BAY BANKS OF VIRGINIA INC - FORM 10-Q

BAY BANKS OF VIRGINIA INC - FORM 10-Q - May 12, 2011

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EX-31.1 - SECTION 302 CEO CERTIFICATION - BAY BANKS OF VIRGINIA INC	dex311.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - BAY BANKS OF VIRGINIA INC	dex312.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - BAY BANKS OF VIRGINIA INC	dex321.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 MARCH 31, 2011

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

COMMISSION FILE NUMBER: 0-22955

BAY BANKS OF VIRGINIA, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


VIRGINIA		54-1838100
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)		(I.R.S. EMPLOYER IDENTIFICATION NO.)

100 SOUTH MAIN STREET, KILMARNOCK, VA		22482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)		(ZIP CODE)

(804) 435-1171

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x yes ¨ no

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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 ¨ 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 “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

2,605,856 shares of common stock on May 10, 2011

FORM 10-Q

For the interim period ending March 31, 2011.

INDEX


PART I - FINANCIAL INFORMATION

ITEM 1.	FINANCIAL STATEMENTS

	CONSOLIDATED BALANCE SHEETS MARCH 31, 2011 (UNAUDITED) AND DECEMBER 31, 2010	3

	CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010 (UNAUDITED)	4

	CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010 (UNAUDITED)	5

	CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010 (UNAUDITED)	6

	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	7

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	18

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	25

ITEM 4.	CONTROLS AND PROCEDURES	25

PART II - OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS	26

ITEM 1A.	RISK FACTORS	26

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	26

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	26

ITEM 4.	REMOVED AND RESERVED	26

ITEM 5.	OTHER INFORMATION	26

ITEM 6.	EXHIBITS	26

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS


	March 31, 2011		December 31, 2010
	(Unaudited)
ASSETS
Cash and due from banks	$	4,263,170	$	3,275,584
Interest-bearing deposits		20,471,652		14,735,892
Federal funds sold		4,834,217		4,727,084
Securities available for sale, at fair value		30,314,256		34,073,728
Restricted securities		2,358,500		2,358,500
Loans, net of allowance for loan losses of $3,213,628 and $3,230,677		242,092,391		244,142,325
Premises and equipment, net		12,551,238		12,697,447
Accrued interest receivable		1,144,775		1,159,924
Other real estate owned, net of valuation allowance		4,722,293		4,085,939
Goodwill		2,807,842		2,807,842
Other assets		2,752,159		3,021,300

*Total assets*	$	328,312,493	$	327,085,565


LIABILITIES
Noninterest-bearing deposits	$	43,902,539	$	44,960,718
Savings and interest-bearing demand deposits		106,316,811		103,908,863
Time deposits		112,517,991		111,984,418

*Total deposits*	$	262,737,341	$	260,853,999

Securities sold under repurchase agreements		6,547,696		7,598,021
Federal Home Loan Bank advances		30,000,000		30,000,000
Other liabilities		1,503,255		1,291,235
Commitments and contingencies		—		—

*Total liabilities*	$	300,788,292	$	299,743,255


SHAREHOLDERS’ EQUITY
Common stock ($5 par value; authorized—5,000,000 shares; outstanding—2,605,856)	$	13,029,280	$	13,029,280
Additional paid-in capital		4,967,836		4,965,460
Retained earnings		9,322,228		9,193,492
Accumulated other comprehensive income, net		204,857		154,078

*Total shareholders’ equity*	$	27,524,201	$	27,342,310


*Total liabilities and shareholders’ equity*	$	328,312,493	$	327,085,565

See Notes to unaudited Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)


Three month periods ended March 31,	2011			2010

INTEREST INCOME
Loans, including fees	$	3,438,163		$	3,607,690
Securities:
Taxable		205,134			244,768
Tax-exempt		64,450			104,321
Federal funds sold		2,972			1,063
Interest-bearing deposit accounts		9,060			10,355

Total interest income		3,719,779			3,968,197


INTEREST EXPENSE
Deposits		820,681			1,071,694
Securities sold under repurchase agreements		3,398			2,806
FHLB advances		342,188			342,188

Total interest expense		1,166,267			1,416,688


Net interest income		2,553,512			2,551,509
Provision for loan losses		55,000			196,422


Net interest income after provision for loan losses		2,498,512			2,355,087


NON-INTEREST INCOME
Income from fiduciary activities		154,433			145,208
Service charges and fees on deposit accounts		166,256			154,207
VISA-related fees		162,958			151,161
Other service charges and fees		165,595			164,756
Secondary market lending fees		37,888			49,593
Gains (losses) on sale of securities available for sale		(1,676	)		1,426
Other real estate gains (losses)		(117,776	)		32,261
Net gains on other investments		4,082			—
Other income		3,118			2,165

Total non-interest income		574,878			700,777


NON-INTEREST EXPENSES
Salaries and employee benefits		1,532,176			1,497,537
Occupancy expense		465,114			522,383
Bank franchise tax		36,780			41,115
Visa expense		127,137			118,832
Telephone expense		43,053			48,191
FDIC assessments		147,098			106,233
Other expense		587,078			585,755

Total non-interest expenses		2,938,436			2,920,046


Net income before income taxes		134,954			135,818

Income tax		6,218			542


Net income	$	128,736		$	135,276


*Basic Earnings Per Share*
Average basic shares outstanding		2,605,856			2,605,856	*
Earnings per share, basic	$	0.05		$	0.05

*Diluted Earnings Per Share*
Average diluted shares outstanding		2,605,856			2,605,856	*
Earnings per share, diluted	$	0.05		$	0.05

*	Adjusted for a 1-for-25 stock dividend on April 23, 2010 and August 27, 2010.

See Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(unaudited)


	Common Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income			Total Shareholders’ Equity
*Balance at January 1, 2010*	$	12,047,357	$	4,842,756	$	9,912,781		$	95,697		$	26,898,591
Comprehensive Income:
Net income		—		—		135,276			—			135,276
Changes in unrealized holding gains on securities arising during the period, net of taxes of $88,659		—		—		—			172,103
Reclassification adjustment for securities gains included in net income, net of taxes of ($485)		—		—		—			(941	)

Total other comprehensive income									171,162			171,162

Total comprehensive income												306,438
Stock-based compensation		—		2,666		—			—			2,666
Stock dividend*		481,402		168,491		(649,893	)		—			—

*Balance at March 31, 2010*	$	12,528,759	$	5,013,913	$	9,398,164		$	266,859		$	27,207,695


*Balance at January 1, 2011*	$	13,029,280	$	4,965,460	$	9,193,492		$	154,078		$	27,342,310

Comprehensive Income:
Net income		—		—		128,736			—			128,736
Changes in unrealized holding gains on securities arising during the period, net of taxes of $25,589		—		—		—			49,673
Reclassification adjustment for securities losses included in net income, net of taxes of $570		—		—		—			1,106

Total other comprehensive income									50,779			50,779

Total comprehensive income												179,515
Stock-based compensation		—		2,376		—			—			2,376


*Balance at March 31, 2011*	$	13,029,280	$	4,967,836	$	9,322,228		$	204,857		$	27,524,201

*	includes 96,280 shares issued on April 23, 2010, as a result of a 1 for 25 stock dividend

See Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


Three months ended March 31,	2011			2010

*Cash Flows From Operating Activities*
Net income	$	128,736		$	135,276
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		206,034			224,458
Net amortization and accretion of securities		17,209			9,997
Provision for loan losses		55,000			196,422
Stock-based compensation		2,376			2,666
Deferred income tax (benefit)		—			(20,805	)
(Gain) loss on securities available-for-sale		1,676			(1,426	)
Increase (decrease) in OREO valuation allowance		104,436			(8,400	)
Loss (Gain) on sale of other real estate		13,341			(32,261	)
Net (gain) on other investments		(4,082	)		—
Decrease in accrued income and other assets		256,856			87,213
Increase in other liabilities		185,861			324,015

