past Due       Past Due       Current       Loans       Accruing       Accrual
Commercial – non real estate
       Commercial and industrial $  - - $ 6 $  - - $ 6 $ 8 355 $ 8 361 $ - - $ 93
Commercial real estate  
       Owner occupied 2 376 996 344 3 716 57 370 61 086 - -   1 339
       Non owner occupied - - - - 179 179 15 617 15 796   - - 179
Construction  
       Residential - -   - - 385 385 2 107 2 492 - - 506
       Commercial 19   44 1 602 1 665 15 022 16 687 143 3 693
Real Estate        
       Farmland - - - -   - - - - 598 598 - - - -
Residential      
       Revolving open end - - - - - - - - 5 015 5 015 - - 17
       1 to 4 family – first liens 1 386 139 360 1 885 78 426 80 311 61 1 408
       1 to 4 family – junior liens   176 - - - - 176 7 354 7 530 - - - -
       5 or more family   - - - - - - - - 3 088 3 088 - - - -
Consumer
       Titled vehicles 1 15 - - 16 2 634 2 650 - - 5
       Deposit accounts - - - - - - - - 617 617 - - - -
       All other consumer 8 4 3 15 2 883 2 898 - - 3
All other - - - - - - - - 116 116 - - - -
Totals $        3 966 $        1 204 $        2 873 $        8 043 $        199 202 $        207 245 $        204 $        7 243
 
Percentage to Total Loans 1.91% 0.58% 1.39% 3.88% 96.12% .10% 3.49%

17



5. Allowance for Loan Losses (Continued)
          
 

Included in the 30 or more days past due loans are non-accrual loans in the amount of $3.7 million. The remaining non-accrual loans of $3.5 million are in current status.

The past due policy of the bank is to report all classes of loans past due in the following categories:

  • 30 to 59 days past due (principal or interest)
  • 60 to 89 days past due (principal or interest)
  • 90 days or more past due (principal or interest)
  • Nonaccrual status.

6. Employee Benefit Plans
 
           Components of net periodic benefit cost for the pension and postretirement benefit plans are shown below:
 
                     Pension Benefits Other Postretirement Benefits
Three Months Ended Three Months Ended
March 31, March 31, March 31, March 31,
      2012       2011       2012       2011
(in thousands) (in thousands)
Components of Net Periodic Benefit Cost
       Service cost $ - - $ - - $ 1 $ 3
         Interest cost 102   100 3 9
       Expected return on plan assets   (119 ) (119 ) - -     - -
       Recognized net actuarial loss   - - 38     - - - -
       Amortization of net obligation at transition - -   - -   - - 5
       Amortization of prior service cost - - - - - - - -
       Amortization of net loss 53 - - - - - -
 
Net periodic benefit cost $ 36 $ 19 $ 4 $ 17
 
Employer Contribution
 
           The company anticipates the 2012 contribution for the pension plan will approximate $2 million and has made this payment as of March 31, 2012. The company has made payments of $4 thousand for the other postretirement benefit plans for the first three months of 2012 and anticipates remaining payments for 2012 to total $13 thousand.

The company’s defined benefit pension plan was frozen as of October 31, 2009. Benefits of all existing participants stopped accruing and no new participants could be admitted to the plan after that date.

The company sponsors an unfunded postretirement life insurance plan covering certain retirees with 25 years of service who are over the age of 60 and an unfunded health care plan for certain retirees that met certain eligibility requirements. These plans are not available to future retirees.

18



7. Weighted Average Number of Shares Outstanding and Earnings Per Share
                 
The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock. Potential diluted common stock had no effect on March 31, 2012 and March 31, 2011 earnings per share.
 
Three Months Ended Three Months Ended
March 31, 2012 March 31, 2011
      Average Shares       Per Share Amount       Average Shares       Per Share Amount
Basic earnings per share 3 390 178 $ .09 3 390 178 $ .08
Effect of dilutive securities:
       Stock options - - - -
 
Diluted earnings per share 3 390 178 $ .09 3 390 178 $ .08
 
For the quarter ended March 31, 2012, stock options representing 111,728 average shares, and for the quarter ended March 31, 2011, stock options representing 120,974 average shares were not included in the calculation of earnings per share as their effect would have been anti-dilutive.
 
8. Recent Accounting Pronouncements
           
In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.
 
