UWHARRIE CAPITAL CORP - Quarter Report: 2011 September (Form 10-Q)

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGEACT OF 1934

For the quarterly period ended September 30, 2011

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGEACT OF 1934

For the transition period from to .

COMMISSION FILE NUMBER 000-22062

UWHARRIE CAPITAL CORP

(Exact name of registrant as specified in its charter)


NORTH CAROLINA		56-1814206
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
		(I.R.S. Employer Identification No.)

132 NORTH FIRST STREET ALBEMARLE, NORTH CAROLINA		28001
132 NORTH FIRST STREET ALBEMARLE, NORTH CAROLINA		28001
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s Telephone number, including area code: (704) 983-6181

N/A

(Former name, former address and former fiscal year, if changed since last report)

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 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. x Yes ¨ 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 (Section 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.

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

Indicate the number of shares outstanding of each of the classes of common stock issuer’s as of the latest practicable date: 7,593,929 shares of common stock outstanding as of November 7, 2011.

Table of Contents


		Page No.

Part I. FINANCIAL INFORMATION

Item 1 -	Financial Statements (Unaudited)

	Consolidated Balance Sheets September 30, 2011 and December 31, 2010	3

	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010	4

	Consolidated Statements of Changes in Shareholders’ Equity Nine Months Ended September 30, 2011	5

	Consolidated Statements of Cash Flows Nine Months Ended September 30, 2011 and 2010	6

	Notes to Consolidated Financial Statements	7

Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3 -	Quantitative and Qualitative Disclosures about Market Risk	36

Item 4 -	Controls and Procedures	36

Part II. OTHER INFORMATION

Item 1 -	Legal Proceedings	37

Item 1A -	Risk Factors	37

Item 2 -	Unregistered Sales of Equity Securities and Use of Proceeds	37

Item 3 -	Defaults Upon Senior Securities	37

Item 4 -	Reserved	37

Item 5 -	Other Information	37

Item 6 -	Exhibits	38

	Exhibit Index	40

-2-

Part I. FINANCIAL INFORMATION

Item 1—Financial Statements

Uwharrie Capital Corp and Subsidiaries

Consolidated Balance Sheets


	September 30, 2011 (Unaudited)			December 31, 2010*
	September 30, 2011 (Unaudited)			December 31, 2010*
	(dollars in thousands)
ASSETS
Cash and due from banks	$	7,455		$	4,948
Interest-earning deposits with banks		9,524			8,676
Securities available for sale, at fair value		91,793			96,395
Loans held for sale		1,787			6,286
Loans:
Loans held for investment		380,828			387,769
Less allowance for loan losses		(7,666	)		(9,067	)

Net loans held for investment		373,162			378,702

Premises and equipment, net		15,073			14,554
Interest receivable		1,918			2,408
Federal Home Loan Bank stock		2,741			3,252
Bank owned life insurance		6,119			5,975
Goodwill		987			987
Other real estate owned		8,898			2,022
Prepaid assets		1,686			2,088
Other assets		9,180			9,133

Total assets	$	530,323		$	535,426

LIABILITIES
Deposits:
Demand noninterest-bearing	$	58,027		$	54,837
Interest checking and money market accounts		175,545			187,493
Savings deposits		39,765			37,624
Time deposits, $100,000 and over		58,994			59,431
Other time deposits		91,838			94,648

Total deposits		424,169			434,033

Short-term borrowed funds		30,080			20,482
Long-term debt		26,236			34,061
Interest payable		307			342
Other liabilities		3,634			3,015

Total liabilities		484,426			491,933

Off balance sheet items, commitments and contingencies (Note 8)

SHAREHOLDERS’ EQUITY
Preferred stock, no par value: 10,000,000 shares authorized;
10,000 shares of series A issued and outstanding		10,000			10,000
500 shares of series B issued and outstanding		500			500
Discount on preferred stock		(225	)		(300	)
Common stock, $1.25 par value: 20,000,000 shares authorized; 7,593,929 shares issued and outstanding		9,492			9,492
Additional paid-in capital plus stock option surplus		14,038			14,034
Unearned ESOP compensation		(726	)		(692	)
Undivided profits		10,813			10,124
Accumulated other comprehensive income		2,005			335

Total shareholders’ equity		45,897			43,493

Total liabilities and shareholders’ equity	$	530,323		$	535,426

(*)	Derived from audited consolidated financial statements

See accompanying notes

-3-

Uwharrie Capital Corp and Subsidiaries

Consolidated Statements of Operations (Unaudited)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2011			2010			2011			2010
	(in thousands, except share and per share data)
Interest Income
Loans, including fees	$	5,499		$	5,393		$	16,258		$	16,187
Investment securities
US Treasury		152			168			594			327
US Government agencies and corporations		294			482			796			1,652
State and political subdivisions		92			72			279			243
Interest-earning deposits with banks and federal funds sold		21			9			39			27

Total interest income		6,058			6,124			17,966			18,436

Interest Expense
Interest checking and money market accounts		202			245			645			723
Savings deposits		82			87			246			239
Time deposits, $100,000 and over		278			297			844			901
Other time deposits		282			406			883			1,304
Short-term borrowed funds		89			176			271			474
Long-term debt		259			267			807			815

Total interest expense		1,192			1,478			3,696			4,456

Net interest income		4,866			4,646			14,270			13,980

Provision for loan losses		483			2,053			2,012			3,096

Net interest income after provision for loan losses		4,383			2,593			12,258			10,884
Noninterest Income
Service charges on deposit accounts		476			583			1,369			1,712
Other service fees and commissions		885			782			2,651			2,211
Gain on sale of securities		—			1,520			933			1,484
Loss fixed assets/other assets		(51	)		(1	)		(56	)		(61	)
Income from mortgage loan sales		407			880			1,121			1,616
Other income		82			173			287			401

Total noninterest income		1,799			3,937			6,305			7,363

Noninterest Expense
Salaries and employee benefits		3,071			2,975			9,166			8,689
Net occupancy expense		305			322			888			860
Equipment expense		179			210			579			568
Data processing costs		213			212			630			623
Office supplies and printing		76			91			247			268
Foreclosed real estate expense		355			112			480			243
Professional fees and services		414			297			1,160			928
Marketing and donations		127			243			424			625
Electronic banking expense		228			211			656			588
Software amortization and maintenance		145			129			421			359
FDIC insurance		171			195			575			547
Other noninterest expense		594			809			1,757			1,895

Total noninterest expense		5,878			5,806			16,983			16,193

Income before income taxes		304			724			1,580			2,054
Income taxes		49			227			407			687

Net income	$	255		$	497		$	1,173		$	1,367

Net Income	$	255		$	497		$	1,173		$	1,367
Dividends – preferred stock		(161	)		(161	)		(484	)		(484	)

Net income available to common shareholders	$	94		$	336		$	689		$	883

Net income per common share
Basic	$	0.01		$	0.04		$	0.09		$	0.12

Diluted	$	0.01		$	0.04		$	0.09		$	0.12

Weighted average shares outstanding
Basic		7,464,970			7,490,196			7,472,411			7,487,875
Diluted		7,464,970			7,490,196			7,472,411			7,487,875

See accompanying notes

-4-

Uwharrie Capital Corp and Subsidiaries

Consolidated Statement of Changes in Shareholders’ Equity (Unaudited)


	Number Common Shares Issued		Preferred Stock Series A		Preferred Stock Series B		Discount on Preferred Stock			Common Stock		Additional Paid-in Capital		Unearned ESOP Compensation			Undivided Profits			Accumulated Other Comprehensive Income		Total
	(in thousands, except share data)
Balance, December 31, 2010		7,593,929	$	10,000	$	500	$	(300	)	$	9,492	$	14,034	$	(692	)	$	10,124		$	335	$	43,493
Net income		—		—		—		—			—		—		—			1,173			—		1,173
Other comprehensive income		—		—		—		—			—		—		—			—			1,670		1,670
Release of ESOP shares		—		—		—		—			—		—		60			—			—		60
Increase in ESOP notes receivable		—		—		—		—			—		—		(94	)		—			—		(94	)
Stock compensation expense		—		—		—		—			—		4		—			—			—		4
Record preferred stock dividend and discount accretion		—		—		—		75			—		—		—			(484	)		—		(409	)

Balance, September 30, 2011		7,593,929	$	10,000	$	500	$	(225	)	$	9,492	$	14,038	$	(726	)	$	10,813		$	2,005	$	45,897

-5-

Uwharrie Capital Corp and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)


	Nine Months Ended September 30,
	2011			2010
	(dollars in thousands)
Cash flows from operating activities
Net income	$	1,173		$	1,367
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		615			595
Net amortization of security premiums/discounts		603			265
Net amortization of mortgage servicing rights		416			537
Impairment of foreclosed real estate		31			76
Provision for loan losses		2,012			3,096
Stock compensation		4			2
Net realized gains on sales / calls available for sales securities		(933	)		(1,484	)
Income from mortgage loan sales		(1,121	)		(1,616	)
Proceeds from sales of loans held for sale		42,793			56,388
Origination of loans held for sale		(37,173	)		(55,823	)
Loss on disposal of premises, equipment and other assets		13			10
Increase in cash surrender value of life insurance		(144	)		(188	)
Loss on sales of foreclosed real estate		43			51
Release of ESOP shares		60			56
Net change in interest receivable		490			(102	)
Net change in other assets		(751	)		(982	)
Net change in interest payable		(35	)		(16	)
Net change in other liabilities		619			(453	)

Net cash provided by operating activities		8,715			1,779

Cash flows from investing activities
Proceeds from sales, maturities and calls of securities available for sale		35,497			52,070
Purchase of securities available for sale		(28,020	)		(61,964	)
Net change in loans		(3,999	)		(34,419	)
Purchase of premises and equipment		(1,147	)		(1,505	)
Proceeds from sales of foreclosed real estate		577			799
Investment in other assets		(185	)		(216	)
Net (increase) decrease in Federal Home Loan Bank stock		511			(178	)

