Edgar Filing: POTOMAC BANCSHARES INC

potomac_10q.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
____________________

FORM 10-Q

(Mark one)

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

	For the quarterly period ended 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 0-24958

POTOMAC BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)

West Virginia		55-0732247
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)

111 East Washington Street
PO Box 906, Charles Town WV		25414-0906
(Address of Principal Executive Offices)		(Zip Code)

Registrant's telephone number, including area code		304-725-8431

Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.


Yes		XX		No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).


Yes		XX		No

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

Large Accelerated Filer

Accelerated Filer

Non-Accelerated Filer

Smaller Reporting Company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).


Yes				No		XX

APPLICABLE ONLY TO CORPORATE REGISTRANTS

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

3,390,178 as of November 14, 2011

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
FORM 10-Q
September 30, 2011

	INDEX

PART I.	FINANCIAL INFORMATION	PAGE

Item 1.	Financial Statements.

	Consolidated Balance Sheets as of September 30, 2011 (Unaudited) and December 31, 2010 (Audited)	3

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

	Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Nine Months
	Ended September 30, 2011 and 2010	5

	Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended
	September 30, 2011 and 2010	6

	Notes to Consolidated Financial Statements (Unaudited)	7 - 26

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	26 - 32

Item 4.	Controls and Procedures.	32

Part II.	OTHER INFORMATION

Item 1.	Legal Proceedings.	32

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	33

Item 4.	(Removed and Reserved).	33

Item 5.	Other Information.	33

Item 6.	Exhibits.	33

Signatures		34

FORWARD-LOOKING STATEMENTS

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

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

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

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

	September 30,			December 31,
	2011			2010
Assets:
Cash and due from banks	$	1 705		$	2 185
Interest-bearing deposits in other financial institutions		15 563			7 995
Federal funds sold		725			2 725
Securities available for sale, at fair value		45 543			42 690
Loans held for sale		- -			76
Loans, net of allowance for loan losses of $5,263 and
$5,012, respectively		202 108			214 238
Premises and equipment, net		8 003			8 270
Other real estate owned, net of valuation allowance of
$2,165 and $95, respectively		6 151			6 563
Accrued interest receivable		888			960
Bank owned life insurance		6 872			6 397
Federal Home Loan Bank of Pittsburgh stock		822			765
Other assets		5 365			4 745

Total Assets	$	293 745		$	297 609

Liabilities and Stockholders’ Equity:
Liabilities:
Deposits
Noninterest-bearing	$	29 721		$	26 695
Interest-bearing		227 976			230 727
Total Deposits		257 697			257 422
Securities sold under agreements to repurchase		5 239			7 382
Federal Home Loan Bank advances		1 823			2 717
Accrued interest payable		245			361
Other liabilities		3 016			2 951
Total Liabilities	$	268 020		$	270 833

Stockholders’ Equity:
Common stock, $1 per share par value; 5,000,000 shares
authorized; 3,671,691 shares issued and outstanding	$	3 672		$	3 672
Surplus		3 943			3 932
Undivided profits		22 286			23 725
Accumulated other comprehensive (loss), net		(1 310	)		(1 687	)
	$	28 591		$	29 642

Less cost of shares acquired for the treasury, 281,513 shares		2 866			2 866

Total Stockholders’ Equity	$	25 725		$	26 776

Total Liabilities and Stockholders’ Equity	$	293 745		$	297 609

See Notes to Consolidated Financial Statements.

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

	For the Three Months						For the Nine Months
	Ended September 30						Ended September 30
	2011			2010			2011			2010
Interest and Dividend Income:
Interest and fees on loans	$	2 929		$	3 226		$	8 801		$	9 772
Interest on securities available for sale - taxable		167			176			527			588
Interest on securities available for sale – nontaxable		62			50			171			148
Interest on federal funds sold		- -			1			1			3
Other interest and dividends		4			6			24			13
Total Interest and Dividend Income		3 162			3 459			9 524		10 524

Interest Expense:
Interest on deposits		606			957			2 259			3 058
Interest on securities sold under agreements to repurchase		19			23			54			63
Federal Home Loan Bank advances		9			13			30			74
Total Interest Expense		634			993			2 343			3 195

Net Interest Income		2 528			2 466			7 181			7 329

Provision for Loan Losses		2 128			213			2 727			984
Net Interest Income after
Provision for Loan Losses		400			2 253			4 454			6 345

Noninterest Income:
Trust and financial services		225			199			677			636
Service charges on deposit accounts		485			480			1 394			1 394
Visa/MC Fees		198			172			567			501
Cash surrender value of life insurance		59			58			175			176
Other operating income		87			113			289			318
Total Noninterest Income		1 054			1 022			3 102			3 025

Noninterest Expenses:
Salaries and employee benefits		1 249			1 177			3 732			3 579
Net occupancy expense of premises		153			161			476			495
Furniture and equipment expenses		250			162			660			599
Advertising and public relations		47			39			103			91
Accounting, auditing and compliance		68			48			148			114
Computer services and online banking		86			62			232			111
Loss (gain) on sale of other real estate		266			(25	)		336			(167	)
FDIC assessment		98			142			356			416
Legal Fees		13			46			42			103
Postage		43			38			122			106
Printing, stationery and supplies		47			34			146			136
Communications		46			46			139			138
Foreclosed property expense		46			182			427			501
Write down of OREO property		1 848			- -			2 133			17
ATM and check card expenses		92			78			245			213
Other operating expenses		322			316			1 001			882
Total Noninterest Expenses		4 674			2 506			10 298			7 334
(Loss) Income before Income Tax (Benefit) Expense		(3 220	)		769			(2 742	)		2 036
Income Tax (Benefit) Expense		(1 418	)		241			(1 370	)		648

Net (Loss) Income	$	(1 802	)	$	528		$	(1 372	)	$	1 388

(Loss) Earnings Per Share, basic and diluted	$	(.53	)	$	.16		$	(.40	)	$	.41

See Notes to Consolidated Financial Statements.

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
($ in thousands, except share and per share data)
(Unaudited)

											Accumulated
											Other
	Common				Undivided			Treasury			Comprehensive			Comprehensive
	Stock		Surplus		Profits			Stock			(Loss)			Income			Total
Balances, December 31, 2009	$	3 672	$	3 898	$	21 931		$	(2 866	)	$	(1 063	)				$	25 572

Comprehensive income
Net income		- -		- -		1 388			- -			- -		$	1 388			1 388
Other comprehensive income:
unrealized holding losses
arising during the period
(net of tax, $2)		- -		- -		- -			- -			(3	)		(3	)		(3	)
Total comprehensive income														$	1 385

Stock-based compensation expense		- -		25		- -			- -			- -						25

Balances, September 30, 2010	$	3 672	$	3 923	$	23 319		$	(2 866	)	$	(1 066	)				$	26 982

Balances, December 31, 2010	$	3 672	$	3 932	$	23 725		$	(2 866	)	$	(1 687	)				$	26 776

Comprehensive loss
Net loss		- -		- -		(1 372	)		- -			- -		$	(1 372	)		(1 372	)
Other comprehensive income:
unrealized holding gains
arising during the period
(net of tax, $194)		- -		- -		- -			- -			377			377			377
Total comprehensive loss														$	( 995	)

Stock-based compensation expense		- -		11		- -			- -			- -						11

Cash dividends ($.02 per share)		- -		- -		(67	)		- -			- -						(67	)

Balances, September 30, 2011	$	3 672	$	3 943	$	22 286		$	(2 866	)	$	(1 310	)				$	25 725

See Notes to Consolidated Financial Statements.