Net cash provided by operating activities	$	967,443		$	917,155


*Cash Flows From Investing Activities*
Proceeds from maturities and principal paydowns of available-for-sale securities	$	2,647,524		$	814,634
Proceeds from sales and calls of available-for-sale securities		1,170,000			2,405,000
Purchases of available-for-sale securities		—			(2,653,028	)
Decrease (increase) in interest bearing deposits in other banks		(5,735,760	)		8,699,028
(Increase) in federal funds sold		(107,133	)		(5,137,212	)
Loan (originations) and principal collections, net		1,222,302			(1,638,761	)
Proceeds from sale of other real estate		45,936			290,761
Purchases of premises and equipment		(55,743	)		(56,199	)

Net cash provided by (used in) investing activities	$	(812,874	)	$	2,724,223


*Cash Flows From Financing Activities*
Increase (decrease) in demand, savings, and other interest-bearing deposits	$	1,349,769		$	(1,074,186	)
Net increase in time deposits		533,573			2,521,919
Net (decrease) in securities sold under repurchase agreements (and federal funds purchased)		(1,050,325	)		(2,824,672	)


Net cash provided by (used in) financing activities	$	833,017		$	(1,376,939	)


Net increase in cash and due from banks		987,586			2,264,439

Cash and due from banks at beginning of period		3,275,584			3,461,483

Cash and due from banks at end of period	$	4,263,170		$	5,725,922


*Supplemental Schedule of Cash Flow Information*
Interest paid	$	1,166,369		$	1,397,425

Income taxes paid		10,111			—

Unrealized gain on investment securities		76,938			259,336


Loans transferred to other real estate owned		772,632			399,000

See Notes to Consolidated Financial Statements.

Notes to Consolidated Financial Statements

Note 1: General

Bay Banks of Virginia, Inc. (the “Company”) owns 100% of the Bank of Lancaster (the “Bank”), 100% of Bay Trust Company, Inc. (the “Trust Company”) and 100% of Steptoes Holdings, LLC (“Steptoes Holdings”). The consolidated financial statements include the accounts of the Bank, the Trust Company, Steptoes Holdings and Bay Banks of Virginia, Inc.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to the general practices within the banking industry. In management’s opinion, all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the consolidated financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

Certain amounts in the consolidated financial statements have been reclassified to conform to current year presentations.

These consolidated financial statements should be read in conjunction with the financial statements and notes to financial statements included in the Company’s 2010 Annual Report to Shareholders.

Note 2: Securities

The aggregate amortized costs and fair values of the available-for-sale securities portfolio are as follows:


March 31, 2011 (unaudited)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value

U.S. Government agencies	$	5,701,334	$	33,123	$	(37,594	)	$	5,696,863
State and municipal obligations		24,084,812		590,833		(58,252	)		24,617,393

	$	29,786,146	$	623,956	$	(95,846	)	$	30,314,256


December 31, 2010	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value

U.S. Government agencies	$	8,738,339	$	43,318	$	(27,800	)	$	8,753,857
State and municipal obligations		24,884,217		502,878		(67,224	)		25,319,871

	$	33,622,556	$	546,196	$	(95,024	)	$	34,073,728

Securities with a market value of $8.0 million were pledged as collateral for repurchase agreements and for other purposes as required by law as of March 31, 2011. The market value of pledged securities at December 31, 2010 was $9.9 million.

Securities in an unrealized loss position at March 31, 2011 and December 31, 2010, by duration of the unrealized loss, are shown below. The unrealized loss positions were directly related to interest rate movements as there is minimal credit risk exposure in these investments. All securities are investment grade or better and all losses are considered temporary. Management does not intend to sell the securities and does not expect to be required to sell the securities. Furthermore, we do expect to recover the entire amortized cost basis. Bonds with unrealized loss positions at March 31, 2011 included 4 federal agencies and 11 municipal bonds, as shown below.


	Less than 12 months				12 months or more				Total
March 31, 2011 (unaudited)	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss

U.S. Government agencies	$	2,331,994	$	37,594	$	—	$	—	$	2,331,994	$	37,594
States and municipal obligations		4,511,219		58,252		—		—		4,511,219		58,252

Total temporarily impaired securities	$	6,843,213	$	95,846	$	—	$	—	$	6,843,213	$	95,846


	Less than 12 months				12 months or more				Total
December 31, 2010	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss

U.S. Government agencies	$	1,964,436	$	27,800	$	—	$	—	$	1,964,436	$	27,800
States and municipal obligations		6,679,896		67,224		—		—		6,679,896		67,224

Total temporarily impaired securities	$	8,644,332	$	95,024	$	—	$	—	$	8,644,332	$	95,024

The Company’s investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock totaled $1.9 million at March 31, 2011 and December 31, 2010. 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 its 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 in 2010, the Company does not consider this investment to be other-than-temporarily impaired at March 31, 2011 and no impairment has been recognized. FHLB stock is shown in the restricted securities line item on the consolidated balance sheets and is not a part of the available-for-sale securities portfolio.

Note 3: Loans

The following is a summary of the balances of loans:


	March 31, 2011			December 31, 2010
	(unaudited)
Mortgage loans on real estate:
Construction, Land and Land Development	$	31,055,310		$	30,620,370
Farmland		1,585,102			1,603,519
Commercial Mortgages (Non-Owner Occupied)		11,572,123			12,787,559
Commercial Mortgages (Owner Occupied)		30,317,728			29,430,716
Residential First Mortgages		112,852,017			115,530,317
Residential Junior Mortgages		30,640,345			30,943,025
Commercial and Industrial loans		18,456,350			17,591,891
Consumer Loans		8,827,044			8,865,605

Total loans	$	245,306,019		$	247,373,002
Allowance for loan losses		(3,213,628	)		(3,230,677	)


Loans, net	$	242,092,391		$	244,142,325

The recorded investment in past due and nonaccruing loans is shown in the following table. A loan past due by more than 90 days is generally placed on nonaccrual unless it is both well secured and in the process of collection.


Loans Past Due and Nonaccruals March 31, 2011 (unaudited)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccruals		Total Past Due and Nonaccruals		Current		Total Loans
Construction, Land and Land Development	$	167,602	$	—	$	—	$	342,618	$	510,220	$	30,545,090	$	31,055,310
Farmland		—		—		—		—		—		1,585,102		1,585,102
Commercial Mortgages (Non-Owner Occupied)		—		318,418		—		67,250		385,668		11,186,455		11,572,123
Commercial Mortgages (Owner Occupied)		—		—		—		424,249		424,249		29,893,479		30,317,728
Residential First Mortgages		1,136,775		413,101		—		2,261,916		3,811,792		109,040,225		112,852,017
Residential Junior Mortgages		254,787		313,583		—		1,162,373		1,730,743		28,909,602		30,640,345
Commercial and Industrial		129,345		—		—		659,984		789,329		17,667,021		18,456,350
Consumer Loans		10,013		50,995		4,576		41,204		106,788		8,720,256		8,827,044

Total	$	1,698,522	$	1,096,097	$	4,576	$	4,959,594	$	7,758,789	$	237,547,230	$	245,306,019


Loans Past Due and Nonaccruals December 31, 2010	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccruals		Total Past Due and Nonaccruals		Current		Total Loans
Construction, Land and Land Development	$	—	$	96,153	$	—	$	342,618	$	438,771	$	30,181,599	$	30,620,370
Farmland		—		—		—		—		—		1,603,519		1,603,519
Commercial Mortgages (Non-Owner Occupied)		318,043		—		—		1,356,108		1,674,151		11,113,408		12,787,559
Commercial Mortgages (Owner Occupied)		—		—		—		424,249		424,249		29,006,467		29,430,716
Residential First Mortgages		1,694,757		281,878		—		2,174,010		4,150,645		111,379,672		115,530,317
Residential Junior Mortgages		370,812		—		730		1,169,919		1,541,461		29,401,564		30,943,025
Commercial and Industrial		408,738		—		198,606		65,001		672,345		16,919,546		17,591,891
Consumer Loans		667,355		5,984		3,013		42,104		718,456		8,147,149		8,865,605

Total	$	3,459,705	$	384,015	$	202,349	$	5,574,009	$	9,620,078	$	237,752,924	$	247,373,002

Note 4: Allowance for Loan Losses

A disaggregation of and an analysis of the change in the allowance for loan losses by segment is shown below.