Net cash provided by (used in) investing activities		3,234			(45,413	)

Cash flows from financing activities
Net increase (decrease) in deposit accounts		(9,864	)		48,775
Net increase (decrease) in short-term borrowed funds		9,598			(4,930	)
Net increase (decrease) in long-term debt		(11,533	)		5,944
Proceeds from issuance of new junior subordinated debt		4,438			—
Repayment of junior subordinated debt		(730	)		—
Increase in unearned ESOP compensation		(94	)		(100	)
Dividends on preferred stock		(409	)		(409	)

Net cash provided by (used in) financing activities		(8,594	)		49,280

Increase in cash and cash equivalents		3,355			5,646
Cash and cash equivalents, beginning of period		13,624			10,859

Cash and cash equivalents, end of period	$	16,979		$	16,505

Supplemental Disclosures of Cash Flow Information
Interest paid	$	3,731		$	2,985
Income taxes paid		216			93
Supplemental Schedule of Non-Cash Activities
Loans transferred to foreclosured real estate		7,527			475
Increase in fair value of securities for sale, net of tax		1,670			1,570

See accompanying notes

-6-

UWHARRIE CAPITAL CORP AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

Note 1—Basis of Presentation

The financial statements and accompanying notes are presented on a consolidated basis including Uwharrie Capital Corp (the “Company”) and its subsidiaries, Bank of Stanly (“Stanly”), Anson Bank & Trust Co. (“Anson”), Cabarrus Bank & Trust Company (“Cabarrus”), Strategic Investment Advisors, Inc. (“SIA”), and Uwharrie Mortgage Inc. Stanly consolidates its subsidiaries, the Strategic Alliance Corporation, BOS Agency, Inc. and Gateway Mortgage, Inc., each of which is wholly-owned by Stanly.

The information contained in the consolidated financial statements is unaudited. In the opinion of management, the consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and material adjustments necessary for a fair presentation of results of interim periods, all of which are of a normal recurring nature, have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for an entire year. Management is not aware of economic events, outside influences or changes in concentrations of business that would require additional clarification or disclosure in the consolidated financial statements.

The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to consolidated financial statements filed as part of the Company’s 2010 Annual Report on Form 10-K. This Quarterly report should be read in conjunction with such Annual Report.

Note 2 – Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	(in thousands)
Net Income	$	255		$	497		$	1,173		$	1,367

Other comprehensive income (loss)
Unrealized gain (losses) on available for sale securities		2,332			995			3,477			3,353
Related tax effect		(808	)		(367	)		(1,234	)		(1,177	)
Reclassification of loss (gains)recognized in net income		—			(1,520	)		(933	)		(1,484	)
Related tax effect		—			586			360			572

Total other comprehensive income		1,524			(306	)		1,670			1,264

Comprehensive income	$	1,779		$	191		$	2,843		$	2,631

-7-

Note 3 – Per Share Data

Basic and diluted net income per common share is computed based on the weighted average number of shares outstanding during each period after retroactively adjusting for stock dividends. Diluted net income per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the net income of the Company. For the three and nine months ended September 30, 2011 and 2010, the Company’s 123,570 and 180,571 stock outstanding options respectively, did not have a dilutive effect on per share results because the exercise prices exceeded the average share values for each period.

Basic and diluted net income per common share have been computed based upon net income available to common shareholders as presented in the accompanying consolidated statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding. The computation of basic and dilutive earnings per share is summarized below:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Weighted average number of common shares outstanding		7,593,929			7,593,929			7,593,929			7,593,929
Effect of ESOP shares		(128,959	)		(103,733	)		(121,518	)		(106,054	)

Adjusted weighted average number of common shares used in computing basic net income per common share		7,464,970			7,490,196			7,472,411			7,487,875
Effect of dilutive stock options		—			—			—			—

Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per common share		7,464,970			7,490,196			7,472,411			7,487,875

Note 4 – Investment Securities

Carrying amounts and fair values of securities available for sale are summarized below:


			Gross		Gross
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
September 30, 2011	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
	(dollars in thousands)
U.S. Treasury	$	32,167	$	1,271	$	—	$	33,438
U.S. Government agencies		19,806		857		—		20,663
GSE—Mortgage-backed securities and CMO’s		26,653		412		71		26,994
State and political subdivisions		10,091		607		—		10,698

Total securities available for sale	$	88,717	$	3,147	$	71	$	91,793

-8-


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value

December 31, 2010
	(dollars in thousands)
U.S. Treasury	$	51,622	$	746	$	1,220	$	51,148
U.S. Government agencies		24,862		766		165		25,463
GSE—Mortgage-backed securities and CMO’s		8,655		294		49		8,900
State and political subdivisions		10,725		267		108		10,884

Total securities available for sale	$	95,864	$	2,073	$	1,542	$	96,395

At September 30, 2011 and December 31, 2010 the Company owned Federal Reserve stock reported at cost of $802,850 and $778,850, respectively, and included in other assets. Also at September 30, 2011 and December 31, 2010, the Company owned Federal Home Loan Bank Stock (FHLB) of $2.7 million and $3.3 million, respectively. The investments in Federal Reserve stock and FHLB stock are required investments related to the Company’s membership and borrowings with these banks. These investments are carried at cost since there is no ready market and historically redemption has been made at par value. The Company estimated that the fair value approximated cost and that these investments were not impaired at September 30, 2011.

Results from sales of securities available for sale for the three month and nine month period ended September 30, 2011 and September 30, 2010 are as follows:


	Three Months Ended September 30,
	2011		2010
	(dollars in thousands)
Gross proceeds from sales	$	—	$	29,875

Realized gains from sales	$	—	$	1,733
Realized losses from sales		—		(213	)

Net realized gains	$	—	$	1,520


	Nine Months Ended September 30,
	2011		2010
	(dollars in thousands)
Gross proceeds from sales	$	25,568	$	42,306

Realized gains from sales	$	933	$	1,957
Realized losses from sales		—		(473	)

Net realized gains	$	933	$	1,484

At September 30, 2011 and December 31, 2010 securities available for sale with a carrying amount of $39.2 million and $40.7 million, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.

The following tables show the gross unrealized losses and fair value of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2011 and December 31, 2010. These unrealized losses on investment securities are a result of temporary fluctuations in the market prices due to market volatility and a rise in interest rates, which will adjust if rates decline, and are in no way a reflection of the quality of the investments. At September 30, 2011 the unrealized losses related to three mortgage backed securities. At December 31, 2010, the unrealized losses related to six U.S. Treasury Notes, two U.S. Government Agencies, three mortgage backed securities and eight North Carolina municipal bonds.

-9-


	Less than 12 Months				12 Months or More				Total
September 30, 2011			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
	(dollars in thousands)
Securities available for sale temporary impairment
GSE—Mortgage-backed securities and CMO’s	$	11,596	$	71	$	—	$	—	$	11,596	$	71
State and political subdivisions		—		—		—		—		—		—

	$	11,596	$	71	$	—	$	—	$	11,596	$	71


	Less than 12 Months				12 Months or More				Total
December 31, 2010			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
	(dollars in thousands)
Securities available for sale temporary impairment
U.S. Treasury	$	26,138	$	1,220	$	—	$	—	$	26,138	$	1,220
U.S. Gov’t agencies		5,736		165		—		—		5,736		165
GSE—Mortgage-backed securities and CMO’s		2,900		49		—		—		2,900		49
State and political subdivisions		4,522		108		—		—		4,522		108

	$	39,296	$	1,542	$	—	$	—	$	39,296	$	1,542

Declines in the fair value of the investment portfolio are believed by management to be temporary in nature. When evaluating an investment for other-than-temporary impairment management considers among other things, the length of time and the extent to which the fair value has been in a loss position, the financial condition of the issuer and the intent and the ability of the Company to hold the investment until the loss position is recovered.

Any unrealized losses were largely due to increases in market interest rates over the yields available at the time of purchase. The fair value is expected to recover as the bonds approach their maturity date or market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of quality but that the losses are temporary in nature. At September 30, 2011, the Company did not intend to sell and was not likely to be required to sell the available for sale securities that were in a loss position prior to full recovery.