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

	For the Nine Months Ended
	September 30			September 30
	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income	$	(1 372	)	$	1 388
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Provision for loan losses		2 727			984
Depreciation		361			419
Write down of other real estate		2 133			17
Discount accretion and premium amortization on securities, net		212			145
Loss (gain) on sale of other real estate		336			(167	)
Loss on disposal of fixed assets		- -			5
Stock compensation expense		11			25
Proceeds from sale of loans		686			1 826
Origination of loans for sale		(610	)		(2 341	)
Changes in assets and liabilities:
Decrease (increase) in accrued interest receivable		72			(58	)
(Increase) decrease in other assets		(1 346	)		345
Decrease in accrued interest payable		(116	)		(19	)
Increase in other liabilities		65			439
Net cash provided by operating activities	$	3 159		$	3 008

CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity of securities available for sale	$	5 110		$	1 000
Proceeds from call of securities available for sale		23 000			22 545
Purchase of securities available for sale		(30 604	)		(26 885	)
Net decrease in loans		5 422			6 937
Purchases of premises and equipment		(94	)		(71	)
Proceeds from sale of other real estate		1 924			2 413
Net cash provided by investing activities	$	4 758		$	5 939

CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in noninterest-bearing deposits	$	3 026		$	(2 685	)
Net decrease in interest-bearing deposits		(2 751	)		(3 207	)
Net (repayment) purchase of securities sold under agreements to repurchase		(2 143	)		978
Net repayment of Federal Home Loan Bank advances		(894	)		(843	)
Cash dividends		(67	)		- -
Net cash used in financing activities	$	(2 829	)	$	(5 757	)

Increase in cash and cash equivalents	$	5 088		$	3 190

CASH AND CASH EQUIVALENTS
Beginning		12 905			12 623
Ending	$	17 993		$	15 813

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest	$	2 459		$	3 214
Income tax payments	$	- -		$	621

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING
AND FINANCING ACTIVITIES
Unrealized gain (loss) on securities available for sale	$	571		$	(5	)
Loans transferred to other real estate owned	$	3 981		$	2 977
Loans made on sale of other real estate	$	142		$	695

See Notes to Consolidated Financial Statements.

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

1.	In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of September 30, 2011 and December 31, 2010, and the results of operations for the three months and nine months ended September 30, 2011 and 2010, and cash flows and statements of changes in stockholders’ equity for the nine months ended September 30, 2011 and 2010. The statements should be read in conjunction with Notes to Consolidated Financial Statements included in the Potomac Bancshares, Inc. annual report for the year ended December 31, 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.

	The consolidated financial statements of Potomac Bancshares, Inc. (the “company”) and its wholly-owned subsidiary, Bank of Charles Town (the “bank”), include the accounts of both companies. All material inter-company balances and transactions have been eliminated in consolidation.

	Certain reclassifications have been made to prior period amounts to conform to the current year presentation.

	In preparing these financial statements, the company has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.

2.	Stock-Based Compensation

	The 2003 Stock Incentive Plan was approved by stockholders on May 13, 2003, which authorized up to 183,600 shares of common stock to be used in the granting of incentive options to employees and directors. On April 24, 2007, the stockholders approved an additional 250,000 shares of common stock to be used in the granting of incentive options to employees and directors. This is the first and only stock incentive plan adopted by the company. Under the plan, the option price cannot be less than the fair market value of the stock on the date granted. An option’s maximum term is ten years from the date of grant. Employee options granted under the plan are subject to a five year vesting schedule. Director options immediately vest.

	Incremental stock-based compensation expense recognized for the nine month periods ending September 30, 2011 and 2010 was $11 thousand and $25 thousand, respectively.

	Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for each separately vesting portion of the award. Fair value is estimated using the Black-Scholes option-pricing model. There were no options granted during the first nine months of 2011 and 2010.

	Stock option plan activity for the nine months ended September 30, 2011 is summarized below:

				Weighted
				Average
		Weighted		Remaining
		Average		Contractual	Aggregate
		Exercise		Life	Intrinsic
	Shares	Price		(in years)	Value
Options outstanding, January 1, 2011	120 974	$	14.76
Granted	- -		- -
Exercised	- -		- -
Canceled or expired	- -		- -
Options outstanding, September 30, 2011	120 974		14.76	4	$	- -
Options exercisable, September 30, 2011	116 896		14.73	4	$	- -

The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on September 30, 2011. The aggregate intrinsic values change based on changes in the market value of the company’s stock.

As of September 30, 2011 there was $4 thousand of total unrecognized compensation expense related to nonvested stock options, which will be recognized over the remaining requisite service period.

3.	Securities

	The amortized cost and fair value of securities available for sale as of September 30, 2011 and December 31, 2010 (in thousands) are as follows:

	September 30, 2011
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		(Losses)			Value
Obligations of U. S. Government
sponsored agencies	$	37 573	$	469	$	(1	)	$	38 041
State and municipal obligations		6 454		255		- -			6 709
Equity securities		1 099		- -		(306	)		793
	$	45 126	$	724	$	(307	)	$	45 543

	December 31, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		(Losses)			Value
Obligations of U. S. Government
sponsored agencies	$	36 207	$	241	$	(160	)	$	36 288
State and municipal obligations		5 537		71		(84	)		5 524
Equity securities		1 100		- -		(222	)		878
	$	42 844	$	312	$	(466	)	$	42 690

The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the company through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The company monitors the portfolio, which is subject to liquidity needs, market rate changes and credit risk changes, to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business behind the instrument. There is one debt security in the consolidated portfolio that has a loss at September 30, 2011. The primary cause of the temporary impairments in the company’s investments in debt securities was fluctuations in interest rates. Because the company intends to hold these investments in debt securities to maturity and it is more likely than not that the company will not be required to sell these investments before a recovery of unrealized losses, the company does not consider these investments to be other-than-temporarily impaired at September 30, 2011 and no impairment has been recognized.

There are three equity security investments in the company’s portfolio with losses at September 30, 2011. The company considers these investments to be temporarily impaired at September 30, 2011 and is recognizing no impairment. These are community bank stock related holdings.

U.S. Government sponsored agencies include the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation debt securities with a fair value of $22.4 million as of September 30, 2011 and $11.7 million as of December 31, 2010

The following table summarizes the fair value and gross unrealized losses for securities aggregated by investment category and length of time that individual securities have been in a continuous gross unrealized loss position as of September 30, 2011 and December 31, 2010 (in thousands).

	September 30, 2011
	Less than 12 months					More than 12 months					Total
			Gross					Gross					Gross
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Obligations of U.S. Government
sponsored agencies	$	999	$	(1	)	$	- -	$	- -		$	999	$	(1	)
State and municipal obligations		- -		- -			- -		- -			- -		- -
Equity securities		- -		- -			793		(306	)		793		(306	)
Total	$	999	$	(1	)	$	793	$	(306	)	$	1 792	$	(307	)

3. Securities (Continued)

	December 31, 2010
	Less than 12 months					More than 12 months					Total
			Gross					Gross					Gross
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Obligations of U.S. Government
sponsored agencies	$	9 899	$	(147	)	$	1 108	$	(13	)	$	11 007	$	(160	)
State and municipal obligations		1 912		(84	)		- -		- -			1 912		(84	)
Equity securities		878		(222	)		- -		- -			878		(222	)
Total	$	12 689	$	(453	)	$	1 108	$	(13	)	$	13 797	$	(466	)

	The company’s investment in Federal Home Loan Bank (FHLB) stock totaled $822 thousand at September 30, 2011. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Despite the FHLB’s temporary suspension of repurchases of excess capital stock on a regular basis, the company does not consider this investment to be other-than-temporarily impaired at September 30, 2011 and no impairment has been recognized. FHLB stock is shown as a separate line item on the balance sheet and is not a part of the available for sale securities portfolio.