Allowance for Loan Losses by Portfolio Segment

For the three months ended March 31, 2011 (unaudited)


	Construction, Land and Land Development			Farmland		Commercial Mortgages (Non Owner Occupied)		Commercial Mortgages (Owner Occupied)			Residential First Mortgages		Residential Junior Mortgages			Commercial and Industrial		Consumer Loans			Unallocated		Total
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	192,518		$	3,000	$	108,000	$	1,270,451		$	206,171	$	460,648		$	69,869	$	210,662		$	709,358	$	3,230,677
(Charge-offs)									(50,508	)				(18,379	)				(19,596	)			$	(88,483	)
Recoveries																			16,434				$	16,434
Provision		(11,000	)		1,000		3,000		(101,708	)		165,567		(56,727	)		15,000		(50,337	)		90,205	$	55,000

Ending Balance	$	181,518		$	4,000	$	111,000	$	1,118,235		$	371,738	$	385,542		$	84,869	$	157,163		$	799,563	$	3,213,628


Individually evaluated for impairment	$	64,518		$	—	$	—	$	254,235		$	210,738	$	190,542		$	—	$	12,163		$	—	$	732,196
Collectively evaluated for impairment	$	117,000		$	4,000	$	111,000	$	864,000		$	161,000	$	195,000		$	84,869	$	145,000		$	799,563	$	2,481,432

LOAN RECEIVABLES:
Ending Balance:
Individually evaluated for impairment	$	342,618		$	—	$	—	$	2,519,998		$	3,170,513	$	1,508,618		$	65,000	$	561,349				$	8,168,096
Collectively evaluated for impairment		30,712,692			1,585,102		11,572,123		27,797,730			109,681,504		29,131,727			18,391,350		8,265,695					237,137,923


Total Gross Loans	$	31,055,310		$	1,585,102	$	11,572,123	$	30,317,728		$	112,852,017	$	30,640,345		$	18,456,350	$	8,827,044				$	245,306,019

Allowance for Loan Losses by Portfolio Segment

For the Year Ended December 31, 2010


	Construction, Land and Land Development		Farmland		Commercial Real Estate (Non-Owner Occupied)		Commercial Real Estate (Owner Occupied)		Residential First Mortgages		Residential Junior Mortgages		Commercial and Industrial		Consumer Loans		Unallocated		Total
Allowance for loan losses:
Beginning Balance																			$	3,769,287
Charge-offs																				(1,491,707	)
Recoveries																				232,883
Provision																				720,214

Ending Balance	$	192,518	$	3,000	$	108,000	$	1,270,451	$	206,171	$	460,648	$	69,869	$	210,662	$	709,358	$	3,230,677


Individually evaluated for impairment	$	64,518	$	—	$	—	$	397,451	$	93,171	$	67,648	$	—	$	17,662	$	—	$	640,450
Collectively evaluated for impairment	$	128,000	$	3,000	$	108,000	$	873,000	$	113,000	$	393,000	$	69,869	$	193,000	$	709,358	$	2,590,227

Loan Receivables:
Ending Balance:
Individually evaluated for impairment	$	342,618	$	—	$	711,850	$	1,966,334	$	1,803,831	$	1,474,024	$	65,000	$	569,918			$	6,933,575
Collectively evaluated for impairment		30,277,752		1,603,519		12,075,709		27,464,382		113,726,486		29,469,001		17,526,891		8,295,687				240,439,427

Total Gross Loans	$	30,620,370	$	1,603,519	$	12,787,559	$	29,430,716	$	115,530,317	$	30,943,025	$	17,591,891	$	8,865,605			$	247,373,002


	December 31, 2010			March 31, 2010
				(unaudited)
Balance, beginning of year	$	3,769,287		$	3,769,287
Provision for loan losses		720,214			196,422
Recoveries		232,883			12,965
Loans charged off		(1,491,707	)		(268,034	)


Balance, end of period	$	3,230,677		$	3,710,640

Internal risk rating grades are assigned to commercial loans not secured by real estate, commercial mortgages, residential mortgages greater than $1 million, loans to real estate developers and contractors, and consumer loans greater than $250,000 with chronic delinquency, as shown in the following table. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. Risk grades are evaluated as new information becomes available for each borrowing relationship or at least quarterly.

As of March 31, 2011 (unaudited)


INTERNAL RISK RATING GRADES	Construction, Land and Land Development		Farmland		Commercial Real Estate (Non-Owner Occupied)		Commercial Real Estate (Owner Occupied)		Commercial and Industrial		Total
Grade:
Pass	$	22,840,984	$	1,585,102	$	10,326,858	$	18,256,800	$	14,356,972	$	67,366,716
Watch		2,042,234		—		495,155		5,246,343		1,847,263		9,630,995
Special mention		4,265,789		—		—		2,608,189		921,052		7,795,030
Substandard		1,906,303		—		750,110		4,206,396		1,103,711		7,966,520
Doubtful		—		—		—		—		227,352		227,352

Total	$	31,055,310	$	1,585,102	$	11,572,123	$	30,317,728	$	18,456,350	$	92,986,613

As of December 31,2010


INTERNAL RISK RATING GRADES	Construction, Land and Land Development		Farmland		Commercial Real Estate (Non-Owner Occupied)		Commercial Real Estate (Owner Occupied)		Commercial and Industrial		Total
Grade:
Pass	$	22,095,455	$	1,603,519	$	8,356,208	$	18,948,652	$	14,323,275	$	65,327,109
Watch		2,066,022		—		2,393,854		5,960,095		986,309		11,406,280
Special mention		4,036,860		—		318,043		2,592,417		1,334,108		8,281,428
Substandard		2,422,033		—		364,902		1,672,803		948,199		5,407,937
Doubtful		—		—		1,354,552		256,749		—		1,611,301

Total	$	30,620,370	$	1,603,519	$	12,787,559	$	29,430,716	$	17,591,891	$	92,034,055

Loans not assigned internal risk rating grades are comprised of residential mortgages and smaller consumer loans. Payment activity of these loans is reviewed monthly by management. Loans are considered to be nonperforming when they are delinquent by 90 days or more or on nonaccrual, as shown in the table below.

As of March 31, 2011 (unaudited)


PAYMENT ACTIVITY STATUS	Residential First Mortgages		Residential Junior Mortgages		Consumer Loans		Total
Performing	$	110,590,101	$	29,477,972	$	8,781,264	$	148,849,337
Nonperforming		2,261,916		1,162,373		45,780		3,470,069

Total	$	112,852,017	$	30,640,345	$	8,827,044	$	152,319,406

As of December 31, 2010


PAYMENT ACTIVITY STATUS	Residential First Mortgages		Residential Junior Mortgages		Consumer Loans		Total
Performing	$	113,356,307	$	29,772,376	$	8,820,488	$	151,949,171
Nonperforming		2,174,010		1,170,649		45,117		3,389,776

Total	$	115,530,317	$	30,943,025	$	8,865,605	$	155,338,947

The following table shows the Company’s recorded investment and the customers’ unpaid principal balances for impaired loans, with the associated allowance amount, if applicable. Also shown are the average recorded investments in impaired loans and the related amount of interest recognized and collected during the time the loans were impaired.


