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EX-32.1 - CITIZENS BANCORP OF VIRGINIA INCex321.htm
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EX-32.2 - CITIZENS BANCORP OF VIRGINIA INCex322.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 June 30, 2011

or

[   ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the transition period from ____________ to _____________

Commission File Number: 0-50576

CITIZENS BANCORP OF VIRGINIA, INC.
(Exact name of registrant as specified in its charter)

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

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

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

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

 
Large accelerated filer  o     Accelerated filer                            o
Non-accelerated filer    o    (Do not check if smaller reporting company)
Smaller Reporting Company           x
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes  £    No  R

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  
2,347,234 shares of Common Stock as of August 9, 2011.
 



 
 

 

 
FORM 10-Q
 
 
For the Period Ended June 30, 2011
 
TABLE OF CONTENTS
Part I.    Financial Information
Page No.
     
Item 1.   Financial Statements
   
Consolidated Balance Sheet
3
   
Consolidated Statements of Income
4
   
Consolidated Statements of Changes in Stockholders’ Equity
5
   
Consolidated Statements of Cash Flows
6
   
Notes to Interim Consolidated Financial Statements
7
   
Item 2.     Management’s Discussion and Analysis of Financial Condition
 
 
and Results of Operations
29
   
Item 4.     Controls and Procedures
43
   
Part II.     Other Information
 
     
Item 1.
Legal Proceedings
44
     
Item 1A.
Risk Factors
44
     
Item 2.  
Unregistered Sales of Equity Securities and Use of Proceeds
44
     
Item 3.
Defaults upon Senior Securities
45
     
Item 4.
[Removed and Reserved]
45
     
Item 5.
Other Information
45
     
Item 6.
Exhibits
45
   
Signatures
46

 
2

 

Part I.  Financial Information
 
 
Item 1.  Financial Statements
 
 
Consolidated Balance Sheets
 
(Dollars in thousands, except share data)
 
   
June 30,
       
   
2011
   
December 31,
 
Assets
 
(Unaudited)
   
2010
 
             
Cash and due from banks
  $ 6,473     $ 5,427  
Interest-bearing deposits in banks
    1,330       1,857  
Federal funds sold
    7,568       15,460  
Securities available for sale, at fair market value
    86,952       82,745  
Restricted securities, at cost
    1,007       1,079  
Loans, net of allowance for loan losses of $2,137
               
    and $2,168
    202,423       200,515  
Premises and equipment, net
    7,035       7,135  
Accrued interest receivable
    1,719       1,816  
Other assets
    2,082       2,846  
Bank owned life insurance
    8,296       8,150  
Other real estate owned, net of valuation allowance of $103 in 2011
         
    and $76 in 2010
    3,557       3,425  
                 
    Total assets
  $ 328,442     $ 330,455  
                 
    Liabilities and Stockholders' Equity
               
                 
Liabilities
               
  Deposits:
               
    Noninterest-bearing
  $ 36,232     $ 33,161  
    Interest-bearing
    236,415       244,827  
    Total deposits
  $ 272,647     $ 277,988  
FHLB advances
    5,000       5,000  
Other borrowings
    5,899       5,149  
Accrued interest payable
    1,011       886  
Accrued expenses and other liabilities
    2,321       1,795  
    Total liabilities
  $ 286,878     $ 290,818  
                 
Stockholders' Equity
               
Preferred stock, $0.50 par value; authorized 1,000,000 shares;
         
       none outstanding
  $ -     $ -  
Common stock, $0.50 par value; authorized 10,000,000 shares;
         
       issued and outstanding, 2,348,509 in 2011 and
    1,174       1,177  
       2,353,509 in 2010
               
Retained earnings
    40,005       39,308  
Accumulated other comprehensive income (loss)
    385       (848 )
    Total stockholders' equity
  $ 41,564     $ 39,637  
                 
    Total liabilities and stockholders' equity
  $ 328,442     $ 330,455  
                 
See accompanying Notes to Interim Consolidated Financial Statements.
 

 
3

 
 
 
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Consolidated Statements of Income (Unaudited)
(Dollars in thousands, except per share data)
 
                     
   
Three Months Ended
   Six Months Ended
   
March 31,
   June 30,
   
2011
 
2010
  2011    2010
Interest and Dividend Income
                   
  Loans, including fees
  $ 3,287   $ 3,461    $  6,529    $  6,881
  Investment securities:
                       
Taxable
    424     556      908      1,054
Tax-exempt
    253     174      511      334
  Federal Funds sold
    3     3      10      8
  Other
    11     6      14      10
Total interest and dividend income
  $ 3,978   $ 4,200    $  7,972    $  8,287
                         
Interest Expense
                       
  Deposits
  $ 947   $ 1,106    $  1,929    $  2,237
  Other borrowings
    39     38      77      75
Total interest expense
  $ 986   $ 1,144    $ 2,006    $  2,312
                         
      Net interest income
  $ 2,992   $ 3,056    $  5,966    $  5,975
                         
Provision for loan losses
    150     150      300      450
                         
Net interest income after provision
                       
       for loan losses
  $ 2,824   $ 2,906    $  5,666    $  5,525
                         
Noninterest Income
                       
  Service charges on deposit accounts
  $ 267   $ 255    $  506    $  516
  Net gain on sales of securities
    -     23      -      27
  Other-than-temporary impairments      (27    -      (7    -
 Less: Noncredit portion of OTTI impairments      13     -      33      -
  Net other-than-temporary impairments        (40 )    -      (40    -
  Net gain on sales of loans
    13     16      27      26
  Income from bank owned life insurance
    75     75      147      143
  ATM fee income
    196     169      377      319
  Other
    81     68      131      132
Total noninterest income
  $ 592   $ 606    $  1,148    $  1,163
                         
Noninterest Expense
                       
  Salaries and employee benefits
  $ 1,371   $ 1,347    $  2,740    $  2,711
  Net occupancy expense
    151     142      300      295
  Equipment expense
    118     129      240      260
  FDIC deposit insurance
    60     143      261      299
  Net (gain) on sale of other real estate owned      (9   (13    (16    (13)
  Impairnt-other real estate owned     27     15      27      15
  Other
    637     636      1,230      1,200
Total noninterest expense
  $ 2,355   $ 2,399    $  4,782    $  4,767
                         
       Income before income taxes
  $ 1,079   $ 1,113    $ 2,032    $  1,921
                         
       Income taxes
    255     297      474      497
                         
       Net income
  $ 824   $ 608    $  1,558    $  1,424
Earnings per share, basic & diluted
  $ 0.35   $ 0.34    $  0.66    $  0.60
 
See accompanying Notes to Interim Consolidated Financial Statements.
 

 
4

 

CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
 
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
 
For the Six Months Ended June 30, 2011 and 2010
 
(Dollars in thousands)
 
                               
               
Accumulated
             
               
Other
             
               
Compre-
             
               
hensive
   
Compre-
       
   
Common
 
Retained
   
Income
   
hensive
       
   
Stock
   
Earnings
   
(Loss)
   
Income
   
Total
 
                               
Balance at December 31, 2009
  $ 1,186     $ 38,177     $ (373 )         $ 38,990  
Comprehensive income:
                                     
   Net Income
    -       1,424       -     $ 1,424       1,424  
Other comprehensive income, net of taxes
                         
Unrealized gains on securities available
                         
           for sale, net of deferred taxes
    -       -       528       528       528  
Less: reclassification adjustment for
                                 
           gain on sale of securities, net of tax
    -       -       (18 )     (18 )     (18 )
Total other comprehensive income
                      510          
       Total comprehensive income
    -       -       -     $ 1,934       -  
Shares repurchased
    (4 )     (71 )     -               (75 )
Cash dividends declared ($0.34 per share)
    -       (804 )     -               (804 )
Balance at June 30, 2010
  $ 1,182     $ 38,726     $ 137             $ 40,045  
                                         
Balance at December 31, 2010
  $ 1,177     $ 39,308     $ (848 )           $ 39,637  
Comprehensive Income:
                                       
   Net income
    -       1,558       -     $ 1,558       1,558  
Other comprehensive income, net of taxes
                         
Unrealized gains on securities available
                         
           for sale, net of deferred taxes
    -       -       1,207       1,207       1,207  
Less: reclassification adjustment for
                                 
           gain on sale of securities, net of tax
    -       -       -       -       -  
Less: reclassification adjustment on
                                 
securities other-than-temporarily
                                 
           impaired, net of tax of ($14)
    -       -       26       26       26  
Total other comprehensive income
                    $ 1,233          
       Total comprehensive income
    -       -       -     $ 2,791       -  
Shares repurchased
    (3 )     (63 )     -               (66 )
Cash dividends declared ($0.34 per share)
    -       (798 )     -               (798 )
Balance at June 30, 2011
  $ 1,174     $ 40,005     $ 385             $ 41,564  
                                         
 
See accompanying Notes to Interim Consolidated Financial Statements.

 
5

 
 
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
 
Consolidated Statements of Cash Flows (Unaudited)
 
(Dollars in thousands)
 
             
   
Six Months Ended
       
   
June 30,
       
   
2011
   
2010
 
Cash Flows from Operating Activities
           
  Net Income
  $ 1,558     $ 1,424  
  Adjustments to reconcile net income to net cash
               
     provided by operating activities:
               
         Depreciation
    262       296  
         Provision for loan losses
    300       450  
         Net (gain) on sales of loans
    (27 )     (26 )
         Origination of loans held for sale
    (1,629 )     (1,845 )
         Proceeds from sales of loans
    1,656       1,871  
         Net (gain) on sales and calls of securities
    -       (27 )
         Other than temporary impairment of securities
    40       -  
         Net amortization of securities
    144       95  
         Impairment of other real estate owned
    27       15  
         Net (gain) on sale of other real estate owned
    (16 )     (13 )
         Changes in assets and liabilities:
               
             Decrease in accrued interest receivable
    97       60  
             (Increase) decrease in other assets
    (15 )     34  
             Increase in accrued interest payable
    125       170  
             Increase (decrease) in accrued expenses and other liabilities
    526       (18 )
         Net cash provided by operating activities
  $ 3,048     $ 2,486  
Cash Flows from Investing Activities
               
  Activity in available for sale securities:
               
         Calls and sales
  $ 7,550       26,305  
         Maturities and prepayments
    4,386       3,892  
         Purchases
    (14,461 )     (35,524 )
  Redemption of restricted securities
    72       -  
  Net (increase) decrease in loans
    (2,502 )     4,925  
  Purchases of land, premises and equipment
    (162 )     (132 )
  Proceeds from sale of other real estate owned
    151       99  
         Net cash (used in) investing activities
  $ (4,966 )   $ (435 )
Cash Flows from Financing Activities
               