-10-

The aggregate amortized cost and fair value of the available for sale securities portfolio at September 30, 2011 and December 31, 2010 by remaining contractual maturity are as follows:


	September 30, 2011
	Amortized Cost		Estimated Fair Value		Book Yield (1)
Securities available for sale
U.S. Treasury
Due within one year	$	999	$	1,011		1.50	%
Due after one but within five years		4,076		4,381		2.59	%
Due after five but within ten years		27,092		28,046		1.80	%

		32,167		33,438		1.90	%

U.S. Government agencies
Due within one year		954		970		4.19	%
Due after one but within five years		18,852		19,693		2.43	%

		19,806		20,663		2.51	%

Mortgage-backed securities
Due after five but within ten years		3,484		3,668		3.27	%
Due after ten years		23,169		23,326		3.24	%

		26,653		26,994		3.24	%

State and political
Due within one year		837		853		3.59	%
Due after one but within five years		2,928		3,086		2.34	%
Due after five but within ten years		4,721		5,046		3.07	%
Due after ten years		1,605		1,713		4.14	%

		10,091		10,698		3.07	%

Total Securities available for sale
Due within one year		2,790		2,834		3.05	%
Due after one but within five years		25,856		27,160		2.44	%
Due after five but within ten years		35,297		36,760		2.12	%
Due after ten years		24,774		25,039		3.30	%

	$	88,717	$	91,793		2.57	%


	December 31, 2010
	Amortized Cost		Estimated Fair Value		Book Yield (1)
Securities available for sale
U.S. Treasury
Due within one year	$	1,000	$	1,006		0.90	%
Due after one but within five years		2,018		2,066		1.70	%
Due after five but within ten years		48,604		48,076		2.28	%

		51,622		51,148		2.23	%

U.S. Government agencies
Due within one year		504		519		3.96	%
Due after one but within five years		18,457		19,208		2.84	%
Due after five but within ten years		5,901		5,736		1.84	%

		24,862		25,463		2.62	%

Mortgage-backed securities
Due after five but within ten years		2,498		2,633		3.97	%
Due after ten years		6,157		6,267		4.22	%

		8,655		8,900		4.15	%

State and political
Due within one year		576		577		2.36	%
Due after one but within five years		3,286		3,437		4.21	%
Due after five but within ten years		4,860		4,859		3.03	%
Due after ten years		2,003		2,011		4.18	%

		10,725		10,884		3.57	%

Total Securities available for sale
Due within one year		2,080		2,102		2.05	%
Due after one but within five years		23,761		24,711		2.93	%
Due after five but within ten years		61,863		61,304		2.37	%
Due after ten years		8,160		8,278		4.21	%

	$	95,864	$	96,395		2.66	%

1)	Yields on securities and investments exempt from federal and/or state income taxes are stated on a fully tax-equivalent basis, assuming a 38.55% tax rate.

-11-

Note 5 – Loans Held for Investment

The composition of net loans held for investment by class as of September 30, 2011 and December 31, 2010 is as follows:


	September 30, 2011			December 31, 2010

	(dollars in thousands)
Commercial
Commercial	$	48,849		$	51,679
Real estate – commercial		113,230			105,123
Other real estate construction loans		40,757			52,270
Noncommercial
Real estate 1-4 family construction		5,430			4,332
Real estate – residential		104,677			103,781
Home equity		51,498			52,034
Consumer loans		15,711			17,721
Other loans		589			739

		380,741			387,679
Less:
Allowance for loan losses		(7,666	)		(9,067	)
Deferred loan (fees) costs, net		87			90

Loans held for investment, net	$	373,162		$	378,702

Note 6—Allowance for Loan Losses

Changes in the allowance for loan losses for the three and nine month periods ended September 30, 2011 and 2010 are presented below:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,

		2011			2010			2011			2010

				(in thousands)
Balance, beginning of period	$	7,274		$	5,635		$	9,067		$	5,276
Provision charged to operations		483			2,053			2,012			3,096
Charge-offs		(118	)		(246	)		(3,514	)		(947	)
Recoveries		28			20			101			37

Net (charge-offs)		(90	)		(226	)		(3,413	)		(910	)
Other		(1	)		—			—			—

Balance at end of period	$	7,666		$	7,462		$	7,666		$	7,462

The following tables discuss the allowance and related activities for the loss by loan class as of and for the three and nine months at September 30, 2011:

For the three months

ended September 30, 2011


	Beginning Balance		Provisions		Other			Chargeoffs			Recoveries		Ending Balance

		(dollars in thousands)
Commercial	$	1,005	$	7	$	(1	)	$	—		$	1	$	1,012
Real estate – commercial		1,360		362		—			—			3		1,725
Other real estate construction		1,297		1		—			—			—		1,298
Real estate construction		24		7		—			—			—		31
Real estate – residential		1,746		75		—			(39	)		—		1,782
Home equity		1,021		14		—			(1	)		2		1,036
Consumer loan		772		8		—			(78	)		22		724
Other loans		49		9		—			—			—		58

Total	$	7,274	$	483	$	(1	)	$	(118	)	$	28	$	7,666

-12-

For the nine months

ended September 30, 2011


	Beginning Balance		Provisions			Other		Chargeoffs			Recoveries		Ending Balance
	(dollars in thousands)
Commercial	$	966	$	201		$	—	$	(159	)	$	4	$	1,012
Real estate – commercial		2,240		280			—		(799	)		4		1,725
Other real estate construction		2,157		703			—		(1,562	)		—		1,298
Real estate construction		33		7			—		(15	)		6		31
Real estate – residential		1,658		431			—		(307	)		—		1,782
Home equity		971		476			—		(413	)		2		1,036
Consumer loan		984		(86	)		—		(259	)		85		724
Other loans		58		—			—		—			—		58

Total	$	9,067	$	2,012		$	—	$	(3,514	)	$	101	$	7,666

The following tables show period-end loans and reserve balances by loan class both individually and collectively evaluated for impairment at September 30, 2011 and December 31, 2010:

September 30, 2011


	Individually Evaluated				Collectively Evaluated				Total
	Reserve		Loans		Reserve		Loans		Reserve		Loans
	(dollars in thousands)
Commercial	$	438	$	1,999	$	574	$	46,850	$	1,012	$	48,849
Real estate – commercial		621		11,455		1,104		101,775		1,725		113,230
Other real estate construction		1,056		6,850		242		33,907		1,298		40,757
Real estate construction		—		1,490		31		3,940		31		5,430
Real estate – residential		826		11,119		956		93,558		1,782		104,677
Home equity		218		1,609		818		49,889		1,036		51,498
Consumer loan		172		309		552		15,402		724		15,711
Other loans		—		—		58		589		58		589

Total	$	3,331	$	34,831	$	4,335	$	345,910	$	7,666	$	380,741

December 31, 2010


	Individually Evaluated				Collectively Evaluated				Total
	Reserve		Loans		Reserve		Loans		Reserve		Loans
	(dollars in thousands)
Commercial	$	399	$	1,439	$	567	$	50,240	$	966	$	51,679
Real estate – commercial		1,384		20,321		856		84,802		2,240		105,123
Other real estate construction		1,818		10,355		339		41,915		2,157		52,270
Real estate construction		—		950		33		3,382		33		4,332
Real estate – residential		762		8,884		896		94,897		1,658		103,781
Home equity		136		1,065		835		50,969		971		52,034
Consumer loan		132		241		852		17,480		984		17,721
Other loans		—		—		58		739		58		739

Total	$	4,631	$	43,255	$	4,436	$	344,424	$	9,067	$	387,679

-13-

Past due loan information is used by management when assessing the adequacy of the allowance for loan loss. The following table summarizes the past due information of the loan portfolio by class:

September 30, 2011


	Loans 30-89 Days Past Due		Loans 90 Days or More Past due		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
	(dollars in thousands)
Commercial	$	237	$	262	$	499	$	48,350	$	48,849	$	—
Real estate—commercial		695		1,982		2,677		110,553		113,230		—
Other real estate construction		848		4,639		5,487		35,270		40,757		—
Real estate 1 -4 family construction		—		—		—		5,430		5,430		—
Real estate—residential		1,500		2,710		4,210		100,467		104,677		—
Home equity		178		316		494		51,004		51,498		—
Consumer loans		188		35		223		15,488		15,711		—
Other loans		—		—		—		589		589		—

Total	$	3,646	$	9,944	$	13,590	$	367,151	$	380,741	$	—

December 31, 2010


	Loans 30-89 Days Past Due		Loans 90 Days or More Past due		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
	(dollars in thousands)
Commercial	$	666	$	501	$	1,167	$	50,512	$	51,679	$	—
Real estate—commercial		1,728		8,702		10,430		94,693		105,123		—
Other real estate construction		206		7,975		8,181		44,089		52,270		—
Real estate 1 -4 family construction		—		500		500		3,832		4,332		—
Real estate—residential		1,648		2,337		3,985		99,796		103,781		—
Home equity		110		75		185		51,849		52,034		—
Consumer loans		267		46		313		17,408		17,721		10
Other loans		—		—		—		739		739		—

Total	$	4,625	$	20,136	$	24,761	$	362,918	$	387,679	$	10

Once a loan becomes 90 days past due, the loan is automatically transferred to a nonaccrual status. Credit card loans are the exception to this policy and remain in accruing 90 days or more until they are paid current or charged off.

The composition of nonaccrual loans by class as of September 30, 2011 and December 31, 2010 is as follows:


	September 30, 2011		December 31, 2010
	(dollars in thousands)
Commercial	$	262	$	501
Real estate—commercial		1,982		8,702
Other real estate construction		4,639		7,975
Real estate 1 – 4 family construction		—		500
Real estate – residential		2,710		2,337
Home equity		316		75
Consumer loans		35		36
Other loans		—		—

	$	9,944	$	20,126

-14-

Management uses a risk-grading program to facilitate the evaluation of probable inherent loan losses and to measure the adequacy of the allowance for loan losses. In this program, risk grades are initially assigned by the loan officers and reviewed and monitored by the lenders and credit administration. The program has eight risk grades summarized in five categories as follows:

Pass: Loans that are pass grade credits include loans that are fundamentally sound and risk factors are reasonable and acceptable. They generally conform to policy with only minor exceptions and any major exceptions are clearly mitigated by other economic factors.

Watch: Loans that are watch credits include loans on management’s watch list where a risk concern may be anticipated in the near future.

Substandard: Loans that are considered substandard are loans that are inadequately protected by current sound net worth, paying capacity of the obligor or the value of the collateral pledged. All nonaccrual loans are graded as substandard.

Doubtful: Loans that are considered to be doubtful have all weaknesses inherent in loans classified substandard, plus the added characteristic that the weaknesses make the collection or liquidation in full on the basis of current existing facts, conditions and values highly questionable and improbable.

Loss: Loans that are considered to be a loss are considered to be uncollectible and of such little value that their continuance as bankable assets is not warranted.