IMPAIRED LOANS	Recorded Investment		Customers’ Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Interest Income Collected
As of March 31, 2011 (unaudited):
With no related allowance:
Construction, land & land development	$	200,000	$	200,000	$	—	$	200,000	$	—	$	—
Residential First Mortgages		2,060,318		2,063,162		—		1,603,083		23,074		13,195
Residential Junior Mortgages (1)		536,970		822,003		—		539,673		—		—
Commercial Mortgages (Non-owner-occupied)		—		—		—		355,925		—		—
Commercial Mortgages (Owner-occupied)		874,195		874,195		—		744,761		12,719		12,806
Commercial & industrial		65,000		115,625		—		65,000		307		307
Consumer (2)		—		—		—		—		—		—

	$	3,736,483	$	4,074,985	$	—	$	3,508,442	$	36,100	$	26,308


With an allowance recorded:
Construction, land & land development	$	142,618	$	142,618	$	64,518	$	142,618	$	—	$	—
Residential First Mortgages		1,110,195		1,113,695		210,738		884,089		5,340		5,340
Residential Junior Mortgages (1)		971,648		971,648		190,542		951,648		596		400
Commercial Mortgages (Non-owner-occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner-occupied)		1,645,803		1,647,201		254,235		1,498,405		18,271		17,652
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		561,349		561,349		12,163		565,634		8,382		14,982

	$	4,431,613	$	4,436,511	$	732,196	$	4,042,394	$	32,589	$	38,374


Total Impaired Loans:
Construction, land & land development	$	342,618	$	342,618	$	64,518	$	342,618	$	—	$	—
Residential First Mortgages		3,170,513		3,176,857		210,738		2,487,172		28,414		18,535
Residential Junior Mortgages (1)		1,508,618		1,793,651		190,542		1,491,321		596		400
Commercial Mortgages (Non-owner-occupied)		—		—		—		355,925		—		—
Commercial Mortgages (Owner-occupied)		2,519,998		2,521,396		254,235		2,243,166		30,990		30,458
Commercial & industrial		65,000		115,625		—		65,000		307		307
Consumer (2)		561,349		561,349		12,163		565,634		8,382		14,982

	$	8,168,096	$	8,511,496	$	732,196	$	7,550,836	$	68,689	$	64,682

(1)	Junior mortgages include equity lines

(2)	includes credit cards


IMPAIRED LOANS	Recorded Investment		Customers’ Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Interest Income Collected
As of December 31, 2010
With no related allowance:
Construction, land & land development	$	200,000	$	200,000	$	—	$	120,000	$	2,213	$	—
Residential First Mortgages		1,145,848		1,148,692		—		910,146		63,077		60,955
Residential Junior Mortgages (1)		542,376		822,003		—		726,032		24,787		24,042
Commercial Mortgages (Non-owner-occupied)		711,850		711,850		—		283,796		—		—
Commercial Mortgages (Owner-occupied)		615,327		615,327		—		1,328,235		20,677		18,552
Commercial & industrial		65,000		93,948		—		145,064		10,884		4,843
Consumer (2)		—		—		—		—		—		—

	$	3,280,401	$	3,591,820	$	—	$	3,513,274	$	121,638	$	108,392


With an allowance recorded:
Construction, land & land development	$	142,618	$	142,618	$	64,518	$	146,155	$	4,723	$	4,791
Residential First Mortgages		657,983		661,483		93,171		210,744		7,547		1,000
Residential Junior Mortgages (1)		931,648		931,648		67,648		746,447		55,726		58,184
Commercial Mortgages (Non-owner-occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner-occupied)		1,351,007		1,368,724		397,451		1,091,400		24,657		37,027
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		569,918		569,918		17,662		456,449		34,232		31,337

	$	3,653,174	$	3,674,391	$	640,450	$	2,651,195	$	126,885	$	132,339


Total Impaired Loans:
Construction, land & land development	$	342,618	$	342,618	$	64,518	$	266,155	$	6,936	$	4,791
Residential First Mortgages		1,803,831		1,810,175		93,171		1,120,890		70,624		61,955
Residential Junior Mortgages (1)		1,474,024		1,753,651		67,648		1,472,479		80,513		82,226
Commercial Mortgages (Non-owner-occupied)		711,850		711,850		—		283,796		—		—
Commercial Mortgages (Owner-occupied)		1,966,334		1,984,051		397,451		2,419,636		45,334		55,579
Commercial & industrial		65,000		93,948		—		145,064		10,884		4,843
Consumer (2)		569,918		569,918		17,662		456,449		34,232		31,337

	$	6,933,575	$	7,266,211	$	640,450	$	6,164,469	$	248,523	$	240,731

(1)	Junior mortgages include equity lines

(2)	includes credit cards

At March 31, 2011 and December 31, 2010, the Bank had one loan that constitutes a troubled debt restructuring and it is included in impaired loans in the Residential First Mortgages segment in the tables above. It is a commercial purpose loan secured by a residence, with a principal balance of $623,692 at March 31, 2011 and December 31, 2010. This loan was modified to extend the amortization period by five years. Additionally, the repayment terms were modified to reflect the seasonal nature of the borrower’s business, to more closely coincide with the borrower’s cash flows.

At March 31, 2011 and December 31, 2010, non-accrual loans excluded from impaired loan disclosure totaled $1,579,220 and $899,350, respectively. If interest on these loans had been accrued, such income would have approximated $14,771 during the three months ended March 31, 2011 and $34,567 during the year ended December 31, 2010.

Note 5: Earnings per share

The following table shows the weighted average number of shares used in computing earnings per share and the effect on the weighted average number of shares of dilutive potential common stock.


	March 31, 2011				March 31, 2010 (1)
Three Months Ended (unaudited)	Average Shares		Per share Amount		Average Shares		Per share Amount
Basic earnings per share		2,605,856	$	0.05		2,605,856	$	0.05


Effect of dilutive securities:
Stock options		—				—


Diluted earnings per share		2,605,856	$	0.05		2,605,856	$	0.05

(1)	Adjusted for a 1-for-25 stock dividend on April 23, 2010 and August 27, 2010.

As of March 31, 2011 and 2010, options on 217,025 and 183,056 shares, respectively, were not included in computing diluted earnings per share, because their effects were anti-dilutive.

Note 6: Stock-Based Compensation

Incremental stock-based compensation expense recognized was $2,376 during the first three months of 2011 and $2,666 for the same period in 2010. As of March 31, 2011, there was unrecognized compensation expense of $792 related to stock options.

Stock option compensation expense is the estimated fair value of options granted using the Black-Scholes Model amortized on a straight-line basis over the vesting period of the award. There were 34,600 options granted and no options exercised during the three month period ended March 31,2011.

Stock option plan activity for the three months ended March 31, 2011, is summarized below:


	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Aggregate Intrinsic Value (1)

Options outstanding, January 1		210,819		$	11.35		5.6

Granted		34,600			4.85
Forfeited		(25,689	)		6.41
Exercised		—			—
Expired		(2,705	)		16.18

Options outstanding, March 31		217,025			10.84		5.8	$	—


Options exercisable, March 31		167,165			12.57		4.6	$	—

(1)

The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on March 31,2011. This amount changes based on changes in the market value of the Company’s stock.

Note 7: Goodwill

The Company has goodwill recorded on the consolidated financial statements relating to the purchase of five branches during the years 1994 through 2000. The balance of the goodwill at March 31, 2011 and December 31, 2010, as reflected on the consolidated balance sheets was $2,807,842. Management determined that these purchases qualified as acquisitions of businesses and that the related unidentifiable intangibles were goodwill. Therefore, amortization was discontinued effective January 1, 2002. The goodwill balance was tested for impairment in the fourth quarter of 2010.

Note 8: Employee Benefit Plans

The Company has a non-contributory, defined benefit pension plan for all full-time employees over 21 years of age. Under this cash balance plan, the account balance for each participant will grow each year with annual pay credits based on age and years of service and monthly interest credits based on an amount established each year by the Company’s Board of Directors. The Company funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.

The Company sponsors a postretirement benefit plan covering current and future retirees who acquire age 55 and 10 years of service or age 65 and 5 years of service. The post-retirement benefit plan provides coverage toward a retiree’s eligible medical and life insurance benefits expenses.