  Net (decrease) increase in deposits
  $ (5,341 )   $ 8,393  
  Net increase (decrease) in other borrowings
    750       (691 )
  Repurchase of common stock
    (66 )     (75 )
  Dividends paid
    (798 )     (804 )
         Net cash (used in) provided by financing activities
  $ (5,455 )   $ 6,823  
         Net (decrease) in cash and cash equivalents
  $ (7,373 )   $ 8,874  
Cash and Cash Equivalents
               
  Beginning of period
    22,744       17,035  
  End of period
  $ 15,371     $ 25,909  
Supplemental Disclosures of Cash Flow Information
               
  Cash paid during the period for:
               
      Interest
  $ 1,881     $ 2,142  
      Income Taxes
  $ 295     $ 804  
Supplemental Disclosures of Noncash Investing and
               
   Financing Activities
               
      Other real estate acquired in settlement of loans
  $ 294     $ 476  
      Unrealized gains on securities available for sale
  $ 1,866     $ 772  
                 
 
See accompanying Notes to Interim Consolidated Financial Statements
 

 
6

 

 
Notes to Interim Consolidated Financial Statements
(Unaudited)
 
Note 1.                                General
 
 
The Consolidated Balance Sheets at June 30, 2011 and December 31, 2010, the Consolidated Statements of Income for the three and six months ended June 30, 2011 and June 30, 2010, and the Consolidated Statements of Changes in Stockholders’ Equity and Cash Flows for the six months ended June 30, 2011 and 2010, were prepared in accordance with instructions for Form 10-Q, and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (GAAP) for complete financial statements. However, in the opinion of Management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) considered necessary to present fairly the financial position at June 30, 2011 and the results of operations for the three and six months ended June 30, 2011 and 2010. The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Citizens Bancorp of Virginia, Inc. Annual Report on Form 10-K for the year ended December 31, 2010. The results of operations for the three-month and six-month periods ended June 30, 2011 are not necessarily indicative of the results to be expected for the full year.
 
Citizens Bancorp of Virginia, Inc. (the “Company”) is a one-bank holding company formed on December 18, 2003.  The Company is the sole shareholder of its only subsidiary, Citizens Bank and Trust Company (the “Bank”).  The Bank conducts and transacts the general business of a commercial bank as authorized by the banking laws of the Commonwealth of Virginia and the rules and regulations of the Federal Reserve System.   The Bank was incorporated in 1873 under the laws of Virginia.  Deposits are insured by the Federal Deposit Insurance Corporation.  As of June 30, 2011 the Bank employed 111 full-time employees.  The address of the principal offices for the Company and the main office of the Bank is 126 South Main Street, Blackstone, Virginia, and all banking offices are located within the Commonwealth of Virginia.
 
 Note 2.                      Securities
 
 
    Investment decisions are made by the Management group of the Company and reflect the overall liquidity and strategic asset/liability objectives of the Company.  Management analyzes the securities portfolio frequently and manages the portfolio to provide an overall positive impact to the Company’s income statement, balance sheet and liquidity needs.  Securities available for sale are summarized below:
 
   
June 30, 2011
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
(Losses)
   
Value
 
U.S. government and
 
(Dollars in thousands)
 
     federal agency
  $ 16,709     $ 63     $ -     $ 16,772  
State and municipal
    28,279       651       (112 )     28,818  
Agency mortgage-backed
    37,504       1,171       -       38,675  
Non-agency mortgage-backed
    2,046       5       (199 )     1,852  
Corporate
    753       82       -       835  
Securities available for sale
  $ 85,291     $ 1,972     $ (311 )   $ 86,952  
                                 
 

 
 
7

 
   
December 31, 2010
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
(Losses)
   
Value
 
U.S. government
 
(Dollars in thousands)
 
   and federal agency
  $ 16,761     $ 36     $ (91 )   $ 16,706  
State and municipal
    29,142       209       (646 )     28,704  
Agency mortgage-backed
    33,828       629       (198 )     34,259  
Non-agency mortgage-backed
    2,466       1       (192 )     2,275  
Corporate
    753       48       -       801  
Securities available for sale
  $ 82,950     $ 923     $ (1,127 )   $ 82,745  
                                 
 
The amortized cost and fair value of securities available for sale by contractual maturity at June 30, 2011 follows.   Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or prepaid without any penalties.
 
   
Amortized
   
Fair
 
   
Cost
   
Value
 
   
(Dollars in thousands)
 
Maturing within one year
  $ 860     $ 882  
Maturing after one year through five years
    9,858       9,955  
Maturing after five years through ten years
    11,023       11,279  
Maturing after ten years
    24,000       24,309  
Agency mortgage-backed securities
    37,504       38,675  
Non-agency mortgage-backed securities
    2,046       1,852  
Securities available for sale
  $ 85,291     $ 86,952  
                 

 
Information pertaining to securities with gross unrealized losses at June 30, 2011 and December 31, 2010, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is summarized as follows:
 
 
   
Less than 12 Months
   
12 Months or More
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
June 30, 2011
 
Value
   
(Loss)
   
Value
   
(Loss)
 
   
(Dollars in thousands)
             
U.S. government
                       
  and federal agency
  $ -     $ -     $ -     $ -  
State and municipal
    6,447       (112 )     -       -  
Agency mortgage-backed
    -       -       -       -  
Non-agency mortgage-backed
    -       -       1,065       (199 )
  Total temporarily
                               
    impaired securities
  $ 6,447     $ (112 )   $ 1,065     $ (199 )
                                 
 
 
 
8

 

 
   
Less than 12 Months
   
12 Months or More
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
December 31, 2010
 
Value
   
(Loss)
   
Value
   
(Loss)
 
   
(Dollars in thousands)
             
U.S. government
                       
  and federal agency
  $ 10,412     $ (91 )   $ -     $ -  
State and municipal
    16,916       (619 )     348       (27 )
Agency mortgage-backed
    10,408       (198 )     -       -  
Non-agency mortgage-backed
    695       (6 )     1,291       (186 )
  Total temporarily
                               
    impaired securities
  $ 38,431     $ (914 )   $ 1,639     $ (213 )
                                 
 
Except as explained below, the unrealized losses in the investment portfolio as of June 30, 2011 are considered temporary and are a result of general market fluctuations that occur daily and which have been more volatile since the current economic recession began.  Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market concerns warrant such evaluation.  Consideration is given to (1) the intent of the Bank to sell the security, (2) whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and (3) whether the Bank expects to recover the securities entire amortized cost basis regardless of the Bank’s intent to sell the security. With the exception of the Company’s investment in non-agency CMO securities, unrealized losses in the investment portfolio are considered temporary. The discussion regarding the OTTI analysis for the non-agency CMO securities is discussed below in greater detail.
 
 
In the Company’s Form 10-K report for December 31, 2010, management discussed its ongoing review of five non-agency collateralized mortgage obligations, also referred to as CMOs, four of which had credit agency ratings that were below investment grade as of December 31, 2010. Management’s analysis for the second quarter of 2011 was performed with data as of May 31, 2011. This analysis indicated that four of the non-agency CMOs remain rated below investment grade; according to the Moody’s and Standard & Poor’s credit rating agencies. Management’s analysis also indicated that all five securities have made consistent monthly payments through May 31, 2011. As of May 31, 2011, all five securities showed a net unrealized loss of 7.5% of the $2.1 million book value, which is a decline of 10 basis points from the 7.6% net unrealized loss on $2.5 million of book value at December 31, 2010.
 
 
Management’s second quarter review of the non-agency CMO securities resulted in the recommendation and approval by the Board of Directors for a credit-related other-than-temporary-impairment (OTTI) write-down of $40,000 as of June 30, 2011. This action results is a cumulative credit-related OTTI write-down of $100,000 for the non-agency CMO securities. Previously, management recorded a $60,000 write-down as of December 31, 2009. The latest $40,000 write-down was determined by using the stress testing methodology that has been used since 2009. The data used for the stress testing model includes: the most current “delinquency pipeline” statistics, actual losses realized from the sale of foreclosed properties, and the level of borrower repayments that have been experienced over the life of the CMO security, to date. The credit-related other-than-temporary-impairment estimate of $100,000, which was computed by the stress testing model, is believed to be a conservative estimate of future losses in three of the five non-agency CMOs. There are a number of factors that management considers when determining a proper OTTI level for each of the CMOs, among them are: the projected date of first loss, the remaining credit support and coverage ratio for each CMO. Consideration is also given to general economic conditions that impact the borrowers and their homes, such as refinancing opportunities for jumbo mortgage borrowers, mortgage interest rates, home values, etc.
 
 

 

 
9

 

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

   
(Dollars in thousands)
       
Credit losses recognized in earnings, beginning of period
  $ 60  
         
Recognition of credit losses for which an OTTI was not
 
previously recognized
    40  
         
Credit losses recognized in earnings, end of period
  $ 100  
         
 
 
 
Federal Home Loan Bank Stock
 
 
The Bank’s investment in Federal Home Loan Bank (“FHLB”) stock totaled $851 thousand at June 30, 2011. FHLB stock is generally viewed as a long-term restricted investment security which is carried at cost, because there is no market for the stock other than for the FHLB or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value.  The Bank does not consider this investment to be other than temporarily impaired at June 30, 2011 and no impairment has been recognized on the Federal Home Loan Bank stock.
 
 
Note  3.                      Loans
 
The loan portfolio was composed of the following:
 

   
June 30,
   
December 31,
 
   
2011
   
2010
 
   
(Dollars in thousands)
 
Residential Real Estate:
           
   1-4 family
  $ 88,545     $ 92,520  
   Home equity
    12,293       10,816  
Commercial Real Estate:
               
   Owner occupied
    25,049       23,884  
   Non-owner occupied
    30,520       28,597  
Farmland
    9,618       8,787  
Construction
    14,934       12,943  
        Total real estate
    180,959       177,547  
                 
Commercial & industrial loans
    14,270       14,500  
Consumer loans
    9,331       10,636  
        Total loans
  $ 204,560     $ 202,683  
                 
                 
 
Loan Origination
 
The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and the Board of Directors approve these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and the Board with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.
 
 
The Company has six loan portfolio level segments and eight loan class levels for reporting purposes.
 
 
 
10

 
 
The six loan portfolio level segments include:
 
·  
Residential real estate loans are loans made to borrowers for the purchase of residential dwellings.
 
·  
Commercial real estate loans are loans made to business entities for the purchase of real estate and buildings that will be used in the business.
 
·  
 Farmland loans are loans made to farming entities to acquire land used for agricultural purposes such as in the cultivation of crops or livestock.
 
·  
Construction and land development loans are loans made to individuals or developers in order to construct homes, develop raw land into buildable acreage, or for commercial construction purposes.
 
·  
Commercial and industrial loans are loans made to small and medium-sized businesses for any number of reasons especially working capital. Loans are typically secured by inventory, business equipment, furniture or receivables and they are frequently guaranteed by principals of the business.
 
