f10q093011.htm

10-Q 1 f10q093011.htm f10q093011.htm

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 Exchange Act of 1934

For the quarterly period ended September 30, 2011

[ ] Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the transition period from ____________ to _____________

Commission File Number: 0-50576

CITIZENS BANCORP OF VIRGINIA, INC.

(Exact name of registrant as specified in its charter)

Virginia (State of incorporation or organization)	20-0469337 (I.R.S. Employer Identification No.)
126 South Main Street Blackstone, VA 23824 (434) 292-7221 (Address and telephone number of principal executive offices)

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. Yes R No £

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

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

Large accelerated filer £ Accelerated filer £

Non-accelerated filer £ Smaller Reporting Company R

(Do not check if smaller reporting company)

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

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

2,331,242 shares of Common Stock as of October 28, 2011.

FORM 10-Q

For the Period Ended September 30, 2011

TABLE OF CONTENTS

Part I. Financial Information		Page No.

Item 1. Financial Statements

Consolidated Balance Sheet		3

Consolidated Statements of Income		4

Consolidated Statements of Changes in Stockholders’ Equity		5

Consolidated Statements of Cash Flows		6

Notes to Interim Consolidated Financial Statements		7

Item 2. Management’s Discussion and Analysis of Financial Condition
	and Results of Operations	30

Item 4. Controls and Procedures		43

Part II. Other Information

Item 1.	Legal Proceedings	44

Item 1A.	Risk Factors	44

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	44

Item 3.	Defaults upon Senior Securities	45

Item 4.	[Removed and Reserved]	45

Item 5.	Other Information	45

Item 6.	Exhibits	45

Signatures		46

Part I. Financial Information

Item 1. Financial Statements

Consolidated Balance Sheets

(Dollars in thousands, except share data)

	September 30,		December 31,
	2011		2010
Assets	(Unaudited)

Cash and due from banks	$	6,894	$	5,427
Interest-bearing deposits in banks		1,837		1,857
Federal funds sold		13,562		15,460
Securities available for sale, at fair market value		82,601		82,745
Restricted securities, at cost		972		1,079
Loans, net of allowance for loan losses of $2,364
and $2,168		197,461		200,515
Premises and equipment, net		6,910		7,135
Accrued interest receivable		1,584		1,816
Other assets		1,765		2,846
Bank owned life insurance		8,372		8,150
Other real estate owned, net of valuation allowance of $111 in 2011
and $76 in 2010		6,844		3,425

Total assets	$	328,802	$	330,455
Liabilities and Stockholders' Equity

Liabilities
Deposits:
Noninterest-bearing	$	37,571	$	33,161
Interest-bearing		234,321		244,827
Total deposits	$	271,892	$	277,988
FHLB advances		5,000		5,000
Other borrowings		6,265		5,149
Accrued interest payable		705		886
Accrued expenses and other liabilities		2,515		1,795
Total liabilities	$	286,377	$	290,818


Stockholders' Equity
Preferred stock, $0.50 par value; authorized 1,000,000 shares;
none outstanding	$	-	$	-
Common stock, $0.50 par value; authorized 10,000,000 shares;
issued and outstanding, 2,331,242 in 2011 and		1,166		1,177
2,353,509 in 2010
Retained earnings		40,157		39,308
Accumulated other comprehensive income (loss)		1,102		(848	)
Total stockholders' equity	$	42,425	$	39,637

Total liabilities and stockholders' equity	$	328,802	$	330,455

See accompanying Notes to Interim Consolidated Financial Statements.

CITIZENS BANCORP OF VIRGINIA, INC.

Consolidated Statements of Income (Unaudited)

(Dollars in thousands, except per share data)


	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2011			2010		2011			2010
Interest and Dividend Income
Loans, including fees	$	3,201		$	3,439	$	9,730		$	10,320
Investment securities:
Taxable		394			459		1,302			1,513
Tax-exempt		258			233		769			567
Federal Funds sold		5			6		15			14
Other		5			6		19			16
Total interest and dividend income	$	3,863		$	4,143	$	11,835		$	12,430

Interest Expense
Deposits	$	854		$	1,089	$	2,783		$	3,326
Other borrowings		39			38		116			113
Total interest expense	$	893		$	1,127	$	2,899		$	3,439

Net interest income	$	2,970		$	3,016	$	8,936		$	8,991

Provision for loan losses		225			150		525			600

Net interest income after provision
for loan losses	$	2,745		$	2,866	$	8,411		$	8,391

Noninterest Income
Service charges on deposit accounts	$	279		$	258	$	785		$	774
Net gain on sales of securities		-			3		-			30
Other-than-temporary impairments		(31	)		-		(37	)		-
Less: Noncredit portion of OTTI impairments		(31	)		-		3			-
Net other-than-temporary impairments		-			-		(40	)		-
Net gain on sales of loans		25			23		52			49
Income from bank owned life insurance		75			74		222			217
ATM fee income		191			165		568			484
Other		89			67		208			199
Total noninterest income	$	659		$	590	$	1,795		$	1,753

Noninterest Expense
Salaries and employee benefits	$	1,372		$	1,372	$	4,112		$	4,083
Net occupancy expense		150			158		450			453
Equipment expense		118			142		358			402
FDIC deposit insurance		65			104		326			403
Net (gain) on sale of other real estate owned		(5	)		-		(21	)		(13	)
Impairment-other real estate owned		8			60		35			75
Other		668			626		1,886			1,826
Total noninterest expense	$	2,376		$	2,462	$	7,146		$	7,229

Income before income taxes	$	1,028		$	994	$	3,060		$	2,915

Income taxes		236			232		710			729

Net income	$	792		$	762	$	2,350		$	2,186
Earnings per share, basic & diluted	$	0.34		$	0.32	$	1.01		$	0.92

See accompanying Notes to Interim Consolidated Financial Statements.

CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Stockholders' Equity (Unaudited)

For the Nine Months Ended September 30, 2011 and 2010

(Dollars in thousands)

							Accumulated
							Other
							Compre-
							hensive			Compre-
	Common			Retained			Income			hensive
	Stock			Earnings			(Loss)			Income			Total

Balance at December 31, 2009	$	1,186		$	38,177		$	(373	)				$	38,990
Comprehensive income:
Net Income		-			2,186			-		$	2,186			2,186
Other comprehensive income, net of taxes
Unrealized gains on securities available
for sale, net of deferred taxes		-			-			1,274			1,274			1,274
Less: reclassification adjustment for
gain on sale of securities, net of tax		-			-			(20	)		(20	)		(20	)
Total other comprehensive income											1,254
Total comprehensive income		-			-			-		$	3,440			-
Shares repurchased		(4	)		(81	)		-						(85	)
Cash dividends declared ($0.51 per share)		-			(1,206	)		-						(1,206	)
Balance at September 30, 2010	$	1,182		$	39,076		$	881					$	41,138

Balance at December 31, 2010	$	1,177		$	39,308		$	(848	)				$	39,637
Comprehensive Income:
Net income		-			2,350			-		$	2,350			2,350
Other comprehensive income, net of taxes
Unrealized gains on securities available
for sale, net of deferred taxes		-			-			1,924			1,924			1,924
Less: reclassification adjustment on
securities other-than-temporarily
impaired, net of tax of ($14)		-			-			26			26			26
Total other comprehensive income										$	1,950
Total comprehensive income		-			-			-		$	4,300			-
Shares repurchased		(11	)		(306	)		-						(317	)
Cash dividends declared ($0.51 per share)		-			(1,195	)		-						(1,195	)
Balance at September 30, 2011	$	1,166		$	40,157		$	1,102					$	42,425

See accompanying Notes to Interim Consolidated Financial Statements.

CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows (Unaudited)
(Dollars in thousands)
	Nine Months Ended
	September 30,
	2011			2010
Cash Flows from Operating Activities
Net Income	$	2,350		$	2,186
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation		393			444
Provision for loan losses		525			600
Net (gain) on sales of loans		(52	)		(49	)
Origination of loans held for sale		(2,911	)		(3,182	)
Proceeds from sales of loans		2,963			3,231
Net (gain) on sales and calls of securities		-			(30	)
Other than temporary impairment of securities		40			-
Net amortization of securities		224			184
Impairment of other real estate owned		35			75
Net (gain) on sale of other real estate owned		(21	)		(13	)
Changes in assets and liabilities:
Decrease (increase) in accrued interest receivable		232			(45	)
(Increase) decrease in other assets		(144	)		38
(Decrease) in accrued interest payable		(181	)		(47	)
Increase (decrease) in accrued expenses and other liabilities		720			(6	)
Net cash provided by operating activities	$	4,173		$	3,386
Cash Flows from Investing Activities
Activity in available for sale securities:
Calls and sales	$	18,140			38,755
Maturities and prepayments		6,753			7,090
Purchases		(22,060	)		(62,929	)
Redemption of restricted securities		107			74
Net (increase) decrease in loans		(1,147	)		5,288
Purchases of land, premises and equipment		(168	)		(141	)
Proceeds from sale of other real estate owned		243			221
Net cash provided by (used in) investing activities	$	1,868		$	(11,642	)
Cash Flows from Financing Activities
Net (decrease) increase in deposits	$	(6,096	)	$	7,674
Net increase (decrease) in other borrowings		1,116			(185	)
Repurchase of common stock		(317	)		(85	)
Dividends paid		(1,195	)		(1,206	)
Net cash (used in) provided by financing activities	$	(6,492	)	$	6,198
Net (decrease) in cash and cash equivalents	$	(451	)	$	(2,058	)
Cash and Cash Equivalents
Beginning of period		22,744			17,035
End of period	$	22,293		$	14,977
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for:
Interest	$	3,080		$	3,486
Income Taxes	$	530		$	1,204
Supplemental Disclosures of Noncash Investing and
Financing Activities
Other real estate acquired in settlement of loans	$	3,676		$	1,133
Unrealized gains on securities available for sale	$	2,952		$	1,900

See accompanying Notes to Interim Consolidated Financial Statements

Notes to Interim Consolidated Financial Statements

(Unaudited)

Note 1. General

The Consolidated Balance Sheets at September 30, 2011 and December 31, 2010, the Consolidated Statements of Income for the three and nine months ended September 30, 2011 and September 30, 2010, and the Consolidated Statements of Changes in Stockholders’ Equity and Cash Flows for the nine months ended September 30, 2011 and 2010, were prepared in accordance with instructions for Form 10-Q, and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (GAAP) for complete financial statements. However, in the opinion of Management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) considered necessary to present fairly the financial position at September 30, 2011 and the results of operations for the three and nine months ended September 30, 2011 and 2010. The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Citizens Bancorp of Virginia, Inc. Annual Report on Form 10-K for the year ended December 31, 2010. The results of operations for the three-month and nine-month periods ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year.Citizens Bancorp of Virginia, Inc. (the “Company”) is a one-bank holding company formed on December 18, 2003. The Company is the sole shareholder of its only subsidiary, Citizens Bank and Trust Company (the “Bank”). The Bank conducts and transacts the general business of a commercial bank as authorized by the banking laws of the Commonwealth of Virginia and the rules and regulations of the Federal Reserve System. The Bank was incorporated in 1873 under the laws of Virginia. Deposits are insured by the Federal Deposit Insurance Corporation. As of September 30, 2011 the Bank employed 109 full-time employees. The address of the principal offices for the Company and the main office of the Bank is 126 South Main Street, Blackstone, Virginia, and all banking offices are located within the Commonwealth of Virginia.