Components of Net Periodic Benefit Cost

(Unaudited)


	Pension Benefits						Post Retirement Benefits
Three months ended March 31,	2011			2010			2011		2010
Service cost	$	68,737		$	62,038		$	5,570	$	5,161
Interest cost		51,994			48,800			7,943		7,839
Expected return on plan assets		(88,287	)		(80,601	)		—		—
Amortization of unrecognized prior service cost		(13,491	)		(13,491	)		—		—
Amortization of unrecognized net loss		10,605			10,733			42		—
Amortization of transition obligation		—			—			728		728


Net periodic benefit cost	$	29,558		$	27,479		$	14,283	$	13,728

The Company expects to make no contribution to its pension plan and $22,571 to its post-retirement benefit plan in 2011. The Company has contributed $3,390 toward the post-retirement plan during the first three months of 2011.

Note 9: Long Term Debt

On March 31, 2011, the Bank had FHLB debt consisting of three advances. The FHLB holds an option to terminate any of the advances on any quarterly payment date. All advances have an early conversion option which gives the FHLB the option to convert, in whole only, into one-month LIBOR-based floating rate advances, effective on any quarterly payment date. If the FHLB elects to convert, the Company may elect to terminate, in whole or in part, without a prepayment fee.

Advances on the FHLB lines are secured by a blanket lien on qualified 1 to 4 family residential real estate loans with a lendable collateral value of $57.9 million. Immediate available credit, as of March 31, 2011, was $25.9 million. With additional collateral, the total line of credit is worth $65.2 million, with $33.2 million available.

The three advances are shown in the following table.


Description	Balance		Acquired		Current Interest Rate			Maturity Date

Convertible	$	15,000,000		5/18/2006		4.81	%		5/18/2011
Convertible		10,000,000		9/12/2006		4.23	%		9/12/2016
Convertible		5,000,000		5/18/2007		4.49	%		5/18/2012

	$	30,000,000

Note 10: Fair Value Measurements

The Company uses fair value to record certain assets and liabilities and to determine fair value disclosures. Authoritative accounting guidance clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Authoritative accounting guidance specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:


Level 1 –		Valuation is based on quoted prices in active markets for identical assets and liabilities.

Level 2 –		Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.

Level 3 –		Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

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 (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 considers observable market data (Level 2).

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010:


			Fair Value Measurements at March 31, 2011 Using
Description	Balance as of March 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(unaudited)
U. S Government agencies	$	5,696,863	$	—	$	5,696,863	$	—
State and municipal obligations		24,617,393		—		24,617,393		—

			Fair Value Measurements at December 31, 2010 Using
Description	Balance as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

U. S Government agencies	$	8,753,857	$	—	$	8,753,857	$	—
State and municipal obligations		25,319,871		—		25,319,871		—

Certain assets are measured at fair value on a nonrecurring basis in accordance with accounting principles generally accepted in the United States. 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:

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’s 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: Certain assets such as other real estate owned are measured at the lower of their carrying value or fair value less estimated costs to sell. At or near the time of foreclosure, the Bank obtains real estate appraisals on the properties acquired through foreclosure. The real estate is then valued at the lesser of the loan balance, including interest receivable, or the appraised value at the time of foreclosure less an estimate of costs to sell the property. Management believes that the fair value component in its valuation follows the provisions of Financial Accounting Standards Board ASC 820 and that current real estate appraisals support a Level 2 valuation.

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


			Fair value measurements at March 31, 2011 using
Description	Balance as of March 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(unaudited)
Impaired Loans, net of valuation allowance	$	3,699,417	$	—	$	3,699,417	$	—
Other real estate owned	$	4,722,293	$	—	$	4,722,293	$	—

			Fair value measurements at December 31, 2010 using
Description	Balance as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired Loans, net of valuation allowance	$	3,012,724	$	—	$	3,012,724	$	—
Other real estate owned	$	4,085,939	$	—	$	4,085,939	$	—

The estimated fair values of financial instruments are shown in the following table. The carrying amounts in the table are included in the balance sheet under the applicable captions.


	March 31, 2011				December 31, 2010
	(unaudited)
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial Assets:
Cash and due from banks	$	4,263,170	$	4,263,170	$	3,275,584	$	3,275,584
Interest-bearing deposits		20,471,652		20,471,652		14,735,892		14,735,892
Federal funds sold		4,834,217		4,834,217		4,727,084		4,727,084
Securities available-for-sale		30,314,256		30,314,256		34,073,728		34,073,728
Restricted securities		2,358,500		2,358,500		2,358,500		2,358,500
Loans, net		242,092,391		241,806,172		244,142,325		243,940,477
Accrued interest receivable		1,144,775		1,144,775		1,159,924		1,159,924

Financial Liabilities:
Non-interest-bearing deposits	$	43,902,539	$	43,902,539	$	44,960,718	$	44,960,718
Savings and other interest-bearing deposits		106,316,811		106,316,811		103,908,863		103,908,863
Time deposits		112,517,991		113,875,233		111,984,418		113,513,561
Securities sold under repurchase agreements		6,547,696		6,547,696		7,598,021		7,598,021
FHLB advances		30,000,000		31,381,744		30,000,000		31,715,392
Accrued interest payable		291,519		291,519		291,621		291,621

The fair values shown do not necessarily represent the amounts which would be received on immediate settlement of the instruments. Authoritative accounting guidance excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The carrying amounts of cash and due from banks, federal funds sold or purchased, accrued interest, non-interest-bearing deposits, savings, and securities sold under repurchase agreements, represent items which do not present significant market risks, are payable on demand, or are of such short duration that carrying value approximates market value.

Available-for-sale securities are carried at the quoted market prices for the individual securities held. Therefore carrying value equals market value. The carrying value of restricted securities approximates fair value based on the redemption provisions.

The fair value of loans is estimated by discounting future cash flows using the interest rates at which similar loans would be made to borrowers.

Time deposits are presented at estimated fair value using interest rates offered for deposits of similar remaining maturities.

The fair value of the FHLB advances is estimated by discounting the future cash flows using the interest rate offered for similar advances.

The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date.

At March 31, 2011 and December 31, 2010, the fair value of loan commitments and standby letters of credit was immaterial. Therefore, they are not included in the table above.

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair value 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 believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising 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.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist in understanding the results of operations and the financial condition of the Company. This discussion should be read in conjunction with the above consolidated financial statements and the notes thereto.

EXECUTIVE SUMMARY

The Company has not been immune to the continued challenges presented by the current economic and financial regulatory environment. However, management is pleased to report continued profitability for the first quarter of 2011. We believe our conservative philosophy is contributing to positive results relative to the community banking industry generally. We are proud of this conservative philosophy and service to our community. The Bank does not invest in non-traditional debt securities or risky derivatives, nor does it have programs that originate Sub-Prime, Alt-A, or other types of mortgages that have a high risk profile.

The quality of the Bank’s loan portfolio appears to be improving, as evidenced by a reduction in non-performing loans to 2.0% of total loans as of March 31, 2011 compared to 2.3% as of December 31, 2010. However, the reduction in non-performing loans has contributed to an increase in foreclosed properties. Even so, non-performing assets, which include other real estate owned (“OREO”), remains 3.9% of total loans and OREO as of both March 31, 2011 and December 31, 2010. Reduced net loan charge-offs during the first quarter of 2011 is more evidence that the quality of the loan portfolio is improving. Annualized net loan charge-offs were down to 0.12% of total loans for the first quarter of 2011 from 0.50% for the fourth quarter of 2010. These ratios compare very favorably to the Bank’s most recent national peer group average of 0.99%.

Deposit insurance premiums remain historically high for all financial institutions holding domestic deposits as the Federal Deposit Insurance Corporation (“FDIC”) rebuilds the Deposit Insurance Fund. However, the FDIC’s revised calculation of the assessment premiums is expected to save the Bank $34 thousand per quarter beginning in the second quarter of 2011.