·  
Consumer loans are loans made to individuals and the loans may be secured by personal property or be unsecured.
 
Residential real estate loans, including home equity loans and lines of credit, are subject to underwriting standards that are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, debt-to-income ratios, credit history, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. While many of the statutory requirements are for the protection of the consumer, underwriting standards aid at mitigating the risks to the Company by setting acceptable loan-approval standards that marginal borrowers may not meet. Additional risk mitigating factors include: residential real estate typically serves as a borrower’s primary residence which encourages timely payments and the avoidance of foreclosure, the average dollar amount of a loan is typically less than that of a commercial real estate loan, and there are a large number of loans which help to diversify the risk potential.
 
 
Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry.
 
 
Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. Management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At June 30, 2011, approximately 45.08% of the outstanding principal balance of the Company’s commercial real estate loans was secured by owner-occupied properties; this is a decrease from 45.51% at December 31, 2010.
 
 
Farmland loans are subject to underwriting standards and processes similar to commercial real estate loans. The loans are considered primarily on the borrower’s ability to make payments originating primarily from the cash flow of the business and secondarily as loans secured by real estate.
 
 
With respect to construction, land and land development loans that are secured by non-owner occupied properties, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten with independent appraisal reviews, lease rates and financial analysis of the borrowers. Construction loans are generally based upon estimates of costs and value associated with the complete project. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.
 
 
11

 
 
Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
 
 
To monitor and manage consumer loan risk, policies and procedures are developed and modified by credit administration and senior management. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage, debt-to-income ratios, credit history, and the number of such loans a borrower can have at one time.
 
 
The Company maintains a credit review department that reviews and validates the credit risk program on a periodic basis. In addition, the Company’s Audit and Risk Management Committee contracts with an independent loan review consulting firm the work of reviewing, among other things, loan relationships exceeding $250,000, a sample of loans underwritten within the authority of loan officers, and the risk grading of criticized and classified assets with balance in excess of $100,000. The firm provides a report to the Audit and Risk Management Committee upon the completion of their annual review. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.
 
 
Concentrations of Credits
 
 
Most of the Company’s lending activity occurs within the Commonwealth of Virginia, more specifically within the South-Central Virginia markets that include Richmond. The majority of the Company’s loan portfolio consists of residential and commercial real estate loans. A substantial portion of its debtors’ ability to honor their contracts and the Company’s ability to realize the value of any underlying collateral, if needed, is influenced by the economic conditions in this market. As of June 30, 2011, there were no concentrations of commercial loans related to any individual purpose that was in excess of 6.29% of total loans.
 

 
12

 

 
Non-accrual and Past Due Loans
 
 
All loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due in accordance with the contractual terms of the underlying loan agreement. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
 
Aging and nonaccrual loans, by individual loan class, as of June 30, 2011 and December 31, 2010 was as follows:
 
     
 
 
 
Loans
30 - 89 Days
Past Due
 
 
 
 
 
 
Loans
90 or More Days
Past Due
 
 
 
 
 
Total
Past Due
Loans
 
 
 
 
 
 
Current
Loans
 
 
 
 
 
Total
Loans
 
 
Accruing Loans
90 or More Days
Loans 1
 
 
 
 
 
Nonaccrual
Loans 1
 
             
 
 
 
At June 30, 2011
         
Residential Real Estate:
 
(In thousands)
 
    1-4 family
 
 $    2,213
 
 $      1,742
 
 $    3,955
 
 $    84,590
 
 $    88,545
 
 $              -
 
 $      1,951
 
    Home equity
 
           15
 
             49
 
           64
 
       12,229
 
       12,293
 
                -
 
              49
 
Commercial Real Estate
                         
    Owner occupied
             -
 
           648
 
         648
 
       24,401
 
       25,049
     
            648
 
    Non-owner occupied
           60
 
           487
 
         547
 
       29,973
 
       30,520
     
            487
 
Farmland
 
             -
 
               8
 
             8
 
        9,610
 
        9,618
 
                -
 
               8
 
Construction
 
           29
 
           128
 
         157
 
       14,777
 
       14,934
 
                -
 
            143
 
Total real estate
 
      2,317
 
        3,062
 
      5,379
 
     175,580
 
     180,959
 
                -
 
         3,286
 
Commercial and industrial
         242
 
           188
 
         430
 
       13,840
 
       14,270
 
            109
 
              79
 
Consumer
 
         115
 
             24
 
         139
 
        9,192
 
        9,331
 
                5
 
              20
 
                                 
           Total loans
 
 $    2,674
 
 $      3,274
 
 $    5,948
 
 $  198,612
 
 $  204,560
 
 $         114
 
 $      3,385
 
 
     
 
 
Loans
30 –
89 Days
Past Due
 
 
 
Loans
90 or More Days
Past Due
 
 
 
 
Total
Past Due
Loans
 
 
 
 
 
Current
Loans
 
 
 
 
 
Total
Loans
 
 
 
 
Accruing Loans
90 or More Days
Loans 1
 
 
 
 
 
Nonaccrual
Loans 1
                 
 
 
 
At December 31, 2010
             
Residential Real Estate:
 
(In thousands)
    1-4 family
 
 $    3,347
 
 $        789
 
 $    4,136
 
 $    88,384
 
 $    92,520
 
 $           28
 
 $      1,788
    Home equity
 
30
 
49
 
79
 
10,737
 
10,816
 
                -
 
              49
Commercial Real Estate
                         
    Owner occupied
 
60
 
636
 
696
 
23,188
 
23,884
     
            637
    Non-owner occupied
58
 
815
 
873
 
27,724
 
28,597
     
            815
Farmland
   
             -
 
11
 
11
 
8,776
 
8,787
 
                -
 
              10
Construction
 
195
 
182
 
377
 
12,566
 
12,943
 
                -
 
            182
Total real estate
 
3,690
 
2,482
 
6,172
 
171,375
 
177,547
 
28
 
3,481
Commercial and industrial
320
 
316
 
636
 
13,864
 
14,500
 
89
 
302
Consumer
   
96
 
38
 
134
 
10,502
 
10,636
 
                -
 
              53
                               
           Total loans
 
 $    4,106
 
 $      2,836
 
 $    6,942
 
 $  195,741
 
 $  202,683
 
 $         117
 
 $      3,836
                               
 
1Accruing loans 90 or more days past due and nonaccrual loans are included in the aging and current loan columns of the tables based on their contractual payments, above.
 
 
13

 
 
Impaired Loans
 
 
Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, which represents either the present value of estimated future cash flows using the loans existing rate or the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
 
Impaired loans, by class, as of June 30, 2011 and December 31, 2010 are shown in the tables below:
 
At June 30, 2011
With no related allowance
 
 
Loans
Unpaid Contractual
Principal Balance
   
 
 
 
Total
Recorded Investment
   
 
 
 
 
Related Allowance
   
 
 
 
Average
Recorded Investment
   
 
 
 
Interest
Income
Recognized
 
Residential Real Estate:
       
(In thousands)
       
    1-4 family
  $ 135     $ 135     $ -     $ 137     $ 5  
    Home equity
    300       300       -       300       5  
Commercial Real Estate:
                                       
    Owner occupied
    101       55       -       68       3  
    Non-owner occupied
    1,327       1,327       -       1,327       46  
Farmland
    1,875       1,875       -       1,658       59  
Construction
    258       254       -       272       9  
Commercial and industrial
    693       160       -       783       31  
Consumer installment
    -       -       -       -       -  
           Total loans
  $ 4,689     $ 4,106     $ -     $ 4,545     $ 158  
With an allowance recorded
                                       
Residential Real Estate:
                                       
    1-4 family
  $ 838     $ 837     $ 143     $ 836     $ 29  
    Home equity
    -       -       -       -       -  
Commercial Real Estate:
                                       
    Owner occupied
    1,115       1,074       82       1,076       41  
    Non-owner occupied
    -       -       -       -       -  
Farmland
    -       -       -       -       -  
Construction
    72       72       34       72       3  
Commercial and industrial
    187       179       55       159       5  
Consumer installment
    -       -       -       -       -  
           Total loans
  $ 2,212     $ 2,162     $ 314     $ 2,143     $ 78  
Total impaired loans1
                                       
Residential Real Estate:
                                       
    1-4 family
  $ 973     $ 972     $ 143     $ 973     $ 34  
    Home equity
    300       300       -       300       5  
Commercial Real Estate:
                                       
        Owner occupied
    1,216       1,129       82       1,144       44  
        Non-owner occupied
    1,327       1,327       -       1,327       46  
Farmland
    1,875       1,875       -       1,658       59  
Construction
    330       326       34       344       12  
Commercial and industrial
    880       339       55       942       36  
Consumer installment
    -       -       -       -       -  
           Total loans
  $ 6,901     $ 6,268     $ 314     $ 6,688     $ 236  
                                         

 
14

 

At December 31, 2010
With no related allowance
 
 
Loans
Unpaid Contractual
Principal Balance
   
 
 
 
Total
Recorded Investment
   
 
 
 
 
Related Allowance
   
 
 
 
Average-
Recorded Investment
   
 
 
 
Interest
Income Recognized
 
Residential Real Estate:
                   
(In thousands)
       
    1-4 family
  $ -     $ -     $ -     $ -     $ -  
    Home equity
    -       -       -       -       -  
Commercial Real Estate:
                                       
    Owner occupied
    881       825       -       850       66  
    Non-owner occupied
    1,386       1,386       -       1,390       97  
Farmland
    1,546       1,546       -       2,081       145  
Construction
    412       409       -       415       27  
Commercial and industrial
    835       303       -       914       70  
Consumer installment
    -       -       -       -       -  
           Total loans
  $ 5,060     $ 4,469     $ -     $ 5,650     $ 405  
With an allowance recorded
                                       
Residential Real Estate:
                                       
    1-4 family
  $ 653     $ 649     $ 113     $ 640     $ 44  
    Home equity
    -       -       -       -       -  
Commercial Real Estate:
                                       
    Owner occupied
    669       637       56       639       30  
    Non-owner occupied
    -       -       -       -       -  
Farmland
    -       -       -       -       -  
Construction
    63       63       24       63       4  
Commercial and industrial
    121       90       45       100       6  
Consumer installment
    8       8       1       8       1  
           Total loans
  $ 1,514     $ 1,447     $ 239     $ 1,450     $ 85  
Total impaired loans1
                                       
Residential Real Estate:
                                       
    1-4 family
  $ 653     $ 649     $ 113     $ 640     $ 44  
    Home equity
    -       -       -       -       -  
Commercial Real Estate:
                                       
        Owner occupied
    1,550       1,462       56       1,489       96  
        Non-owner occupied
    1,386       1,386       -       1,390       97  
Farmland
    1,546       1,546       -       2,081       145  
Construction
    475       472       24       478       31  
Commercial and industrial
    956       393       45       1,014       76  
Consumer installment
    8       8       1       8       1  
           Total loans
  $ 6,574     $ 5,916     $ 239     $ 7,100     $ 490  
                                         
1TDR's (Troubled Debt Restructurings) included in the impaired loan tables above at June 30, 2011
 
and December 31, 2010 totaled $3.240 million and $1.720 million respectively.
 