The tables below summarize risk grades of the loan portfolio by class at September 30, 2011 and December 31 2010:

September 30, 2011


	Pass		Watch		Sub- standard		Doubtful		Total
	(dollars in thousands)
Commercial	$	45,677	$	1,552	$	1,525	$	95	$	48,849
Real estate – commercial		96,974		4,854		10,664		738		113,230
Other real estate construction		33,316		102		7,339		—		40,757
Real estate 1 – 4 family construction		4,480		—		950		—		5,430
Real estate – residential		93,171		2,942		8,564		—		104,677
Home equity		49,707		664		1,127		—		51,498
Consumer loans		15,233		198		268		12		15,711
Other loans		589		—		—		—		589

Total	$	339,147	$	10,312	$	30,437	$	845	$	380,741

December 31, 2010


	Pass		Watch		Sub- standard		Doubtful		Total
	(dollars in thousands)
Commercial	$	50,108	$	185	$	1,386	$	—	$	51,679
Real estate – commercial		81,410		4,520		18,455		738		105,123
Other real estate construction		41,709		301		10,260		—		52,270
Real estate 1 – 4 family construction		3,381		—		951		—		4,332
Real estate – residential		94,077		1,787		7,917		—		103,781
Home equity		50,902		158		974		—		52,034
Consumer loans		17,458		102		129		32		17,721
Other loans		739		—		—		—		739

Total	$	339,784	$	7,053	$	40,072	$	770	$	387,679

-15-

Loans that are in nonaccrual status or 90 days past due and still accruing are considered to be nonperforming. The following tables show the performing and nonperforming loans by class at September 30, 2011 and December 31, 2010:

September 30, 2011


	Performing		Non- Performing		Total

	(dollars in thousands)
Commercial	$	48,587	$	262	$	48,849
Real estate – commercial		111,248		1,982		113,230
Other real estate construction		36,118		4,639		40,757
Real estate 1 – 4 family construction		5,430		—		5,430
Real estate – residential		101,967		2,710		104,677
Home equity		51,182		316		51,498
Consumer loans		15,676		35		15,711
Other loans		589		—		589

Total	$	370,797	$	9,944	$	380,741

December 31, 2010


	Performing		Non- Performing		Total

	(dollars in thousands)
Commercial	$	51,178	$	501	$	51,679
Real estate – commercial		96,421		8,702		105,123
Other real estate construction		44,295		7,975		52,270
Real estate 1 – 4 family construction		3,832		500		4,332
Real estate – residential		101,444		2,337		103,781
Home equity		51,959		75		52,034
Consumer loans		17,675		46		17,721
Other loans		739		—		739

Total	$	367,543	$	20,136	$	387,679

Loans are considered impaired when, based on current information and events it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement. If a loan is deemed impaired a specific calculation is performed and a specific reserve is allocated, if necessary. The tables below summarize the loans deemed impaired and the amount of specific reserves allocated by class at September 30, 2011 and December 31, 2010:

September 30, 2011


			Recorded		Recorded				For the Quarter Ended				Year to Date
	Unpaid Principal Balance		Investment With No Allowance		Investment With Allowance		Related Allowance		Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income

	(dollars in thousands)
Commercial	$	1,999	$	836	$	1,163	$	438	$	1,912	$	32	$	1,529	$	75
Real estate – commercial		13,432		9,256		2,199		622		12,496		167		16,162		430
Other real estate construction		7,228		2,721		4,129		1,056		6,749		48		8,456		79
Real estate 1 – 4 family construction		1,490		1,490		—		—		1,490		31		1,347		57
Real estate – residential		11,119		7,053		4,066		825		10,522		43		9,947		368
Home Equity loans		1,610		1,037		572		218		1,435		24		1,348		46
Consumer loans		309		40		269		172		321		4		297		14
Other Loans		—		—		—		—		—		—		—		—

Total	$	37,187	$	22,433	$	12,398	$	3,331	$	34,925	$	349	$	39,086	$	1,069

-16-

December 31, 2010


	Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Related Allowance

	(dollars in thousands)
Commercial	$	1,439	$	918	$	521	$	399
Real estate – commercial		21,985		16,088		4,233		1,384
Other real estate construction		10,357		2,585		7,770		1,818
Real estate 1 – 4 family construction		950		950		—		—
Real estate – residential		8,884		5,118		3,766		762
Home Equity loans		1,066		677		388		136
Consumer loans		241		23		218		132
Other loans		—		—		—		—

Total	$	44,922	$	26,359	$	16,896	$	4,631

Note 7 – Troubled Debts Restructures

A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification involves providing a concession to the existing loan contract. The Company offers various types of concessions when modifying loans to troubled borrowers, however, forgiveness of principal is rarely granted. Concessions offered are term extensions, capitalizing accrued interest, reducing interest rates to below current market rates or a combination of any of these. Combinations from time to time may include allowing a customer to be placed on interest-only payments. The presentations below in the other category are TDR’s with a combination of concessions. At the time of a TDR, additional collateral or a guarantor may be requested.

Loans modified as a TDR are typically already on nonaccrual status and partial chargeoffs may have in some cases already been taken against the outstanding loan balance. The Company classifies TDR loans as impaired loans and evaluates the need for an allowance for loan loss on a loan-by-loan basis. An allowance is based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the estimated fair value of the underlying collateral less any selling costs, if the loan is deemed to be collateral dependent.

-17-

For the three and nine months ended September 30, 2011, the following table presents a breakdown of the types of concessions made by loan class:

For the three months

ended September 30, 2011


			Pre-Modification		Post-Modification
	Number		Outstanding Recorded		Outstanding Recorded
	of Contracts		Investment		Investment
	(dollars in thousands)
Other:
Commercial		—	$	—	$	—
Real estate – commercial		—		—		—
Other real estate construction		—		—		—
Real estate 1 – 4 family construction		—		—		—
Real estate – residential		2		348		347
Home equity		—		—		—
Consumer loans		1		5		5
Other loans		—		—		—

		3	$	353	$	352

Total		3	$	353	$	352

-18-

For the nine months

ended September 30, 2011


	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(dollars in thousands)
Below market interest rate:
Commercial		—	$	—	$	—
Real estate – commercial		—		—		—
Other real estate construction		—		—		—
Real estate 1 – 4 family construction		—		—		—
Real estate – residential		2		331		330
Home equity		—		—		—
Consumer loans		—		—		—
Other loans		—		—		—

		2	$	331	$	330

Extended payment terms:
Commercial		—	$	—	$	—
Real estate – commercial		—		—		—
Other real estate construction		—		—		—
Real estate 1 – 4 family construction		—		—		—
Real estate – residential		2		135		135
Home equity		—		—		—
Consumer loans		—		—		—
Other loans		—		—		—

		2	$	135	$	135

Other:
Commercial		1	$	42	$	36
Real estate – commercial		—		—		—
Other real estate construction		—		—		—
Real estate 1 – 4 family construction		—		—		—
Real estate – residential		14		1,803		1,784
Home equity		—		—		—
Consumer loans		4		109		100
Other loans		—		—		—

		19	$	1,954	$	1,920

Total		23	$	2,420	$	2,385

-19-

The following table presents loans that were modified as troubled debt restructurings within the previous twelve months, from October 1, 2010 and for which there was a payment default during the three and nine months ended September 30, 2011:


	Three months ended September 30, 2011				Nine months ended September 30, 2011
	Number of Loans		Recorded Investment		Number of Loans		Recorded Investment
	(dollars in thousands)
Below market interest rate:
Commercial		—	$	—		—	$	—
Real estate – commercial		—		—		—		—
Other real estate construction		—		—		—		—
Real estate 1 – 4 family construction		—		—		—		—
Real estate – residential		—		—		1		210
Home Equity loans		—		—		—		—
Consumer loans		—		—		—		—
Other loans		—		—		—		—

		—	$	—		1	$	210

Other:
Commercial		—	$	—		—	$	—
Real estate – commercial		—		—		—		—
Other real estate construction		—		—		—		—
Real estate 1 – 4 family construction		—		—		—		—
Real estate – residential		—		—		3		349
Home Equity loans		—		—		—		—
Consumer loans		—		—		2		85
Other loans		—		—		—		—

		—	$	—		5	$	434

Total		—	$	—		6	$	644

A default on a troubled debt restructure is defined as being past due 90 days or being out of compliance with the modification agreement. As mentioned, the Company considers TDRs to be impaired loans. A default generally leads to a partial chargeoff or further impairment. If this happens the chargeoff is included in the expected loss calculation “in the loans collectively evaluated” portion of our allowance for loan loss model.

The following table presents the successes and failures of the types of modifications within the previous twelve months as of September 30, 2011:


	Paid In Full				Paying as restructured				Converted to nonaccrual				Foreclosure/ Default
	Number of		Recorded		Number of		Recorded		Number of		Recorded		Number of		Recorded
	Loans		Investments		Loans		Investments		Loans		Investments		Loans		Investments
	(dollars in thousands)
Below market interest rate		—	$	—		2	$	330		—	$	—		—	$	—
Extended payment terms		—		—		2		135		—		—		—		—
Other Loans		—		—		15		1,546		4		374		—		—

Total		—	$	—		19	$	2,011		4	$	374		—	$	—

Note 8—Commitments and Contingencies

The subsidiary banks are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of their customers. These financial instruments include commitments to extend credit, lines of credit and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying financial statements.

-20-

The banks’ risk of loss with the unfunded loans and lines of credit or standby letters of credit is represented by the contractual amount of these instruments. The banks use the same credit policies in making commitments under such instruments as they do for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Credit card commitments are unsecured. At September 30, 2011, outstanding financial instruments whose contract amounts represent credit risk were approximately:


(in thousands)
Commitments to extend credit	$	64,826
Credit card commitments		8,458
Standby letters of credit		1,545

Total commitments	$	74,829

Note 9 – Fair Value Disclosures

Accounting Standards Codification (ASC) 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements, but clarifies and standardizes some divergent practices that have emerged since prior guidance was issued. ASC 820 creates a three-level hierarchy under which individual fair value estimates are to be ranked based on the relative reliability of the inputs used in the valuation.