Interest margins are being managed effectively. Declines in interest income during the first quarter of 2011 have been entirely mitigated by reductions in interest expense. Loan yields remain low, contributing to reduced interest income, which is also negatively impacted to a lesser degree by non-accruing loans. However, management’s strategy has been to reduce the cost of funds through shifts in the mix of deposits, with focus on core customer relationships, creating compensating reductions in interest expense, and therefore preventing further declines in net interest income as noted previously. Looking forward, as time deposits and FHLB borrowings mature and new instruments are purchased at lower rates, reductions in interest expense are expected to continue. As a result, continued improvements in net interest income during the remainder of 2011 are anticipated.

The size of the loan portfolio has declined slightly since December 31, 2010. Although the Bank originates millions of dollars in new loans each month, the level of originations has not been sufficient to mitigate loan pay downs, prepayments and foreclosures. A significant portion of the Bank’s local economy is driven by residential real estate and the local trend in real estate activity showed decreases in sales volume and number of closed sales during the first quarter of 2011. This has contributed to the decline in interest income. However, local realtors reported that inquiries are up and general traffic in the offices is on the upswing. Regarding commercial loan activity, it remains slow in the current economy.

The Company’s liquidity, core capital levels and regulatory ratios remain good. According to the Bank’s regulators, the Bank remains well capitalized. Given continued economic uncertainty, management continues to give priority to protecting capital and maintaining elevated levels of liquidity.

Management continues efforts to identify and implement earnings opportunities and diligently manage controllable expenses. Unfortunately, foreclosed properties held in OREO are taking a toll as noticeable write-downs, maintenance expenses and losses on sales are now evident.

The Bank’s new branch office in Burgess, which opened in June 2008, is already making a positive contribution to earnings, and the newest branch in Colonial Beach, which opened in March 2009, is on plan. Management believes these new offices will position the Company to take advantage of a recovering economy.

For more information, visit the Company’s website at www.baybanks.com. Information contained on the Company’s website is not a part of this report.

CRITICAL ACCOUNTING POLICIES

GENERAL. The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (“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. For example, historical loss factors are one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors used. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of transactions would be the same, the timing of events that would impact those transactions could change.

ALLOWANCE FOR LOAN LOSSES (“ALL”). ALL is an estimate which reflects management’s judgment of probable losses inherent in the loan portfolio. The ALL is based on two basic principles of accounting: (1) that losses be accrued when they are probable of occurring and estimable and (2) that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The ALL is increased by charges to income, through the provision for loan losses expense, and decreased by charge-offs (net of recoveries).

Management calculates the ALL and evaluates it for adequacy every quarter. This process is lengthy and thorough. The calculation is based on information such as past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions. The quarterly process includes consideration of certain borrowers’ payment histories compared to the terms of each loan agreement and other adverse factors such as divorce, loss of employment income, and bankruptcy. Each loan is then given a risk grade which represents the extent (or lack) of weakness. This grading process occurs dynamically throughout each quarter as new information is learned about each borrowing relationship.

The ALL calculation has three main elements. First, large commercial and construction loan relationships with adverse risk rating grades, in bankruptcy, nonaccruing, or more than 30 days past due are evaluated for impairment. For loans determined to be impaired, a specific allowance is provided when the loan balance exceeds its discounted collateral value. Real estate collateral value is determined based on appraisals done by third parties. At such time as a loan is assigned to a ‘watch’ grade, if the most recent appraisal is more than two years old, a new appraisal will generally be ordered. Discounts applied to collateral include estimated realtor commissions on real estate (in consideration of selling costs should the Bank end up owning the property), and industry-standard reductions in values for accounts receivable, inventory and other varying forms of collateral.

Second, loans not deemed impaired under the first element plus smaller commercial loans, residential mortgages and consumer loans are collectively evaluated in groups of homogenous pools called segments, then a historical loss factor is applied to each segment of loans. The historical loss factor for each segment is calculated by averaging the losses over the prior six quarters.

Finally, a set of qualitative factors, such as changes in credit quality, changes in loan staff experience, changes in loan policies and underwriting guidelines, and changes in national and local economic conditions, is used to estimate the value of intrinsic risk in each of the segments.

The summation of these three elements results in the total estimated ALL. Management may also include an unallocated component to cover uncertainties in the level of probable losses. This estimate is inherently subjective and actual losses could be greater or less than the estimates. For a more detailed description of the ALL, see Note 1 to the Consolidated Financial Statements in Item 8 of the previously filed Form 10-K for the year ended December 31, 2010.

EARNINGS SUMMATION

For the three months ended March 31, 2011, net income was $129 thousand, a decrease of 4.8% compared to the $135 thousand for the similar period in 2010. Diluted earnings per average share were $0.05 for both the three months ended March 31, 2011 and 2010. Annualized return on average assets was 0.2% for both the three months ended March 31, 2011and 2010, also. Annualized return on average equity was 1.9% for the three months ended March 31, 2011, down from 2.0% for the similar period ended March 31, 2010.

The principal source of earnings for the Company is net interest income. Net interest income is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of interest-earning assets. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, the associated yields and rates, and the volume of non-performing assets have an effect on net interest income, the net interest margin, and net income. Although interest income is down $248 thousand in the first quarter of 2011 compared to the same quarter in 2010, interest expense is down $250 thousand, maintaining the level of net interest income. The $248 thousand decrease in interest income was driven by both lower average loan balances and reduced loan yields. The $250 thousand decrease in interest expense was primarily due to reductions in time deposit balances and rates. Due to lower net loan charge-offs, which resulted in decreased provision expense, net interest income after the provision for loan losses is up $143 thousand, or 6.1%.

Net Interest Income Analysis (unaudited)


	Average Balances, Income and Expense, Yields and Rates
(Fully taxable equivalent basis)
	Three months ended 3/31/2011							Three months ended 3/31/2010

(Dollars in Thousands)	Average Balance		Income/ Expense		Yield/ Cost			Average Balance		Income/ Expense		Yield/ Cost
INTEREST EARNING ASSETS:
Taxable investments	$	26,748	$	205		3.07	%	$	24,482	$	245		4.00	%
Tax-exempt investments (1)		6,852		97		5.66	%		11,263		158		5.60	%

Total investments		33,600		302		3.59	%		35,745		403		4.50	%
Gross loans (2)		246,717		3,438		5.59	%		252,174		3,608		5.74	%
Interest-bearing deposits		14,227		9		0.26	%		14,715		10		0.29	%
Federal funds sold		6,330		3		0.19	%		2,776		1		0.16	%

Total Interest Earning Assets	$	300,874	$	3,752		4.99	%	$	305,410	$	4,022		5.27	%

INTEREST-BEARING LIABILITIES:
Savings deposits	$	48,324	$	99		0.83	%	$	44,480	$	97		0.88	%
NOW deposits		37,767		24		0.26	%		35,538		28		0.32	%
Time deposits => $100,000		47,307		289		2.48	%		52,957		378		2.89	%
Time deposits < $100,000		64,480		372		2.33	%		72,228		520		2.92	%
Money market deposit accounts		19,451		37		0.77	%		21,429		49		0.93	%

Total Deposits	$	217,329	$	821		1.53	%	$	226,632	$	1,072		1.92	%

Securities sold under repurchase agreements	$	6,706	$	3		0.21	%	$	5,238	$	3		0.23	%
FHLB advances		30,000		342		4.62	%		30,000		342		4.62	%

Total Interest-Bearing Liabilities	$	254,035	$	1,166		1.86	%	$	261,870	$	1,417		2.19	%


Net interest income and net interest margin			$	2,587		3.44	%			$	2,605		3.41	%
Net interest rate spread						3.13	%						3.07	%

Notes:

(1)	Yield and income assumes a federal tax rate of 34%.

(2)	Includes Visa Program & nonaccrual loans.