Note 2. Securities

Investment decisions are made by the Management group of the Company and reflect the overall liquidity and strategic asset/liability objectives of the Company. Management analyzes the securities portfolio frequently and manages the portfolio to provide an overall positive impact to the Company’s income statement, balance sheet and liquidity needs. Securities available for sale are summarized below:

	September 30, 2011
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		(Losses)			Value
U.S. government and	(Dollars in thousands)
federal agency	$	10,504	$	45	$	-		$	10,548
State and municipal		28,760		1,337		(4	)		30,094
Agency mortgage-backed		37,972		1,534		-			39,506
Non-agency mortgage-backed		1,864		-		(231	)		1,633
Corporate		753		67		-			820
Securities available for sale	$	79,853	$	2,983	$	(235	)	$	82,601

	December 31, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		(Losses)			Value
U.S. government	(Dollars in thousands)
and federal agency	$	16,761	$	36	$	(91	)	$	16,706
State and municipal		29,142		209		(646	)		28,704
Agency mortgage-backed		33,828		629		(198	)		34,259
Non-agency mortgage-backed		2,466		1		(192	)		2,275
Corporate		753		48		-			801
Securities available for sale	$	82,950	$	923	$	(1,127	)	$	82,745

The amortized cost and fair value of securities available for sale by contractual maturity at September 30, 2011 follows. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or prepaid without any penalties.

	Amortized		Fair
	Cost		Value
	(Dollars in thousands)
Maturing within one year	$	1,763	$	1,800
Maturing after one year through five years		6,982		7,035
Maturing after five years through ten years		7,023		7,352
Maturing after ten years		24,249		25,275
Agency mortgage-backed securities		37,972		39,506
Non-agency mortgage-backed securities		1,864		1,633
Securities available for sale	$	79,853	$	82,601

Information pertaining to securities with gross unrealized losses at September 30, 2011 and December 31, 2010, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is summarized as follows:

	Less than 12 Months					12 Months or More
	Fair		Unrealized			Fair		Unrealized
September 30, 2011	Value		(Loss)			Value		(Loss)
	(Dollars in thousands)
U.S. government
and federal agency	$	751	$	(0	)	$	-	$	-
State and municipal		504		(4	)		-		-
Agency mortgage-backed		-		-			-		-
Non-agency mortgage-backed		722		(3	)		1,011		(228	)
Total temporarily
impaired securities	$	1,976	$	(7	)	$	1,011	$	(228	)

	Less than 12 Months					12 Months or More
	Fair		Unrealized			Fair		Unrealized
December 31, 2010	Value		(Loss)			Value		(Loss)
	(Dollars in thousands)
U.S. government
and federal agency	$	10,412	$	(91	)	$	-	$	-
State and municipal		16,916		(619	)		348		(27	)
Agency mortgage-backed		10,408		(198	)		-		-
Non-agency mortgage-backed		695		(6	)		1,291		(186	)
Total temporarily
impaired securities	$	38,431	$	(914	)	$	1,639	$	(213	)

Except as explained below, the unrealized losses in the investment portfolio as of September 30, 2011 are considered temporary and are a result of general market fluctuations that occur daily and which have been more volatile since the current economic recession began. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the intent of the Bank to sell the security, (2) whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and (3) whether the Bank expects to recover the securities entire amortized cost basis regardless of the Bank’s intent to sell the security. With the exception of the Company’s investment in non-agency CMO securities, unrealized losses in the investment portfolio are considered temporary. The discussion regarding the OTTI analysis for the non-agency CMO securities is discussed below in greater detail.

In the Company’s Form 10-K report for December 31, 2010, management discussed its ongoing review of five non-agency collateralized mortgage obligations, also referred to as CMOs, four of which had credit agency ratings that were below investment grade as of December 31, 2010. Management’s analysis for the third quarter of 2011 was performed with reported data as of August 2011. This analysis indicated that four of the non-agency CMOs remain rated below investment grade; according to the Moody’s and Standard & Poor’s credit rating agencies. Management’s analysis also indicated that all five securities have made consistent monthly payments through August 31, 2011. As of August 31, 2011, all five securities showed a net unrealized loss of 10.8% of the $2.1 million book value, which is a decline of 330 basis points from the 7.5% net unrealized loss on $2.2 million of book value at May 31, 2011.

Management’s third quarter review of the non-agency CMO securities resulted in the conclusion that no additional impairment was indicated for any of the securities beyond the cumulative credit-related other-than-temporary-impairment (OTTI) write-down of $100,000 that has been recorded to date. Previously, management recorded a $60,000 write-down as of December 31, 2009 and an additional $40,000 as of June 30, 2011. The data used for the stress testing model includes: the most current “delinquency pipeline” statistics, actual losses realized from the sale of foreclosed properties, and the level of borrower repayments that have been experienced over the life of the CMO security, to date. The credit-related other-than-temporary-impairment estimate of $100,000, which was computed by the stress testing model, is believed to be a conservative estimate of future losses in three of the five non-agency CMOs. There are a number of factors that management considers when determining a proper OTTI level for each of the CMOs, among them are: the projected date of first loss, the remaining credit support and coverage ratio for each CMO. Consideration is also given to general economic conditions that impact the borrowers and their homes, such as refinancing opportunities for jumbo mortgage borrowers, mortgage interest rates, home values, etc.

A roll-forward of the OTTI amount related to credit losses on debt securities for the period ended September 30, 2011 is as follows:

	(Dollars in thousands)

Credit losses recognized in earnings, beginning of period	$	100

Recognition of credit losses for which an OTTI was not
previously recognized		-

Credit losses recognized in earnings, end of period	$	100

Federal Home Loan Bank Stock

The Bank’s investment in Federal Home Loan Bank (“FHLB”) stock totaled $815 thousand at September 30, 2011. FHLB stock is generally viewed as a long-term restricted investment security which is carried at cost, because there is no market for the stock other than for the FHLB or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Bank does not consider this investment to be other than temporarily impaired at September 30, 2011 and no impairment has been recognized on the Federal Home Loan Bank stock.

Note 3. Loans

The loan portfolio was composed of the following:

	September 30,		December 31,
	2011		2010
	(Dollars in thousands)
Residential Real Estate:
1-4 family	$	86,969	$	92,520
Home equity		12,458		10,816
Commercial Real Estate:
Owner occupied		23,866		23,884
Non-owner occupied		29,376		28,597
Farmland		11,149		8,787
Construction		14,600		12,943
Total real estate		178,418		177,547

Commercial & industrial loans		12,513		14,500
Consumer loans		8,894		10,636
Total loans	$	199,825	$	202,683

Loan Origination

The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and the Board of Directors approve these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and the Board with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

The Company has six loan portfolio level segments and eight loan class levels for reporting purposes.

The six loan portfolio level segments include:

·	Residential real estate loans are loans made to borrowers for the purchase of residential dwellings.

·	Commercial real estate loans are loans made to business entities for the purchase of real estate and buildings that will be used in the business..

·	Farmland loans are loans made to farming entities to acquire land used for agricultural purposes such as in the cultivation of crops or livestock.

·	Construction and land development loans are loans made to individuals or developers in order to construct homes, develop raw land into buildable acreage, or for commercial construction purposes.

·	Commercial and industrial loans are loans made to small and medium-sized businesses for any number of reasons especially working capital. Loans are typically secured by inventory, business equipment, furniture or receivables and they are frequently guaranteed by principals of the business.

·	Consumer loans are loans made to individuals and the loans may be secured by personal property or be unsecured.

Residential real estate loans, including home equity loans and lines of credit, are subject to underwriting standards that are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, debt-to-income ratios, credit history, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. While many of the statutory requirements are for the protection of the consumer, underwriting standards aid at mitigating the risks to the Company by setting acceptable loan-approval standards that marginal borrowers may not meet. Additional risk mitigating factors include: residential real estate typically serves as a borrower’s primary residence which encourages timely payments and the avoidance of foreclosure, the average dollar amount of a loan is typically less than that of a commercial real estate loan, and there are a large number of loans which help to diversify the risk potential.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry.

Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. Management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At September 30, 2011, approximately 44.83% of the outstanding principal balance of the Company’s commercial real estate loans was secured by owner-occupied properties; this is a decrease from 45.51% at December 31, 2010.

Farmland loans are subject to underwriting standards and processes similar to commercial real estate loans. The loans are considered primarily on the borrower’s ability to make payments originating primarily from the cash flow of the business and secondarily as loans secured by real estate.

With respect to construction, land and land development loans that are secured by non-owner occupied properties, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten with independent appraisal reviews, lease rates and financial analysis of the borrowers. Construction loans are generally based upon estimates of costs and value associated with the complete project. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher

risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

To monitor and manage consumer loan risk, policies and procedures are developed and modified by credit administration and senior management. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage, debt-to-income ratios, credit history, and the number of such loans a borrower can have at one time.

The Company maintains a credit review department that reviews and validates the credit risk program on a periodic basis. In addition, the Company’s Audit and Risk Management Committee contracts with an independent loan review consulting firm the work of reviewing, among other things, loan relationships exceeding $250,000, a sample of loans underwritten within the authority of loan officers, and the risk grading of criticized and classified assets with a balance in excess of $100,000. The firm provides a report to the Audit and Risk Management Committee upon the completion of their annual review. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

Concentrations of Credits

Most of the Company’s lending activity occurs within the Commonwealth of Virginia, more specifically within the South-Central Virginia markets that include Richmond. The majority of the Company’s loan portfolio consists of residential and commercial real estate loans. A substantial portion of its debtors’ ability to honor their contracts and the Company’s ability to realize the value of any underlying collateral, if needed, is influenced by the economic conditions in this market. As of September 30, 2011, there were no concentrations of commercial loans related to any individual purpose that was in excess of 6.38% of total loans.

Non-accrual and Past Due Loans

All loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due in accordance with the contractual terms of the underlying loan agreement. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Aging and nonaccrual loans, by individual loan class, as of September 30, 2011 and December 31, 2010 was as follows:

At September 30, 2011	Loans 30 – 89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or More Days Loans 1		Nonaccrual Loans 1
							(In thousands)
Residential Real Estate
1-4 family	$	1,557	$	1,081	$	2,638	$	84,331	$	86,969	$	60	$	1,202
Home equity		-		49		49		12,409		12,458		-		49
Commercial Real Estate
Owner occupied		-		688		688		23,178		23,866				689
Non-owner occupied		191		479		670		28,706		29,376				479
Farmland		-		7		7		11,142		11,149		-		7
Construction		179		142		321		14,279		14,600		-		142
Total real estate		1,927		2,446		4,373		174,045		178,418		60		2,568
Commercial and industrial		300		43		343		12,170		12,513		-		133
Consumer		178		17		195		8,699		8,894		-		18

Total loans	$	2,405	$	2,506	$	4,911	$	194,914	$	199,825	$	60	$	2,719

At December 31, 2010

Loans

30 –

89 Days

Past Due

Loans

90 or More

Days

Past Due

Total

Past Due

Loans

Current

Loans

Total

Loans

Accruing

Loans

90 or More Days

Loans 1

Nonaccrual

Loans 1

(In thousands)

Residential Real Estate

1-4 family	$	3,347	$	789	$	4,136	$	88,384	$	92,520	$	28	$	1,788
Home equity		30		49		79		10,737		10,816		-		49
Commercial Real Estate
Owner occupied		60		636		696		23,188		23,884				637
Non-owner occupied		58		815		873		27,724		28,597				815
Farmland		-		11		11		8,776		8,787		-		10
Construction		195		182		377		12,566		12,943		-		182
Total real estate		3,690		2,482		6,172		171,375		177,547		28		3,481
Commercial and industrial		320		316		636		13,864		14,500		89		302
Consumer		96		38		134		10,502		10,636		-		53

Total loans	$	4,106	$	2,836	$	6,942	$	195,741	$	202,683	$	117	$	3,836

1Accruing loans 90 or more days past due and nonaccrual loans are included in the aging and current loan columns of the tables based on their contractual payments, above.