ASC 820 defines fair value as the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, the Company considers the principal or most advantageous market in which those assets or liabilities are sold and considers assumptions that market participants would use when pricing those assets or liabilities. Fair values determined using Level 1 inputs rely on active and observable markets to price identical assets or liabilities. In situations where identical assets and liabilities are not traded in active markets, fair values may be determined based on Level 2 inputs, which exist when observable data exists for similar assets and liabilities. Fair values for assets and liabilities for which identical or similar assets and liabilities are not actively traded in observable markets are based on Level 3 inputs, which are considered to be unobservable.

Among the Company’s assets and liabilities, investment securities available for sale are reported at their fair values on a recurring basis. Certain other assets are adjusted to their fair value on a nonrecurring basis, including impaired loans: loans held for sale, which are carried at the lower of cost or market: other real estate owned and loan servicing rights, where fair value is determined using similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions; foreclosed real estate, which is carried at lower of cost or fair market value and goodwill, which is periodically tested for impairment. Deposits, short-term borrowings and long-term obligations are not reported at fair value.

Prices for US Treasury and government agency securities are readily available in the active markets in which those securities are traded, and the resulting fair values are shown in the ‘Level 1 input’ column. Prices for mortgage-backed securities and for state, county and municipal securities are obtained for similar securities, and the resulting fair values are shown in the ‘Level 2 input’ column. Prices for all other non-marketable investments are determined based on various assumptions that are not observable. The fair values for these investment securities are shown in the ‘Level 3 input’ column. Non-marketable investment securities, which are carried at their purchase price, include those that may only be redeemed by the issuer. The changes in securities between Level 1 and Level 2 were related to the purchase and sale of several securities and not the migration of securities between levels.

-21-

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment by using one of several methods including collateral value, fair value of similar debt and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the present value of the expected repayments or fair value of collateral exceed the recorded investments in such loans. At September 30, 2011, substantially all of the total impaired loans were evaluated based on the fair value of the underlying collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the underlying collateral is further impaired below the appraised value the Company records the impaired loan as nonrecurring Level 3.

Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.

Servicing assets are evaluated for impairment based upon the fair value. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions.

The following table provides fair value information for assets and liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010:


	September 30, 2011
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3
Securities available for sale:
US Treasury	$	33,438	$	33,438	$	—	$	—
US Government Agencies		20,663		20,663		—		—
GSE – Mortgage-backed securities and CMO’s		26,994		—		26,994		—
State and political subdivisions		10,698		—		10,698		—

Total assets at fair value	$	91,793	$	54,101	$	37,692	$	—

Total liabilities at fair value	$	—	$	—	$	—	$	—

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	December 31, 2010
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3
Securities available for sale:
US Treasury	$	51,148	$	51,148	$	—	$	—
US Government Agencies		25,463		25,463		—		—
GSE – Mortgage-backed securities and CMO’s		8,900		—		8,900		—
State and political subdivisions		10,884		—		10,884		—

Total assets at fair value	$	96,395	$	76,611	$	19,784	$	—

Total liabilities at fair value	$	—	$	—	$	—	$	—

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below as of September 30, 2011 and December 31, 2010:


	September 30, 2011
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3
Impaired loans	$	9,067	$	—	$	—	$	9,067
Loans held for sale		1,787		—		1,787		—
Other real estate owned		248		—		—		248

Total assets at fair value	$	11,102	$	—	$	1,787	$	9,315

Total liabilities at fair value	$	—	$	—	$	—	$	—


	December 31, 2010
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3
Impaired loans	$	12,265	$	—	$	—	$	12,265
Loans held for sale		6,286		—		6,286		—
Other real estate owned		275		—		—		275

Total assets at fair value	$	18,826	$	—	$	6,286	$	12,540

Total liabilities at fair value	$	—	$	—	$	—	$	—

ASC 825 allows an entity to elect to measure certain financial assets and liabilities at fair value with changes in fair value recognized in the income statement each period. The statement also requires additional disclosures to identify the effects of an entity’s fair value election on its earnings. Upon the adoption of ASC 825, the Company did not elect to report any assets and liabilities at fair value.

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Note 10—Fair Values of Financial Instruments and Interest Rate Risk

ASC 825, “Disclosures about Fair Value of Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those that are not measured and reported at fair value on a recurring basis or non-recurring basis.

The fair value estimates presented at September 30, 2011 and December 31, 2010, are based on relevant market information and information about the financial instruments. Fair value estimates are intended to represent the price for which an asset could be sold or the price a liability could be settled for. However, given there is no active market or observable market transactions for many of the Company’s financial instruments, the Company has made estimates of many of these fair values that are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimated values. The estimated fair values disclosed in the following table do not represent market values of all assets and liabilities of the Company and should not be interpreted to represent the underlying value of the Company. The following table reflects a comparison of carrying amounts and the estimated fair value of the financial instruments as of September 30, 2011 and December 31, 2010:


	September 30, 2011				December 31, 2010
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
	(dollars in thousands)
Financial Assets
Cash and cash equivalents	$	16,979	$	16,979	$	13,624	$	13,624
Securities available for sale		91,793		91,793		96,395		96,395
Loans held for investment, net		373,162		389,628		378,702		392,017
Loans held for sale		1,787		1,787		6,286		6,286
FHLB Stock and FRB Stock		3,543		3,543		4,031		4,031
Bank-owned life insurance		6,119		6,119		5,975		5,975
Mortgage servicing rights		2,092		2,313		2,134		2,522
Accrued interest receivables		1,918		1,918		2,408		2,408

Financial Liabilities
Deposits	$	424,169	$	422,452	$	434,033	$	439,298
Short-term borrowings		30,080		30,080		20,482		20,482
Long-term debt		26,236		27,230		34,061		35,625
Accrued interest payable		307		307		342		342

The carrying amount of cash and cash equivalents and accrued interest approximate their fair values due to the short period of time until their expected realization. Securities available for sale are carried at fair value based on quoted market prices. The carrying amount of bank-owned life insurance is the current cash surrender value. It is not practicable to determine fair value of Federal Home Loan Bank and Federal Reserve Bank stock due to restrictions placed on its transferability, so it is presented at its carrying value.

The following methods and assumptions were used by the Company in estimating the fair value of financial instruments:

•

Loans – The fair value of loans is estimated based on discounted expected cash flows using the current interest rates at which similar loans would be made. Loans held for sale, which represent current mortgage production forward sales not yet delivered, are valued based on current market prices. The fair value of loans does not consider the lack of liquidity and uncertainty in the market that would effect the valuation.

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•

Deposits – The fair value of checking, savings and money market deposits is deemed equal to the amount payable on demand. The fair value of certificates of deposit is estimated based on discounted cash flow analyses using offered market rates. The fair value of deposits does not consider any customer-related intangibles.

•

Borrowings – The fair value disclosed for short-term borrowings, which are composed of overnight borrowings and debt due within one year, approximate the carrying value for such debt. The estimated fair value for long-term borrowings are estimated based on discounted cash flow analyses using offered market rates.

At September 30, 2011, the subsidiary banks had outstanding standby letters of credit and commitments to extend credit. These off-balance sheet financial instruments are generally exercisable at the market rate prevailing at the date the underlying transaction will be completed; therefore, they were deemed to have no current fair value. See Note 8.

Note 11 – Recent Accounting Pronouncements

In January 2010, the FASB issued ASU 2010-06, an update to ASC 820-10, “Fair Value Measurements.” This update adds a new requirement to disclose transfers in and out of level 1 and level 2, along with the reasons for the transfers, and requires a gross presentation of purchases and sales of level 3 activities. Additionally, the update clarifies that entities provide fair value measurement disclosures for each class of assets and liabilities and that entities provide enhanced disclosures around level 2 valuation techniques and inputs. The Company adopted the disclosure requirements for level 1 and level 2 transfers and the expanded fair value measurement and valuation disclosures effective January 1, 2010. The disclosure requirements for level 3 activities are effective for the Company on January 1, 2011. The adoption of the disclosure requirements for level 1 and level 2 transfers and the expanded qualitative disclosures, had no impact on the Company’s financial position, results of operations, and EPS. The Company adopted the level 3 disclosure requirements in the first quarter of 2011 and it had no impact on its financial position, results of operations, and EPS.

In July 2010, the FASB issued ASU 2010-20, an update to ASC 310 “Receivables”. The update to ASC 310 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a roll forward of the allowance for credit losses as well as information about modified, impaired, non-accrual and past due loans and credit quality indicators. ASU 2010-20 became effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period became effective for the Company’s financial statements beginning on January 1, 2011. The Company has adopted this update and included the disclosure in the notes to the financial statements.

In April 2011, the FASB issued ASU No. 2011-02, an update to ASC 310 “Receivables”. The update to ASC 310 clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-02, that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties.

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ASU 2011-02 will be effective for the Company on July 1, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011. Adoption of ASU 2011-02 did not have a material impact on the Company’s financial statements.

In June 2011, the FASB issued ASU 2011-05, an update to ASC 220, “Comprehensive Income.” This update requires that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. ASU 2011-05 is effective for annual periods beginning after December 15, 2011, and is not expected to have a significant impact on the Company’s financial statements.

In September 2011, the FASB issued ASU 2011-08, an update to ASC 350 “Intangibles—Goodwill and Other.” This update gives entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. ASU 2011-08 is effective for annual and interim impairment tests beginning after December 15, 2011, and is not expected to have a significant impact on the Company’s financial statements.