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU is the result of joint efforts by the FASB and International Accounting Standards Board (IASB) to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and International Financial Reporting Standards (IFRS). The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. The company has included the required disclosures in its consolidated financial statements.
 
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share. The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. The company has included the required disclosures in its consolidated financial statements.

19



8. Recent Accounting Pronouncements (continued)
         
In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The company does not expect the adoption of ASU 2011- 11 to have a material impact on its consolidated financial statements.
 
In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220) – Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” The amendments are being made to allow the Board time to re-deliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU 2011-05. All other requirements in ASU 2011-05 are not affected by ASU 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. The company has included the required disclosures in its consolidated financial statements.
 
9. Fair Value Measurements
 
Determination of Fair Value
 
The company uses fair value measurements to record fair value adjustments for certain assets and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
 
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
 
Fair Value Hierarchy
 
In accordance with this guidance, the company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
 
Level 1—Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
 
Level 2—Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

20



9. Fair Value Measurements (Continued)
         
Level 3—Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.
 
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
 
The following methods and assumptions were used by the company in estimating fair value disclosures for financial instruments:
 
Cash and Short-Term Investments
 
The carrying amounts of cash and short-term instruments approximate fair values based on the short-term nature of the assets.
 
Securities
 
Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). Certain of the equity securities with inactive markets utilize Level 3 which may include judgment or estimation.
 
Loans
 
For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered.
 
Loans held for sale
 
The fair value of loans held for sale is based on outstanding commitments from investors.
 
FHLB Stock
 
The carrying amounts of FHLB stock approximate fair value based on redemption provisions of the FHLB.
 
Bank Owned Life Insurance (BOLI)
 
The carrying amounts of BOLI approximate fair value.
 
Deposit Liabilities
 
The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity fixed rate certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
 
Short-Term Borrowings
 
The carrying amounts of borrowings under repurchase agreements and federal funds purchased approximate fair value.
 
FHLB Advances
 
The fair values of the company’s FHLB advances are estimated using discounted cash flow analysis based on the company’s incremental borrowing rates for similar types of borrowing arrangements.

21



9. Fair Value Measurements (Continued)
 
          Accrued Interest
 
The carrying amounts of accrued interest approximate fair value.
 
Off-Balance Sheet Financial Instruments
 
At March 31, 2012 and December 31, 2011, the fair value of loan commitments and standby-letters of credit was immaterial. Therefore, they have not been included in the following table.
 
The carrying amounts and estimated fair values of the company’s financial instruments are as follows (in thousands):
 
Fair Value Measurements at March 31, 2012 using
Quoted Prices
in Active Significant
Markets for Other Significant
          Identical Observable Unobservable
            Assets       Inputs       Inputs      
Carrying Value Level 1 Level 2 Level 3 Balance
  Assets
Cash and cash equivalents $      29 081 $      29 081 $      - $      - $      29 081
Securities available for sale 39 201 - 38 537 664 39 201
Loans, net 200 845 - 197 710 5 593 203 303
Loans held for sale 672 - 672 - 672
FHLB Stock 789 - 789 - 789
BOLI 6 990 - 6 990 - 6 990
Accrued interest receivable 819 - 819 - 819
Liabilities
Deposits $ 265 028 $ - $ 266 209 $ - $ 266 209
Securities sold under
       agreement to repurchase 4 333 - 4 333 - 4,333
FHLB advances 1 221 - 1 228 - 1 228
Accrued interest payable 168 - 168 - 168

22



9. Fair Value Measurements (Continued)
         
          Fair Value Measurements at December 31, 2011 using
Quoted Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
            Assets       Inputs       Inputs      
Carrying Value Level 1 Level 2 Level 3 Balance
Assets
Cash and cash equivalents $      13 724 $      13 724 $      - $      - $      13 724
Securities available for sale 42 331 - 41 687 644 42 331
Loans, net 202 761 - 196 240 6 497 202 737
  Loans held for sale 198 - 198 - 198
FHLB Stock 808 - 808 - 808
BOLI 6 932 - 6 932 - 6 932
Accrued interest receivable 832 - 832 - 832
Liabilities
Deposits $ 253 117 $ - $ 253 885 $ - $ 253 885
Securities sold under
       agreement to repurchase 3 415 - 3 415 - 3 415
FHLB advances 1 523 - 1 534 - 1 534
Accrued interest payable 204 - 204 - 204

          Assets and Liabilities Measured at Fair Value on a Recurring Basis
 
  The following table presents the balances (in thousands) of financial assets measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011:

Fair Value Measurements at March 31, 2012 Using
Quoted Prices
in Active Significant
Markets for Other Significant
      Balance as of       Identical       Observable       Unobservable
March 31 Assets Inputs Inputs
Description   2012 (Level 1) (Level 2) (Level 3)
Available for sale debt securities
       U.S. Government sponsored
              agency securities $      31 658 $      - - $      31 658 $      - -
       State and municipal securities 6 691 - - 6 691 - -
 
Total available for sale debt securities 38 349 - - 38 349 - -
 
Available for sale equity securities
       Financial services industry 852 - - 188 664
 
Total available for sale securities $ 39 201 $ - - $ 38 537 $ 664

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9. Fair Value Measurements (Continued)
         
Fair Value Measurements at December 31, 2011 Using
Quoted Prices
in Active Significant
Markets for Other Significant
Balance as of Identical Observable Unobservable
December 31 Assets Inputs Inputs
Description         2011       (Level 1)       (Level 2)       (Level 3)
Available for sale debt securities
       U.S. Government sponsored
              agency securities $      34 823 $      - - $      34 823 $      - -
       State and municipal securities 6 715 - - 6 715 - -
 
Total available for sale debt securities 41 538 - - 41 538 - -
 
Available for sale equity securities
       Financial services industry 793 - - 149 644
 
Total available for sale securities $ 42 331 $ - - $ 41 687 $ 644

          Assets Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3) (in thousands)

Quantitative information about Level 3 Fair Value Measurement for March 31, 2012
      Fair                   Range
Value Valuation Technique(s) Unobservable Input (Weighted Average)
Asset
 
Available for sale equity securities
       Financial services industry $      664 Discounted Market Price Lack of marketability 10% - 30% (20%)
to approximate book value
 
              Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
    ($ in thousands)
                     
       
Available for Sale Equity Securities
Beginning Balance January 1, 2012   $     644                              
                           
       Transfers into Level 3     - -                  
       Transfers out of Level 3     - -                  
       Total gains (unrealized)                        
              included in other                        
                     comprehensive income     20                
                         
Ending Balance March 31, 2012   $      664                  

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9. Fair Value Measurements (Continued)
           
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
 
Certain assets are measured at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
 
The following describes the valuation techniques used by the company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:
 
Loans held for sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the periods ended March 31, 2012 and December 31, 2011. Gains and losses on the sale of loans are recorded within other operating income on the consolidated statements of operations.
 
Impaired Loans: Loans are generally designated as impaired when, in the judgment of management based on current information and events, it is probable that some amounts due according to the contractual terms of the loan agreement may not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered (Level 3). The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.
 
Other Real Estate Owned: Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. The value of real estate collateral is determined by internal evaluation or an appraisal outside of the company or a comparative market analysis (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, or property is in the process of being appraised then the fair value is considered Level 3.
 
The following table summarizes the company’s financial assets that were measured at fair value (in thousands) on a nonrecurring basis as of March 31, 2012 and December 31, 2011.
 
          Carrying Value at March 31, 2012
Quoted Prices  
In Active Significant
  Markets for Other Significant
Identical Observable Unobservable
      Balance as of       Assets       Input       Input
Description   March 31, 2012 (Level 1) (Level 2) (Level 3)
Assets
       Loans Held For Sale $      672 $      - - $      672 $      --
       Impaired loans with a
              valuation allowance 7 907 - - 2 314 5 593
 
       OREO 6 782 - - 6 381 401

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Carrying Value at December 31, 2011
Quoted Prices
      In Active Significant
            Markets for       Other       Significant
Identical Observable Unobservable
Balance as of Assets Input Input
Description   December 31, 2011 (Level 1) (Level 2) (Level 3)
Assets
       Loans Held For Sale $      198 $      - - $      198 $      - -
       Impaired loans with a
              valuation allowance 6 805 - - 308 6 497
 
       OREO 6 393 - - 4 365 2 028

Quantitative information about Level 3 Fair Value Measurement for March 31, 2012
Fair Range
      Value (000s)       Valuation Technique(s)       Unobservable Input       (Weighted Average)
Asset
 
Impaired loans with a
       Valuation allowance $      5 593 Appraisal and income or Market discount 0% - 100% (10%)
market valuation
 
OREO 401 Appraisal, internal evaluation or Market discount 0% - 5% (5%)
market analysis