Impaired Loans

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, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, which represents either the present value of estimated future cash flows using the loans existing rate or the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Impaired loans, by class, as of September 30, 2011 and December 31, 2010 are shown in the tables below:

At September 30, 2011

Loans

Unpaid

Contractual

Principal

Balance

Total

Recorded

Investment

Allowance

Average

Recorded Investment

Interest

Income

Recognized

With no related allowance

Residential Real Estate:

(In thousands)

1-4 family	$	204	$	180	$	-	$	181	$	10
Home equity		301		301		-		300		7
Commercial Real Estate:
Owner occupied		145		94		-		103		8
Non-owner occupied		-		-		-		-		-
Farmland		1,375		1,375		-		1,375		77
Construction		266		228		-		262		13
Commercial and industrial		653		120		-		680		41
Consumer installment		-		-		-		-		-
Total loans	$	2,944	$	2,298	$	-	$	2,901	$	156
With an allowance recorded
Residential Real Estate:
1-4 family	$	291	$	283	$	120	$	841	$	43
Home equity		-		-		-		-		-
Commercial Real Estate:
Owner occupied		1,117		1,068		73		1,075		63
Non-owner occupied		-		-		-		-		-
Farmland		-		-		-				-
Construction		72		72		24		72		5
Commercial and industrial		97		108		31		96		4
Consumer installment		-		-		-		-		-
Total loans	$	1,577	$	1,531	$	248	$	2,084	$	115
Total impaired loans1
Residential Real Estate:
1-4 family	$	495	$	463	$	120	$	1,022	$	53
Home equity		301		301		-		300		7
Commercial Real Estate:
Owner occupied		1,262		1,162		73		1,178		71
Non-owner occupied		-		-		-		-		-
Farmland		1,375		1,375		-		1,375		77
Construction		338		300		24		334		18
Commercial and industrial		750		228		31		776		45
Consumer installment		-		-		-		-		-
Total loans	$	4,521	$	3,829	$	248	$	4,985	$	271

At December 31, 2010	Loans Unpaid Contractual Principal Balance		Total Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance
Residential Real Estate:	(In thousands)
1-4 family	$	-	$	-	$	-	$	-	$	-
Home equity		-		-		-		-		-
Commercial Real Estate:
Owner occupied		881		825		-		850		66
Non-owner occupied		1,386		1,386		-		1,390		97
Farmland		1,546		1,546		-		2,081		145
Construction		412		409		-		415		27
Commercial and industrial		835		303		-		914		70
Consumer installment		-		-		-		-		-
Total loans	$	5,060	$	4,469	$	-	$	5,650	$	405
With an allowance recorded
Residential Real Estate:
1-4 family	$	653	$	649	$	113	$	640	$	44
Home equity		-		-		-		-		-
Commercial Real Estate:
Owner occupied		669		637		56		639		30
Non-owner occupied		-		-		-		-		-
Farmland		-		-		-		-		-
Construction		63		63		24		63		4
Commercial and industrial		121		90		45		100		6
Consumer installment		8		8		1		8		1
Total loans	$	1,514	$	1,447	$	239	$	1,450	$	85
Total impaired loans1
Residential Real Estate:
1-4 family	$	653	$	649	$	113	$	640	$	44
Home equity		-		-		-		-		-
Commercial Real Estate:
Owner occupied		1,550		1,462		56		1,489		96
Non-owner occupied		1,386		1,386		-		1,390		97
Farmland		1,546		1,546		-		2,081		145
Construction		475		472		24		478		31
Commercial and industrial		956		393		45		1,014		76
Consumer installment		8		8		1		8		1
Total loans	$	6,574	$	5,916	$	239	$	7,100	$	490

1 Troubled Debt Restructurings included in the impaired loan tables above at September 30, 2011
and December 31, 2010 totaled $1.889 million and $1.720 million respectively.

Troubled Debt Restructurings

As a result of adopting the amendments in ASU 2011-02 on July 1, 2011, the Company reassessed all loans that were renewed on or after January 1, 2011 for identification as a troubled debt restructuring (“TDR”). The Company identified as troubled debt restructurings certain loans for which impairment had previously been measured collectively within their homogeneous pool. Upon identifying those loans as TDRs, the Company identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective evaluation of the impairment measurement guidance for those receivables newly identified as impaired. The impact of this new guidance did not have a material impact on the Company’s non-performing assets, allowance for loan losses, earnings, or capital.

The Company considers troubled debt restructurings to be impaired loans. A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider. Included in the impaired loan disclosure above is a loan for $302 thousand that is considered to be troubled debt restructurings as of September 30, 2011. This loan was granted a payment concession whereas the required principal pay downs were suspended and the customer was paying interest-only. Any loan that is considered to be a TDR is specifically evaluated for impairment in accordance with the Company’s allowance for loan loss methodology.

The following table provides a summary of modified loans that continue to accrue interest under the terms of the restructuring agreement, which are considered to be performing as of September 30, 2011 (dollars in thousands):

	Three Months Ended			Nine Months Ended
	September 30, 2011			September 30, 2011

		Pre	Post		Pre	Post
	Number of	Modification	Modification	Number of	Modification	Modification
	Loans	Balance	Balance	Loans	Balance	Balance
Real estate loans:
1-4 family	-	$ -	$ -	-	$ -	$ -
Home equity	-	-	-	1	300	302
Commercial real estate loans:
Owner occupied	-	-	-	-	-	-
Non-owner occupied	-	-	-	-	-	-
Farmland	-	-	-	-	-	-
Construction	-	-	-	-	-	-
Total real estate loans	-	$ -	$ -	1	$ 300	$ 302

Commercial and industrial	-	-	-	-	-	-
Consumer	-	-	-	-	-	-

Total loans	-	$ -	$ -	1	$ 300	$ 302

Troubled Debt Restructurings, by class that were modified during the last twelve months that have gone into default under the restructured loan terms during the last three and nine months ended September 30, 2011:


	Three months ended		Nine months ended
	September 30, 2011		September 30, 2011
	Number		Number
	of Loans	Defaulted Balance	of Loans	Defaulted Balance
Real estate loans:
1-4 family	-	$ -	-	$ -
Home equity	-	-	-	-
Commercial real estate loans:
Owner occupied	-	-	-	-
Non-owner occupied	1	1,337	1	1,337
Farmland	-	-	-	-
Construction	-	-	-	-
Total real estate loans	1	$ 1,337	1	$ 1,337

Commercial and industrial	-	-	-	-
Consumer	-	-	-	-

Total loans	1	$ 1,337	-	$ 1,337

The restructured loan, shown in the TDR default table above was originally granted a payment concession that provided for monthly, interest-only payments. The loan became an insubstance foreclosure at September 30, 2011.

The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 risk grades is as follows:

Grade 1 – “Excellent” This grade includes loans to borrowers with superior capacity to pay interest and principal. Foreseeable economic changes are unlikely to impair the borrowers’ strength. Typically, borrowers have an excellent organizational structure in place with highly regarded and experienced management. Stable business, relatively unaffected by business, credit, or product cycles, business is significant in its market and has a well-defined market share. Borrower will have ready access to both public debt and equity markets under most conditions. Collateral is highly liquid, substantial margins are maintained, and primary/secondary sources of repayment are excellent.

Grade 2 – “Good” This grade includes loans to borrowers that represent a solid, demonstrated capacity to pay interest and principal, but material downturns in economic conditions may impact the borrowers’ financial condition. Typically, borrowers exhibit low levels of leverage and the overall capitalization of the company is deemed satisfactory. Trends for revenue, core profitability and financial ratios are consistently above average with industry peers. Cash flow adequately covers dividends/withdrawals, and historic debt service in excess of 1.5 times. Collateral coverage is greater than 2.0 times or less than 50% loan-to-value ratio. Borrower has a stable, well-regarded and qualified management team in place, along with strong financial controls being evident. Normal industry stability, sales and profits are affected by business, credit or product cycles. Market share is stable. Borrower has the capability to refinance with another institution.

Grade 3 – “Standard” This grade includes loans to borrowers which have historically demonstrated an above adequate capacity to repay forecasted principal and interest charges; with debt service coverage of 1.20 times based on at least two years of historical earnings. Borrowers have inherent, definable weaknesses; however the weaknesses are not necessarily uncommon to a particular business, loan type or industry. Changes in economic circumstances could have non-material immediate repercussions on the borrowers’ financial condition. Collateral support is deemed to be satisfactory based on appropriate discount factoring to allow a recovery sufficient to pay-off the debt. Collateral could be reasonably collected and/or liquidated in the general market. Additional collateral may be deemed an abundance of caution. Earnings are generally positive, subject to influences of current market conditions and distributions are reasonable in relation to the overall financial picture of the company. Guarantor support is deemed to be marginal as evidenced by personal assets, which probably could not support the business in full, if needed.

Grade 4 – “Acceptable” This grade includes loans to borrowers that will have inherent, definable weaknesses, however these weaknesses are not necessarily uncommon to a particular business, loan type, or industry. Economic changes could have negative repercussions on the financial condition. Borrowers overall financial position would indicate financing in the market is feasible, at rates and terms typical of current market conditions. Debt service coverage is deemed acceptable at 1.00 to 1.19 times on a combined basis for at least two years of historical earnings. Borrowers exhibit moderately high to high levels of leverage as noted against policy and Risk Management Association industry averages. Tangible net worth is marginally positive or even showing signs of a deficit net worth. Collateral support is deemed to be acceptable or even marginal, but not strong based on appropriate discounting, asset quality may be questionable given specific nature of assets, and often secondary non-business assets are required. Earnings are marginally positive or a trend of negative earnings is identified and distributions are considered to be in excess of reasonableness. Guarantor support is deemed to be marginal as evidenced by personal assets, which probably could not support the business in full if needed. Repayment history also shows a discernable level of delinquent payments.

Grade 5 – This grade includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near term.

Grade 6 – This grade is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This grade is intended to be temporary and includes loans to borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation.

Grade 7 – This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest may or may not have been stopped. This grade also includes loans where interest is more than 120 days past due and not fully secured and loans where a specific valuation allowance may be necessary, but does not exceed 30% of the principal balance.

Grade 8 – This grade includes “Doubtful” loans in accordance with regulatory guidelines. Such loans are placed on non-accrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance in excess of 30% of the principal balance.

Grade 9 – This grade includes “Loss” loans in accordance with regulatory guidelines. Such loans are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be repaid, nor does it in any way imply that there has been a forgiveness of debt.

The following tables present credit quality by loan class as of September 30, 2011 and December 31, 2010.

Special

At September 30, 2011

Pass

Watch

Mention

Substandard

Doubtful

Loss

Total

Residential Real Estate:	(In thousands)
1-4 family	$	77,987	$	4,663	$	1,652	$	2,667	$	-	$	-	$	86,969
Home equity		11,591		472		44		351		-		-		12,458
Commercial Real Estate:
Owner occupied		20,941		1,030		1,206		689		-		-		23,866
Non-owner occupied		27,109		1,506		288		473		-		-		29,376
Farmland		8,753		524		493		1,379		-		-		11,149
Construction		13,495		404		347		282		72		-		14,600
Total real estate loans		159,876		8,599		4,030		5,841		72		-		178,418
Commercial and industrial		9,642		1,463		1,180		228		-		-		12,513
Consumer		8,820		23		6		45		-		-		8,894

Total loans	$	178,338	$	10,085	$	5,216	$	6,114	$	72	$	-	$	199,825

Special

At December 31, 2010

Pass

Watch

Mention

Substandard

Doubtful

Loss

Total

Residential Real Estate:	(In thousands)
1-4 family	$	86,147	$	1,428	$	1,233	$	3,662	$	50	$	-	$	92,520
Home equity		10,219		205		43		349		-		-		10,816
Commercial Real Estate:
Owner occupied		21,410		1,058		759		536		121		-		23,884
Non-owner occupied		25,438		848		1,438		873		-		-		28,597
Farmland		7,230		-		-		1,557		-		-		8,787
Construction		12,236		72		163		472		-		-		12,943
Total real estate loans		162,680		3,611		3,636		7,449		171		-		177,547
Commercial and industrial		11,491		2,505		111		319		74		-		14,500
Consumer		10,524		12		12		88		-		-		10,636

Total loans	$	184,695	$	6,128	$	3,759	$	7,856	$	245	$	-	$	202,683

Note 4. Allowance for Loan Losses

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by loan segment and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for possible loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The Company's allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other qualitative risk factors both internal and external to the Company. Provisions for loan losses increase the amount of the allowance based upon the above considerations. Amounts computed to produce an appropriate allowance amount in one period can subsequently be affected by any recoveries of previously charged-off amounts, which are credited to the allowance, and by the reduction of overall loan balances from one period to another. These events, as well as others, can result in producing an "unallocated reserve component" at the end of any period, which is not attributable to any specific loan segment.