	At September 30, 2011 and December 31, 2010, securities with carrying values of approximately $11.9 million and $24 million, respectively, were pledged to secure municipal deposits, securities sold under agreements to repurchase, other borrowings, and for other purposes as required or permitted by law.

4.	Loans

	The loan portfolio, stated at face amount, is composed of the following:

	September 30,		December 31,
	2011		2010
	(in thousands)
Commercial – non real estate
Commercial and industrial	$	7 579	$	7 920
Commercial real estate
Owner occupied		61 823		67 517
Non-owner occupied		13 734		12 098
Construction
Residential		3 805		5 922
Commercial		17 885		18 252
Real Estate
Farmland		635		792
Residential
Revolving open end		5 039		5 975
1 to 4 family – first liens		79 254		82 691
1 to 4 family – junior liens		7 853		8 871
5 or more family		3 110		1 976
Consumer loans
Titled vehicles		2 998		3 713
Deposit accounts		748		737
All other consumer loans		2 782		2 350
All other loans		126		436
Total loans		207 371		219 250
Less: allowance for loan losses		5 263		5 012

	$	202 108	$	214 238

4.	Loans (Continued)

	The FHLB of Pittsburgh has a blanket lien on all the company’s loans except those loans specifically pledged to the Federal Reserve and removed from the FHLB lien. Currently, the FHLB lien is securing an advance to the company in the amount of $1.8 million and letters of credit issued on behalf of a customer of the company in the amount of $11 million.

5.	Allowance for Loan Losses

	The following is a summary of transactions (in thousands) in the allowance for loan losses:

	September 30,			December 31,			September 30,
	2011			2010			2010
Balance at beginning of period	$	5 012		$	5 718		$	5 718

Provision charged to operating expense		2 727			1 599			984
Recoveries added to the allowance		138			321			182
Loan losses charged to the allowance		(2 614	)		(2 626	)		(2 012	)

Balance at end of period	$	5 263		$	5 012		$	4 872

Allowance for Loan Losses – By Segment

September 30, 2011

(in thousands)

							Commercial												All
	Farmland			Commercial			Real Estate			Construction			Consumer			Residential			Other			Unallocated		Total
Beginning balance	$	166		$	239		$	859		$	2 022		$	20		$	1 691		$	1		$	14	$	5 012
Charge-offs		- -			(20	)		(59	)		(1 123	)		(119	)		(1 293	)		- -			- -		(2 614	)
Recoveries		- -			18			6			5			100			9			- -			- -		138
Provision		(149	)		(85	)		273			247			70			2 328			(1	)		44		2 727

Ending balance	$	17		$	152		$	1 079		$	1 151		$	71		$	2 735		$	0		$	58	$	5 263

Individually evaluated
for impairment	$	- -		$	143		$	840		$	718		$	4		$	379		$	- -		$	- -	$	2 084
Collectively evaluated
for impairment		17			9			239			433			67			2 356			0			58		3 179
	$	17		$	152		$	1 079		$	1 151		$	71		$	2 735		$	0		$	58	$	5 263

Financing receivables:
Ending balance	$	635		$	7 579		$	75 557		$	21 690		$	6 528		$	95 256		$	126		$	- -	$	207 371

Ending balance:
Individually evaluated
for impairment	$	- -		$	143		$	9 827		$	5 603		$	75		$	3 623		$	- -		$	- -	$	19 271
Collectively evaluated
for impairment		635			7 436			65 730			16 087			6 453			91 633			126			- -		188 100
Total	$	635		$	7 579		$	75 557		$	21 690		$	6 528		$	95 256		$	126		$	- -	$	207 371

5.	Allowance for Loan Losses (Continued)

Allowance for Loan Losses – By Segment
December 31, 2010
(in thousands)

					Commercial								All
	Farmland		Commercial		Real Estate		Construction		Consumer		Residential		Other		Unallocated		Total
Ending balance	$	166	$	239	$	859	$	2 022	$	20	$	1 691	$	1	$	14	$	5 012

Individually evaluated
for impairment	$	161	$	217	$	528	$	1 812	$	- -	$	429	$	- -	$	- -	$	3 147
Collectively evaluated
for impairment		5		22		331		210		20		1 262		1		14		1 865
	$	166	$	239	$	859	$	2 022	$	20	$	1 691	$	1	$	14	$	5 012

Financing receivables:
Ending balance	$	792	$	7 920	$	79 615	$	24 174	$	6 800	$	99 513	$	436	$	- -	$	219 250

Ending balance:
Individually evaluated
for impairment	$	539	$	367	$	9 398	$	11 484	$	- -	$	2 874	$	- -	$	- -	$	24 662
Collectively evaluated
for impairment		253		7 553		70 217		12 690		6 800		96 639		436		- -		194 588
Total	$	792	$	7 920	$	79 615	$	24 174	$	6 800	$	99 513	$	436	$	- -	$	219 250

Credit Quality Information – By Class

September 30, 2011

(in thousands)

			Special		Sub-
Internal Risk Rating Grades	Pass		Mention		Standard		Doubtful		Loss
Commercial – non real estate
Commercial and industrial	$	7 198	$	238	$	69	$	74	$	- -
Commercial real estate
Owner occupied		39 723		12 979		6 855		2 266		- -
Non-owner occupied		12 760		333		585		56		- -
Construction
Residential		1 906		1 000		242		657		- -
Commercial		11 204		2 181		2 622		1 878		- -
Real estate
Farmland		635		- -		- -		- -		- -
Consumer
Titled vehicles		N/A		N/A		N/A		N/A		N/A
Deposit accounts		N/A		N/A		N/A		N/A		N/A
All other		N/A		25		N/A		N/A		N/A
Residential
Revolving open end		N/A		1 279		277		N/A		N/A
1-4 family – first liens		N/A		4 096		1 523		333		- -
1-4 family – junior liens		N/A		308		- -		- -		- -
5 or more family		N/A		300		- -		- -		- -

Totals	$	73 426	$	22 739	$	12 173	$	5 264	$	- -

5.	Allowance for Loan Losses (Continued)

Credit Quality Information – By Class
September 30, 2011
(in thousands)

Non Risk Rated Loans	Performing		Nonperforming
Consumer – non real estate
Titled vehicles	$	2 992	$	6
Deposit accounts		748		- -
All other		2 752		5
Residential
Revolving open end		3 453		30
1-4 family – first liens		72 393		909
1-4 Family – junior liens		7 545		- -
5 or more family		2 810		- -
All other		126		- -
Totals	$	92 819	$	950

Credit Quality Information – By Class
December 31, 2010
(in thousands)

			Special		Sub-
Internal Risk Rating Grades	Pass		Mention		Standard		Doubtful		Loss
Commercial – non real estate
Commercial and industrial	$	7 371	$	180	$	95	$	106	$	166
Commercial real estate
Owner occupied		53 078		5 041		3 829		5 375		194
Non-owner occupied		11 470		628		- -		- -		- -
Construction
Residential		282		489		4 005		1 095		51
Commercial		10 348		2 789		3 575		1 363		- -
Real estate
Farmland		253		- -		- -		539		- -
Consumer
Titled vehicles		N/A		N/A		N/A		N/A		N/A
Deposit accounts		N/A		N/A		N/A		N/A		N/A
All other		N/A		N/A		N/A		N/A		N/A
Residential
Revolving open end		N/A		N/A		N/A		N/A		N/A
1-4 family – first liens		N/A		3 234		956		1 434		242
1-4 family – junior liens		N/A		187		42		175		25
5 or more family		N/A		308		- -		- -		- -
Totals	$	82 802	$	12 856	$	12 502	$	10 087	$	678

As a matter of practice, we do not risk rate consumer or residential mortgage loans. Any of these loans listed in the risk rating table above are associated with commercial loans that have been risk rated as per our policy. Once a loan is designated as a loss, it will usually be cleared from the loan portfolio within 90 days. The majority of the loss loans above are in process of foreclosure and will be transferred to other real estate owned (including possible charge-offs) when foreclosures are completed.