 
The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 risk grades is as follows:
 
 
Grade 1 – “Excellent” This grade includes loans to borrowers with superior capacity to pay interest and principal. Foreseeable economic changes are unlikely to impair the borrowers’ strength. Typically, borrowers have an excellent organizational structure in place with highly regarded and experienced management.  Stable business, relatively unaffected by business, credit, or product cycles, business is significant in its market and has a well-defined market share. Borrower will have ready access to both public debt and equity markets under most conditions. Collateral is highly liquid, substantial margins are maintained, and primary/secondary sources of repayment are excellent.
 
 
 
15

 
 
Grade 2 – “Good” This grade includes loans to borrowers that represent a solid, demonstrated capacity to pay interest and principal, but material downturns in economic conditions may impact the borrowers’ financial condition. Typically, borrowers exhibit low levels of leverage and the overall capitalization of the company is deemed satisfactory. Trends for revenue, core profitability and financial ratios are consistently above average with industry peers. Cash flow adequately covers dividends/withdrawals, and historic debt service in excess of 1.5 times. Collateral coverage is greater than 2.0 times or less than 50% loan-to-value ratio. Borrower has a stable, well-regarded and qualified management team in place, along with strong financial controls being evident. Normal industry stability, sales and profits are affected by business, credit or product cycles.  Market share is stable. Borrower has the capability to refinance with another institution.
 
Grade 3 – “Standard” This grade includes loans to borrowers which have historically demonstrated an above adequate capacity to repay forecasted principal and interest charges; with debt service coverage of 1.20 times based on at least two years of historical earnings. Borrowers have inherent, definable weaknesses; however the weaknesses are not necessarily uncommon to a particular business, loan type or industry. Changes in economic circumstances could have non-material immediate repercussions on the borrowers’ financial condition. Collateral support is deemed to be satisfactory based on appropriate discount factoring to allow a recovery sufficient to pay-off the debt. Collateral could be reasonably collected and/or liquidated in the general market. Additional collateral may be deemed an abundance of caution. Earnings are generally positive, subject to influences of current market conditions and distributions are reasonable in relation to the overall financial picture of the company. Guarantor support is deemed to be marginal as evidenced by personal assets, which probably could not support the business in full, if needed.
 
Grade 4 – “Acceptable” This grade includes loans to borrowers that will have inherent, definable weaknesses, however these weaknesses are not necessarily uncommon to a particular business, loan type, or industry. Economic changes could have negative repercussions on the financial condition. Borrowers overall financial position would indicate financing in the market is feasible, at rates and terms typical of current market conditions. Debt service coverage is deemed acceptable at 1.00 to 1.19 times on a combined basis for at least two years of historical earnings. Borrowers exhibit moderately high to high levels of leverage as noted against policy and Risk Management Association industry averages. Tangible net worth is marginally positive or even showing signs of a deficit net worth. Collateral support is deemed to be acceptable or even marginal, but not strong based on appropriate discounting, asset quality may be questionable given specific nature of assets, often secondary non-business assets are required. Earnings are marginally positive or a trend of negative earnings is identified and distributions are considered to be in excess of reasonableness. Guarantor support is deemed to be marginal as evidenced by personal assets, which probably could not support the business in full if needed. Repayment history also shows a discernable level of delinquent payments.
 
Grade 5 – This grade includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near term.
 
Grade 6 – This grade is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This grade is intended to be temporary and includes loans to borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation.
 
Grade 7 – This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest may or may not have been stopped. This grade also includes loans where interest is more than 120 days past due and not fully secured and loans where a specific valuation allowance may be necessary, but does not exceed 30% of the principal balance.
 
Grade 8 – This grade includes “Doubtful” loans in accordance with regulatory guidelines. Such loans are placed on non-accrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance in excess of 30% of the principal balance.
 
 
 
16

 
 
Grade 9 – This grade includes “Loss” loans in accordance with regulatory guidelines. Such loans are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be repaid, nor does it in any way imply that there has been a forgiveness of debt.
 
 
The following tables present credit quality by loan class as of June 30, 2011 and December 31, 2010.
 

             
Special
               
At June 30, 2011
 
Pass
 
Watch
 
Mention
 
Substandard
Doubtful
 
Loss
 
Total
Residential Real Estate:
(In thousands)
    1-4 family
 
 $     82,319
 
 $       1,700
 
 $           958
 
 $       3,568
 
 $                -
 
 $                -
 
 $       88,545
    Home equity
 
        11,674
 
              229
 
                41
 
              349
 
                    -
 
                    -
 
          12,293
Commercial Real Estate:
                         
    Owner occupied
 
        22,522
 
           1,071
 
              808
 
              528
 
              120
 
                    -
 
          25,049
    Non-owner occupied
 
        27,795
 
              812
 
           1,431
 
              481
 
                    -
 
                    -
 
          30,519
Farmland
   
           7,737
 
                    -
 
                    -
 
           1,881
 
                    -
 
                    -
 
            9,618
Construction
 
        14,271
 
              120
 
              162
 
              309
 
                72
 
                    -
 
          14,934
    Total real estate loans
      166,318
 
           3,932
 
           3,400
 
           7,116
 
              192
 
                    -
 
        180,958
Commercial and industrial
        11,415
 
           2,474
 
              111
 
              270
 
                    -
 
                    -
 
          14,270
Consumer
   
           9,232
 
                26
 
                   9
 
                64
 
                    -
 
                    -
 
            9,331
                               
           Total loans
 
 $   186,965
 
 $       6,432
 
 $       3,520
 
 $       7,450
 
 $           192
 
 $                -
 
 $    204,559
             
 
 
Special
               
At December 31, 2010
 
Pass
 
Watch
 
Mention
 
Substandard
Doubtful
 
Loss
 
Total
Residential Real Estate:
(In thousands)
    1-4 family
 
 $     86,147
 
 $       1,428
 
 $       1,233
 
 $       3,662
 
 $             50
 
 $                -
 
 $       92,520
    Home equity
 
        10,219
 
              205
 
                43
 
              349
 
                    -
 
                    -
 
          10,816
Commercial Real Estate:
                         
    Owner occupied
 
        21,410
 
           1,058
 
              759
 
              536
 
              121
 
                    -
 
          23,884
    Non-owner occupied
 
        25,438
 
              848
 
           1,438
 
              873
 
                    -
 
                    -
 
          28,597
Farmland
   
           7,230
 
                    -
 
                    -
 
           1,557
 
                    -
 
                    -
 
            8,787
Construction
 
        12,236
 
                72
 
              163
 
              472
 
                    -
 
                    -
 
          12,943
    Total real estate loans
      162,680
 
           3,611
 
           3,636
 
           7,449
 
              171
 
                    -
 
        177,547
Commercial and industrial
        11,491
 
           2,505
 
              111
 
              319
 
                74
 
                    -
 
          14,500
Consumer
   
        10,524
 
                12
 
                12
 
                88
 
                    -
 
                    -
 
          10,636
                               
           Total loans
 
 $   184,695
 
 $       6,128
 
 $       3,759
 
 $       7,856
 
 $           245
 
 $                -
 
 $    202,683
                               
 
Note 4.                      Allowance for Loan Losses
 
The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by loan segment and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for possible loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.
 
 
17

 
 
The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
 
 
The Company's allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other qualitative risk factors both internal and external to the Company. Provisions for loan losses increase the amount of the allowance based upon the above considerations. Amounts computed to produce an appropriate allowance amount in one period can subsequently be affected by any recoveries of previously charged-off amounts, which are credited to the allowance, and by the reduction of overall loan balances from one period to another. These events, as well as others, can result in producing an "unallocated reserve component" at the end of any period, which is not attributable to any specific loan segment.
 
 
The allowance established for probable losses on specific loans is based on a regular analysis and evaluation of problem loans. Commercial loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 7 or higher, the loan is analyzed to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for possible loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.
 
 
18

 
 
The historical component is calculated based on the historical charge-off experience of loan segments. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similar groups of residential real estate loans, commercial real estate loans, commercial and industrial loans, and consumer loans. The methodology employed to determine the historical loss ratio takes into consideration the net charge-offs for the most recent 36-months plus any specific reserve that are in place against individually impaired loans, by loan segment, at the time of the ratio calculation.
 
 
The general reserve component is based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Company’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component will have a certain percentage assigned to it and this percent will be applied against the specific loan segments that are impacted by the various factors, mentioned above. The results of the general component are then included to determine an appropriate valuation allowance.
 
Loans that are either partially or totally identified as losses by management, internal loan review and/or bank examiners are charged-off. Certain unsecured consumer loan accounts are charged-off automatically based on regulatory requirements.
 
 
(The remainder of this page is blank, intentionally.)
 

 
19

 


 
The following tables detail activity in the allowance for possible loan losses by portfolio segment as of June 30, 2011 and December 31, 2010. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
 
   
 
Residential Real Estate
   
 
Commercial Real Estate
   
 
 
Farmland
   
 
 
Construction
   
Commercial and
Industrial
   
 
 
Consumer
   
 
 
Unallocated
   
 
 
Total
 
June 30, 2011
                                               
Beginning balance
  $ 876     $ 535     $ 25     $ 203     $ 224     $ 56     $ 249     $ 2,168  
Provision for possible losses
    301       37       (1 )     74       54       70       (235 )     300  
Charge-offs
    (222 )     -       -       (31 )     (25 )     (72 )     -       (350 )
Recoveries
    2       -       -       -       6       11       -       19  
Net charge-offs
    (220 )     -       -       (31 )     (19 )     (61 )     -       (331 )
Ending balance
  $ 957     $ 572     $ 24     $ 246     $ 259     $ 65     $ 14     $ 2,137  
                                                                 
Period-end amount allocated to:
                                                         
Loans individually evaluated
                                                         
        for impairment
  $ 143     $ 82     $ -     $ 34     $ 55     $ -     $ -     $ 314  
Loans collectively evaluated
                                                         
        for impairment
    814       490       24       212       204       65       14       1,823  
Ending balance
  $ 957     $ 572     $ 24     $ 246     $ 259     $ 65     $ 14     $ 2,137  
                                                                 
     Total Loans
  $ 100,838     $ 55,569     $ 9,618     $ 14,934     $ 14,270     $ 9,331     $ -     $ 204,560  
                                                                 