From time to time the FASB issues exposure drafts of proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

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Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q may contain certain forward-looking statements consisting of estimates with respect to the financial condition, results of operations and business of the Company that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to, general economic conditions, changes in interest rates, deposit flows, loan demand, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting the Company’s operations, pricing, products and services. Any use of “we” or “our” in the following discussion refers to the Company.

Comparison of Financial Condition at September 30, 2011 and December 31, 2010.

During the nine months ended September 30, 2011, the Company’s total assets decreased $5.1 million, from $535.4 million to $530.3 million. During the same period, loans held for investment decreased $7.0 million and investment securities decreased $4.6 million.

Cash and cash equivalents increased $3.4 million during the nine months ended September 30, 2011. Cash and due from banks increased $2.5 million, while interest-earning deposits with banks increased $848,000.

Investment securities decreased $4.6 million to $91.8 million for the nine months ended September 30, 2011. During the first nine months of 2011 in an effort to improve our interest rate risk position, management made the decision to shorten the duration of our investment portfolio by selling $24.6 million of securities, including $22.7 million of US Treasuries and government agency bonds and $1.9 million of small mortgage backed securities. The Company realized a gain of $933,000 on these transactions. The proceeds from these sales are being reinvested in defensive duration mortgage backed securities which will provide a shorter maturity and a monthly cash flow and protection in a rising rate environment. On September 30, 2011, the Company had net unrealized gains of $3.1 million.

Loans held for investment decreased from $387.8 million to $380.8 million, a decrease of $7.0 million. Contributing to this decrease was a significant pay down of $4.5 million with one customer relationship. The Company also had net loan chargeoffs of $3.4 million during the first nine months of 2011 and transferred $7.5 million to other real estate owned. The Company experienced positive growth trends in its commercial real estate loans as well as in both the one-to-four family residential real estate and residential construction areas of the loan portfolio. Commercial real estate experienced the largest growth increasing 7.7% or $8.1 million. This growth was largely due to one customer relationship with a construction loan converting to a permanent loan totaling $5.5 million. All remaining areas of the loan portfolio decreased during the first nine months of 2011. Loans held for sale decreased 71.6% or $4.5 million during the period. The decrease was attributed to an increase in mortgage rates and a decrease in demand. The allowance for loan losses was $7.7 million at September 30, 2011, which represented 2.01% of the loan portfolio.

Other changes in our consolidated assets are related to premises and equipment, interest receivable, Federal Home Loan Bank stock, bank owned life insurance, other real estate owned, prepaid assets and other assets. Premises and equipment, bank owned life insurance and other real estate owned increased $519,000, $144,000 and $6.9 million, respectively. The Company foreclosed on several loans during the period, with two relationships totaling $5.1 million contributing largely to the increase in other real estate owned. Accrued interest receivable and prepaid assets declined $490,000 and $402,000, respectively. Federal Home Loan Bank stock decreased $511,000 because member institutions are required to increase or decrease their ownership as their utilization of FHLB borrowings change. Other assets increased $47,000 during the nine month period.

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Customer deposits, our primary funding source, experienced a $9.9 million decrease during the period ended September 30, 2011, decreasing from approximately$434.0 million to $424.2 million. Demand noninterest-bearing checking increased $3.2 million, while savings deposits increased $2.1 million for the period. Time deposits $100,000 and over decreased $437,000, while other time deposits declined $2.8 million during the first nine months of 2011. Interest checking and money market deposits decreased $12.0 million. This decrease is attributable to decreases in two relationships, one of which is public fund money, where the balances maintained are seasonal in nature and have declined to their annual low point.

Total borrowings, which consist of both short-term and long-term borrowed funds primarily from the Federal Home Loan Bank, increased $1.8 million for the period. At September 30, 2011, $35.5 million of the $56.3 million in total borrowings were comprised of Federal Home Loan Bank advances.

At September 30, 2011, total shareholders’ equity was $45.9 million, an increase of $2.4 million from December 31, 2010. Net income for the period was $1.2 million. Unrealized gains and losses on investment securities, net of tax, increased $1.7 million. These increases were offset as the Company also recorded $409,000 in dividends on its outstanding series A and B preferred stock for the nine month period. The Company also made principal payments totaling $60,000 and released 12,216 ESOP shares, while drawing down a $94,000 advance on the ESOP line of credit. These transactions had a net effect of a $34,000 decrease in equity. At September 30, 2011, the Company and its subsidiary banks exceeded all applicable regulatory capital requirements.

Comparison of Results of Operations For the Three Months Ended September 30, 2011 and 2010.

Net Income and Net Income Available to Common Shareholders

Uwharrie Capital Corp reported net income of $255,000 for the three months ended September 30, 2011, as compared to $497,000 for the three months ended September 30, 2010, a decrease of $242,000. Net income available to common shareholders was $94,000 or $0.01 per common share at September 30, 2011, compared at $336,000 or $0.04 per common share at September 30, 2010. Net income available to common shareholders is net income less any dividends on preferred stock related to the $10.0 million of capital received from the United States Department of the Treasury under the Capital Purchase Program in December 2008.

Net Interest Income

As with most financial institutions, the primary component of earnings for our banks is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of noninterest-bearing liabilities and capital.

Net interest income for the three months ended September 30, 2011 was $4.9 million as compared with $4.6 million during the quarter ending September 30, 2010, resulting in an increase of $220,000. During the current quarter the volume of interest-earning assets and the

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volume of our interest-bearing liabilities decreased. The decrease in the volume of interest-bearing liabilities outpaced the decrease in our assets by $31,000. The average yield on our interest-earning assets decreased four basis points to 5.08%, while the average rate we paid for our interest-bearing liabilities decreased 27 basis points. The Company’s assets that are interest rate sensitive adjust at the time the Federal Reserve adjusts interest rates, while interest-bearing time deposits adjust at the time of maturity. These changes resulted in a increase of 23 basis points in our interest rate spread, from 3.73% for the first three months of 2010 to 3.96% for the corresponding period in 2011. Our net interest margin was 4.10% and 3.90% for the comparable periods in 2011 and 2010, respectively.

The following table presents average balance sheets and a net interest income analysis for the three months ended September 30, 2011 and 2010:

Average Balance Sheet and Net Interest Income Analysis

For the Three Months Ended September 30,


(in thousands)
	Average Balance				Income/Expenses				Rate/Yield
	2011		2010		2011		2010		2011			2010
Interest-earning assets:
Taxable securities	$	80,236	$	84,066	$	446	$	650		2.21	%		3.07	%
Nontaxable securities (1)		10,611		7,606		92		72		5.60	%		6.09	%
Short-term investments		11,149		7,804		21		9		0.75	%		0.46	%
Taxable loans		369,370		375,681		5,392		5,335		5.79	%		5.63	%
Non-taxable loans (1)		11,442		6,110		107		58		6.02	%		6.17	%

Total interest-earning assets		482,808		481,267		6,058		6,124		5.08	%		5.12	%

Interest-bearing liabilities:
Interest-bearing deposits		372,969		364,212		844		1,035		0.90	%		1.13	%
Short-term borrowed funds		25,878		22,639		89		176		1.36	%		3.08	%
Long-term debt		24,274		35,885		259		267		4.23	%		2.95	%

Total interest bearing liabilities		423,121		422,736		1,192		1,478		1.12	%		1.39	%

Net interest spread	$	59,687	$	58,531	$	4,866	$	4,646		3.96	%		3.73	%

Net interest margin (1)
(% of earning assets)										4.10	%		3.90	%

(1)	Yields related to securities and loans exempt from income taxes are stated on a fully tax-equivalent basis, assuming a 38.55% tax rate.

Provision and Allowance for Loan Losses

The provision for loan losses was $483,000 for the three months ending September 30, 2011 compared to $2.1 million for the same period in 2010. There were net loan charge-offs of $90,000 for the three months ended September 30, 2011 as compared with net loan charge-offs of $226,000 during the same period of 2010. Refer to the Asset Quality discussion on page 33 for further information.

Noninterest Income

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was a decline in NSF fees of $73,000 for the comparable periods due to the implementation of Regulation E that added further restrictions. Other service fees and commissions experienced a 13.2% increase for the comparable three month period, generated mainly from brokerage commissions and asset management fees which increased $56,000.

Noninterest Expense

Noninterest expense for the quarter ended September 30, 2011 was $5.9 million compared to $5.8 million for the same period of 2010, an increase of $72,000. Salaries and employee benefits, the largest component of noninterest expense, increased $96,000 for the quarter ending September 30, 2011. Professional fees and services increased $117,000, which was largely attributable, to an increase in legal fees related to foreclosed loans. Foreclosed real estate expense increased $243,000 from the prior period in 2010. These increases were offset by declines in several other expense areas. Net occupancy expense and equipment expense had a combined decrease of $48,000, while marketing and donations declined $116,000. Other noninterest expense decreased $215,000 for the comparable three month periods. The table below reflects the composition of other noninterest expense.

Other noninterest expense


	Three Months Ended
	September 30,
	2011		2010
	(in thousands)
Postage	$	50	$	61
Telephone and data lines		40		60
Loan collection expense		68		94
Shareholder relations expense		57		43
Dues and subscriptions		35		48
Other		344		503

Total	$	594	$	809

Income Tax Expense

The Company had income tax expense of $49,000 for the three months ended September 30, 2011 resulting in an effective tax rate of 16.12% compared to income tax expense of $227,000 and an effective rate of 31.4% in the 2010 period. Income taxes computed at the statutory rate are reduced somewhat by the eligible amount of interest earned on state and municipal securities, tax free municipal loans and income earned on bank owned life insurance that increased during the 2011 quarter.

Comparison of Results of Operations For the Nine Months Ended September 30, 2011 and 2010.