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
          ($ in thousands)
 
      Impaired Loans         Other Real Estate Owned  
  Beginning Balance January 1, 2012 $                      6 497 2 028                              
 
       Transfers into Level 3 645 - -
       Transfers out of Level 3 (1 521 ) (1 223 )
       Realized and unrealized gains and (losses)
              included in earnings 25 (44 )
       Settlements (53 ) (360 )
 
Ending Balance March 31, 2012 $ 5 593 $                                   401

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
           
CRITICAL ACCOUNTING POLICIES
   
General
 
The company’s financial statements are prepared in accordance with U. S. generally accepted accounting principles. The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, U. S. generally accepted accounting principles may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

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ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (1) losses be accrued when they are probable of occurring and are capable of estimation and (2) losses be accrued based on the differences between the margin value of collateral and the loan balance.

The allowance consists of specific and general components. The specific component relates to loans (other than consumer and residential mortgage loans) that are classified as substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows or collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for environmental factors such as economic, concentration and growth trends. The bank uses a twelve month rolling average period for use in calculating the historical loss factor.

FINANCIAL OVERVIEW

The first quarter of 2012 has provided positive results with net income of $320 thousand, up almost 25% over the same period in 2011. The bank has produced two consecutive quarters of income despite the challenging economic environment. There has been significant positive movement in the unemployment rate in our local market over the past twelve months. We are seeing loan growth in the residential real estate portfolio.

In addition to those items outside management control, the actions taken in the past year are creating improvement in economic performance. Interest expense as a result of decreases in deposit rates, are a significant reason for our ability to produce a profit. Management has aggressively marketed our inventory of other real estate. However, the inventory is still higher than what we would prefer. Management is hopeful that sales of other real estate will continue at a moderate pace.

Total assets have increased $10.9 million or 3.8% from the December 31, 2011 total of $287.4 million to $298.3 million at March 31, 2012. Net loans have decreased approximately $1.9 million from the December 31, 2011 total of $202.8 million to $200.9 million at March 31, 2012 due to the pay down of existing loans, loan charge-offs and the transfer of loans to OREO. Other real estate, net of valuation allowance, has increased $389 thousand. With the decrease in loans and increase in deposits excess funds have been invested in securities, and overnight funds at the Federal Reserve.

Total deposits have increased $11.9 million or 4.7% at March 31, 2012 compared to December 31, 2011. Interest-bearing deposits have increased 2.6% during the first quarter of 2012, with non-interest bearing deposits increasing 16.9%. Other liabilities have decreased approximately $2 million dollars. The decrease is primarily due to a $2 million contribution to the pension plan.

The Tier 1 capital to average assets ratio (leverage capital ratio) is 8.70% at March 31, 2012 compared to 8.56% at December 31, 2011. This capital ratio is within the regulatory guidelines for “well capitalized”.

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The following table is an analysis of the company’s allowance for loan losses with amounts shown in thousands. Management monitors the loan portfolio on a continual basis with procedures that allow for problem loans and potentially problem loans to be highlighted and watched. Written reports are prepared on a monthly basis for all loans including commercial loans graded below a certain level for management review and are reported to the Board of Directors on a quarterly basis. In addition, a subcommittee of the board of directors meets monthly to review all classified assets. Based on experience, these loan policies and the bank’s grading and review system, management believes the loan loss allowance is adequate.

March 31, December 31, March 31,
2012 2011 2011
Balance at beginning of period $     4 484       $     5 012       $     5 012
Charge-offs:
       Commercial, financial and agricultural - - 20 - -
       Real estate – construction 354 1 673 57
       Real estate – mortgage 50 2 189 540
       Consumer 54 172 45
              Total charge-offs 458 4 054 642
Recoveries:
       Commercial, financial and agricultural 6   30 5
       Real estate – construction 2 5 5
       Real estate – mortgage   4 17 9
       Consumer 54 131 33
              Total recoveries 66 183   52
Net charge-offs 392 3 871 590
Provision charged to operations 309   3 343 423
Balance at end of period $ 4 401 $ 4 484 $ 4 845
 
Ratio of net charge-offs (annualized) during the period
       to average loans outstanding during the period 0.76% 1.84% 1.09%

Loans are placed on nonaccrual status when the loan officer or collections officer who is supervising a particular loan determines that it is no longer prudent for a loan to continue to accrue interest, the loan is to be placed on nonaccrual status.