Loans individually evaluated
                                                         
        for impairment
    1,272       2,456       1,875       326       339       -       -       6,268  
Loans collectively evaluated
                                                         
        for impairment
    99,566       53,113       7,743       14,608       13,931       9,331       -       198,292  
                                                                 

 
20

 


   
 
Residential Real Estate
   
 
Commercial Real Estate
   
 
 
Farmland
   
 
 
Construction
   
Commercial
and
Industrial
         
 
 
Consumer
   
 
 
Unallocated
 
 
 
 
Total
December 31, 2010
                                           
Beginning balance
  $ 686     $ 503     $ 33     $ 205     $ 823     $ 97     $ 326     $ 2,673  
Provision for possible losses
    566       112       (8 )     280       (111 )     (12 )     (77 )     750  
Charge-offs
    (381 )     (80 )     -       (293 )     (488 )     (50 )     -       (1,292 )
Recoveries
    5       -       -       11       -       21       -       37  
Net charge-offs
    (376 )     (80 )     -       (282 )     (488 )     (29 )     -       (1,255 )
Ending balance
  $ 876     $ 535     $ 25     $ 203     $ 224     $ 56     $ 249     $ 2,168  
                                                                   
Period-end amount allocated to:
                                                           
Loans individually evaluated
                                                           
        for impairment
  $ 113     $ 56     $ -     $ 24     $ 45     $ 1     $ -     $ 239  
Loans collectively evaluated
                                                           
        for impairment
    763       479       25       179       179       55       249       1,929  
Ending balance
  $ 876     $ 535     $ 25     $ 203     $ 224     $ 56     $ 249     $ 2,168  
                                                                   
     Total Loans
  $ 103,336     $ 52,481     $ 8,787     $ 12,943     $ 14,500     $ 10,636     $ -     $ 202,683  
                                                                   
Loans individually evaluated
                                                           
        for impairment
    649       2,848       1,546       472       393       8       -       5,916  
Loans collectively evaluated
                                                           
        for impairment
    102,687       49,633       7,241       12,471       14,107       10,628       -       196,767  

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


 
21

 


 
Note 5.                                Other Real Estate Owned
 
The tables below present a summary of the activity related to other real estate owned (dollars in thousands):
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
       
   
2011
   
2010
   
2011
   
2010
 
Balance at beginning of period
  $ 3,525     $ 1,197     $ 3,425     $ 1,073  
Additions
    159       353       294       476  
Sales
    (100 )     (87 )     (135 )     (86 )
Direct write-downs
    (27 )     (15 )     (27 )     (15 )
Balance at end of period
  $ 3,557     $ 1,448     $ 3,557     $ 1,448  
                                 
Operating expenses, net of
                               
   rental income
  $ 17     $ 30     $ 29     $ 33  
                                 

 
Direct write-downs of individual properties are a charge against earnings in the periods, as shown above.
 
 
Note 6.                                FHLB Advances
 
 
At June 30, 2011 and December 31, 2010, the Company had outstanding advances totaling $5 million with the Federal Home Loan Bank of Atlanta, detailed below.
 
   
June 30,
   
December 31,
 
   
2011
   
2010
 
   
(Dollars in thousands)
 
Five-year / two-year convertible advance at 2.47%
       
   maturing February 5, 2013
  $ 5,000     $ 5,000  
                 

 
Note 7.                       Other Borrowings
 
 
Other borrowings consist of $5.9 million and $5.1 million in overnight repurchase agreements as of June 30, 2011 and December 31, 2010, respectively.  These balances are from deposit balances outstanding in the Investment Sweeps Account product, which is an overnight repurchase agreement product, not insured by the FDIC, but collateralized by the Bank with securities of the US Government and Federal Agencies.   This product is offered to commercial customers only.
 
 
Note 8.                      Earnings Per Share
 
 
The weighted average number of shares used in computing earnings per share was 2,348,509 shares for the three months ended June 30, 2011 and 2,364,942 shares for the three months ended June 30, 2010, 2,348,647 for the six months ended June 30, 2011 and 2,366,926 shares for the six months ended June 30, 2010. The Company has no potentially dilutive stock options or stock warrants outstanding.
 

 
22

 

Note 9.                      Defined Benefit Pension Plan

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

 
Three Months Ended
 
Six Months Ended
   
June 30,
     
June 30,
   
(Dollars in thousands)
 
2011
 
2010
 
2011
 
2010
                 
Service cost
 
 $          75
 
 $        69
 
 $        150
 
 $      138
Interest Cost
 
             71
 
           66
 
           142
 
         132
Expected return on plan assets
           (81)
 
          (73)
 
         (162)
 
        (146)
Amortization of prior service cost
           (24)
 
          (24)
 
           (48)
 
          (48)
Amortization of net actuarial loss
             22
 
           19
 
             44
 
           38
Net periodic benefit cost
 
 $          63
 
 $        57
 
 $        126
 
 $      114
                 

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

Note 10.                      Fair Value Measurements

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

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

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

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

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

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

 
23

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

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

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

The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows:
 
   
June 30, 2011
   
December 31, 2010
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
         
(Dollars in thousands)
       
Financial assets:
                       
   Cash and cash equivalents
  $ 15,371     $ 15,371     $ 22,744     $ 22,744  
   Securities available for sale
    86,952       86,952       82,745       82,745  
   Restricted securities
    1,007       1,007       1,079       1,079  
   Loans, net
    202,423       215,704       200,515       215,132  
   Accrued interest receivable
    1,719       1,719       1,816       1,816  
   Bank owned life insurance
    8,296       8,296       8,150       8,150  
                                 
Financial liabilities:
                               
   Deposits
  $ 272,647     $ 272,411     $ 277,988     $ 279,598  
   Other borrowings
    10,899       11,017       10,149       10,346  
   Accrued interest payable
    1,011       1,011       887       887  
                                 

 
The Company assumes interest rate risk as part of its normal operations.  As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company.  Management attempts to match maturities of assets and liabilities to the extent possible to minimize interest rate risk.  However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment.  Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment.  Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.
 
Accounting Standards Codification 820 Fair Value Measurements and Disclosures defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follow:
 
Level 1
inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
 
Level 2
inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
 
Level 3
inputs to the valuation methodology are unobservable and significant to the fair value measurement.
 
 
 
24

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

         
Fair Value Measurements at June 30, 2011 Using
 
         
Quoted Prices
             
         
in Active
   
Significant
       
         
Markets for
   
Other
   
Significant
 
   
Balance as of
 
Identical
   
Observable
   
Unobservable
 
   
June 30,
   
Assets
   
Inputs
   
Inputs
 
Description
 
2011
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
   
(Dollars in thousands)
 
Assets:
                       
  Securities available
                       
     for sale
                       
      U.S. Government
                       
        and federal agency
  $ 16,772     $ -     $ 16,772     $ -  
      State and municipal
    28,818       -       28,818       -  
      Agency mortgage-backed
    38,675       -       38,675       -  
      Non-agency mortgage-backed
    1,852       -       1,852       -  
      Corporate
    835       -       835       -  
                                 
                                 

         
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)
 
   
(Dollars in thousands)
 
Assets:
                       
  Securities available
                       
     for sale
                       
      U.S. Government
                       
        and federal agency
  $ 16,705     $ -     $ 16,705     $ -  
      State and municipal
    28,704       -       28,704       -  
      Agency mortgage-backed
    34,259       -       34,259       -  
      Non-agency mortgage-backed
    2,275       -       2,275       -  
      Corporate
    801       -       801       -  
                                 
 

 
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:
 
Securities available for sale:
 
Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level1).   If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).
 
Accounting principles permit the measurement of certain assets at fair value on a nonrecurring basis.   Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
 
 
 
25

 
 
The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis during the period:
 
         
Carrying value at June 30, 2011
 
         
Quoted Prices
             
         
in Active
   
Significant
       
         
Markets for
   
Other
   
Significant
 
   
Balance as of
   
Identical
   
Observable
   
Unobservable
 
   
June 30,
   
Assets
   
Inputs
   
Inputs
 
Description
 
2011
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
   
(Dollars in thousands)
             
Assets:
                       
  Impaired Loans, net of
  $ 1,848     $ -     $ 1,848     $ -  
    valuation allowance
                               
  Other real estate owned
  $ 3,557     $ -     $ 3,557     $ -  
                                 
                                 
           
Carrying value at December 31, 2010
 
           
Quoted Prices
                 
           
in Active
   
Significant
         
           
Markets for
   
Other
   
Significant
 
   
Balance as of
   
Identical
   
Observable
   
Unobservable
 
   
December 31,
   
Assets
   
Inputs
   
Inputs
 
Description
    2010    
(Level 1)
   
(Level 2)
   
(Level 3)
 
   
(Dollars in thousands)
                 
Assets:
                               
  Impaired Loans, net of
  $ 1,208     $ -     $ 1,043     $ 165  
    valuation allowance
                               
  Other real estate owned
  $ 3,425     $ -     $ 2,925     $ 500  
                                 
Impaired loans
 
Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2).
 
 
However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data.   Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.
 
Other Real Estate Owned
 
The fair values are estimated based upon recent appraisal values of the property less costs to sell the property. Certain inputs used in appraisals are not always observable, and therefore Other Real Estate Owned may be categorized as Level 3. When inputs in appraisals are observable, they are classified as Level 2.
 

 
26

 

 
Note 11.                      Recent Accounting Pronouncements
 
 
In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years.  The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
 
 
In July 2010, the FASB issued ASU 2010-20, “Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.”  The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into 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, “Business Combinations (Topic 805) – Disclosure of Supplementary Pro Forma Information for Business Combinations.”  The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period.  If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period.  ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  Early adoption is permitted. The Company will adopt this new guidance should it enter into a business combination in the future.
 
 
The Securities Exchange Commission (SEC) issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting.”  The rule requires companies to submit financial statements in extensible business reporting language (XBRL) format with their SEC filings on a phased-in schedule.  Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010.  All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011. The Company filed its quarterly financial statements in the XBRL format with the filing of Form 10-Q for June 30, 2011.
 
 
In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series.  This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification.  The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series.  The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
 
 
 
27

 
 
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. A tabular presentation of this data will be required with reports prepared for the third calendar quarter of 2011.  
 
 
In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion.  The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2011-03 will have on its consolidated financial statements.
 
 
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.”  This ASU is the result of joint efforts by the FASB and IASB to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements.  The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and IFRSs.  The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. The Company is currently assessing the impact that ASU 2011-04 will have on its consolidated financial statements.
 
 
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.”  The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity.  The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income.  In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income.  The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share.  The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. The Company is currently assessing the impact that ASU 2011-05 will have on its consolidated financial statements.
 