The annualized net interest margin was 3.44% for the three months ended March 31, 2011, up from 3.41% for the same period in 2010. The main reason for this improvement is reductions in deposit costs. Unfortunately, because interest rates remain at historic lows, new loans are generally added to the loan portfolio at lower yields than the average yield of the portfolio as a whole. Combined with paydowns and payoffs of generally higher yielding loans, and shrinkage of the loan portfolio, interest income has continued to decline. However, deposit rates have declined to reduce the cost of funding and hence interest expense, more than mitigating declines in interest income, and thus preserving net interest income. Further reductions in the cost of funds are anticipated as time deposits and FHLB advances mature and are replaced at lower rates. This trend is expected to continue and to have positive effects on the net interest margin.

Average interest-earning assets decreased 1.5% to $300.9 million for the three months ended March 31, 2011 as compared to $305.4 million for the three months ended March 31, 2011. Average interest-earning assets as a percent of total average assets was 91.6% for the three months ended March 31, 2011 as compared to 92.4% for the comparable period of 2010. As shown in the table above, for the three months ended March 31, 2011, the loan portfolio, with $246.7 million, is the largest category of interest-earning assets.

Average interest-bearing liabilities decreased 3.0% to $254.0 million for the three months ended March 31, 2011, as compared to $261.9 million for the three months ended March 31, 2010. The largest category of interest-bearing liabilities is time deposits, with combined average balances of $111.8 million for the three months ended March 31, 2011, down from $125.2 million for the similar period in 2010. Noticeable increases in average balances occurred in NOW and savings account deposits.

The net interest spread, which is the difference between the annualized yield on earning assets and the annualized cost of interest-bearing liabilities, increased to 3.13% for the three months ended March 31, 2011 compared to 3.07% for the same period in 2010.

LIQUIDITY

Liquidity represents an institution’s ability to meet present and future financial obligations (such as commitments to fund loans) through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with other banks, federal funds sold and investments and loans maturing within one year. The Company’s ability to obtain deposits and purchase funds at favorable rates determines its liquidity. Management believes that the Company maintains overall liquidity that is sufficient to satisfy its depositors’ requirements and to meet its customers’ credit needs.

At March 31, 2011, federal funds sold totaled $4.8 million, interest-bearing deposits at the Federal Reserve Bank of Richmond totaled $20.5 million, and securities maturing in one year or less totaled $7.5 million. The liquidity ratio as of March 31, 2011 was 16.7% as compared to 15.3% as of December 31, 2010. The Company determines this ratio by dividing the sum of cash and cash equivalents, investment securities maturing in one year or less, loans maturing in one year or less and federal funds sold, by total assets. The Bank has a formal liquidity management policy and contingency plan. Given current economic uncertainty, management is maintaining an historically high level of liquidity.

In addition, as noted earlier, the Company has a line of credit with the FHLB worth $57.9 million, plus federal funds lines of credit with correspondent banks totaling $20.3 million.

OFF BALANCE SHEET COMMITMENTS

In the normal course of business, the Company offers various financial products to its customers to meet their credit and liquidity needs. These instruments frequently involve elements of liquidity, credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheets. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby-letters of credit is represented by the contractual amount of these instruments. Subject to its normal credit standards and risk monitoring procedures, the Company makes contractual commitments to extend credit. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Conditional commitments are issued by the Company in the form of performance stand-by letters of credit, which guarantee the performance of a customer to a third-party. The credit risk of issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.


Off Balance Sheet Arrangements
	March 31, 2011		December 31, 2010
(Dollars in Thousands)
Total Loan Commitments Outstanding	$	29,035	$	32,351
Standby-by Letters of Credit		434		446

The Company maintains liquidity and credit facilities with non-affiliated banks in excess of the total loan commitments and stand-by letters of credit. As these commitments are earning assets only upon takedown of the instrument by the customer, thereby increasing loan balances, management expects the revenue of the Company to be enhanced as these credit facilities are utilized.

There have been no material changes to the off balance sheet items disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operation” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

CONTRACTUAL OBLIGATIONS

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

CAPITAL RESOURCES

Capital resources represent funds, earned or obtained, over which a financial institution can exercise greater long-term control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of the Company’s resources 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 to absorb potential losses, yet allow management to effectively leverage its capital to maximize return to shareholders. The Company’s capital, also known as equity, is comprised mainly of outstanding stock and retained earnings. Capital can be increased with securities offerings or through earnings. The Company has a formal capital policy and plan and management believes that the capital level at March 31, 2011, is sufficient to support current economic uncertainty.

From December 31, 2010 to March 31, 2011, total shareholders’ equity increased from $27.3 million to $27.5 million. Several factors impact shareholder’s equity, including net income, earnings returned to shareholders through cash dividends and regulatory capital requirements.

The Company’s capital resources are also impacted by net unrealized gains or losses on securities. The available-for-sale securities portfolio is marked to market monthly and unrealized gains or losses, net of taxes, are recognized as accumulated other comprehensive income or loss on the balance sheet and statement of changes in shareholders’ equity. Another factor effecting Accumulated Other Comprehensive Income or Loss is changes in the fair value of the Company’s pension and post-retirement benefit plans. Shareholders’ equity before accumulated other comprehensive income was $27.3 million on March 31, 2011 compared to $27.2 on December 31, 2010. Accumulated other comprehensive income increased $51 thousand between December 31, 2010 and March 31, 2011, a result of unrealized gains in the investment portfolio.

Book value per share, basic, increased by 0.6% to $10.56 on March 31, 2011 from $10.49 on December 31, 2010. Book value per share, basic, before accumulated comprehensive income on March 31, 2011, compared to December 31, 2010, increased to $10.48 from $10.43. No cash dividends were paid for the three-month period ended March 31, 2011, nor for the comparable period ended March 31, 2010. Of the 5,000,000 common shares authorized, 2,605,856 were outstanding on March 31, 2011.

The Company began a share repurchase program in August of 1999 and has continued the program into 2011. No repurchases were made during the first three months of 2011 or during the comparable period in 2010.

The Bank is subject to minimum regulatory capital ratios as defined by Federal Financial Institutions Examination Council guidelines. These ratios continue to be well in excess of regulatory minimums. As of March 31, 2011, the Bank maintained Tier 1 capital of $24.2 million, net risk weighted assets of $229.0 million, and Tier 2 capital of $2.9 million. On March 31, 2011, the Tier 1 capital to risk weighted assets ratio was 10.5%, the total capital ratio was 11.8%, and the Tier 1 leverage ratio was 7.5%.

FINANCIAL CONDITION

Total assets increased by 0.4 % to $328.3 million during the three months ended March 31, 2011. Cash and cash equivalents, which produce no income, increased to $4.3 million on March 31, 2011 from $3.3 million at year-end 2010.

During the three months ended March 31, 2011, gross loans declined by $2.1 million or 0.8%, to $245.3 million from $247.4 million at year-end 2010. The largest component of this decrease was in residential first mortgages with a 2.3% decrease to $112.8 million. Consumer loans, including residential real estate, are generally underwritten based on the borrower’s debt-to-income ratio, credit score or payment history and the ratio of the requested loan amount to the value of any collateral. There are established underwriting criteria for these parameters to determine if a loan will be considered an acceptable credit risk. For commercial borrowers, factors we assess include the legal entity of the borrower, the capacity of the borrower to cover its debt service obligations, the strength and creditworthiness of any guarantor support, the value of any collateral relative to the loan amount, stability and predictability of the borrower’s cash flow, and the borrower’s standing with the State Corporation Commission.

As of March 31, 2011, loans valued at $8.2 million were considered impaired, whereas $6.9 million were considered impaired as of December 31, 2010, an increase of $1.3 million. The main reason for the increase is the addition of two lending relationships, valued at $810 thousand. Management has reviewed these impaired credits and the underlying collateral and expects no additional losses above those which are specifically reserved in the ALL.