Credit Quality Information – By Class (Continued)
December 31, 2010
(in thousands)

Non Risk Rated Loans	Performing		Nonperforming
Consumer – non real estate
Titled vehicles	$	3 705	$	8
Deposit accounts		737		- -
All other		2 345		7
Residential
Revolving open end		5 962		13
1-4 family – first liens		75 901		1 101
1-4 Family – junior liens		8 442		- -
5 or more family		1 668		- -
All other		436		- -
Totals	$	99 196	$	1 129

5. Allowance for Loan Losses (Continued)

Impaired Loans – By Class
September 30, 2011
(in thousands)

With no related allowance:
							Average		Interest
	Unpaid		Recorded		Related		Recorded		Income
	Principal		Investment		Allowance		Investment		Recognized
Commercial – non real estate
Commercial and industrial	$	- -	$	- -	$	N/A	$	82	$	- -
Commercial real estate
Owner occupied		1 550		1 542		N/A		3 522		41
Non-owner occupied		- -		- -		N/A		15		- -
Construction
Residential		792		778		N/A		989		11
Commercial		3 127		3 077		N/A		2 962		98
Real estate
Farmland		- -		- -		N/A		- -		- -
Residential
Revolving open end		277		277		N/A		115		12
1 to 4 family –first liens		450		419		N/A		1 282		- -
1 to 4 family – junior liens		- -		- -		N/A		229		- -
5 or more family		- -		- -		N/A		- -		- -
Consumer
Titled vehicles		- -		- -		N/A		- -		- -
Deposit accounts		- -		- -		N/A		- -		- -
All other consumer		- -		- -		N/A		- -		- -
All other		- -		- -		N/A		4		- -
	$	6 196	$	6 093	$	N/A	$	9 200	$	162

With an allowance recorded:
							Average		Interest
	Unpaid		Recorded		Related		Recorded		Income
	Principal		Investment		Allowance		Investment		Recognized
Commercial – non real estate
Commercial and industrial	$	144	$	143	$	143	$	176	$	3
Commercial real estate
Owner occupied		7 703		7 644		751		5 326		253
Non-owner occupied		647		641		89		163		3
Construction
Residential		- -		- -		- -		1 638		- -
Commercial		1 764		1 748		718		3 199		66
Real estate
Farmland		- -		- -		- -		216		- -
Residential
Revolving open end		- -		- -		- -		76		- -
1 to 4 family – first liens		2 243		2 234		343		2 085		55
1 to 4 family – junior liens		696		693		36		174		15
5 or more family		- -		- -		- -		- -		- -
Consumer
Titled vehicles		- -		- -		- -		- -		- -
Deposit accounts		- -		- -		- -		- -		- -
All other consumer		76		75		4		15		2
All other		- -		- -		- -		- -		- -
	$	13 273	$	13 178	$	2 084	$	13 068	$	397

Totals:
Commercial – non real estate	$	144	$	143	$	143	$	258	$	3
Commercial real estate		9 900		9 827		840		9 026		297
Construction		5 683		5 603		718		8 788		175
Real estate –farmland		- -		- -		- -		216		- -
Residential		3 666		3 623		379		3 961		82
Consumer		76		75		4		19		2
All other		- -		- -		- -		- -		- -
	$	19 469	$	19 271	$	2 084	$	22 268	$	559

5. Allowance for Loan Losses (Continued)

Impaired Loans – By Class
December 31, 2010
(in thousands)

With no related allowance:
							Average		Interest
	Unpaid		Recorded		Related		Recorded		Income
	Principal		Investment		Allowance		Investment		Recognized
Commercial – non real estate
Commercial and industrial	$	117	$	95	$	N/A	$	53	$	- -
Commercial real estate
Owner occupied		4 206		4 256		N/A		3 591		158
Non-owner occupied		75		- -		N/A		15		- -
Construction
Residential		1 188		1 183		N/A		1 769		52
Commercial		2 641		2 631		N/A		3 655		112
Real estate
Farmland		- -		- -		N/A		- -		- -
Residential
Revolving open end		- -		- -		N/A		- -		- -
1 to 4 family – first liens		1 259		1 242		N/A		1 351		15
1 to 4 family – junior liens		175		175		N/A		142		3
5 or more family		- -		- -		N/A		- -		- -
Consumer
Titled vehicles		- -		- -		N/A		- -		- -
Deposit accounts		- -		- -		N/A		- -		- -
All other consumer		- -		- -		N/A		- -		- -
All other		- -		- -		N/A		- -		- -
	$	9 661	$	9 582	$	N/A	$	10 576	$	340

With an allowance recorded:
							Average		Interest
	Unpaid		Recorded		Related		Recorded		Income
	Principal		Investment		Allowance		Investment		Recognized
Commercial – non real estate
Commercial and industrial	$	274	$	272	$	217	$	355	$	6
Commercial real estate
Owner occupied		5 201		5 142		528		4 972		272
Non-owner occupied		- -		- -		- -		- -		- -
Construction
Residential		2 786		2 767		600		3 910		175
Commercial		4 924		4 903		1 212		3 242		216
Real estate
Farmland		549		539		161		547		- -
Residential
Revolving open end		- -		- -		- -		- -		- -
1 to 4 family – first liens		1 412		1 390		362		1 186		56
1 to 4 family – junior liens		71		67		67		220		- -
5 or more family		- -		- -		- -		- -		- -
Consumer
Titled vehicles		- -		- -		- -		- -		- -
Deposit accounts		- -		- -		- -		- -		- -
All other consumer		- -		- -		- -		4		- -
All other		- -		- -		- -		- -		- -
	$	15 217	$	15 080	$	3 147	$	14 436	$	725

Totals:
Commercial – non real estate	$	391	$	367	$	217	$	408	$	6
Commercial real estate		9 482		9 398		528		8 578		430
Construction		11 539		11 484		1 812		12 576		555
Real estate – farmland		549		539		161		547		- -
Residential		2 917		2 874		429		2 899		74
Consumer		- -		- -		- -		4		- -
All other		- -		- -		- -		- -		- -
	$	24 878	$	24 662	$	3 147	$	25 012	$	1 065

5. Allowance for Loan Losses (Continued)

Modifications
As of September 30, 2011
(in thousands except number of contracts)

	For the Three Months Ended						For the Nine Months Ended
	September 30, 2011						September 30, 2011
			Pre-		Post-				Pre-		Post-
			Modification		Modification				Modification		Modification
	Number		Outstanding		Outstanding		Number		Outstanding		Outstanding
	Of		Recorded		Recorded		Of		Recorded		Recorded
	Contracts		Investment		Investment		Contracts		Investment		Investment
Troubled Debt Restructurings