The allowance established for probable losses on specific loans is based on a regular analysis and evaluation of problem loans. Commercial loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 7 or higher, the loan is analyzed to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for possible loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

The historical component is calculated based on the historical charge-off experience of loan segments. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similar groups of residential real estate loans, commercial real estate loans, commercial and industrial loans, and consumer loans. The methodology employed to determine the historical loss ratio takes into consideration the net charge-offs for the most recent 36-months plus any specific reserve that are in place against individually impaired loans, by loan segment, at the time of the ratio calculation.

The general reserve component is based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Company’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component will have a certain percentage assigned to it and this percent will be applied against the specific loan segments that are impacted by the various factors, mentioned above. The results of the general component are then included to determine an appropriate valuation allowance.

Loans that are either partially or totally identified as losses by management, internal loan review and/or bank examiners are charged-off. Certain unsecured consumer loan accounts are charged-off automatically based on regulatory requirements.

(The remainder of this page is blank, intentionally.)

The following tables detail activity in the allowance for possible loan losses by portfolio segment for the nine months ended September 30, 2011 and for the year ended December 31, 2010. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

	Residential			Commercial							Commercial
	Real			Real							and
September 30, 2011	Estate			Estate		Farmland		Construction			Industrial			Consumer			Unallocated		Total

Beginning balance	$	876		$	535	$	25	$	203		$	224		$	56		$	249	$	2,168
Provision for possible losses		222			7		3		65			33			71			124		525
Charge-offs		(257	)		-		-		(31	)		(25	)		(75	)		-		(388	)
Recoveries		36			-		-		-			9			14			-		59
Net charge-offs		(221	)		-		-		(31	)		(16	)		(61	)		-		(329	)
Ending balance	$	877		$	542	$	28	$	237		$	241		$	66		$	373	$	2,364

Period-end amount allocated to:
Loans individually evaluated
for impairment	$	120		$	73	$	-	$	24		$	31		$	-		$	-	$	248
Loans collectively evaluated
for impairment		757			469		28		213			210			66			373		2,116
Ending balance	$	877		$	542	$	28	$	237		$	241		$	66		$	373	$	2,364

Total Loans	$	99,427		$	53,242	$	11,149	$	14,600		$	12,513		$	8,894		$	-	$	199,825

Loans individually evaluated
for impairment		764			1,162		1,375		301			228			-			-		3,830
Loans collectively evaluated
for impairment		98,663			52,080		9,774		14,299			12,285			8,894			-		195,995

	Residential Real Estate			Commercial Real Estate			Farmland			Construction			Commercial and Industrial			Consumer			Unallocated			Total
December 31, 2010
Beginning balance	$	686		$	503		$	33		$	205		$	823		$	97		$	326		$	2,673
Provision for possible losses		566			112			(8	)		280			(111	)		(12	)		(77	)		750
Charge-offs		(381	)		(80	)		-			(293	)		(488	)		(50	)		-			(1,292	)
Recoveries		5			-			-			11			-			21			-			37
Net charge-offs		(376	)		(80	)		-			(282	)		(488	)		(29	)		-			(1,255	)
Ending balance	$	876		$	535		$	25		$	203		$	224		$	56		$	249		$	2,168

Period-end amount allocated to:
Loans individually evaluated
for impairment	$	113		$	56		$	-		$	24		$	45		$	1		$	-		$	239
Loans collectively evaluated
for impairment		763			479			25			179			179			55			249			1,929
Ending balance	$	876		$	535		$	25		$	203		$	224		$	56		$	249		$	2,168

Total Loans	$	103,336		$	52,481		$	8,787		$	12,943		$	14,500		$	10,636		$	-		$	202,683

Loans individually evaluated
for impairment		649			2,848			1,546			472			393			8			-			5,916
Loans collectively evaluated
for impairment		102,687			49,633			7,241			12,471			14,107			10,628			-			196,767

A further discussion of the Company’s Allowance for Loan Losses appears later in this report in the Management Discussion and Analysis segment under the section titled, “Financial Condition and Results of Operations.”

Note 5. Other Real Estate Owned

The tables below present a summary of the activity related to other real estate owned (dollars in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2011			2010			2011			2010
Balance at beginning of period	$	3,557		$	1,448		$	3,425		$	1,073
Additions		3,382			657			3,676			1,133
Sales		(87	)		(120	)		(222	)		(206	)
Direct write-downs		(8	)		(61	)		(35	)		(76	)
Balance at end of period	$	6,844		$	1,924		$	6,844		$	1,924

Operating expenses, net of
rental income	$	35		$	30		$	68		$	63

Direct write-downs of individual properties are a charge against earnings in the periods, as shown above.

Note 6. FHLB Advances

At September 30, 2011 and December 31, 2010, the Company had outstanding advances totaling $5 million with the Federal Home Loan Bank of Atlanta, detailed below.

	September 30,		December 31,
	2011		2010
	(Dollars in thousands)
Five-year / two-year convertible advance at 2.47%
maturing February 5, 2013	$	5,000	$	5,000

On October 11, 2011, management concluded the refinancing of the above advance into a 2-year, fixed rate advance at an interest rate of 1.93%. This new advance will reduce the borrowing costs by 54 basis points and extend the maturity from February 5, 2013 to October 11, 2013. The Bank did incur a prepayment penalty for the early termination of the convertible advance. The penalty is imbedded into the new fixed rate advance, since the terms of the debt were not substantially different and the cash flow effects on a present value basis was less than 10%, the penalty is imbedded into the new fixed rate advance.

Note 7. Other Borrowings

Other borrowings consist of $6.3 million and $5.1 million in overnight repurchase agreements as of September 30, 2011 and December 31, 2010, respectively. These balances are from deposit balances outstanding in the Investment Sweeps Account product, which is an overnight repurchase agreement product, not insured by the FDIC, but collateralized by the Bank with securities of the US Government and Federal Agencies. This product is offered to commercial customers only.

Note 8. Earnings Per Share

The weighted average number of shares used in computing earnings per share was 2,340,193 shares for the three months ended September 30, 2011 and 2,364,252 shares for the three months ended September 30, 2010, 2,345,798 for the nine months ended September 30, 2011 and 2,366,025 shares for the nine months ended September 30, 2010. The Company has no potentially dilutive stock options or stock warrants outstanding.

Note 9. Defined Benefit Pension Plan

The components of Net Periodic Benefit Cost for the three and nine months ended September 30, 2011 and 2010 were as follows:

	Three Months Ended							Nine Months Ended
		September 30,						September 30,
(Dollars in thousands)		2011			2010			2011			2010

Service cost		$	75		$	69		$	225		$	207
Interest Cost			71			66			213			198
Expected return on plan assets			(81	)		(73	)		(243	)		(219	)
Amortization of prior service cost			(24	)		(24	)		(72	)		(72	)
Amortization of net actuarial loss			22			19			66			57
Net periodic benefit cost		$	63		$	57		$	189		$	171

The pension plan has a fiscal year ending September 30, providing the Company the flexibility as to the plan year in which it makes pension plan contributions. The defined benefit pension liability is computed at every December 31, only. The Company made its required 2011 fiscal year contribution to the pension plan in December 2010 in the amount of $202,283. The Company anticipates making the 2011 contribution by December 31, 2011. The Company estimates this contribution to be approximately $250,000.

Note 10. Fair Value Measurements

Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Accounting Standards Codification 820 Fair Value Measurements and Disclosures excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The Company in estimating fair value disclosures for financial instruments used the following methods and assumptions:

Cash and cash equivalents: The carrying amounts of cash and short-term instruments approximate fair values.

Securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Loans: For variable-rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one-to-four family residential) and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses based upon interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

Bank owned life insurance: The carrying amounts of bank owned life insurance approximate fair value.

Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and certain types of money market accounts) are, by definition, equal to the amounts payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Borrowings: The carrying amounts of federal funds purchased and other short term borrowings maturing within 90 days approximate their fair values. Fair values for Federal Home Loan Bank advances are estimated based upon current advance rates for the remaining term of the advance.

Accrued interest: The carrying amounts of accrued interest approximate fair value.

Off-balance-sheet instruments: Fair values for off-balance-sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. At June 30, 2011 and December 31, 2010, the fair value of loan commitments and standby letters of credit was deemed to be immaterial.

The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows:

	September 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
			(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	22,293	$	22,293	$	22,744	$	22,744
Securities available for sale		82,601		82,601		82,745		82,745
Restricted securities		972		972		1,079		1,079
Loans, net		197,461		211,199		200,515		215,132
Accrued interest receivable		1,584		1,584		1,816		1,816
Bank owned life insurance		8,372		8,372		8,150		8,150

Financial liabilities:
Deposits	$	271,892	$	273,423	$	277,988	$	279,598
Other borrowings		11,265		11,262		10,149		10,346
Accrued interest payable		705		705		886		886

The Company assumes interest rate risk as part of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent possible to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

Accounting Standards Codification 820 Fair Value Measurements and Disclosures defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follow:

Level 1

inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2

inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3

inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The following tables present the balances of financial assets measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010.

			Fair Value Measurements at September 30, 2011 Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
	Balance as of		Identical		Observable		Unobservable
	September 30,		Assets		Inputs		Inputs
Description	2011		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Securities available
for sale
U.S. Government
and federal agency	$	10,548	$	-	$	10,548	$	-
State and municipal		30,094		-		30,094		-
Agency mortgage-backed		39,506		-		39,506		-
Non-agency mortgage-backed		1,633		-		1,633		-
Corporate		820		-		820		-


			Fair Value Measurements at December 31, 2010 Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Signigicant
	Balance as of		Identical		Observable		Unobservable
	December 31,		Assets		Inputs		Inputs
Description		2010	(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Securities available
for sale
U.S. Government
and federal agency	$	16,706	$	-	$	16,706	$	-
State and municipal		28,704		-		28,704		-
Agency mortgage-backed		34,259		-		34,259		-
Non-agency mortgage-backed		2,275		-		2,275		-
Corporate		801		-		801		-

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available for sale:

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

Accounting principles permit the measurement of certain assets at fair value on a nonrecurring basis. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis during the period:

			Carrying value at September 30, 2011
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
	Balance as of		Identical		Observable		Unobservable
	September 30,		Assets		Inputs		Inputs
Description	2011		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired Loans, net of	$	1,283	$	-	$	1,283	$	-
valuation allowance
Other real estate owned	$	6,844	$	-	$	4,551	$	2,293

			Carrying value at December 31, 2010
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
	Balance as of		Identical		Observable		Unobservable
	December 31,		Assets		Inputs		Inputs
Description	2010		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired Loans, net of	$	1,208	$	-	$	1,043	$	165
valuation allowance
Other real estate owned	$	3,425	$	-	$	2,925	$	500

Impaired loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2).

However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned

The fair values are estimated based upon recent appraisal values of the property less costs to sell the property. Certain inputs used in appraisals are not always observable, and therefore Other Real Estate Owned may be categorized as Level 3. When inputs in appraisals are observable, they are classified as Level 2. The classification methodology is similar to that described above for impaired loans.