 

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

 
28

 

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

 
Management’s discussion and analysis provides the reader with additional information that is helpful in gaining a greater understanding of the Company’s operating results, liquidity, capital resources and financial condition. This discussion and analysis should be read in conjunction with the Company’s Consolidated Financial Statements and Notes to the Interim Consolidated Financial Statements included in this quarterly report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.  Results of operations for the three months and six months ended June 30, 2011 are not necessarily indicative of the results for the year ending December 31, 2011 or any future period.
 
 
Forward-Looking Statements and Factors that Could Affect Future Results
 
 
Certain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in the Company’s future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Company that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company’s management or Board of Directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
 
 
Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
 
 
·  
changes in general economic and business conditions in our market area;
 
 
·  
level of market interest rates;
 
 
·  
risks inherent in making loans such as repayment risks and fluctuating collateral values;
 
 
·  
Government intervention in the U.S. financial system;
 
 
·  
The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, and securities) with which the Company and the Bank must comply;
 
 
·  
the successful management of interest rate risk; including changes in interest rates and interest rate policies;
 
 
·  
the value of securities held in the Company’s investment portfolio;
 
 
·  
successfully manage the Company’s growth and implement its growth strategies;
 
 
·  
rely on the Company’s Management team, including its ability to attract and retain key personnel;
 
 
·  
continue to attract low cost core deposits to fund asset growth;
 
 
·  
compete with other banks and financial institutions and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;
 
 
·  
the ability to rely on third party vendors that perform critical services for the Company;
 
 
 
29

 
 
·  
technology utilized by the Company;
 
 
·  
maintain expense controls and asset qualities as new branches are opened or acquired;
 
 
·  
demand, development and acceptance of new products and services;
 
 
·  
The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;
 
 
·  
maintain capital levels adequate to support the Company’s growth; and
 
 
·  
plan for changing trends in customer profiles and behavior.
 
 
Because of these uncertainties, actual future results may be materially different from the results indicated by these forward looking statements.  In addition, past results of operations do not necessarily indicate future results.
 
 
CRITICAL ACCOUNTING POLICIES
 
 
General
 
 
The  financial  condition  and results of  operations  presented in the Consolidated Financial  Statements, accompanying Notes to Interim Consolidated Financial Statements and  Management's discussion and analysis are, to a large degree, dependent upon  the  accounting  and reporting policies of the Company.  The Company’s accounting and reporting polices are in accordance with generally accepted accounting principles within the United States of America and with general practices within the banking industry.  The selection and application of these accounting policies by Management involve judgments, estimates, and uncertainties that are susceptible to change.
 
 
Presented below is a discussion of those accounting policies that Management believes are the most important to the portrayal and understanding of the Company’s financial condition and results of operations.  The Critical Accounting Policies require Management's most difficult, subjective and complex judgments about matters that are inherently uncertain.  In the event that different assumptions or conditions were to prevail,  and depending  upon the severity of such changes, materially different  financial  condition  or  results  of  operations  is  a reasonable  likelihood.
 
 
Allowance for Loan Losses
 
 
The Company monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio.  The Company maintains policies and procedures that address the systems of controls over the following areas of maintenance of the allowance:  the systematic methodology used to determine the appropriate level of the allowance to provide assurance that the systems are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; the loan grading system; and the general economic environment.
 
 
The Company evaluates various loans individually for impairment as required by ASC 310 Receivables.  Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by Management.  The evaluations are based upon discounted expected cash flows or collateral valuations.  If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.
 
 
For loans without individual measures of impairment, the Company makes estimates of losses for groups of loans as required by Accounting Standards Codification 450-20 Loss Contingencies.  Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan.  The resulting estimate of losses for groups of loans are adjusted for relevant  environmental factors and other conditions of the portfolio of loans, including:  borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.
 
 
 
30

 
 
The allowance for loan losses is determined by using estimates of historical losses by category for all loans; with the exception of “criticized loans”.  Criticized loans are determined as a result of management evaluating and risk grading individual delinquent loans.  Management may assign an estimated amount of reserve for criticized loans if there is the likelihood that not all of the loan amounts due will be collected based upon the most current information concerning the financial condition of the debtors and guarantors as well as the current evaluations of collateral value.  The evaluation of criticized loans as to the need and adequacy of any reserves is performed at least quarterly or more frequently if conditions affecting certain loans should change. The impact of environmental factors such as the local and regional economic conditions, attributes of certain loan categories and other relevant matters are considered in estimating the allowance for loan losses and these factors are reviewed at least quarterly in order to capture any indications of worsening or improving environmental factors.
 
 
The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of loan losses. This estimate of losses is compared to the allowance for loan losses of the Company as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses.
 
 
The Company recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high.  If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which the amount may be material to the consolidated financial statements.
 
 
For additional information regarding critical accounting policies, refer to Note 1 - Summary of Significant Accounting Policies in the notes to consolidated financial statements and the sections captioned “Application of Critical Accounting Policies and Accounting Estimates” and “Allowance and Provision for Possible Loan Losses” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the 2010 Form 10-K. There have been no significant changes in the Company’s application of critical accounting policies related to the allowance for possible loan losses since December 31, 2010.
 
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Balance Sheet
 
 
Total assets for the Company decreased to $328.4 million at June 30, 2011 compared to $330.5 million at December 31, 2010, representing a decrease of $2.1 million or 0.61%.
 
 
Total net loans at June 30, 2011 were $202.4 million, an increase of $1.9 million from the December 31, 2010 amount of $200.5 million. For the three months ended June 30, 2011, $9.9 million in loans were originated, a 2.9% decrease as compared to $10.2 million for the three months ended June 30, 2010. Loan originations in the Bank’s markets have generally been at lower levels as compared to when the economy was more robust. Despite the decline of activity when comparing the second quarter of 2011 to the second quarter of 2010, looking at the six month period one gains a different view. For the six months ended June 30, 2011, loan originations were $20.8 million or $2.9 million greater than the $17.9 million originated for the first six months of 2010. Management has been ready and willing to lend and the Bank has had a strong capital position during this economic crisis. The increase in loan originations for the six months of 2011 as compared to the same period in 2010 is the result of new commercial relationships. Consumers are approaching any new lending opportunities cautiously, often choosing to refinance and consolidate existing loan balances to take advantage of the lower rate environment. Loan opportunities to businesses are similarly difficult to obtain given the business owners’ uncertainty regarding the strength of the regional economy, a reluctance to be highly leveraged and a lack of high quality borrowers.
 
 
 
31

 
Gross loan balances at June 30, 2011 as compared to December 31, 2010 indicated that during the first six months of 2011 loans secured by real estate increased $3.4 million or 2.2% and this was partially offset by a decrease in consumer, commercial and agricultural loans totaling $1.5 million or 6.17% decrease from December 31, 2010. Real estate secured loans totaled $181.0 million or 88.5% of the loan portfolio at June 30, 2011 as compared to $177.5 million and 87.67% of the loan portfolio at December 31, 2010. The non-real estate segments of the loan portfolio include agricultural, tax-exempt municipal, commercial and consumer loans.  At June 30, 2011 the totals for each segment were $334 thousand, $239 thousand, $13.5 million and $9.3 million, respectively.
 
 
Management is maintaining its standard loan pricing methodology and underwriting standards during these difficult economic times. We believe that refusing to relax these standards is critical for maintaining loan quality, even though this strategy may result in a slower growth rate of the loan portfolio. It is Management’s goal for the Bank to continue to be a source of credit for creditworthy commercial businesses, farmers, and consumers during this difficult economic environment. Gross loans as a percent of total assets were 62.3% at June 30, 2011, as compared to 61.3% at December 31, 2010.
 
 
Available for sale securities increased to $87.0 million at June 30, 2011, or 26.5% of total assets, which is an increase of $4.3 million from $82.7 million at December 31, 2010. The increase in the investment portfolio from year-end is attributed to being able to obtain securities that met management’s objectives for the portfolio in terms of credit and interest rate risks. At June 30, 2011 the investment portfolio had an unrealized gain of $1.1 million net of Federal income taxes, which is an increase of $1.2 million when compared to an unrealized loss of $135 thousand, net of Federal income taxes, at December 31, 2010.  Management’s current strategy for the investment portfolio is to focus investment purchases so that investment maturities will be laddered over a period of time when interest rates are rising. Current economists’ forecasts are not anticipating a significant change in market interest rates for the remainder of 2011.
 
 
During the second quarter of 2011, the consolidated investment portfolio had $4.85 million in securities that were called or approximately 5.5% of the consolidated investment portfolio’s average balance of $88.9 million for the second quarter of 2011. This amount represents an increase of $1.725 from the $3.125 million of called securities in the first quarter of 2011 and it is a decrease of $4.55 million from the $9.4 million in called securities for the fourth quarter of 2010. Portfolio projections for the remainder of 2011 anticipate an additional $8.5 million in callable securities to be called if interest rates remain at the June 30, 2011 levels.
 
 
The availability of securities with the credit grade and duration preferred by management continue to be in short supply. Management’s strategy is to re-invest the called securities without taking on excessive duration risk; while maintaining a diverse, high quality investment portfolio for the Company and the Bank. While the strategy is being successfully implemented, the yield of the recently purchased securities is lower than the yield of the securities that were called. The expectations are that the yield on the investment portfolio may decline in the near-term, and management does expect a decline in the overall portfolio yield to be acceptable given the forward-looking strategy of having securities mature as interest rates rise in the future. The investment securities of both the Company and the Bank at June 30, 2011 were held as “available for sale”.
 
 
Restricted securities totaled $1.007 million at June 30, 2011 and represent equity investments held by the Bank in the Federal Reserve Bank of Richmond, the Federal Home Loan Bank of Atlanta and the Community Bankers’ Bank. At December 31, 2010, the restricted securities totaled $1.079 million. The $72 thousand decline in restricted securities, as of June 30, 2011, was the result of a reduction in the holdings of Federal Home Loan Bank of Atlanta stock.
 
 
Interest bearing deposits in other banks decreased by $527 thousand at June 30, 2011 to $1.330 million as compared to $1.857 million at December 31, 2010.  Federal funds sold decreased $7.9 million to $7.6 million at June 30, 2011 from $15.5 million at December 31, 2010.  The Company’s liquidity on hand at June 30, 2011 as represented by cash, due from banks, interest bearing deposits in banks and federal funds sold was $15.4 million or 4.7% of total assets which is $7.3 million lower than $22.7 million or 6.9% of total assets at December 31, 2010.
 
 
32

 
 
Allowance for Loan Losses
 
 
The allowance for loan losses at June 30, 2011 was $2.137 million compared to $2.168 million at December 31, 2010. The allowance for loan losses, as a percentage of total outstanding loans, decreased to 1.04% at June 30, 2011 from 1.07% at December 31, 2010. The Company charged off $297.2 thousand in loans, recovered $11.0 thousand from previous write-offs, and provided an additional $150 thousand to the allowance during the three months ended June 30, 2011.
 