Commercial – non real estate
Commercial and industrial		- -	$	- -	$	- -		- -	$	- -	$	- -
Commercial real estate
Owner Occupied		3		431		431		3		431		431
Non owner occupied		- -		- -		- -		- -		- -		- -
Construction
Residential		- -		- -		- -		- -		- -		- -
Commercial		1		27		27		6		329		329
Real Estate
Farmland		- -		- -		- -		- -		- -		- -
Residential
Revolving open end 1 to 4 family		- -		- -		- -		- -		- -		- -
1 to 4 family – first liens		3		153		170		16		1 580		1 694
1 to 4 family – junior liens		11		415		415		20		705		705
5 or more family		- -		- -		- -		- -		- -		- -
Consumer
Titled Vehicles		- -		- -		- -		- -		- -		- -
Deposit Accounts		- -		- -		- -		- -		- -		- -
All other consumer		2		56		56		3		77		77

All Other		- -		- -		- -		- -		- -		- -

Totals		20	$	1 082	$	1 099		48	$	3 122	$	3 236

As of September 30, 2011 there are two troubled debt restructurings that are thirty or more days past due and one loan that was in non-accrual status before being modified and will be put back on accrual status when they make six timely payments.

	For the Three Months				For the Nine Months
	Ended September 30,2011				Ended September 30,2011
	Number		Outstanding		Number		Outstanding
	Of		Recorded		Of		Recorded
	Contracts		Investment		Contracts		Investment
Troubled Debt Restructurings
That Subsequently Defaulted

Commercial – non real estate
Commercial and industrial		- -	$	- -		- -	$	- -
Commercial real estate
Owner Occupied		- -		- -		- -		- -
Non owner occupied		- -		- -		- -		- -
Construction
Residential		- -		- -		- -		- -
Commercial		- -		- -		- -		- -
Real Estate						- -		- -
Farmland		- -		- -		- -		- -
Residential
Revolving open end 1 to 4 family		- -		- -		- -		- -
1 to 4 family – first liens		1		127		1		127
1 to 4 family – junior liens		3		104		3		104
5 or more family		- -		- -		- -		- -
Consumer
Titled Vehicles		- -		- -		- -		- -
Deposit Accounts		- -		- -		- -		- -
All other consumer		- -		- -		- -		- -
All Other		- -		- -		- -		- -
Totals		4	$	231		4	$	231

5.	Allowance for Loan Losses (Continued)

	Recorded reserves for impaired loans total $2.1 million compared to total nonaccrual loans of $2.8 million. These loans are kept under constant scrutiny by the loan officers and credit administration.

Nonaccrual and Past Due Loans – By Class
September 30, 2011
(in thousands)


	30-59		60-89		90 Days								90 Days
	Days		Days		or more		Total				Total		Past Due		Non
	Past Due		Past Due		Past Due		Past Due		Current		Loans		Accruing		Accrual
Commercial – non real estate
Commercial and industrial	$	61	$	- -	$	- -	$	61	$	7 518	$	7 579	$	- -	$	- -
Commercial real estate
Owner Occupied		- -		112		537		649		61 174		61 823		116		420
Non owner occupied		1 014		333		253		1 600		12 134		13 734		- -		253
Construction
Residential		- -		- -		272		272		3 533		3 805		- -		272
Commercial		1 478		99		478		2 055		15 830		17 885		- -		524
Real Estate
Farmland		- -		- -		- -		- -		635		635		- -		- -
Residential
Revolving open end		- -		- -		- -		- -		5 039		5 039		- -		31
1 to 4 family – first liens		1 101		41		976		2 118		77 136		79 254		252		1 329
1 to 4 family – junior liens		116		- -		40		156		7 697		7 853		40		- -
5 or more family		- -		- -		- -		- -		3 110		3 110		- -		- -
Consumer
Titled Vehicles		21		- -		2		23		2 975		2 998		2		5
Deposit Accounts		- -		- -		- -		- -		748		748		- -		- -
All other consumer		31		- -		29		60		2 722		2 782		25		5
All Other		- -		- -		- -		- -		126		126		- -		- -
Totals	$	3 822	$	585	$	2 587	$	6 994	$	200 377	$	207 371	$	435	$	2 839

Percentage to Total Loans		1.84%		0.28%		1.25%		3.37%		96.63%				0.21%		1.37%

Nonaccrual and Past Due Loans – By Class
December 31, 2010
(in thousands)


	30-59		60-89		90 Days								90 Days
	Days		Days		or more		Total				Total		Past Due		Non
	Past Due		Past Due		Past Due		Past Due		Current		Loans		Accruing		Accrual
Commercial – non real estate
Commercial and industrial	$	80	$	92	$	2	$	174	$	7 746	$	7 920	$	- -	$	97
Commercial real estate
Owner Occupied		612		- -		- -		612		66 905		67 517		- -		- -
Non owner occupied		194		- -		- -		194		11 904		12 098		- -		- -
Construction
Residential		238		- -		- -		238		5 684		5 922		- -		- -
Commercial		115		- -		285		400		17 852		18 252		- -		405
Real Estate
Farmland		- -		- -		539		539		253		792		- -		539
Residential
Revolving open end		- -		- -		- -		- -		5 975		5 975		- -		38
1 to 4 family – first liens		2 269		416		881		3 566		79 125		82 691		- -		1 099
1 to 4 family – junior liens		135		19		- -		154		8 717		8 871		- -		42
5 or more family		- -		- -		- -		- -		1 976		1 976		- -		- -
Consumer
Titled Vehicles		37		2		- -		39		4 310		4 349		- -		8
Deposit Accounts		11		- -		- -		11		774		785		- -		- -
All other consumer		3		- -		5		8		1 658		1 666		- -		5
All Other		- -		- -		- -		- -		436		436		- -		- -
Totals	$	3 694	$	529	$	1 712	$	5 935	$	213 315	$	219 250	$	- -	$	2 233

Percentage to Total Loans		1.69%		0.24%		0.78%		2.71%		97.29%				- -%		1.02%

5.	Allowance for Loan Losses (Continued)

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

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

6.	Employee Benefit Plans

	Components of net periodic benefit cost for the pension and postretirement benefit plans are shown below:

	Pension Benefits						Other Postretirement Benefits
	Three Months Ended						Three Months Ended
	September 30,			September 30,			September 30,		September 30,
	2011			2010			2011		2010
	(in thousands)						(in thousands)
Components of Net Periodic Benefit Cost
Service cost	$	- -		$	- -		$	3	$	3
Interest cost		100			104			9		8
Expected return on plan assets		(119	)		(115	)		- -		- -
Amortization of net obligation at transition		- -			- -			4		4
Recognized net actuarial loss		38			24			- -		- -

Net periodic benefit cost	$	19		$	13		$	16	$	15

	Pension Benefits						Other Postretirement Benefits
	Nine Months Ended						Nine Months Ended
	September 30,			September 30,			September 30,		September 30,
	2011			2010			2011		2010
	(in thousands)						(in thousands)
Components of Net Periodic Benefit Cost
Service cost	$	- -		$	- -		$	10	$	9
Interest cost		301			309			27		26
Expected return on plan assets		(356	)		(345	)		- -		- -
Amortization of net obligation at transition		- -			- -			13		12
Recognized net actuarial loss		112			72			- -		- -

Net periodic benefit cost	$	57		$	36		$	50	$	47

Employer Contribution

The company anticipates the 2011 contribution for the pension plan will approximate $10 thousand and has made this payment as of September 30, 2011. The company has made payments of $14 thousand for the other postretirement benefit plans for the first nine months of 2011 and anticipates remaining payments for 2011 to total $6 thousand.