Note 11. Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20, “Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into an entity’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures, were required for periods beginning on or after December 15, 2010. The Company has included the required disclosures in its consolidated financial statements.

In December 2010, the FASB issued ASU 2010-28, “Intangible – Goodwill and Other (Topic 350) – When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805) – Disclosure of Supplementary Pro Forma Information for Business Combinations.” The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The Company will adopt this new guidance should it enter into a business combination in the future.

The Securities Exchange Commission (SEC) issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting.” The rule requires companies to submit financial statements in extensible business reporting language (XBRL) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011. The Company filed its quarterly financial statements in the XBRL format with the filing of Form 10-Q for June 30, 2011.

In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty. The amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company has included the required disclosure in its consolidated financial statement notes.

In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2011-03 will have on its consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU is the result of joint efforts by the FASB and IASB to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and IFRSs. The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. The Company is currently assessing the impact that ASU 2011-04 will have on its consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share. The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. The Company is currently assessing the impact that ASU 2011-05 will have on its consolidated financial statements.

In August 2011, the SEC issued Final Rule No. 33-9250, “Technical Amendments to Commission Rules and Forms related to the FASB’s Accounting Standards Codification.” The SEC has adopted technical amendments to various rules and forms under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940. These revisions were necessary to conform to the FASB Accounting Standards Codification. The technical amendments include revision of certain rules in Regulation S-X, certain items in Regulation S-K, and various rules and forms prescribed under the Securities Act, Exchange Act and Investment Company Act. The Release was effective as of August 12,

2011. The adoption of the release did not have a material impact on the Company’s consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, “Intangible – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment.” The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The Company is currently assessing the impact that ASU 2011-08 will have on its consolidated financial statements.

(The remainder of this page is blank, intentionally.)

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

Management’s discussion and analysis provides the reader with additional information that is helpful in gaining a greater understanding of the Company’s operating results, liquidity, capital resources and financial condition. This discussion and analysis should be read in conjunction with the Company’s Consolidated Financial Statements and Notes to the Interim Consolidated Financial Statements included in this quarterly report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. Results of operations for the three months and nine months ended September 30, 2011 are not necessarily indicative of the results for the year ending December 31, 2011 or any future period.

Forward-Looking Statements and Factors that Could Affect Future Results

Certain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in the Company’s future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Company that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company’s management or Board of Directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

·	changes in general economic and business conditions in our market area;

·	level of market interest rates;

·	risks inherent in making loans such as repayment risks and fluctuating collateral values;

·	Government intervention in the U.S. financial system;

·	The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, and securities) with which the Company and the Bank must comply;

·	the successful management of interest rate risk; including changes in interest rates and interest rate policies;

·	the value of securities held in the Company’s investment portfolio;

·	successfully manage the Company’s growth and implement its growth strategies;

·	rely on the Company’s Management team, including its ability to attract and retain key personnel;

·	continue to attract low cost core deposits to fund asset growth;

·	compete with other banks and financial institutions and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;

·	the ability to rely on third party vendors that perform critical services for the Company;

·	technology utilized by the Company;

·	maintain expense controls and asset qualities as new branches are opened or acquired;

·	demand, development and acceptance of new products and services;

·	The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;

·	maintain capital levels adequate to support the Company’s growth; and

·	plan for changing trends in customer profiles and behavior.

Because of these uncertainties, actual future results may be materially different from the results indicated by these forward looking statements. In addition, past results of operations do not necessarily indicate future results.

CRITICAL ACCOUNTING POLICIES

General

The financial condition and results of operations presented in the Consolidated Financial Statements, accompanying Notes to Interim Consolidated Financial Statements and Management's discussion and analysis are, to a large degree, dependent upon the accounting and reporting policies of the Company. The Company’s accounting and reporting polices are in accordance with generally accepted accounting principles within the United States of America and with general practices within the banking industry. The selection and application of these accounting policies by Management involve judgments, estimates, and uncertainties that are susceptible to change.

Presented below is a discussion of those accounting policies that Management believes are the most important to the portrayal and understanding of the Company’s financial condition and results of operations. The Critical Accounting Policies require Management's most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, materially different financial condition or results of operations is a reasonable likelihood.

Allowance for Loan Losses

The Company monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. The Company maintains policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance that the systems are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; the loan grading system; and the general economic environment.

The Company evaluates various loans individually for impairment as required by ASC 310 Receivables. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by Management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.

For loans without individual measures of impairment, the Company makes estimates of losses for groups of loans as required by Accounting Standards Codification 450-20 Loss Contingencies. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

The allowance for loan losses is determined by using estimates of historical losses by category for all loans; with the exception of “criticized loans”. Criticized loans are determined as a result of management evaluating and risk grading individual delinquent loans. Management may assign an estimated amount of reserve for criticized loans if there is the likelihood that not all of the loan amounts due will be collected

based upon the most current information concerning the financial condition of the debtors and guarantors as well as the current evaluations of collateral value. The evaluation of criticized loans as to the need and adequacy of any reserves is performed at least quarterly or more frequently if conditions affecting certain loans should change. The impact of environmental factors such as the local and regional economic conditions, attributes of certain loan categories and other relevant matters are considered in estimating the allowance for loan losses and these factors are reviewed at least quarterly in order to capture any indications of worsening or improving environmental factors.

The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of loan losses. This estimate of losses is compared to the allowance for loan losses of the Company as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses.

The Company recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which the amount may be material to the consolidated financial statements.

For additional information regarding critical accounting policies, refer to Note 1 - Summary of Significant Accounting Policies in the notes to consolidated financial statements and the sections captioned “Application of Critical Accounting Policies and Accounting Estimates” and “Allowance and Provision for Possible Loan Losses” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the 2010 Form 10-K. There have been no significant changes in the Company’s application of critical accounting policies related to the allowance for possible loan losses since December 31, 2010.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Balance Sheet

Total assets for the Company at September 30, 2011 were $328.8 million compared to $330.5 million at December 31, 2010, representing a decrease of $1.7 million or 0.50%.

Total net loans at September 30, 2011 were $197.5 million, a decrease of $3.0 million from the December 31, 2010 amount of $200.5 million. For the three months ended September 30, 2011, $9.4 million in loans were originated, an increase of $2.0 million or 27.0% as compared to $7.4 million for the three months ended September 30, 2010. Loan originations in the Bank’s markets have generally been at lower levels as compared to when the economy was more robust. For 2011, quarterly loan originations have generally been steady at $10.9 million for the quarter ended March 31, 2011, $9.9 million for the quarter ended June 30, 2011 and $9.4 million for the quarter ended September 30, 2011. Year-to-date comparisons are also positive for 2011 with a total of $30.2 million in new loan originations as compared to $25.3 million for 2010; an increase of $4.9 million or 19.4%. Management has been ready and willing to lend and the Bank has maintained a strong capital position during this economic crisis. Consumers are approaching any new lending opportunities cautiously, often choosing to refinance and consolidate existing loan balances to take advantage of the lower rate environment. Loan opportunities to businesses are similarly difficult to obtain given the business owners’ uncertainty regarding the strength of the regional economy and a reluctance to be highly leveraged in addition to the general lack of high quality borrowers.

Gross loan balances at September 30, 2011 as compared to December 31, 2010 indicated that during the first nine months of 2011 loans secured by real estate increased $871 thousand or .50% and this was partially offset by a decrease in consumer, commercial and agricultural loans totaling $3.7 million or 14.8% decrease from December 31, 2010. Real estate secured loans totaled $178.4 million or 89.3% of the loan portfolio at September 30, 2011 as compared to $177.5 million and 87.67% of the loan portfolio at December 31, 2010. The non-real estate segments of the loan portfolio include agricultural, tax-exempt municipal, commercial and consumer loans. At September 30, 2011 the totals for each segment were $329 thousand, $300 thousand, $11.9 million and $8.9 million, respectively.

Management is maintaining its standard loan pricing methodology and underwriting standards during these difficult economic times. We believe that refusing to relax these standards is critical for maintaining loan quality, even though this strategy may result in a slower growth rate of the loan portfolio. It is Management’s goal for the Bank to continue to be a source of credit for creditworthy commercial businesses, farmers, and consumers during this difficult economic environment. Gross loans as a percent of total assets were 60.8% at September 30, 2011, as compared to 61.3% at December 31, 2010.

Available for sale securities at September 30, 2011 totaled $82.6 million or 25.1% of total assets, which is a decrease of $144 thousand from $82.7 million at December 31, 2010. The investment portfolio experienced $10.6 million in securities that were called by their issuer during the three months ended September 30, 2011, as compared to a year-to-date period amount of issuer calls totaled $18.1 million. Management is diligent at reinvesting proceeds from called securities, however, securities that meet the criteria established by management with regards to credit risk and interest rate risk are not always readily available. At September 30, 2011 the investment portfolio had an unrealized gain of $1.8 million net of Federal income taxes, which is an increase of $1.9 million when compared to an unrealized loss of $135 thousand, net of Federal income taxes, at December 31, 2010. Management’s current strategy for the investment portfolio is to focus investment purchases so that investment maturities will be laddered over a period of time when interest rates are rising. Current economists’ forecasts are not anticipating a significant change in market interest rates for the remainder of 2011.

During the third quarter of 2011, the consolidated investment portfolio had $10.6 million in securities that were called or approximately 12.6% of the consolidated investment portfolio’s average balance of $84.1 million for the third quarter of 2011. This amount represents an increase of $5.75 million from the $4.85 million of called securities in the second quarter of 2011 and it is an increase of $7.5 million from the $3.1 million in called securities for the first quarter of 2011.

The availability of securities with the credit grade and duration preferred by management continue to be in short supply. Management’s strategy is to re-invest the called securities without taking on excessive duration risk; while maintaining a diverse, high quality investment portfolio for the Company and the Bank. While the strategy is being successfully implemented, the yield of the recently purchased securities is lower than the yield of the securities that were called. The expectations are that the yield on the investment portfolio may decline in the near-term, and management does expect a decline in the overall portfolio yield to be acceptable given the forward-looking strategy of having securities mature as interest rates rise in the future. The investment securities of both the Company and the Bank at September 30, 2011 were held as “available for sale”.

Restricted securities totaled $972 thousand at September 30, 2011 and represent equity investments held by the Bank in the Federal Reserve Bank of Richmond, the Federal Home Loan Bank of Atlanta and the Community Bankers’ Bank. At December 31, 2010, the restricted securities totaled $1.079 million. The $107 thousand decline in restricted securities, as of September 30, 2011, was the result of a reduction in the holdings of Federal Home Loan Bank of Atlanta stock.

Interest bearing deposits in other banks decreased $20 thousand at September 30, 2011 to $1.837 million as compared to $1.857 million at December 31, 2010. Federal funds sold decreased $1.9 million to $13.6 million at September 30, 2011 from $15.5 million at December 31, 2010. The Company’s liquidity on hand at September 30, 2011 as represented by cash, due from banks, interest bearing deposits in banks and federal funds sold was $22.3 million or 6.8% of total assets which is $400 thousand lower than $22.7 million or 6.9% of total assets at December 31, 2010.

Allowance for Loan Losses

The allowance for loan losses at September 30, 2011 was $2.364 million compared to $2.168 million at December 31, 2010. The allowance for loan losses, as a percentage of total outstanding loans, increased to 1.18% at September 30, 2011 from 1.07% at December 31, 2010. The Company charged off $38 thousand in loans, recovered $39 thousand from previous write-offs, and provided an additional $225 thousand to the allowance during the three months ended September 30, 2011.