Net Income and Net Income Available to Common Shareholders

Uwharrie Capital Corp reported net income of $1.2 million for the nine months ended September 30, 2011, as compared to $1.4 million for the nine months ended September 30, 2010, a decrease of $194,000. Net income available to common shareholders was $689,000 or $0.09 per common share at September 30, 2011, compared to $883,000 or $0.12 per common share at September 30, 2010. Net income available to common shareholders is net income less any dividends on preferred stock related to the $10.0 million of capital received from the United States Department of the Treasury under the Capital Purchase Program in December 2008.

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Net Interest Income

Net interest income for the nine months ended September 30, 2011 was $14.3 million as compared with $14.0 million during the nine months ended September 30, 2010, resulting in an increase of $290,000. During the nine months ending September 30, 2011 our growth in the volume of interest-earning assets outpaced the growth in interest-bearing liabilities by $665,000. The average yield on our interest-earning assets decreased 39 basis points to 5.03%, while the average rate we paid for our interest-bearing liabilities decreased 31 basis points. The Company’s assets that are interest rate sensitive adjust at the time the Federal Reserve adjusts interest rates, while interest-bearing time deposits adjust at the time of maturity. The aforementioned changes resulted in a decrease of eight basis points in our interest rate spread, from 3.95% for the first nine months of 2010 to 3.87% for the corresponding period in 2011. Our net interest margin was 4.01% and 4.13% for the comparable nine month periods in 2011 and 2010, respectively. A portion of the Company’s loan portfolio has interest rate floors and caps in place on the loans. This feature has allowed the Company to maintain a strong interest margin despite a decline in rates; however, this feature could hurt the margin in a rising rate environment.

The following table presents average balance sheets and a net interest income analysis for the nine months ended September 30, 2011 and 2010:

Average Balance Sheet and Net Interest Income Analysis

For the Nine Months Ended September 30,


(in thousands)
	Average Balance				Income/Expenses				Rate/Yield
	2011		2010		2011		2010		2011			2010
Interest-earning assets:
Taxable securities	$	80,317	$	76,625	$	1,391	$	1,980		2.32	%		3.45	%
Nontaxable securities (1)		10,593		8,298		278		242		5.72	%		6.35	%
Short-term investments		12,054		5,986		39		27		0.43	%		0.60	%
Taxable loans		374,484		364,210		15,989		16,006		5.71	%		5.88	%
Non-taxable loans (1)		9,501		6,360		269		181		6.16	%		6.18	%

Total interest-earning assets		486,949		461,479		17,966		18,436		5.03	%		5.42	%

Interest-bearing liabilities:
Interest-bearing deposits		374,564		348,354		2,618		3,167		0.93	%		1.22	%
Short-term borrowed funds		24,254		24,434		271		474		1.49	%		2.59	%
Long-term debt		26,503		32,671		807		815		4.07	%		3.34	%

Total interest bearing liabilities		425,321		405,459		3,696		4,456		1.16	%		1.47	%

Net interest spread	$	61,628	$	56,020	$	14,270	$	13,980		3.87	%		3.95	%

Net interest margin (1)
(% of earning assets)										4.01	%		4.13	%

(1)	Yields related to securities and loans exempt from income taxes are stated on a fully tax-equivalent basis, assuming a 38.55% tax rate.

Provision and Allowance for Loan Losses

The provision for loan losses was $2.0 million for the nine months ending September 30, 2011 compared to $3.1 million for the same period in 2010. There were net loan charge-offs of $3.4 million for the nine months ended September 30, 2011 as compared with net loan charge-offs of $910,000 during the same period of 2010. Refer to the Asset Quality discussion on page 33 for further information.

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Noninterest Income

The Company generates most of its revenue from net interest income; however, like all financial institutions, diversification of our earnings base is of major importance in our long term success. Total noninterest income decreased $1.1 million for the nine month period ending September 30, 2011 as compared to the same period in 2010. Income from mortgage loan sales decreased $495,000 from $1.6 million for the nine months ended September 30, 2010 to $1.1 million for the same period in 2011. Service charges on deposit accounts produced earnings of $1.4 million for the nine months ended September 30, 2011, a decrease of $343,000. The primary factor was a decrease in NSF fees of $264,000, due in large part to changes in regulatory governance. Other service fees and commissions experienced a 19.9% increase for the comparable nine month period. This is due in part to a reduction in the write-down of servicing assets due to the refinancing of mortgage loans. Also, income generated from brokerage commissions and asset management fees increased $244,000. The Company realized gains on the sale of investments in the amount of $933,000 in the first nine months of 2011, as compared to realized gains of $1.5 million for the same period in 2010.

Noninterest Expense

Noninterest expense for the nine months ended September 30, 2011 was $17.0 million compared to $16.2 million for the same period of 2010, an increase of $790,000. Salaries and employee benefits, the largest component of noninterest expense, increased $477,000 to $9.2 million for the period ending September 30, 2011. Net occupancy expense and equipment expense had a combined increase of $39,000. Professional fees and services increased $232,000, primarily due to an increase in legal fees related to loan collections and foreclosed real estate expense increased $237,000. These increases were offset by decreases in marketing and donations of $201,000 and other noninterest expense of $138,000 for the comparable nine month periods. The table below reflects the composition of other noninterest expense.

Other noninterest expense


	Nine Months Ended
	September 30,
	2011		2010
	(in thousands)
Postage	$	148		162
Telephone and data lines		133		173
Loan collection expense		214		190
Shareholder relations expense		136		136
Dues and subscriptions		137		138
Other		989		1,096

Total	$	1,757	$	1,895

Income Tax Expense

The Company had income tax expense of $407,000 for the nine months ended September 30, 2011 resulting in an effective tax rate of 25.76% compared to income tax expense of $687,000 and an effective rate of 33.45% in the 2010 period. Income taxes computed at the statutory rate are reduced somewhat by the eligible amount of interest earned on state and municipal securities, tax free municipal loans and income earned on bank owned life insurance which increased during the period.

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Asset Quality

The Company’s allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. The allowance is increased by provisions charged to operations and by recoveries of amounts previously charged off and is reduced by loans charged off. Management continuously evaluates the adequacy of the allowance for loan loss. In evaluating the adequacy of the allowance, management considers the following: the growth, composition and industry diversification of the portfolio; historical loan loss experience; current delinquency levels; adverse situations that may affect a borrower’s ability to repay; estimated value of any underlying collateral; prevailing economic conditions and other relevant factors. The Company’s credit administration function, through a review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality improves or deteriorates, the credit administration department has the responsibility to change the borrower’s risk grade accordingly. For loans determined to be impaired, the allowance is based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loans observable market price or the estimated fair value of the underlying collateral less the selling costs, if the loan is deemed to be collateral dependent. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans, which may be susceptible to significant change. In addition, regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and may require additions for estimated losses based upon judgments different from those of management.

Management uses a risk-grading program to facilitate the evaluation of probable inherent loan losses and the adequacy of the allowance for loan losses. In this program, risk grades are initially assigned by loan officers and reviewed and monitored by credit administration. The Company strives to maintain its loan portfolio in accordance with conservative loan underwriting policies that result in loans specifically tailored to the needs of its market area. Every effort is made to identify and minimize the credit risks associated with such lending strategies. The Company has no foreign loans and does not engage in significant lease financing or highly leveraged transactions. The Company follows a loan review program designed to evaluate the credit risk in the loan portfolio. This process includes the maintenance of an internally classified watch list that is designed to help management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower’s ability to repay, the borrower’s payment history and the current delinquent status. As a result of this process, certain loans are categorized as substandard, doubtful or loss, and reserves are allocated based on management’s judgment and historical experience.

The allowance for loan losses represents management’s best estimate of an appropriate amount to provide for inherent risk in the loan portfolio in the normal course of business. While management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ from the assumptions used in making the determinations. Furthermore, while management believes it has established the allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that banking regulators, in reviewing the Company’s portfolio, will not require an adjustment to the allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary, should the quality of any loans deteriorate as a result of the factors discussed herein. Any material increase in the allowance for loan losses may adversely affect the Company’s financial condition and results of operations.

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The provision for loan losses was $2.0 million for the period ended September 30, 2011, as compared to $3.1 million for the same period in 2010. At September 30, 2011 the levels of our impaired loans, which include all loans in nonaccrual status and other loans deemed by management to be impaired, were $34.8 million compared to $43.3 million at December 31, 2010, a decrease of $8.4 million. Total nonaccrual loans, which are a component of impaired loans, decreased from $19.7 million at December 31, 2010 to $9.5 million at September 30, 2011. The primary factor in the decrease in both impaired and nonaccrual loans was the increase in foreclosures and the subsequent increase of $6.9 million in other real estate owned. The Company also had a $1.6 million loan relationship that was current and performing for a period of time but which was placed in nonaccrual until there was a proven payment history could be reestablished. This relationship was transferred out of nonaccrual and into the current portfolio during the second quarter of 2011. The Company had net loan charge-offs for the first nine months of 2011 of $3.4 million compared to net loan charge-offs of $910,000 for the same period in 2010. Of the increase in chargeoffs, $1.1 million was related to one relationship.