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

7.	Weighted Average Number of Shares Outstanding and Earnings Per Share

	The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of potential diluted common stock. Potential diluted common stock had no effect on the three months and nine months ended September 30, 2011 and September 30, 2010 earnings per share.

	Three Months Ended				Three Months Ended
	September 30, 2011				September 30, 2010
	Average Shares	Per Share Amount			Average Shares	Per Share Amount
Basic earnings per share	3 390 178	$	(.53	)	3 390 178	$	.16
Effect of dilutive securities:
Stock options	- -				- -

Diluted earnings per share	3 390 178	$	(.53	)	3 390 178	$	.16

	Nine Months Ended				Nine Months Ended
	September 30, 2011				September 30, 2010
	Average Shares	Per Share Amount			Average Shares	Per Share Amount
Basic earnings per share	3 390 178	$	(.40	)	3 390 178	$	.41
Effect of dilutive securities:
Stock options	- -				- -

Diluted earnings per share	3 390 178	$	(.40	)	3 390 178	$	.41

	For the three months and nine months ended September 30, 2011, stock options representing 120,974 average shares, and for the three months and nine months ended September 30, 2010, stock options representing 126,224 average shares were not included in the calculation of earnings per share as their effect would have been anti-dilutive.

8.	Recent Accounting Pronouncements

	In 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.

8.	Recent Accounting Pronouncements (continued)

	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 complied with this Rule beginning with the filing of the June 30, 2011 Form 10-Q.

	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 adopted ASU 2011-02 and included the required disclosures in its consolidated financial statements.

	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.

8.	Recent Accounting Pronouncements (continued)

	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 those rules and forms 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.

9.	Fair Value Measurements

	Determination of Fair Value

	The company uses fair value measurements to record fair value adjustments for certain assets and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

	The recent fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

	Fair Value Hierarchy

	In accordance with this guidance, the company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

	Level 1—Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

	Level 2—Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

	Level 3—Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques.

	A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

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

	Cash and Short-Term Investments

	The carrying amounts of cash and short-term instruments approximate fair values based on the short-term nature of the assets.

	Securities

	Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). Certain of the equity securities with inactive markets utilize Level 3 which may include judgement or estimation.

9.	Fair Value Measurements (Continued)

	Loans

	For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered.

	FHLB Stock

	The carrying amounts of FHLB stock approximate fair value based on redemption provisions of the FHLB.

	Bank Owned Life Insurance (BOLI)

	The carrying amounts of BOLI approximate fair value.

	Deposit Liabilities

	The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity fixed rate certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

	Short-Term Borrowings

	The carrying amounts of borrowings under repurchase agreements and federal funds purchased approximate fair value.

	FHLB Advances

	The fair values of the company’s FHLB advances are estimated using discounted cash flow analysis based on the company’s incremental borrowing rates for similar types of borrowing arrangements.

	Accrued Interest

	The carrying amounts of accrued interest approximate fair value.

	Off-Balance Sheet Financial Instruments

	At September 30, 2011 and December 31, 2010, the fair value of loan commitments and standby-letters of credit was immaterial. Therefore, they have not been included in the following table.

9.	Fair Value Measurements (Continued)

	The carrying amounts and estimated fair values of the company’s financial instruments are as follows:

		September 30, 2011				December 31, 2010
		Carrying		Fair		Carrying		Fair
		Amount		Value		Amount		Value
		(in thousands)				(in thousands)
Financial assets:
	Cash	$	17 268	$	17 268	$	10 180	$	10 180
	Federal funds sold		725		725		2 725		2 725
	Securities available for sale		45 543		45 543		42 690		42 690
	Loans, net		202 108		201 864		214 238		212 200
	Loans held for sale		- -		- -		76		76
	FHLB stock		822		822		765		765
	BOLI		6 872		6 872		6 397		6 397
	Accrued interest receivable		888		888		960		960

Financial liabilities:
	Deposits	$	257 697	$	258 612	$	257 422	$	258 240
	Securities sold under
	agreements to repurchase		5 239		5 239		7 382		7 382
	FHLB advances		1 823		1 839		2 717		2 734
	Accrued interest payable		245		245		361		361

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents the balances (in thousands) of financial assets measured at fair value on a recurring basis as of 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)
Available for sale debt securities
U.S. Government sponsored
agency securities	$	38 041	$	- -	$	38 041	$	- -
State and municipal securities		6 709		- -		6 709		- -

Total available for sale debt securities		44 750		- -		44 750		- -

Available for sale equity securities
Financial services industry		793		- -		135		658

Total available for sale securities	$	45 543	$	- -	$	44 885	$	658

9.	Fair Value Measurements (Continued)

			Fair Value Measurements at December 31, 2010 Using
			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)
Available for sale debt securities
U.S. Government sponsored
agency securities	$	36 288	$	- -	$	36 288	$	- -
State and municipal securities		5 524		- -		5 524		- -

Total available for sale debt securities		41 812		- -		41 812		- -

Available for sale equity securities
Financial services industry		878		- -		878		- -

Total available for sale securities	$	42 690	$	- -	$	42 690	$	- -

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

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	(in thousands)

	Available for Sale Equity Securities
Beginning Balance January 1, 2011	$	- -

Transfers into Level 3		834
Transfers out of Level 3		- -
Total losses (unrealized)
included in other
comprehensive income		(176	)

Ending Balance September 30, 2011	$	658

	Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

	Certain assets are measured at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

	The following describes the valuation techniques used by the company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

	Loans held for sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the periods ended September 30, 2011 and December 31, 2010. Gains and losses on the sale of loans are recorded within other operating income on the consolidated statements of operations.

	Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is likely that some amounts due according to the contractual terms of the loan agreement may not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered (Level 3). The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.

9.	Fair Value Measurements (Continued)

	Other Real Estate Owned: Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal outside of the company or comparative market analysis 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, or property is in the process of being appraised then the fair value is considered Level 3.

	The following table summarizes the company’s financial assets that were measured at fair value (in thousands) on a nonrecurring basis as of September 30, 2011 and December 31, 2010.

Carrying Value at September 30, 2011

Quoted Prices

In Active

Significant

Markets for

Other

Significant

Identical

Observable

Unobservable

Balance as of

Assets

Input

Description

September 30, 2011

(Level 1)

(Level 2)

(Level 3)

Assets

Impaired loans with a

valuation allowance

11 094

- -

5 034

6 060

OREO

6 151

- -

5 355

796

Carrying Value at December 31, 2010

Quoted Prices

In Active

Significant

Markets for

Other

Significant

Identical

Observable

Unobservable

Balance as of

Assets

Input

Description

December 31, 2010

(Level 1)

(Level 2)

(Level 3)

Assets

Loans held for sale

Impaired loans with a

valuation allowance

11 933

- -

10 593

1 340

OREO

6 563

- -

6 563

- -

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

	CRITICAL ACCOUNTING POLICIES

	General

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

Allowance for Loan Losses

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

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as loss, doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for environmental factors such as economic, concentration, and growth trends. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects that margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

FINANCIAL OVERVIEW

The quarter ended September 30, 2011 has produced little, if any, clarity to the economic outlook. The local economy has remained relatively unchanged. The housing market and unemployment continue to be a drag on the local economy. Management has counteracted the reductions in loan income by reducing expenses wherever possible, and continuing to reduce interest expense on deposits. There have been no significant adverse effects on deposit balances.