 
The ratio of net charge-offs to average loans, net of deferred fees was 0.56% for the three months ended June 30, 2011 and this compares to 0.26% for the same period in 2010. For 2011, $252.9 thousand or 72.1% of the total charge-offs were related to loans secured by real estate, $25.0 thousand or 7.1% of the total charge-offs were secured by other assets and $72.6 thousand or 20.7% were related to consumer loan charge-offs. For the three months ended June 30, 2010, $225.2 thousand in real estate-secured loans were charged-off or 75.8% of total charge-offs for the period and $72.0 thousand or 24.2% of total charge-offs were charge-offs against consumer loans. Management expects an increase in charge-offs for the remainder of 2011. The majority of the charge-offs are expected to be related to loans secured by real estate.
 
 
Management’s methodology for estimating the appropriate level of the allowance for loan losses is based upon bank regulatory guidance and generally accepted accounting principles for maintaining adequate reserves against loan losses. Periodically, management does classify certain loans and provides specific reserves for these loans when it is determined that negative conditions affecting the customer have occurred and will expose the Bank to a potential loss on a given loan(s). Management continues to work aggressively with debtors to resolve delinquencies and mitigate potential repossession or foreclosure of collateral.
 
 
Management’s calculation of the allowance for loan losses consists of three main segments, 1- estimating future loan losses by loan category using the Bank’s historical average net losses for each category, 2- the impact of various environmental factors such as the decline in real estate value, unemployment, the volume of past due loans, etc., and 3- the determination of criticized loans, where classified/impaired loans are individually evaluated for probable loss based upon what the Bank could recover from liquidating collateral and from individual guarantors on the loan.  Loans classified as loss, doubtful or substandard are adequately reserved for at the report date and are not expected to have a material impact beyond what has been reserved.  Specific reserves for impaired loans will be adjusted should material changes occur to a loan’s collateral value or if there is any further deterioration of the credit.  Management is closely monitoring any potential indication of credit deterioration, beyond the classified loans currently reported.
 
 
The allowance for loan losses-to-total loans ratio decreased from 1.07% of gross loans at December 31, 2010 to 1.04% of gross loans at June 30, 2011. The change in the ratio, of 3 basis point, is primarily the result of the increase of $1.9 million in gross loan balances at June 30, 3011 as compared to December 31, 2010. For the six months ended June 30, 2011, net charge-offs totaled $330.8 thousand and the historical net charge-offs ratio used in the calculation of the allowance increased from the quarter ended December 31, 2010; given that the ratio is comprised of a rolling 36-month history of net charge-offs. The second quarter provision for loan losses of $150 thousand was the same amount that was provided during the second quarter of 2010. In evaluating the adequacy of the allowance for loan losses, criticized loans are one component, out of a total of three components that generally fluctuate most in quarter-to-quarter comparisons. These fluctuations can occur in the total balance of criticized loans and/or in the amount of allowance that is specifically reserved for individual loans. The amount of criticized loans at December 31, 2010 was $12.1 million. This category decreased $800 thousand to $11.3 million at June 30, 2011. Management is focused on ensuring that the allowance for loan losses reflects the added risks posed as a result of the prolonged economic recession. Management believes the allowance for loan losses is adequate to cover credit losses inherent in the loan portfolio at June 30, 2011.
 
 
Management reviews external economic factors quarterly and reports changes to these factors, which are a major component of the allowance calculation.  Management continues to work at improving the status of criticized credits for which the Bank maintains significant reserves.  These efforts include the addition of more collateral and/or the collection of payments which serve to improve these credits. For a more detailed discussion on the computation of the of allowance for loan losses, see “Note 4 – Allowance for Loan Losses” in the Notes to Interim Consolidated Financial Statements earlier in this report, also under the section heading of “Critical Accounting Policies” and the discussion “Provision for Loan Losses” found later in this report.
 
 
33

 
 
Deposits
 
Total deposits of $272.6 million at June 30, 2011 represented a decrease of $5.3 million from $278.0 million at December 31, 2010. Total certificates of deposit at June 30, 2011 were $124.1 million, $9.3 million lower from $133.4 million at December 31, 2010.  Certificates of deposit are higher costing funds as compared to checking, savings or money market accounts. CDs represented 45.5% of total deposit balances at June 30, 2011 as compared to 48.0% of total deposit balances at December 31, 2010. The significant reason for the decrease in certificates of deposits at June 30, 2011 as compared to December 31, 2010 was the non-renewal of certain large dollar deposits that consisted namely of a $3 million certificate for a local municipality and another consumer CD for approximately $1.1 million, meanwhile some customers preferred to move maturing CD funds into more liquid accounts such as money market accounts.
 
 
Non-interest bearing deposits totaled $36.2 million at June 30, 2011, which is a 9.0% increase from $33.2 million at December 31, 2010. Interest-bearing deposits totaled $236.4 million or 86.7% of total deposits at June 30, 2011 which is a decrease of $8.4 million or 3.4% from the $244.8 million and 88.1% of total deposits at December 31, 2010. The Bank continues to make progress in attracting low-cost deposit accounts. The ratio of low-cost deposit account balances as a percentage of total average deposit account balances was 51.5% for the six months ended June 30, 2011 as compared to 49.8% for the same period ended June 30, 2010. Management continues to adhere to its deposit pricing plan that maximizes the benefits of the low interest rate environment by reducing the Bank’s interest costs.
 
 
Borrowings
 
 
Borrowings include overnight repurchase agreements from commercial customers that utilize the Business Investment Sweeps product and long-term advances from the Federal Home Loan Bank of Atlanta (the “FHLB”).  A secondary source of other borrowings would be overnight advances from lines of credit established with correspondent banks.  For additional details on borrowing sources, see the “Liquidity” section later in this report.  At June 30, 2011 the Company had total borrowings of $10.9 million that consisted of $5.9 million in overnight repurchase agreements and an outstanding term advance with the FHLB of $5.0 million.  This is compared to $10.1 million in borrowings at December 31, 2010.
 
 
Stockholders’ Equity
 
 
Stockholders’ equity was $41.6 million at June 30, 2011 compared to $39.6 million at December 31, 2010. The book value per common share was $17.70 at June 30, 2011 compared to $16.84 at December 31, 2010. On April 15, 2011, shareholders were paid a quarterly dividend of $0.17 per share or $399 thousand. On June 23, 2011, the Board of Directors approved another quarterly cash dividend of $0.17 per share, or $399 thousand, payable to shareholders on July 15, 2011. Total average outstanding shares for the first half of 2011 were 2,348,647 shares as compared to the average outstanding shares of 2,363,947 shares for the year ended December 31, 2010.
 
 
The Board of Directors and Management recognize the intrinsic value of the Company. The banking industry as a whole has seen stock prices decline since 2007 due in part to the investment community’s concern about the overall banking industry’s ability to withstand the severe economic recession that impacted the industry in several areas such as interest margin compression, losses due to subprime lending, and the decline in housing and commercial real estate values. The Company’s stock is not actively traded: for example, the average daily trading volume for the first six months of 2011 was 436 shares as compared to 272 shares traded on an average daily basis during the first six months of 2010; which is 0.02% and 0.01% of the average outstanding shares for the respective periods. This lack of liquidity in the Company’s stock is the primary reason for the existing stock repurchase program which has been in place since September 2007.
 
 
 
34

 
The Board reauthorized the stock repurchase plan on May 26, 2011, effective June 1, 2011 until November 30, 2011. The Agreement permits the purchase of up to 40,000 shares during the six-month term. The plan is renewable every six months, at the discretion of the Board of Directors.  The renewal of the stock repurchase plan will be considered at the November 17, 2011 Board of Directors meeting.
 
 
The change in Accumulated Other Comprehensive Income at June 30, 2011 versus December 31, 2010 was a result of an improvement in the market value of the Company’s consolidated investment securities portfolio. At June 30, 2011, the Company had an unrealized gain on available for sale securities of $1.098 million, net of income taxes, an increase of $1.233 million from the unrealized loss of $135 thousand, net of income taxes, at December 31, 2010.  At June 30, 2011 and December 31, 2010, Accumulated Other Comprehensive Income included $712 thousand in unfunded pension liability, net of income taxes.  The unfunded pension liability is recomputed only as of each December 31.
 
 
Off-Balance Sheet Arrangements
 
 
Financial instruments include commitments to extend credit and standby letters of credit. These commitments include standby letters of credit of approximately $604 at June 30, 2011 and $671 thousand at December 31, 2010. These instruments contain various elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Additionally, unfunded loan commitments of approximately $21.6 million at June 30, 2011, and $23.5 million at December 31, 2010.
 
 
Net Income
 
 
For the six months ended June 30, 2011 the Company reported net income of $1.558 million as compared to $1.424 million for the same period in 2010 which is an increase of $134 thousand. Income per basic and diluted share was $0.66 for the six months ended June 30, 2011 as compared to $0.60 per basic and diluted share for the period ended June 30, 2010.
 
 
The Company had an annualized return on average assets of .95% and an annualized return on average equity of 7.68% for the six months ended June 30, 2011, as compared to an annualized return on average assets and average equity of .88% and 7.23%, respectively, for the same period in 2010.
 
 
For the three months ended June 30, 2011 the Company reported net income of $824 thousand as compared to $816 thousand for the same period in 2010, which is an increase of $8 thousand.   Income per basic and diluted share was $0.35 for the three months ended June 30, 2011 as compared to $0.34 per basic and diluted share for the period ended June 30, 2010.
 
 
The year-to-year increase in net income of $134 thousand for the six month period  is attributable to the following favorable factors:
 
 
·  
A decrease in the provision for loan losses of $150 thousand.
 
 
·  
A decrease in interest expense of $306 thousand.
 
 
These factors were partially offset by unfavorable results in:
 
 
·  
A decrease of $315 thousand in interest income due to a change in the mix of earning assets which produced lower earning asset yields.
 
 
·  
An increase in non-interest expense of $15 thousand.
 
 
·  
A decrease of $15 thousand in non-interest income.
 
 
 
35

 
Net Interest Income
 
 
Net interest income is the Company’s primary source of earnings and represents the difference between interest and fees earned on loans, investments and other earning assets and the interest expense paid on deposits and other interest bearing liabilities. The cost of funds represents interest expense on deposits and other borrowings. Non-interest bearing deposit accounts and capital are other components representing funding sources. Changes in the volume and mix of earning assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income. The following narrative discussion is to complement the Average Balances, Interest Yields and Rates, and Net Interest Margin table which immediately follows and presents interest income on a tax-equivalent basis.  The Company’s investment securities portfolio is the only category reflected in the table that is adjusted for tax-exempt interest income. The discussion using a tax-equivalent basis allows the reader to more accurately compare yields of the investment securities to all other taxable interest-bearing assets.  Therefore, GAAP income presented on the income statement for investment securities totaling $1.419 million, for the six months ended June 30, 2011, has been adjusted to $1.688 million in order to reflect the taxable equivalence of the tax-exempt securities, using a Federal income tax rate of 34%.  The prior period shown on the table was likewise adjusted.
 