The ratio of net charge-offs to average loans, net of deferred fees was -0.20% for the three months ended September 30, 2011 and this compares to 0.38% for the same period in 2010. For the three months ended September 30, 2011, $36 thousand of the $38 thousand in charge-offs for the period were real estate secured loans and $2 thousand in consumer loans were charged off. This compares to the three months ended September 30, 2010, when a total of $68 thousand in loans were charged off and consisted of the following: $29 thousand in real estate-secured loans, $15 thousand in commercial loans,

and $24 thousand in consumer loans. For the first nine months of 2011, total charge-offs were $389 thousand with $288 thousand or 74.3% of the total charge-offs related to loans secured by real estate, $25 thousand or 6.4% of the total charge-offs were for commercial loans and $75 thousand or 19.3% were related to consumer loan charge-offs. Management anticipates an increase in charge-offs for the remainder of 2011. The majority of the charge-offs are expected to be related to loans secured by real estate.

Management’s methodology for estimating the appropriate level of the allowance for loan losses is based upon bank regulatory guidance and generally accepted accounting principles for maintaining adequate reserves against loan losses. Periodically, management does classify certain loans and provides specific reserves for these loans when it is determined that negative conditions affecting the customer have occurred and will expose the Bank to a potential loss on a given loan(s). Management continues to work aggressively with debtors to resolve delinquencies and mitigate potential repossession or foreclosure of collateral.

Management’s calculation of the allowance for loan losses consists of three main segments, 1- estimating future loan losses by loan category using the Bank’s historical average net losses for each category, 2- the impact of various environmental factors such as the decline in real estate value, unemployment, the volume of past due loans, etc., and 3- the determination of criticized loans, where classified/impaired loans are individually evaluated for probable loss based upon what the Bank could recover from liquidating collateral and from individual guarantors on the loan. Loans classified as loss, doubtful or substandard are adequately reserved for at the report date and are not expected to have a material impact beyond what has been reserved. Specific reserves for impaired loans will be adjusted should material changes occur to a loan’s collateral value or if there is any further deterioration of the credit. Management is closely monitoring any potential indication of credit deterioration, beyond the classified loans currently reported.

The allowance for loan losses-to-total loans ratio increased from 1.07% of gross loans at December 31, 2010 to 1.18% of gross loans at September 30, 2011. The change in the ratio, of 11 basis points, is primarily the result of a higher quarterly provision for loan losses of $225 thousand and a decrease of $2.9 million in gross loan balances at September 30, 2011 as compared to December 31, 2010. The third quarter provision of $225 thousand was $75 thousand greater than the $150 thousand that was provided during the third quarter of 2010. Management determined that a higher provision for the allowance for loan losses was needed in the third quarter as a result of three commercial real estate loans totaling $2.3 million becoming insubstance foreclosures. For the nine months ended September 30, 2011, charge-offs, net of recoveries, were $330 thousand. In evaluating the adequacy of the allowance for loan losses, criticized loans are one component, out of a total of three components that generally fluctuate most in quarter-to-quarter comparisons. These fluctuations can occur in the total balance of criticized loans and/or in the amount of allowance that is specifically reserved for individual loans. The amount of criticized loans at December 31, 2010 was $11.9 million. This category decreased $458 thousand to $11.4 million at September 30, 2011. The net decrease in criticized loans was mainly the result of $3.7 million in loans moving to OREO and being offset with performing loans moving to a “criticized loan” status. Management is focused on ensuring that the allowance for loan losses reflects the added risks posed as a result of the prolonged economic recession. Management believes the allowance for loan losses is adequate to cover credit losses inherent in the loan portfolio at September 30, 2011.

Management reviews external economic factors quarterly and reports changes to these factors, which are a major component of the allowance calculation. Management continues to work at improving the status of criticized credits for which the Bank maintains significant reserves. These efforts include the addition of more collateral and/or the collection of payments which serve to improve these credits. For a more detailed discussion on the computation of the of allowance for loan losses, see “Note 4 – Allowance for Loan Losses” in the Notes to Interim Consolidated Financial Statements earlier in this report, also under the section heading of “Critical Accounting Policies” and the discussion “Provision for Loan Losses” found earlier in this report.

Deposits

Total deposits of $271.9 million at September 30, 2011 represented a decrease of $6.1 million from $278.0 million at December 31, 2010. Total certificates of deposit at September 30, 2011 were $116.9 million, $16.5 million lower from $133.4 million at December 31, 2010. Certificates of deposit are higher costing funds as compared to checking, savings or money market accounts. CDs represented 43.0% of total deposit balances at September 30, 2011 as compared to 48.0% of total deposit balances at

December 31, 2010. The significant reason for the decrease in certificates of deposits at September 30, 2011 as compared to December 31, 2010 was the non-renewal of certain large dollar deposits that consisted namely of a $3 million certificate for a local municipality and some customers preferred to move maturing CD funds into more liquid accounts such as money market accounts where rates are higher than some of the shorter CD terms.

Non-interest bearing deposits totaled $37.6 million at September 30, 2011, which is a 13.3% increase from $33.2 million at December 31, 2010. Interest-bearing deposits totaled $234.3 million or 86.2% of total deposits at September 30, 2011 which is a decrease of $10.5 million or 4.3% from the $244.8 million and 88.1% of total deposits at December 31, 2010. The ratio of low-cost deposit account balances as a percentage of total average deposit account balances was 54.2% for the nine months ended September 30, 2011 as compared to 51.6% for the same period ended September 30, 2010. Low-cost deposit accounts are defined as interest-bearing deposits and non-interest bearing deposits, excluding certificates of deposit. Management continues to adhere to its deposit pricing plan that maximizes the benefits of the low interest rate environment by reducing the Bank’s interest costs.

Borrowings

Borrowings include overnight repurchase agreements from commercial customers that utilize the Business Investment Sweeps product and long-term advances from the Federal Home Loan Bank of Atlanta (the “FHLB”). A secondary source of other borrowings would be overnight advances from lines of credit established with correspondent banks. For additional details on borrowing sources, see the “Liquidity” section later in this report. At September 30, 2011 the Company had total borrowings of $11.3 million that consisted of $6.3 million in overnight repurchase agreements and an outstanding term advance with the FHLB of $5.0 million. This is compared to $10.1 million in borrowings at December 31, 2010.

On October 11, 2011, management concluded the refinancing of the $5 million advance from the Federal Home Loan Bank of Atlanta. The 5 year/2-year convertible advance at a rate of 2.47% was restructured into a 2-year, fixed rate advance at an interest rate of 1.93%. This new advance will reduce the borrowing costs by 54 basis points and extend the original advance’s maturity from February 5, 2013 to October 11, 2013. The Bank did incur a prepayment penalty for the early termination of the convertible advance, since the terms of the debt were not substantially different and the cash flow effects on a present value basis was less than 10%, the penalty is imbedded into the new fixed rate advance. The annual savings expected from this refinancing is expected to be $27 thousand.

Stockholders’ Equity

Stockholders’ equity was $42.4 million at September 30, 2011 compared to $39.6 million at December 31, 2010. The book value per common share was $18.20 at September 30, 2011 compared to $16.84 at December 31, 2010. On July 15, 2011, shareholders were paid a quarterly dividend of $0.17 per share or $399 thousand. On September 22, 2011, the Board of Directors approved another quarterly cash dividend of $0.17 per share, or $396 thousand, payable to shareholders on October 14, 2011. Total average outstanding shares for the first nine months of 2011 were 2,345,798 shares as compared to the average outstanding shares of 2,363,947 shares for the year ended December 31, 2010.

The Board of Directors and Management recognize the intrinsic value of the Company. The banking industry as a whole has seen stock prices decline since 2007 due in part to the investment community’s concern about the overall banking industry’s ability to withstand the severe economic recession that impacted the industry in several areas such as interest margin compression, losses due to subprime lending, and the decline in housing and commercial real estate values. The Company’s stock is not actively traded: for example, the average daily trading volume for the first nine months of 2011 was 516 shares as compared to 312 shares traded on an average daily basis during the first nine months of 2010; which is 0.02% and 0.01% of the average outstanding shares for the respective periods. This lack of liquidity in the Company’s stock is the primary reason for the existing stock repurchase program which has been in place since September 2007.

The Board reauthorized the stock repurchase plan on May 26, 2011, effective June 1, 2011 until November 30, 2011. The Agreement permits the purchase of up to 40,000 shares during the six-month term. The plan is renewable every six months, at the discretion of the Board of Directors. The renewal of the stock repurchase plan will be considered at the November 17, 2011 Board of Directors meeting.

The change in Accumulated Other Comprehensive Income at September 30, 2011 versus December 31, 2010 was a result of an improvement in the market value of the Company’s consolidated investment

securities portfolio. At September 30, 2011, the Company had an unrealized gain on available for sale securities of $1.814 million, net of income taxes, an increase of $1.949 million from the unrealized loss of $135 thousand, net of income taxes, at December 31, 2010. At September 30, 2011 and December 31, 2010, Accumulated Other Comprehensive Income included $712 thousand in unfunded pension liability, net of income taxes. The unfunded pension liability is recomputed only as of each December 31.

Off-Balance Sheet Arrangements

Financial instruments include commitments to extend credit and standby letters of credit. These commitments include standby letters of credit of approximately $1.2 million at September 30, 2011 and $671 thousand at December 31, 2010. These instruments contain various elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Additionally, unfunded loan commitments of approximately $17.0 million at September 30, 2011, and $23.5 million at December 31, 2010.

Net Income

For the nine months ended September 30, 2011 the Company reported net income of $2.350 million as compared to $2.186 million for the same period in 2010 which is an increase of $164 thousand. Income per basic and diluted share was $1.01 for the nine months ended September 30, 2011 as compared to $0.92 per basic and diluted share for the period ended September 30, 2010.

The Company had an annualized return on average assets of .96% and an annualized return on average equity of 7.60% for the nine months ended September 30, 2011, as compared to an annualized return on average assets and average equity of .89% and 7.28%, respectively, for the same period in 2010.

For the three months ended September 30, 2011 the Company reported net income of $792 thousand as compared to $762 thousand for the same period in 2010, which is an increase of $30 thousand. Income per basic and diluted share was $0.34 for the three months ended September 30, 2011 as compared to $0.32 per basic and diluted share for the period ended September 30, 2010.

The year-to-year increase in net income of $164 thousand for the nine month period is attributable to the following favorable factors:

·	A decrease in interest expense of $540 thousand due to the re-pricing of certificates of deposits and a shift in the mix of deposits to lower-cost deposit accounts.

·	A decrease in the provision for loan losses of $75 thousand.

·	An increase in non-interest income of $42 thousand.

·	A decrease in non-interest expenses of $83 thousand.

·	A decrease in the provision for income taxes of $19 thousand.

These factors were partially offset by unfavorable results in:

·	A decrease of $595 thousand in interest income due to a change in the mix of earning assets and a lower interest rate environment, which produced lower earning asset yields.

Net Interest Income

Net interest income is the Company’s primary source of earnings and represents the difference between interest and fees earned on loans, investments and other earning assets and the interest expense paid on deposits and other interest bearing liabilities. The cost of funds represents interest expense on deposits and other borrowings. Non-interest bearing deposit accounts and capital are other components representing funding sources. Changes in the volume and mix of earning assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income. The following narrative discussion is to complement the Average Balances, Interest Yields and Rates, and Net Interest Margin table which immediately follows and presents interest income on a tax-equivalent basis. The Company’s investment securities portfolio is the only category reflected in the table that is adjusted for tax-exempt interest income. The discussion using a tax-equivalent basis allows the reader to more accurately compare yields of the investment securities to all other taxable interest-bearing assets. Therefore, GAAP income presented on the income statement for investment securities totaling $2.071 million, for the nine months ended September 30, 2011, has been adjusted to $2.467 million in order to

reflect the taxable equivalence of the tax-exempt securities, using a Federal income tax rate of 34%. The prior period shown on the table was likewise adjusted.