Management continues to pursue potential loan relationships and is vigilantly marketing our current inventory of foreclosed properties. It is management’s opinion that one of the key elements to improving our situation and that of the local economy is to reduce this housing inventory currently owned by financial institutions. We expect economic growth to be slow and do not expect the real estate market to return to pre-recession levels.

The net loss for the quarter of $1.8 million and a net loss year to date of $1.3 million are primarily due to two charges posted in this quarter. First, we reduced the value of our foreclosed property assets by some $1.85 million upon obtaining updated appraisals on foreclosed property carried on our balance sheet. We evaluate these assets on an ongoing basis especially in a “declining real estate market” which our area continues to experience. About two thirds of the write-down involves residential lot developments foreclosed upon and charged down in 2009. These properties have continued to lose value due to very weak demand by consumers for new housing and little demand from builders for lots. A surplus of foreclosed properties on the market continues to keep prices low, so until new and existing housing values reach some sort of price equilibrium, there will be little demand for both lots and new construction.

A second charge of $2.1 million involves additions to our loan loss reserve as businesses and consumers continue to struggle because of the sluggish economy. In conjunction with our ongoing loan review process, an analysis of both primary and secondary sources of repayment including an assessment of the current value of collateral is performed. Again, most of the collateral that secures our loans is real estate and those values are down significantly.

Total assets have decreased $3.9 million or 1.3% from the December 31, 2010 total of $297.6 million to $293.7 million at September 30, 2011. Net loans have decreased approximately $12.1 million from the December 31, 2010 total of $214.2 million to $202.1 million at September 30, 2011 due to minimal loan demand, the pay down of existing loans, loan charge-offs and the transfer of loans to OREO. Other real estate, net of valuation allowance, has decreased $412 thousand. With the decrease in loans, excess funds have been invested in securities, and overnight funds at the Federal Reserve.

Total deposits have increased $275 thousand or .1% at September 30, 2011 compared to December 31, 2010. Interest-bearing deposits have decreased 1.2% during the first three quarters of 2011, with non-interest bearing deposits increasing 11.3%.

The Tier 1 capital to average assets ratio (leverage capital ratio) is 8.42% at September 30, 2011 compared to 9.36% at December 31, 2010. This capital ratio is within the regulatory guidelines for “well capitalized”.

The debate in Congress regarding the national debt ceiling, federal budget deficit concerns and overall weakness in the economy recently resulted in a downgrade of U.S. government securities by Standard and Poor’s, one of the three major credit rating agencies. This downgrade and the possible future downgrade by one or both of the other two major ratings agencies could create uncertainty in the U.S. and global financial markets. These actions could cause other events which, directly or indirectly, may adversely affect the company’s operations, earnings and financial condition.

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

	September 30,		December 31,		September 30,
	2011		2010		2010
Balance at beginning of period	$	5 012	$	5 718	$	5 718
Charge-offs:
Commercial, financial and agricultural		20		313		294
Real estate – construction		1 123		775		555
Real estate – mortgage		1 352		1 245		949
Consumer		119		293		214
Total charge-offs		2 614		2 626		2 012
Recoveries:
Commercial, financial and agricultural		18		25		- -
Real estate – construction		5		- -		- -
Real estate – mortgage		15		95		20
Consumer		100		201		162
Total recoveries		138		321		182
Net charge-offs		2 476		2 305		1 830
Provision charged to operations		2 727		1 599		984
Balance at end of period	$	5 263	$	5 012	$	4 872

Ratio of net charge-offs (annualized) during the period
to average loans outstanding during the period		1.56%		1.01%		1.07%

As a result of the regular loan reviews by management, the allowance for loan losses increased when comparing data as of September 30, 2011 to September 30, 2010. Many of the loans foreclosed upon or currently in nonaccrual status are related to the real estate industry. In comparing data for the loan loss reserve for the September 30, 2011 quarter end to December 31, 2010 information, the reserve has increased in relation to a continued weak economy. Management continues to review these assets on a regular basis.

Loans are placed on nonaccrual status when principal or interest is delinquent for 90 days or more and in the process of collection. Interest income generally is recognized on specific impaired loans unless the likelihood of further loss is expected. Interest income on other non-accrual loans is recognized only to the extent of interest payments received. The majority of the current non-accrual loans as shown in the chart below are in the process of collection. Following is a table showing the risk elements in the loan portfolio with amounts in thousands.

	September 30,		December 31,		September 30,
	2011		2010		2010
Nonperforming Assets
Nonaccrual loans (1)	$	2 839	$	2 233	$	2 134
Foreclosed properties		6 151		6 563		6 363
Total nonperforming assets	$	8 990	$	8 796	$	8 497

Performing troubled debt restructures (2)	$	3 083	$	- -	$	- -

Loans past due 90 days accruing interest	$	435	$	- -	$	99
Allowance for loan losses to period end loans		2.54%		2.29%		2.19%
Nonperforming assets to period end loans and
foreclosed properties, net		4.21%		3.90%		3.71%

Performing troubled debt restructures to period end loans		1.51%		- -%		- -%

(1)		Currently there is 1 TDR in non-performing assets with a balance of $50K.
(2)		Within this amount are two TDR’s with balances totaling $155k and both are 30 or more days past due.

The details of the income statements for the three month and nine month periods ended September 30, 2011 and 2010 are highlighted below.

Ø Year to date net loss in 2011 is $1.37 million compared to net income of $1.39 million in 2010. Quarterly net loss is $1.8 million in 2011 compared to net income of $528 thousand for the same quarter of 2010. The loan portfolio has decreased as the result of foreclosures and normal run off. Decline in property values have further affected the net income as other real estate write downs have been charged against income. In addition there were net gains on sale of other real estate in 2010 compared to net losses in 2011.

Ø The primary driver of both the year to date loss and quarterly loss are attributable to increases in the loan loss provision and write downs of OREO property. The year to date provision for loan loss has increased $1.7 million over the same period in 2010. The quarterly provision increased $1.9 million over the same quarter in 2010. Likewise, the write down of OREO property had a year to date increase of $2.1 million and a quarterly increase of $1.8 million. Both of these figures represent comparisons to the same time period in 2010.

Ø At September 30, 2011, year to date total interest and dividend income is down 9.5% compared to September 30, 2010. A comparison of quarterly interest and dividend income provides a reduction of 8.6%. In each scenario the reasons for the decrease in income are the same. Loan yields are down slightly over the past year and the loan portfolio has decreased. As of September 30 there are also $2.8 million in loans on nonaccrual status. As of September 30, 2011 loans are down 5.4% compared to December 31, 2010.

Ø At September 30, 2011, year to date interest expense was 26.7% below 2010 expense for the same time period. The quarterly results show a 36.2% drop in interest expense as compared to the same quarter in 2010. The decrease in expense is primarily due to a reduction in interest rates on deposit accounts as part of a planned strategy.

Ø Net interest margin at September 30, 2011 is 3.54%. This is down from the net interest margin of 3.56% for the same period in 2010. During the first nine months of 2011, the overall average rate on loans dropped to 5.56% at September 30, 2011 compared to 5.71% for the same period in 2010. During this same period the overall average rate being paid on deposits decreased to 1.29% from 1.72% at September 30, 2010.

Noninterest income increased 2.5% for the nine months ended September 30, 2011 compared to September 30, 2010 and increased 3.13% for the three months ended September 30, 2011 compared to the three months ended September 30, 2010. Some significant income items are listed here.