The allowance expressed as a percentage of gross loans held for investment decreased 33 basis points from 2.34% at December 31, 2010 to 2.01% at September 30, 2011. The decrease in the allowance was a direct impact of the write down and chargeoff of impaired loans. The collectively evaluated reserve allowance as a percentage of collectively evaluated loans was 1.29% at December 31, 2010 and 1.25% at September 30, 2011, while the individually evaluated allowance as a percentage of individually evaluated loans decreased from 10.71% to 9.56%, a decrease of 115 basis points. During the first nine months of 2011, along with the aforementioned chargeoff of $1.1 million, the Company had several partial charge-offs contributing to the decrease. During the third quarter of 2010 we upgraded our allowance for loan loss model to capture not only the mean loss of individual loans but also the rare event of severe loss that can occur within the loan portfolio. The changes were made in the part of the model used to compute the general reserves. Specifically, the Company began calculating probable losses on loans by computing a probability of loss and expected loss scenario by call codes. Together, these components created from Ordinary Least Squares (OLS) Regression of historical losses against multiple Macro-Economic factors make up the basis of the new allowance model. The loans that are impaired and included in the specific reserve are excluded from these calculations. During the first quarter of 2011 the Company added an additional section to its loan loss model to account for other qualitative and/or environmental factors. This new section accounted for $45,000 in increased reserves during the quarter. Nonperforming loans, which consist of nonaccrual loans and loans past due 90 days and still accruing, to total loans decreased from 5.19% at December 31, 2010, to 2.61% at September 30, 2011. As discussed above, during the period the Company had a net increase of $6.9 million in other real estate owned. The primary components of the increase in other real estate owned were, two loan relationships which consisted of six pieces of property totaling $5.1 million. Management believes the current level of the allowance for loan losses is appropriate in light of the risk inherent in the loan portfolio.

Restructured loans at September 30, 2011 totaled $8.7 million and are included in impaired loans above. Restructured loans at December 31, 2010 totaled $5.1 million of which $4.6 million are included in impaired loans above.

The following nonperforming loan table shows the comparison for the nine months ended September 30, 2011 to December 31, 2010:

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Nonperforming Assets

(dollars in thousands)


	September 30,			December 31,
	2011			2010
Nonperforming assets:
Accruing loans past due 90 days or more	$	—		$	10
Nonaccrual loans		9,944			20,126
Other real estate owned		8,898			2,022

Total nonperforming assets	$	18,842		$	22,158

Allowance for loans losses	$	7,666		$	9,067
Nonperforming loans to total loans		2.61	%		5.19	%
Allowance for loan losses to total loans		2.01	%		2.34	%
Nonperforming assets to total assets		3.55	%		4.14	%
Allowance for loan losses to nonperforming loans		77.09	%		45.03	%

Liquidity and Capital Resources

The objective of the Company’s liquidity management policy is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on any opportunities for expansion. Liquidity management addresses the ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature and to fund new loans and investments as opportunities arise.

The Company’s primary sources of internally generated funds are principal and interest payments on loans, cash flows generated from operations and cash flow generated by investments. Growth in deposits is typically the primary source of funds for loan growth. The Company and its subsidiary banks have multiple funding sources in addition to deposits that can be used to increase liquidity and provide additional financial flexibility. These sources are the subsidiary banks’ established federal funds lines with correspondent banks aggregating $23.8 million at September 30, 2011, with available credit of $23.8 million, established borrowing relationships with the Federal Home Loan Bank, with available credit of $18.5 million, access to borrowings from the Federal Reserve Bank discount window, with available credit of $21.7 million and the issuance of commercial paper. The Company also secured long-term debt from other sources. Total debt from all these sources aggregated $56.3 million at September 30, 2011, compared to $54.5 million at December 31, 2010.

Banks and bank holding companies, as regulated institutions, must meet required levels of capital. The Federal Reserve, the primary federal regulator of the Company and its subsidiary banks, has adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets.

Regulatory guidelines require a minimum of total capital to risk-adjusted assets ratio of 8 percent and a Tier 1 leverage ratio of 4 percent. Banks that meet or exceed a Tier 1 risk-based capital ratio of 6 percent, a total risked-based capital ratio of 10 percent and a leverage ratio of 5 percent are considered “well capitalized” by regulatory standards. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with those guidelines.

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The Company and its subsidiary banks have each maintained capital levels exceeding minimum levels for “well capitalized” banks and bank holding companies. The Company expects to continue to exceed minimum capital requirements without altering current operations or strategy. During the first quarter of 2011, the Company completed a private placement of junior subordinated debt securities that had a rate of 5.75 percent and an eight year maturity. These securities qualify as regulatory capital for the first three years after their issuance, after which the amount that qualifies as regulatory capital will be reduced by 20 percent a year until maturity. The Company also called $7.4 million in previously outstanding junior subordinated debt securities, which were privately placed during 2008. At September 30, 2011, the Company had $11.1 million in subordinated debt outstanding and $10.0 million in outstanding preferred stock issued to the United States Department of the Treasury.

Accounting and Regulatory Matters

Management is not aware of any known trends, events, uncertainties or current recommendations by regulatory authorities that will have or that are reasonably likely to have a material effect on the Company’s liquidity, capital resources, or other operations.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company’s primary market risk is interest rate risk. Interest rate risk is the result of differing maturities or repricing intervals of interest-earning assets and interest-bearing liabilities and the fact that rates on these financial instruments do not change uniformly. These conditions may impact the earnings generated by the Company’s interest earning assets or the cost of its interest-bearing liabilities, thus directly impacting the Company’s overall earnings. The Company’s management actively monitors and manages interest rate risk. One way this is accomplished is through the development of and adherence to the Company’s asset/liability policy. This policy sets forth management’s strategy for matching the risk characteristics of the Companys interest-earning assets and liabilities so as to mitigate the effect of changes in the rate environment. In management’s opinion, the Company’s market risk profile has not changed significantly since December 31, 2010.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

At the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act (“Exchange Act”) Rule 13a-15.

Based upon that evaluation, the principal executive officer and principal financial officer concluded that in their opinion, the Company’s disclosure controls and procedures were effective (1) to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow for timely decisions regarding required disclosure.

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Changes in Internal Control over Financial Reporting

Management of the Company has evaluated, with the participation of the Company’s principal executive officer and principal financial officer, changes in the Company’s internal controls over financial reporting (as defined in Rule 13a -15(f) and 15d – 15(f) of the Exchange Act) during the second quarter of 2011. In connection with such evaluation, the Company has determined that there were no changes in the Company’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company reviews its disclosure controls and procedures, which may include its internal control over financial reporting, on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensuring that the Company’s systems evolve with its business.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

Neither the Company nor its subsidiaries, nor any of their properties are subject to any material legal proceedings. From time to time the Banks are engaged in ordinary routine litigation incidental to their business.

Item 1A. Risk Factors

Not applicable for smaller reporting companies.

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

Trades of the Company’s stock occur in the Over-the-Counter marketplace from time to time. The Company also has in place a Stock Repurchase Plan that provides liquidity to its shareholders in the event a willing buyer is not available to purchase shares that are offered for sale. The Company is under no obligation to purchase shares offered; however, it will accommodate such offers as its Stock Repurchase Plan allows. This plan was initially adopted in 1995 and is approved annually by resolution of the Board of Directors or the Executive Committee of the Board.

Pursuant to the terms of the United States Department of the Treasury’s investment in the Company’s preferred stock under the Capital Purchase Program (“CPP”), the Company must obtain the prior consent of the United States Department of the Treasury to repurchase its common stock under the Stock Purchase Plan or otherwise or to pay a cash dividend.

Item 3. Defaults Upon Senior Securities

None

Item 4. Reserved

Item 5. Other Information

None

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Item 6. Exhibits


Exhibit
Number		Description of Exhibit

3.1		Registrant’s Articles of Incorporation *

3.2		Registrant’s By-laws *****

4		Form of stock certificate *

4.1		Form of Security Holders Agreement *******

10.1		Incentive Stock Option Plan, as amended *

10.2		Employee Stock Ownership Plan and Trust **

10.3		2006 Incentive Stock Option Plan ***

10.4		2006 Employee Stock Purchase Plan ***

10.5		Amendment to the Employee Stock Ownership Plan and Trust ****

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 (filed herewith)

31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 (filed herewith)

32		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)

101		Interactive data files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011, in XBRL (eXtensible Business Reporting Language) ******

*		Incorporated by reference from exhibits to Registrant’s Registration Statement on Form S-4 (Reg. No. 33-58882).

**		Incorporated by reference to Registrant’s Annual Report on Form 10-KSB for the Fiscal year ended 1999.

***		Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the Quarter ended June 30, 2007.

****		Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the Quarter ended September 30, 2008.

*****		Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the Quarter ended September 30, 2009.

******		Pursuant to Regulation 406T of Regulation S-T, these interactive data files are furnished and not filed or part of a registration statement or prospectus for purposes of section 11 or 12 of the Securities Act of 1933, as amended, or section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

*******		Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the Quarter ended June 30, 2011.

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Signatures

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

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EXHIBIT INDEX


Exhibit
Number		Description of Exhibit

3.1		Registrant’s Articles of Incorporation *

3.2		Registrant’s By-laws *****

4		Form of stock certificate *

4.1		Form of Security Holders Agreement *******

10.1		Incentive Stock Option Plan, as amended *

10.2		Employee Stock Ownership Plan and Trust **

10.3		2006 Incentive Stock Option Plan ***

10.4		2006 Employee Stock Purchase Plan ***

10.5		Amendment to the Employee Stock Ownership Plan and Trust ****

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 (filed herewith)

31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 (filed herewith)

32		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)

101		Interactive data files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011, in XBRL (eXtensible Business Reporting Language) ******

*		Incorporated by reference from exhibits to Registrant’s Registration Statement on Form S-4 (Reg. No. 33-58882).

**		Incorporated by reference to Registrant’s Annual Report on Form 10-KSB for the Fiscal year ended 1999.

***		Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the Quarter ended June 30, 2007.

****		Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the Quarter ended September 30, 2008.

*****		Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the Quarter ended September 30, 2009.

******		Pursuant to Regulation 406T of Regulation S-T, these interactive data files are furnished and not filed or part of a registration statement or prospectus for purposes of section 11 or 12 of the Securities Act of 1933, as amended, or section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

*******		Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the Quarter ended June 30, 2011.

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