Generally it is the policy of this bank to stop accruing interest when principal or interest is greater than 90 days past due based upon the loan’s contractual terms, unless the loan is well secured and in the process of collection. Furthermore, should the bank become aware of events which have occurred or are expected to occur which causes doubt as to the full collectability of principal or interest in the future, even though the loan is currently less than 90 days past due, the loan is considered for nonaccrual status.

In order to justify the continuation of the accrual of interest on a loan which is greater than 90 days past due, the loan must be well secured and in the process of collection. The majority of the current non-accrual loans as shown in the chart below are in the process of collection. Following is a table showing the risk elements in the loan portfolio with amounts in thousands.

March 31, December 31, March 31,
2012       2011       2011
Nonperforming Assets
       Nonaccrual loans (1) $     6 308 $     7 243 $     2 674
       Foreclosed properties 6 782 6 393 6 980
              Total nonperforming assets $ 13 090 $ 13 636 $ 9 654
                 
       Performing troubled debt restructures (2) $ 8 655 $ 9 078 $ - -
 
       Loans past due 90 days accruing interest $ 0 $ 204   $ 276
       Allowance for loan losses to period end loans 2.14%     2.16% 2.28%
       Nonperforming assets to period end loans and
             foreclosed properties, net 6.17% 6.38% 4.40%
 
       Performing troubled debt restructures to period end loans 4.22% 4.38% - -%

(1) Currently there are 7 TDR’s in non-performing assets with a balance of $3.4 million.
(2) Within this amount is 1 TDR with a balance totaling $35 thousand 30 or more days past due.

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The details of the income statements for the three month period ended March 31, 2012 and 2011 are highlighted below.

Ø Year to date net income in 2012 is $320 thousand compared to net income of $257 thousand in 2011. The loan portfolio has decreased as the result of foreclosures and normal run off. Deposits have increased slightly. However, the increase in volume has been offset by significant decreases in rates paid on deposit accounts. Decline in property values have further affected the net income as other real estate write downs have been charged against income. In addition net losses on the sale of other real estate doubled in the first quarter of 2012 compared to net losses in the same period in 2011.

Ø Interest income has decreased to $2.9 million at March 31, 2012 from $3.2 million at March 31, 2011. The reduction is primarily due to a decrease of approximately $240 thousand in the loan portfolio. This coupled with historically low interest rates has created the slight reduction in interest income.

Ø Total interest expense has decreased 50.4% in 2012 compared to 2011. Interest on deposits has decreased 49.7% during the first quarter of 2012 when compared with the first quarter of 2011.

Ø Provision for loan loss has decreased 27% when compared to the March 31, 2011 quarter.

Ø Net interest margin at March 31, 2012 is 3.80%. This is an increase from the net interest margin of 3.56% at December 31, 2011 and 3.44% at March 31, 2011. During the first three months of 2012, the overall average rate on loans decreased to 5.36% at March 31, 2012 compared to 5.53% at December 31, 2011 and 5.64% for the quarter ending March 31, 2011. The overall average rate being paid on deposits decreased to .83% from 1.21% at December 31, 2011 and from 1.53% at March 31, 2011.

Noninterest income increased 6.5% for the three months ended March 31, 2012 compared to March 31, 2011 and decreased 18% for the three months ended March 31, 2012 compared to the three months ended December 31, 2011. Some significant income items are listed here.

Ø Trust income increased 11.3% when compared to the March 31, 2011 quarter and increased 13.36% when compared to the December 31, 2011 quarter. The increase, in both cases, are due to new customer volume as rates have remained relatively steady.

Ø Visa and MasterCard fees have increased 13.8% on a year to date basis compared to the same period in 2011. The increase is due to an overall increase in consumer spending and the likelihood that consumers continue to get more comfortable with using credit/debit cards versus cash.

Ø The primary cause of the decrease in non-interest income compared to the December quarter was the termination of an other post-retirement benefit plan in the fourth quarter of 2011.

Year to date total noninterest expense increased about 8.27% for the three months ended March 31, 2012 compared to the same period in 2011. The quarterly result was an increase of 4% over the December 31, 2011 quarter. Excluding expenses and losses related to foreclosed properties non-interest expense increased by 1.04% when compared to the March 31, 2011 quarter, and decreased 1.82% when compared to the December 31, 2011 quarter. Some details of the remaining accounts are listed below.