For the three months ended September 30, 2011 net interest income (on a tax-equivalent basis) was $3.103 million as compared to $3.136 million for the three months ended September 30, 2010, a decrease of $33 thousand or 1.1%. Interest income (on a tax-equivalent basis) decreased $267 thousand for the third quarter of 2011 as compared to the year-earlier period. Interest income was primarily affected by a shift in balances moving out of loans and into investment securities. Average loan balances when compared to the prior year period, declined $9.5 million at a yield of 6.38%. These balances for the most part moved into investment securities, which had a $6.4 million increase over the prior year period and earned a tax-equivalent yield of 3.80%. This change in the mix of earning assets was the primary factor in the lower interest income for 2011 as compared to 2010. Investment income (on a tax-equivalent basis) decreased $27 thousand in the three months ended September 30, 2011 as compared to the three months ended September 30, 2010, largely as a result of calls on higher yielding securities within the Company’s portfolio. In addition to the decrease in investment income, lower loan income negatively affected interest income. Loan income declined $590 thousand in the year-to-year period due to increases in non-accrual loans, lower average outstanding balances, and lower interest rates seen for new loans and loans that are re-pricing to lower rates. Interest income for deposits at other banks remained on par for the quarter ended September 30, 2011 as compared to the same period a year ago, with yields declining 44 basis points in the year-to-year comparison.

A small portion of the liquidity generated by the Company’s investment securities portfolio was used to repurchase outstanding common shares under the stock repurchase plan described later in this Report under Part 2, Item 2, Unregistered Sales of Equity Securities and Use of Proceeds.

For the nine months ended September 30, 2011 net interest income (on a tax-equivalent basis) was $9.332 million as compared to $9.288 million for the nine months ended September 30, 2010, an increase of $44 thousand or .48%. The average loan balances for the nine months ended September 30, 2011 were $203.8 million or $9.5 million lower than the nine months ended September 30, 2010, when average loan balances were $213.3 million. Loan yields for the first nine months of 2011 were 6.38% or 9 basis points lower than yields of 6.47% for the comparable period in 2010.

The average investment securities balance for the first nine months of 2011 was $86.5 million or $6.3 million higher than the average of $80.2 for the first nine months of 2010. The investment portfolio’s average balance increase of $6.3 million was the result of the outflow of loan balances due to payoffs, the inflow of funds into deposit accounts and fully investing federal fund balances that existed at December 31, 2010. The tax equivalent yield for the investment securities for the first nine months of 2011 was 3.80% or 15 basis points lower than the first nine months of 2010.

The tax-equivalent yield on earning assets for the three months ended September 30, 2011 was 5.31%, a decrease of 20 basis points from the yield of 5.51% reported in the comparable period of 2010. The tax equivalent yield on earning assets for the nine months ended September 30, 2011 was 5.44%, a decrease of 19 basis points from the yield of 5.63% for the nine months ended September 30 2010. The decrease in the earning assets yield for the period ended September 30, 2011 as compared to the same periods in 2010 is primarily the result of the following occurrences: the reduction of short-term interest rates and its impact on new loans and securities held for investment, the re-pricing of existing loans and investment securities to lower yields and a shift of loan balances into investment securities.

Reconciliation of GAAP Net Interest Income to Tax-exempt Net Interest Income

	Three Months Ended				Nine Months Ended
(Dollars in thousands)	Sept. 30, 2011		Sept. 30, 2010		Sept. 30, 2011		Sept. 30, 2010

Net interest income, GAAP basis		2,970		3,016		8,936		8,991

Tax benefit from tax-exempt securities		133		120		396		297

Net interest income, tax-exempt basis		3,103		3,136		9,332		9,288

Tax-exempt securities tax benefit is computed at the statutory rate of 34%.

For the three months ended September 30, 2011 the average balance for interest bearing liabilities was $248.1 million or $6.0 million lower than the $254.1 million for the three months ended September 30, 2010. The cost of interest bearing liabilities for the third quarter of 2011 was 1.26%, a decrease of 30 basis points from the 1.56% cost for the third quarter of 2010.

Average interest bearing liabilities for the nine months ended September 30, 2011 were $251.2 million or $190 thousand more than the $251.0 million for the first nine months of 2010. The cost of interest bearing liabilities for the nine months ended September 30, 2011 was 1.54% as compared to 1.83% for the nine months ended September 30, 2010, a decrease of 29 basis points. We believe that the increase in interest bearing deposits is attributable to customers seeking a safe refuge for funds that are being withdrawn from mutual and stock funds, as well as a greater awareness by customers for the need to have full FDIC deposit insurance coverage. While moving funds to banks, customers are hesitant to purchase certificates of deposits and are opting for shorter, better paying alternatives, such as money market deposit accounts. Management is aware of the liquidity risk that this customer behavior presents for the Bank and plans have been developed to manage such risk if it should present itself in the future.

Average non-interest deposit balances for the nine months ended September 30, 2011 were $33.4 million or $401 thousand less than the $33.8 million for the same period of 2010. While a number of factors contribute to this decrease, we believe that it is likely because consumers and businesses are in the process of deleveraging themselves (paying down debt), and an increasing number of households that are facing reduced incomes due to reduced work schedules or layoffs and they are being forced to erode their cash balances to cover everyday living expenses.

The net interest margin is net interest income expressed as a percentage of average earning assets. The tax equivalent net interest margin for the three months ended September 30, 2011 was 4.12% which is 6 basis points higher than the net interest margin for the quarter ended September 30, 2010 of 4.06%. The net interest margin increased by 4 basis points to 4.15% for the nine months ended September 30, 2011 as compared to 4.11% for the same period in 2010.

The table on the following page labeled “Average Balances, Interest Yields and Rates, and Net Interest Margin” presents the average balances and rates of the various categories of the Company’s assets and liabilities. Included in the table is a measurement of interest rate spread and margin. Interest rate spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest expense on the interest bearing liabilities. While net interest spread provides a quick comparison of earnings rates versus the cost of funds, Management believes that the interest margin provides a better measurement of performance. Investment securities’ income and yields are adjusted to reflect their tax equivalency.

Average Balances, Interest Yields and Rates, and Net Interest Margin

	Nine Months Ended September 30,
	2011							2010
	Average				Average			Average				Average
(Dollars in Thousands)	Balance		Interest		Yield/Rate			Balance		Interest		Yield/Rate

ASSETS:
Interest earning assets:
Interest bearing deposits with other banks and
other short-term investments	$	1,653	$	19		1.54	%	$	1,083	$	16		1.98	%
Loans (1)		203,846		9,730		6.38	%		213,331		10,320		6.47	%
Investment securities available for sale (2)		86,547		2,467		3.80	%		80,191		2,377		3.95	%
Federal funds sold		8,740		15		0.23	%		7,680		14		0.24	%
Total interest earning assets	$	300,786	$	12,231		5.44	%	$	302,285	$	12,727		5.63	%

Total average non-earning assets		30,292							28,146
Less: allowance for credit losses		2,235							2,913
Net average non-earning assets		28,057							25,233
TOTAL AVERAGE ASSETS	$	328,843						$	327,518


LIABILITIES AND STOCKHOLDERS'
EQUITY:

Interest bearing liabilities:
Interest bearing demand	$	41,507	$	55		0.18	%	$	38,934	$	51		0.18	%
Savings		73,452		337		0.61	%		68,834		462		0.90	%
Time deposits		125,137		2,391		2.55	%		132,959		2,813		2.83	%
Other borrowings		11,080		116		1.40	%		10,259		113		1.47	%
Total interest bearing liabilities	$	251,176	$	2,899		1.54	%	$	250,986	$	3,439		1.83	%


Noninterest bearing liabilities:
Noininterest bearing demand		33,425							33,826
Other liabilities		2,897							2,578
Total noninterest bearing liabilities		36,322							36,404


Stockholders' equity		41,345							40,128
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY	$	328,843						$	327,518

Net interest income			$	9,332						$	9,288
Net interest spread						3.90	%						3.80	%
Net interest margin						4.15	%						4.11	%

(1) Includes Loans Held for Sale and average daily balance of non-accrual loans.
(2) Income and yield are reported on a tax equivalent basis assuming a federal tax rate of 34%.

Provision for Loan Losses

For the three months ended September 30, 2011, the Bank provided $225 thousand to the Allowance for Loan Losses. This provision amount is $75 thousand more than the amount provided for the three months ended September 30, 2010. For the nine months ended September 30, 2011, $525 thousand was recorded as provision which is a decrease of $75 thousand from the $600 thousand provided for the nine months ended September 30, 2010. The amount of provision recorded for 2011 is appropriate with management’s ongoing analysis of non-performing loans and currently performing loans that show the potential to deteriorate further.

As of September 30, 2011, the Bank’s non-accrual loans were $2.719 million as compared to $3.836 million at December 31, 2010; or a decrease of $1.117 million from year-end. For the same reporting periods, total impaired loans were $3.830 million at September 30, 2011 and $5.916 million at December 31, 2010; or a decrease of $2.086 million from year-end. Approximately $2.7 million of the decline in non-accrual and impaired loans was the result of loans moving to other real estate owned during the nine months ended September 30, 2011.

Management analyzes the Bank’s collateral position and probable future loss on any loan and provides specific reserves for those loans (as needed), prior to those loans actually becoming nonperforming loans. Therefore, when a loan becomes nonperforming, it is likely to already have an allowance provided for it without the need for additional provision during the same quarter when the loan moves to nonperforming status. Also see the discussion on criticized loans, earlier in this report, under the “Allowance for Loan Losses” heading.

Noninterest Income

Noninterest income includes deposit fees, gains on the sales of securities, loans held for sale, other-than-temporary impairments and ATM fees. Noninterest Income for the three months ended September 30, 2011 increased $69 thousand or 11.7% to $659 thousand from $590 thousand for the three months ended at September 30, 2010. For the nine months ended September 30, 2011, noninterest income increased 2.4% to $1.795 million compared to $1.753 million, or $42 thousand more than the same period in 2010. Revenue from the net gain on sale of securities, and the net amount recorded for other-than-temporary impairments, is considered as non-recurring revenue, therefore noninterest income, excluding these items was $1.835 million for the nine months ended September 30, 2011 and $1.723 million for the same period in 2010; an increase of $112 thousand.

Below is a representation of the changes to the significant components of noninterest income.

	Three months ended							Nine months ended
(Dollars in thousands)	Sept. 30,		Sept. 30,		%			Sept. 30,			Sept. 30,		%
	2011		2010		Change			2011			2010		Change

Noninterest Income
Service charges on deposit accounts	$	279	$	258		8.1	%	$	785		$	774		1.4	%
Net gain on sales of loans		25		23		8.7	%		52			49		6.1	%
Net gain on sale of securities		-		3		-100.0	%		-			30		-100.0	%
Other-than-temporary impairments		-		-		100.0	%		(7	)		-		100.0	%
Less:Noncredit portion of OTTI impairments		-		-		100.0	%		33			-		100.0	%
Net other-than-temporary impairments		-		-		100.0	%		(40	)		-		100.0	%
Income from bank owned life ins.		75		74		1.4	%		222			217		2.3	%
ATM fee income		191		165		15.8	%		568			484		17.4	%
Other income		89		67		32.8	%		208			199		4.5	%
Total noninterest income	$	659	$	590		11.7	%	$	1,795		$	1,753		2.4	%

Service charges on deposit accounts increased $21 thousand for the three months ended September 30, 2011 to $279 thousand from $258 at September 30, 2010 and increased 1.34 or $11 thousand for the nine months ended September 30, 2011 compared to the same period in 2010, chiefly due to changes in the Bank’s customer behavior and the continuing popularity of “totally free” checking products. The revised overdraft policies limited the daily amount of overdraft fees that a customer could be assessed, the automated closure of long-term overdrawn checking accounts, and providing customers’ information on overdraft fees charged to their account in the current cycle and for the year-to-date. Management is also exploring other deposit account changes in response to the effects of Federal regulations.

Net gain on sales of loans increased $2 thousand for the three months ended September 30, 2011 to $25 thousand from $23 thousand at September 30, 2010 and increased 6.1% or $3 thousand for the nine months ended September 30 2011 compared to the same period in 2010 as customers took advantage of the low-rate environment to lock in longer term residential mortgage loans.