Risk rating grades are assigned conservatively, causing some homogenous loans, like residential mortgages, to fall into the pool of adversely risk rated loans and thereby evaluated for impairment, even though they may be performing as agreed and therefore not impaired. An expanded set of risk rating grades was completed and implemented during December, 2010, which expanded the number of pass grades to improve monitoring of performing loans.

Non-performing Assets


	March 31, 2011					December 31, 2010
(percentages are as a percent of total loans)	$		%			$		%
Loans past due 90 days or more	$	4,576		0.0	%	$	202,349		0.1	%
Non-accruing loans	$	4,959,594		2.0	%	$	5,574,009		2.3	%

Total non-performing loans	$	4,964,170		2.0	%	$	5,776,358		2.3	%


(percentages are as a percent of total loans plus OREO)
Other real estate owned	$	4,722,293		1.9	%	$	4,085,939		1.6	%

Total non-performing assets	$	9,686,463		3.9	%	$	9,862,297		3.9	%

Non-performing loans, which include loans past due 90 days or more and non-accruing loans, as a percentage of total loans declined to 2.0% as of March 31, 2011 from 2.3% as of December 31, 2010. Non-accruing loans totaled $5.0 million as of March 31, 2011, down from $5.7 million as of year-end 2010. Loans still accruing interest but delinquent for 90 days or more totaled $4.6 thousand on March 31, 2011, down from $202 thousand on December 31, 2010. Non-performing assets, which include OREO in addition to non-performing loans, remained at 3.9% at March 31, 2011 compared to December 31, 2010. This compares favorably to the Bank’s most recent national peer group ratio of 4.6% from December 31, 2010.

Loans charged off during the first three months of 2011, net of recoveries, totaled $72 thousand compared to $255 thousand for the comparable period in 2010. This is a material reduction in the annualized net charge-off ratio from 0.40% for the first quarter of 2010 to 0.12% for the first quarter of 2011, and also compares favorably to the Bank’s most recent national peer group ratio of 0.99%. The majority of these charge-offs were anticipated and specific reserves had been provided for them in the ALL. Although trends in the quality of the Bank’s loan portfolio appear to be improving, management is maintaining a conservative level of the ALL at 1.31% of total loans, which is unchanged compared to December 31, 2010.

The Company now maintains $4.7 million of OREO as of March 31, 2011 compared to $4.1 million at year-end 2010. OREO consists of six residences, nine lots, one former restaurant, a lodging property, a lodging property with a restaurant, two former convenience stores, a former seafood house and one piece of farmland. In the first three months of 2011, one OREO property with a book value of $59 thousand was sold for a loss of $13 thousand, and three properties with a total value of $773 thousand from one borrower were added through a deed in lieu of foreclosure. All properties maintained as OREO are valued at the lesser of carrying value or fair value less estimated costs to sell and are actively marketed.

As of March 31, 2011, securities available-for-sale at market value totaled $30.3 million as compared to $34.0 million on December 31, 2010. This represents a net decrease of $3.8 million or 11.1% for the three months. As of March 31, 2011, these securities represented 9.2% of total assets and 10.1% of earning assets. The Company’s entire investment portfolio is classified as available-for-sale and marked to market on a monthly basis. These gains or losses are booked as an adjustment to shareholders’ equity based upon market conditions, and are not realized as an adjustment to earnings until the securities are actually sold or an other than temporary impairment occurs. Management does not consider any of the securities to be other than temporarily impaired.

As of March 31, 2011, total deposits were $262.7 million compared to $260.9 million at year-end 2010. This represents an increase in balances of $1.9 million or 0.7% during the three months. This increase was due materially to savings and interest bearing demand deposits with a 2.3% increase of $2.4 million.

RESULTS OF OPERATIONS

NON-INTEREST INCOME

Non-interest income for the three months ended March 31, 2011, was down by $126 thousand, or 18.0%, compared to the three months ended March 31, 2010. The main driver of this increase is write-downs of $104 thousand on OREO. Income from Investment Advantage was down to $42 thousand from $62 thousand for the same period of 2010, a decline of $20 thousand. Investment Advantage contributes the majority of income to other service charges and fees, and since income from Investment Advantage is commission-based, declines in investment activity will cause declines in the Company’s income. VISA® related fees increased by $12 thousand in the first three months of 2011 compared to the similar period in 2010.

Income from fiduciary activities was up by $9 thousand for the first three months of 2011 compared to the similar period of 2010. The Company’s fiduciary income is derived from the operations of its subsidiary, Bay Trust Company, which offers a broad range of trust and related fiduciary services. Among these are estate settlement and testamentary trusts, revocable and irrevocable personal trusts, managed agency, custodial accounts, and rollover IRAs, both self-directed and managed. Fiduciary income is largely affected by changes in the performance of the stock and bond market, which directly impacts the market value of the accounts upon which fees are earned and therefore the levels of this fee income.

NON-INTEREST EXPENSE

For the three months ended March 31, 2011, non-interest expenses totaled $2.9 million, an increase of only $18 thousand, or 0.6%, compared to the same period in 2010, due mainly to a $35 thousand increase in salaries and employee benefits expense and a $41 thousand increase in FDIC assessments. A noticeable reduction of $57 thousand in occupancy expense mitigated much of those increases. As noted in the Executive Summary, FDIC assessment expense is expected to decline by $34 thousand per quarter beginning in the second quarter of 2011. The main driver of the reduced occupancy expense is declines in depreciation expense for equipment acquired in 2008 which is now fully depreciated.

The largest component of non-interest expense is salaries and benefits at $1.5 million. Salaries and benefits expense is up by $35 thousand, or 2.3%, for the first three months of 2011 compared to the same period in 2010. This is due primarily to several vacant positions during the first quarter of 2010 which have since been filled.

Other non-interest expenses include bank franchise taxes, which decreased to $37 thousand for the first three months of 2011 compared to $41 thousand for the same period in 2010; expenses related to the Visa® program, which increased to $127 thousand for the first three months of 2011 compared to $119 thousand for the same period in 2010; other expense, which increased by $1 thousand to $587 thousand for the first three months of 2011 compared to the same period in 2010; and telephone expenses, which decreased to $43 thousand for the current period compared to $48 thousand for the same period in 2010. Telephone expenses include the cost of the Company’s Customer Care Center and data network communications.

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, “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 a company’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, will be 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 2010-29, “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 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 2010-28, “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 Update 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.

The Securities Exchange Commission (“SEC”) has issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting”, which requires companies to submit financial statements in XBRL (extensible business reporting language) 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, including the Company, are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 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 was 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, “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 Update 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 is currently assessing the impact that ASU 2011-02 will have on its consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required.

ITEM 4. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As of the end of the period to which this report relates, the Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934. In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that objectives of the disclosure controls and procedures are met. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential conditions. Based upon their evaluation, the Company’s Chief Executive Officer and Principal Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings as of March 31, 2011.

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

There was no change to the Company’s internal control over financial reporting during the quarter ended March 31, 2011 that 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

In the ordinary course of its operations, the Company is a party to various legal proceedings. Based upon information currently available, management believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the business, financial condition, or results of operations of the Company.

ITEM 1A. RISK FACTORS

Not required.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The Company began a share repurchase program in August of 1999 and has continued the program into 2011. There are a total of 280,000 shares authorized for repurchase under the program. No shares were repurchased during the quarter ended March 31, 2011.

ITEM 3. DEFAULT UPON SENIOR SECURITIES

None to report.

ITEM 4. REMOVED AND RESERVED

ITEM 5. OTHER INFORMATION

None to report.

ITEM 6. EXHIBITS


31.1		Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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.


	Bay Banks of Virginia, Inc.
	(Registrant)

May 12, 2011	By:	/s/ Robert F. Hurliman
		Robert F. Hurliman
		Chairman of the Board
		(Interim Principal Executive Officer)

	By:	/s/ Deborah M. Evans
		Deborah M. Evans
		Treasurer
		(Principal Financial Officer)

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company