Ø Equipment expense increased 21% over the March 31, 2011 quarter. The increase is a combination of increases in expenses related to our banking software and the expense of new computers purchased.

Ø Computer services and online banking expense increased 52.2% over the first quarter 2011 results. The increase is due to increases in costs related to the bank’s core software and additional online banking expenses related to new resources provided to customers.

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Ø Loss on sale of other real estate increased 100% in the first quarter of 2012 as compared to the first quarter of 2011. The increase is primarily due to the housing market slump lowering values in our market area coupled with a moderate amount of foreclosed properties remaining in the market.

Ø The FDIC assessment expense has decreased 36% from the March 31, 2011 quarterly total. The decrease is due to the change in the base rate of the calculation. The rate is now calculated on average assets as opposed to total deposits.

Ø Other professional fees have increased 45.2% over the March 2011 quarter. The primary reason for the increase is one time professional fees related to the design of new materials explaining the changes in the deposit accounts and fees related to updating materials for the bank’s new “tag line”.

Ø Foreclosed property expense has increased 14.5% in 2012 compared to 2011. The increase in expense is due to new inventory being added to other real estate and ongoing costs of existing inventory not yet sold.

Ø Write down of other real estate has increased significantly during the first quarter of 2012 compared to both the December 31, 2011 and March 31, 2011 quarters. The increase is due to the continual drop in property values. The write downs were executed based on new appraisals.

Ø ATM and check card expenses have increased 31% in the first three months of 2012 compared to the same time period in 2011. The increase is due to a significant increase in the number of transactions as well as a slight increase in per transaction fees.

LIQUIDITY

Liquidity is a measure of the Bank’s ability to respond to sudden changes in funding needs or funding sources. Examples of sudden changes could involve a sudden increase in loan demand, a funding need, or it might involve a large decrease in deposited funds, a funding source. The role of cash management is to manage assets and liabilities so that the Bank can respond to such fluctuations in sources and uses of cash. Management spends much of its time assessing our liquidity position.

Management is informed of the liquidity information via reports and committee discussion. The President is provided a weekly “dashboard” report of our liquidity information. The Asset/Liability Committee reviews and discusses our liquidity position on a quarterly basis. The committee has set a benchmark minimum liquidity ratio of 15%.

Public funds are required to have collateral pledged against their balances above the FDIC insurance limits. Generally the bank has pledged securities or obtained letters of credit from the Federal Home Loan Bank of Pittsburgh to cover public funds. Two additional strategies to cover these funds are now being used. In the case of public funds in the form of CDs, the bank is utilizing the CDARS network to insure their funds. We are also using the Insured Cash Sweep (ICS) product to secure public funds. Both of the programs provide complete coverage through FDIC insurance. Most importantly, the securities that had been pledged against the public funds can be used as a source of cash if the need would arise. The securities are effectively converted from a non liquid asset to a liquid asset.

Liquid assets of the company include cash and due from banks, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The company’s statement of cash flows details this liquidity since January 1, 2012.

     Operating Activities. The company’s net income usually provides cash from the bank’s operating activities. The net income figure is adjusted for certain noncash transactions such as depreciation expense that reduces net income but does not require a cash outlay. During 2012, the net income as adjusted has used cash of $1.2 million. Interest income earned on loans and investment securities is the company’s major income source.

     Investing Activities. Customer core deposits and company noncore funding provide the funds used to invest in loans and investment securities. In addition, the principal portion of loan payments, loan payoffs and maturity of investment securities provide cash flow. Purchases of bank premises and equipment are an investing activity. We have taken advantage of our noncore funding capabilities since deposit growth is not always sufficient. The net amount of cash provided by investing activities in 2012 is $4.0 million.

30



     Financing Activities. Customer core deposits and company noncore funding provide the financing for the investing activities as stated above. If the company has an excess of funds on any given day, the bank will sell these funds to make additional interest income to fund activities. Likewise, if the company has a shortage of funds on any given day it will purchase funds and pay interest for the use of these funds. Financing activities also include payment of dividends to shareholders, purchase of shares of the company’s common stock for the treasury and repayment of any noncore funding. The net amount of cash provided by financing activities in 2012 is $12.5 million.

At March 31, 2012, cash and due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell, federal funds sold and loans and securities maturing within one year were $47.2 million.