·	Net gain on sale of securities The Company has not sold securities during the three or nine month periods ended September 30, 2011. Previous year gains were occurred as a result of bond issuers calling securities at par, prior to maturity and not the result of securities sales.

Other-than-temporary impairments At June 30, 2011, management recorded an other-than-temporary impairment relating to what is determined to be a permanent credit loss involving non-agency CMO securities in the amount of $40 thousand. There was no impairment charge related to credit loss for any of the portfolio securities taken in 2010. For further discussion on other-than-temporary impairments see “Note 2” earlier in this report.

ATM fee income increased $22 thousand for the three months ended September 30, 2011 to $191 thousand from $165 thousand at September 30, 2010 and increased 17.4% or $84 thousand for the nine months ended September 30, 2011 compared to the same period in 2010 as a result of increased ATM and point of sale transactions by the Bank’s customers and fees received from non-customers using the Bank’s ATMs. A portion of this increase is the result of changes management has made to the existing Bank/interchange relationships.

Other income increased $22 thousand for the three months ended September 30, 2011 to $89 thousand from $67 thousand at September 30, 2010 and increased 4.5% or $9 thousand for the nine months ended September 30, 2011 compared to the same period in 2010. Other income generally consists of incidental fees and services that tend to be variable in nature.

Noninterest Expense

Noninterest expense includes employee compensation and benefits-related costs, occupancy and equipment expense, other real estate owned (“OREO”), data processing and other overhead costs. Noninterest expense decreased 3.5% for the quarter ended September 30, 2011 to $2.376 million from $2.462 million at September 30, 2010. For the nine months ended September 30, 2011, noninterest expenses decreased $83 thousand to $7.146 million as compared to $7.229 million for the comparable period in 2010, or a decrease of 1.1%. The revenues recognized on sales of OREO and the losses incurred from the impairment of OREO are considered non-recurring, therefore noninterest expense, excluding these items was $7.132 million for the nine months ended September 30, 2011 and $7.167 million for the same period in 2010; a decrease of $35 thousand.

Management’s strategy is to maintain strict controls over noninterest expenses, and where possible, these efforts are being realized with declines being seen in noninterest expenses over the previous year. Costs associated with loan collection efforts and OREO properties are areas where higher-than-normal increases have occurred. The following table outlines the changes in significant components:

	Three months ended								Nine months ended
(Dollars in thousands)	Sept. 30,			Sept. 30,		%			Sept. 30,			Sept. 30,			%
	2011			2010		Change			2011			2010			Change
Noninterest Expense
Salaries and employee benefits	$	1,372		$	1,372		0.0	%	$	4,112		$	4,083			0.7	%
Net occupancy expense		150			158		-5.1	%		450			453			-0.7	%
Equipment expense		118			142		-16.9	%		358			402			-10.9	%
FDIC Insurance		65			104		-37.5	%		326			403			-19.1	%
Data Processing		71			57		24.6	%		214			169			26.6	%
Net (gain) on sale of oreo properties		(5	)		-		N/M			(21	)		(13	)		61.5	%
Impairment - oreo properties		8			60		-86.7	%		35			75			-53.3	%
Other operating expense		597			569		4.9	%		1,672			1,657			0.9	%
Total noninterest expense	$	2,376		$	2,462		-3.5	%	$	7,146		$	7,229			-1.1	%

Salaries and employee benefits were unchanged for the three months ended September 30, 2011 and September 30, 2010 at $1.372 million. For the first nine months of 2011 costs were $4.112 million or $29 thousand greater than the $4.083 million reported for the nine months ended September 30, 2010 and this was primarily due to a decline in loan origination cost deferrals.

·	Net occupancy expense decreased $8 thousand for the three months ended September 30, 2011 to $150 thousand from $158 thousand at September 30, 2010 and a decline of 0.7% or $3 thousand for the first nine months of 2011 primarily as a result of lower maintenance costs.

Equipment expense decreased $24 thousand for the three months ended September 30, 2011 to $118 thousand from $142 thousand at September 30, 2010 and decline of 10.9% or $44 thousand for the year-to-date total that was primarily due to lower depreciation expense as equipment becomes fully depreciated.

FDIC deposit insurance decreased $39 thousand for the three months ended September 30, 2011 to $65 thousand from $104 thousand at September 30, 2010 and a decrease of $77 thousand or 19.1% for the first nine months of 2011 as compared to the same period in 2010, which is a result of the new calculation employed by the FDIC to determine a financial institution’s quarterly assessment.

·	Data processing expense increased $14 thousand for the three months ended September 30, 2011 to $71 thousand from $57 thousand at September 30, 2010 and an increase of 26.6% or $45 thousand for the first nine months of 2011 as compared to the same period for 2010.

Net (gain) on sale of OREO properties was $5 thousand for the three months ended September 30, 2011. There was no sale of OREO properties in the third quarter of 2010. For the nine months ended September 30, 2011, net gains on properties sold were $21 thousand or $8 thousand greater than the net gains of $13 thousand for the same period in 2010.

Impairment – other real estate owned decreased $52 thousand for the three months ended September 30, 2011 to $8 thousand from $60 thousand for the three months ended September 30, 2010. Impairment for the nine months ended September 30, 2011 was $35 thousand as compared to $75 thousand for the same period in 2010; a $40 thousand decrease. In accordance with accounting standards ASC 310 and ASC 360, management had certain OREO properties re-appraised and those properties values had declined and this change was reported as an impairment charge.

Other operating expense increased $28 thousand for the three months ended September 30, 2011 to $597 thousand from $569 thousand at September 30, 2010 and an increase of 0.9% or $15 thousand for the first nine months of 2011; as compared to the same period in 2010. Costs related to the Commonwealth’s Franchise Tax, ATM network, collection-related expenses, and other real estate owned properties costs, net of rental income are included in this category.

Liquidity

Liquidity management involves the ability to meet the cash flow requirements of depositors wanting to withdraw funds, of borrowers needing assurance that sufficient funds will be available to meet their credit needs and the Company’s current and future expenditures. Liquidity can best be demonstrated by an analysis of cash flows. The primary source of cash flows is from operating activities. Operating activities provided $4.180 million of liquidity for the nine-month period ended September 30, 2011, compared to $3.386 million for the same nine months in 2010; or an increase of $794 thousand. The principal elements of these operating flows are net income, increased for significant non-cash expenses for the provision for loan losses, depreciation and securities amortization.

Other sources or uses of liquidity come from investing activities and financing activities. Investing activities provided net cash totaling $1.861 million that was primarily the result of calls, maturities and prepayments from the investment securities portfolio which exceeded security purchases by $2.833 million, while the net increase in loans used funds totaling $1.147 million for the nine months ended September 30, 2011. For the nine months ended September 30, 2011, financing activities required use of liquidity principally due to the net decrease in deposit account balances of $6.096 million. Financing activities can be sources of liquidity as a result of issuing debt, borrowed funds or the additional issuance of Company stock.

At September 30, 2011, the Company had $22.293 million in cash and cash equivalents on hand.

The Company maintains extensive sources of liquidity including blanket collateral borrowing lines with the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Atlanta which had a net availability of $26.3 million at September 30, 2011. In addition, there are short-term unsecured borrowing lines totaling $27.4 million at September 30, 2011, which are with three correspondent banks.

As of September 30, 2011 the Bank has the following lines of credit available.

Collateralized Lines of Credit
Federal Home Loan Bank of Atlanta	$	28,117,580
Federal Reserve Bank of Richmond		3,213,630
Less: Outstanding advances		(5,000,000	)
Sub-total Collateralized Lines of Credit	$	26,331,210

Unsecured, Short-term Lines
CenterState Bank	$	6,000,000
Community Bankers Bank		11,400,000
First Tennessee Bank NA		10,000,000
Sub-total Unsecured, Short-term Lines	$	27,400,000

Total Available Lines of Credit	$	53,731,210

Other borrowings consisted of $6.265 million in short-term borrowings and from balances outstanding in the Investment Sweeps Account product at September 30, 2011; at December 31, 2010 the balance of this product was $5.1 million. The Investment Sweeps Account is an overnight repurchase agreement product, not insured by FDIC, but guaranteed by the Bank with US Government and Federal Agency securities. This product is offered to commercial customers only.

The Company monitors its liquidity position on a regular basis and continuously adjusts its assets to maintain adequate liquidity levels. The Company has established satisfactory liquidity targets and reports its liquidity ratios to the Board of Directors on a monthly basis. The Company considers its sources of liquidity to be sufficient to meet its estimated needs.

Item 4. Controls and Procedures

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

Under the supervision and with the participation of our Management, including our Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on that evaluation, the Company has concluded that these controls and procedures are effective. In addition, our Management, including our Chief Executive Officer and Chief Financial Officer, is also responsible for establishing and maintaining adequate internal control over financial reporting.

There was no change in the Company’s internal control over financial reporting that occurred during the three months ended September 30, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company, including its subsidiaries, is a party or of which the property of the Company is subject.

Item 1A. Risk Factors

Other than as set forth below, there are no material changes to the Company’s risk factors as disclosed in its Annual Report on Form 10-K for the year ended December 31, 2010 and Quarterly Report on Form 10-Q for the period ended June 30, 2011..

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

The Board of Directors voted to approve continuation of the common stock repurchase plan at their regularly scheduled meeting held on May 26, 2011. The renewed plan period was effective June 1, 2011 and expires November 30, 2011. Purchases under the plan are limited to an individual six-month total of 40,000 shares and the maximum per share price to be paid is $16.00. The stock repurchase plan was originally announced on August 20, 2007.

The Board of Directors reviews the results of the repurchase plan monthly. The continuation of the repurchase plan is evaluated by the Directors prior to the reauthorization of the repurchase plan for an additional 6-month period. The Company will consider whether or not it will repurchase additional shares based upon a number of factors including market conditions, the Company’s performance, and other strategic planning considerations.

The table below indicates the shares that were no repurchased shares during the most recent fiscal quarter:

Common Stock Repurchase Plan Table

					Total number		Maximum number
					of shares		of shares that
	Total number		Average		purchased as		may yet be
	of shares		price paid		part of publicly		purchased
Period	purchased		per share		announced plan		under the plan

July 1 to July 31, 2011	1,275		13.75		1,275		38,725
August 1 to August 31, 2011		10,992		14.67		10,992		27,733
Sept. 1 to Sept. 30, 2011		5,000		14.75		5,000		22,733
Total		17,267	$	14.62		17,267		22,733

Item 3. Defaults upon Senior Securities

None outstanding.

Item 4. [Removed and Reserved]

Item 5. Other Information

None.

Item 6. Exhibits

See Exhibit Index.

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 thereunto duly authorized.

	CITIZENS BANCORP OF VIRGINIA, INC.
		(Registrant)
Date: November 14, 2011	By:	/s/Joseph D. Borgerding
		Joseph D. Borgerding
		President and Chief Executive Officer

Date: November 14, 2011	By:	/s/Ronald E. Baron
		Ronald E. Baron
		Senior Vice President and Chief Financial Officer

EXHIBIT INDEX

Exhibit Number

31.1	Rule 13a-14(a) Certification of Principal Executive Officer

31.2	Rule 13a-14(a) Certification of Principal Financial Officer

32.2	Statement of Principal Executive Officer Pursuant to 18 U.S.C. ss. 1350

32.2	Statement of Principal Financial Officer Pursuant to 18 U.S.C. ss.1350

101

The following materials from Citizens Bancorp of Virginia, Inc.'s Quarterly Report on Form 10-Q for the three months ended September 30, 2011,

formatted in Extensible Business Reporting language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income,

(iii) Consolidated Statements of Changes in shareholders' Equity, (iv) Consolidated Statements of Cash Flows and (v) Notes to Interim Consolidated

Financial Statements.