Ø Visa and Mastercard fees have increased 13.2% on a year to date basis compared to the same period in 2010. The increase is due to an overall increase in consumer spending and the likelihood that consumers continue to get more comfortable with using credit/debit cards versus cash.

Ø Quarterly comparisons show a 13.1% increase in income from fiduciary activities and a 15.1% increase in fees from Visa and Mastercard. These results are in comparison to the quarter ended September 30, 2010.

Year to date total noninterest expense increased about 40.4% for the nine months ended September 30, 2011 compared to the same period in 2010. The quarterly result was an increase of 86.5% over the September 2010 quarter. Excluding write downs and losses from sales of other real estate, noninterest expense was up 4.6% and 1.1% for the nine and three month periods, respectively. Some details of the remaining accounts are listed below.

Ø Furniture and equipment expense increased 10.2% over September 30, 2010. The quarterly comparisons show an increase of 54.3% over the September 2010 quarter. The primary reason for the increase is maintenance expense related to our core banking software.

Ø Advertising and public relations expense increased 13.2% compared to the same period in 2010. The expense is 20.5% greater than the September 2010 quarter.

Ø Accounting, audit and compliance fees are up 29.8% over September 30, 2010. These same fees show an increase of 41.7% as compared to the September 30, 2010 quarter. The increase is due to auditing services provided by an outside vendor to help assess our loan portfolio.

Ø ATM and check card expenses have increased 15% in the first nine months of 2011 compared to the same time period in 2010. The increase jumps to 18% when compared to the quarter ended September 30, 2010. The increase is due to the purchase of card stock (which generally occurs on a bi-annual basis) as well as an increase in the number of cards being reissued because of fraud, damage or loss by the customer.

Ø Postage expense has increased 15.1% over September 30, 2010. The quarterly results show increases of 13.2% over the quarter ended September 30, 2010. The increase is primarily related to postage costs related to promotional materials and customer notifications. In the third quarter we expensed the postage costs for the shipment of the 140th anniversary calendars and mailings to notify customers of our privacy policy and changes in our fees on deposit accounts. Two of these three items are one time expenses not in the normal course of business.

Ø 2011 year to date other operating expenses have increased 13.5% compared to the same period in 2010. The significant contributing factors include trust investing outsource, other professional fees, other taxes, training and study, and credit reports and investigation.

LIQUIDITY

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

Management is informed of the liquidity information via reports and committee discussion. The president is provided a weekly “dashboard” report of our liquidity information. The Asset/Liability Committee reviews and discusses our liquidity position on a quarterly basis. The committee has set a benchmark minimum liquidity ratio of 15%. Management has recently implemented on a strategy to free up some pledged assets for liquidity purposes.

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

Liquid assets of the company include cash and due from banks, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The company’s statement of cash flows details this liquidity since January 1, 2011.

Operating Activities. The company’s net income usually provides cash from the bank’s operating activities. The net income figure is adjusted for certain noncash transactions such as depreciation expense that reduces net income but does not require a cash outlay. During 2011, the net loss as adjusted has provided cash of $3.1 million. Interest income earned on loans and investment securities is the company’s major income source.

Investing Activities. Customer core deposits and company noncore funding provide the funds used to invest in loans and investment securities. In addition, the principal portion of loan payments, loan payoffs and maturity of investment securities provide cash flow. Purchases of bank premises and equipment are an investing activity. We have taken advantage of our noncore funding capabilities since deposit growth is not always sufficient. The net amount of cash provided by investing activities in 2011 is $4.8 million.

Financing Activities. Customer core deposits and company noncore funding provide the financing for the investing activities as stated above. If the company has an excess of funds on any given day, the bank will sell these funds to make additional interest income to fund activities. Likewise, if the company has a shortage of funds on any given day it will purchase funds and pay interest for the use of these funds. Financing activities also include payment of dividends to shareholders, purchase of shares of the company’s common stock for the treasury and repayment of any noncore funding. The net amount of cash used in financing activities in 2011 is $2.8 million.

At September 30, 2011, cash and due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell, federal funds sold and loans and securities maturing within one year were $41.5 million.

Noncore funding capabilities, including borrowing, provide additional liquidity. The subsidiary bank maintains a federal funds line with one financial institution and is a member of the Federal Home Loan Bank of Pittsburgh. In March 2010, the subsidiary bank modified a $3 million borrowing amortizing over three years from the Federal Home Loan Bank. In July 2009 the subsidiary bank secured a credit line with the Federal Reserve discount window. At September 30, 2011, the subsidiary bank has total credit available through these institutions of approximately $35.7 million.

ANALYSIS OF CAPITAL

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

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

	September 30, 2011 (000’s)
				Minimum
				Capital
	Actual			Requirement
	Amount		Ratio	Amount		Ratio
Total capital to risk weighted assets	$	27 656	13.09%	$	16 903	8.00%
Tier 1 capital to risk weighted assets	$	24 983	11.82%	$	8 451	4.00%
Tier 1 capital to average assets	$	24 983	8.42%	$	11 886	4.00%

	December 31, 2010 (000’s)
				Minimum
				Capital
	Actual			Requirement
	Amount		Ratio	Amount		Ratio
Total capital to risk weighted assets	$	30 798	14.24%	$	17 306	8.00%
Tier 1 capital to risk weighted assets	$	28 065	12.97%	$	8 653	4.00%
Tier 1 capital to average assets	$	28 065	9.36%	$	11 992	4.00%

Item 4. Controls and Procedures

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

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

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

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

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

ISSUER PURCHASES OF EQUITY SECURITIES

			(c) Total Number
			of Shares
	(a) Total		Purchased as	(d) Maximum Number
	Number of	(b) Average	Part of Publicly	of Shares that May
	Shares	Price Paid	Announced	Yet be Purchased
Period	Purchased	Per Share	Programs	Under the Program
July 1 through
July 31	NONE	- -	283 553	62 515
August 1 through
August 31	NONE	- -	283 553	62 515
September 1 through
September 30	NONE	- -	283 553	62 515

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

Item 4. (Removed and Reserved)

Item 5. Other Information

(b)

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

Item 6. Exhibits

	31.1		Certification Under Exchange Act Rule 13a-14, Chief Executive Officer (and Section 302 of Sarbanes-Oxley Act of 2002)

	31.2		Certification Under Exchange Act Rule 13a-14, Chief Financial Officer (and Section 302 of Sarbanes-Oxley Act of 2002)

	32		Certification Pursuant to 18 U.S.C. Section 1350, Chief Executive Officer and Chief Financial Officer (pursuant to Section 906 of Sarbanes-Oxley Act of 2002)

	101.INS		XBRL Instance Document. **

	101.SCH		XBRL Taxonomy Extension Schema. **

	101.CAL		XBRL Taxonomy Extension Calculation Linkbase. **

	101.LAB		XBRL Taxonomy Extension Label Linkbase. **

	101.PRE		XBRL Taxonomy Extension Presentation Linkbase. **

	101.DEF		XBRL Taxonomy Definition Linkbase. **

	**		Furnished, not filed, herewith

SIGNATURES

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

		POTOMAC BANCSHARES, INC.

Date:	November 14, 2011	/s/ Robert F. Baronner, Jr.
		Robert F. Baronner, Jr.
		President & CEO

Date:	November 14, 2011	/s/ Dean Cognetti
		Dean Cognetti
		Sr. Vice President and Interim Chief Financial Officer