Noncore funding capabilities, including borrowing, provide additional liquidity. The subsidiary bank maintains a federal funds line with one financial institution and is a member of the Federal Home Loan Bank of Pittsburgh. In July 2009 the subsidiary bank secured a credit line with the Federal Reserve discount window. At March 31, 2012, the subsidiary bank has total credit available through these institutions of approximately $89.2 million.

ANALYSIS OF CAPITAL

     The adequacy of the company’s capital is reviewed by management on an ongoing basis in terms of the size, composition, and quality of the company’s asset and liability levels, and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses.

     The Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Corporation have adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total capital to risk-weighted assets is 8.0%, of which at least 4.0% must be Tier 1 capital, composed of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. All capital ratios are within the regulatory guidelines for a “well-capitalized” institution as noted below.

March 31, 2012 (000’s)
 
Minimum
Capital
Actual Requirement
Amount       Ratio       Amount Ratio
Total capital to risk weighted assets $ 27 910 13.46% $ 16 583       8.00%
Tier 1 capital to risk weighted assets $ 25 297 12.20% $ 8 291 4.00%
Tier 1 capital to average assets $ 25 297 8.70% $ 11 625 4.00%
 
 
December 31, 2011 (000’s)
 
Minimum
Capital
Actual Requirement
Amount Ratio   Amount Ratio
Total capital to risk weighted assets $      27 487         13.10%   $      16 782   8.00%
Tier 1 capital to risk weighted assets $ 24 842 11.84% $ 8 391 4.00%
Tier 1 capital to average assets $ 24 842 8.56% $ 11 602 4.00%

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Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the date of this quarterly report. Based on that evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

There are no material legal proceedings to which the Registrant or its subsidiary, directors or officers is a party or by which they, or any of them, are threatened. All legal proceedings presently pending or threatened against Potomac Bancshares, Inc. and its subsidiary involve routine litigation incidental to the business of the company or the subsidiary and are either not material in respect to the amount in controversy or fully covered by insurance.

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

ISSUER PURCHASES OF EQUITY SECURITIES

(c) Total Number
of Shares
(a) Total Purchased as (d) Maximum Number
Number of (b) Average Part of Publicly of Shares that May
Shares Price Paid Announced Yet be Purchased
Period       Purchased       Per Share       Programs       Under the Program
January 1 through
January 31 NONE - - 283 553 83 617
February 1 through          
February 29 NONE   - - 283 553 83 617
March 1 through
March 31 NONE - - 283 553 83 617

On February 12, 2002, the company’s Board of Directors originally authorized the repurchase program. The program authorized the repurchase of up to 10% of the company’s stock over the next twelve months. The stock may be purchased in the open market and/or in privately negotiated transactions as management and the board of directors determine prudent. The program has been extended on annual basis at Potomac’s reorganization meeting.

Item 4. Mine Safety Disclosures.

     Not applicable.

Item 5. Other Information

       (b)        There have been no changes to the procedures by which security holders may recommend nominees to the registrant’s board of directors since the registrant last provided disclosure in response to Item 7(d)(2)(ii)(G) of Schedule 14A.
 

32



Item 6. Exhibits

                31.1       Certification Under Exchange Act Rule 13a-14, Chief Executive Officer (and Section 302 of Sarbanes-Oxley Act of 2002)
 
    31.2 Certification Under Exchange Act Rule 13a-14, Chief Financial Officer (and Section 302 of Sarbanes-Oxley Act of 2002)
 
    32 Certification Pursuant to 18 U.S.C. Section 1350, Chief Executive Officer and Chief Financial Officer (pursuant to Section 906 of Sarbanes-Oxley Act of 2002)
 
101.INS XBRL Instance Document. **
 
101.SCH XBRL Taxonomy Extension Schema. **
 
101.CAL XBRL Taxonomy Extension Calculation Linkbase. **
 
101.LAB XBRL Taxonomy Extension Label Linkbase. **
 
101.PRE   XBRL Taxonomy Extension Presentation Linkbase. **
 
101.DEF XBRL Taxonomy Definition Linkbase. **
 
** Furnished, not filed, herewith

33



SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

      POTOMAC BANCSHARES, INC.
 
Date: May 15, 2012   /s/ Robert F. Baronner, Jr.
Robert F. Baronner, Jr.
President & CEO
 
Date: May 15, 2012 /s/ Dean Cognetti
Dean Cognetti
Sr. Vice President and Chief Financial Officer

34