 
For the three months ended June 30, 2011 net interest income (on a tax-equivalent basis) was $3.122 million as compared to $3.145 million for the three months ended June 30, 2010, a decrease of $23 thousand or 0.73%. Interest income (on a tax-equivalent basis) decreased $181 thousand for the second quarter of 2011 as compared to the year-earlier period. Interest income was primarily affected by a shift in balances moving out of loans and into investment securities.   Average loan balances when compared to the prior year period, declined $7.8 million at a yield of 6.42%. These balances for the most part moved into investment securities, which had a $6.8 million increase over the prior year period and earned a tax-equivalent yield of 3.62%. This change in the mix of earning assets was the primary factor in the lower interest income for 2011 as compared to 2010. Investment income (on a tax-equivalent basis) decreased $9 thousand in the three months ended June 30, 2011 as compared to the three months ended June 30, 2010, largely as a result of calls on higher yielding securities within the Company’s portfolio. In addition to the decrease in investment income, lower loan income negatively affected interest income. Loan income declined $173 thousand in the year-to-year period due to increases in non-accrual loans, lower average outstanding balances, and lower interest rates seen for new loans and loans that are repricing to lower rates.  Interest income for deposits at other banks remained on par for the quarter ended June 30, 2011 as compared to the same period a year ago, with yields declining 52 basis points in the year-to-year comparison.
 
 
A small portion of the liquidity generated by the Company’s investment securities portfolio was used to repurchase outstanding common shares under the stock repurchase plan described later in this Report under Part 2, Item 2, Unregistered Sales of Equity Securities and Use of Proceeds.
 
 
For the six months ended June 30, 2011 net interest income (on a tax-equivalent basis) was $6.229 million as compared to $6.150 million for the six months ended June 30, 2010, an increase of $79 thousand or 1.28%. The average loan balances for the six months ended June 30, 2011 were $203.7 million or $10.8 million lower than the six months ended June 30, 2010, when average loan balances were $214.5 million. Loan yields for the first six months of 2011 were 6.46% or 1 basis point lower than yields of 6.47% for the comparable period in 2010.
 
 
The average investment securities balance for the first six months of 2011 was $87.8 million or $9.8 million higher than the average of $78.0 for the first six months of 2010. The investment portfolio’s average balance increase of $9.8 million was the result of the outflow of loan balances due to payoffs, the inflow of funds into deposit accounts and fully investing federal fund balances that existed at December 31, 2010. The tax equivalent yield for the investment securities for the first six months of 2011 was 3.85% or 16 basis points lower than the first six months of 2010.
 
 
The tax-equivalent yield on earning assets for the three months ended June 30, 2011 was 5.44%, a decrease of 24 basis points from the yield of 5.68% reported in the comparable period of 2010. The tax equivalent yield on earning assets for the six months ended June 30, 2011 was 5.50%, a decrease of 19 basis points from the yield of 5.69% for the six months ended June 30 2010. The decrease in the earning assets yield for the period ended June 30, 2011 as compared to the same periods in 2010 is primarily the result of the following occurrences: the reduction of short-term interest rates and its impact on new loans and securities held for investment, the re-pricing of existing loans and investment securities to lower yields and a shift of loan balances into investment securities.
 

 
36

 
Reconciliation of GAAP Net Interest Income to Tax-exempt Net Interest Income
 
                         
   
Three Months Ended
   
Six Months Ended
 
(Dollars in thousands)
 
June 30, 2011
 
June 30, 2010
   
June 30, 2011
   
June 30, 2010
 
                         
Net interest income, GAAP basis
    2,992       3,056       5,966       5,975  
                                 
   Tax benefit from tax-exempt securities
    130       89       263       175  
                                 
Net interest income, tax-exempt basis
    3,122       3,145       6,229       6,150  
                                 
Tax-exempt securities tax benefit is computed at the statutory rate of 34%.
         

 
For the three months ended June 30, 2011 the average balance for interest bearing liabilities was $252.3 million or $417 thousand greater than the $251.9 million for the three months ended June 30, 2010.  The cost of interest bearing liabilities for the second quarter of 2011 was 1.57%, a decrease of 25 basis points from the 1.82% cost for the second quarter of 2010.
 
 
Average interest bearing liabilities for the six months ended June 30, 2011 were $252.8 million or $3.3 million more than the $249.4 million for the first six months of 2010. The cost of interest bearing liabilities for the six months ended June 30, 2011 was 1.60% as compared to 1.87% for the six months ended June 30, 2010, a decrease of 27 basis points. The increase in interest bearing deposits is attributable to customers seeking a safe refuge for funds that are being withdrawn from mutual and stock funds as well as a greater awareness by customers for the need to have full FDIC deposit insurance coverage.  While moving funds to banks, customers are hesitant to purchase certificates of deposits and opting for shorter, better paying alternatives such as money market deposit accounts.  Management is aware of the liquidity risk that this customer behavior presents for the Bank and plans have been developed to manage such risk if it should present itself in the future.
 
 
Average non-interest deposit balances for the six months ended June 30, 2011 were $33.2 million or $500 thousand less than the $33.7 million for the same period of 2010. While a number of factors could be attributable to this decrease, the most likely scenarios include the fact that consumers and businesses are in the process of deleveraging themselves (paying down debt) and an increasing number of households that are facing reduced incomes due to reduced work schedules or layoffs and they are being forced to erode their cash balances to cover everyday living expenses.
 
 
The net interest margin is net interest income expressed as a percentage of average earning assets.  The tax equivalent net interest margin for the three months ended June 30, 2011 was 4.14% which is 3 basis points lower than the net interest margin for the quarter ended June 30, 2010 of 4.17%. The net interest margin increased by 3 basis points to 4.16% for the six months ended June 30, 2011 as compared to 4.13% for the same period in 2010.
 
 
The table on the following page labeled “Average Balances, Interest Yields and Rates, and Net Interest Margin” presents the average balances and rates of the various categories of the Company’s assets and liabilities.  Included in the table is a measurement of interest rate spread and margin. Interest rate spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest expense on the interest bearing liabilities.  While net interest spread provides a quick comparison of earnings rates versus the cost of funds, Management believes that the interest margin provides a better measurement of performance.  Investment securities’ income and yields are adjusted to reflect their tax equivalency.
 

 
37

 

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

   
Six Months Ended June 30,
                   
   
2011
               
2010
             
   
Average
         
Average
   
Average
         
Average
 
(Dollars in Thousands)
 
Balance
   
Interest
   
Yield/Rate
   
Balance
   
Interest
   
Yield/Rate
 
                                     
ASSETS:
                                   
Interest earning assets:
                                   
Interest bearing deposits with other banks and
                               
   other short-term investments
  $ 1,814     $ 14       1.56 %   $ 1,078     $ 10       1.48 %
Loans (1)
    203,694       6,529       6.46 %     214,489       6,881       6.47 %
Investment securities available for sale  (2)
    87,770       1,683       3.84 %     78,024       1,563       4.01 %
Federal funds sold
    8,498       10       0.23 %     6,397       8       0.25 %
   Total interest earning assets
  $ 301,776     $ 8,236       5.50 %   $ 299,988     $ 8,462       5.69 %
                                                 
Total average non-earning assets
    30,132                       28,291                  
Less: allowance for credit losses
    2,245                       2,854                  
   Net average non-earning assets
    27,887                       25,437                  
   TOTAL AVERAGE ASSETS
  $ 329,663                     $ 325,425                  
                                                 
                                                 
LIABILITIES AND STOCKHOLDERS'
                                               
   EQUITY:
                                               
                                                 
Interest bearing liabilities:
                                               
Interest bearing demand
  $ 40,873     $ 36       0.18 %   $ 38,494     $ 33       0.17 %
Savings
    73,203       227       0.63 %     68,742       326       0.96 %
Time deposits
    127,774       1,666       2.63 %     131,937       1,878       2.87 %
Other borrowings
    10,908       77       1.42 %     10,248       75       1.48 %
   Total interest bearing liabilities
  $ 252,758     $ 2,006       1.60 %   $ 249,421     $ 2,312       1.87 %
                                                 
                                                 
Noninterest bearing liabilities:
                                               
Noininterest bearing demand
    33,190                       33,716                  
Other liabilities
    2,823                       2,597                  
   Total noninterest bearing liabilities
    36,013                       36,313                  
                                                 
                                                 
Stockholders' equity
    40,892                       39,691                  
TOTAL LIABILITIES AND STOCKHOLDERS'
                                         
       EQUITY
  $ 329,663                     $ 325,425                  
                                                 
Net interest income
          $ 6,230                     $ 6,150          
Net interest spread
                    3.90 %                     3.82 %
Net interest margin
                    4.16 %                     4.13 %
                                                 
(1) Includes Loans Held for Sale and average daily balance of non-accrual loans.
                 
(2) Income and yield are reported on a tax equivalent basis assuming a federal tax rate of 34%.
         




 
38

 

 
Provision for Loan Losses
 
 
For the three months ended June 30, 2011, the Bank provided $150 thousand to the Allowance for Loan Losses. This provision amount is exactly the amount provided for the three months ended June 30, 2010. For the six months ended June 30, 2011, $300 thousand was recorded as provision which is a decrease of $150 thousand from the $450 thousand provided for the six months ended June 30, 2010. The amount of provision recorded for 2011 is appropriate with management’s ongoing analysis of non-performing loans and currently performing loans that show the potential to deteriorate further.
 
 
As of June 30, 2011, the Bank’s non-accrual loans were $3.385 million as compared to $3.836 million at December 31, 2010; or a decrease of $451 thousand from year-end.  For the same reporting periods, total impaired loans were $6.268 million at June 30, 2011 and $5.916 million at December 31, 2010; or an increase of $352 thousand from year-end.
 
 
Management analyzes the Bank’s collateral position and probable future loss on any loan and provides specific reserves for those loans (as needed), prior to those loans actually becoming nonperforming loans. Therefore, when a loan becomes nonperforming, it is likely to already have an allowance provided for it without the need for additional provision during the same quarter when the loan moves to nonperforming status. Also see the discussion on criticized loans, earlier in this report, under the “Allowance for Loan Losses” heading.
 
 
Noninterest Income
 
 
Noninterest income includes deposit fees, gains on the sales of securities, loans held for sale, other-than-temporary impairments and ATM fees.  Noninterest Income for the three months ended June 30, 2011 decreased 2.3% to $592 thousand from $606 thousand at June 30, 2010. For the six months ended June 30, 2011, noninterest income decreased 1.3% to $1.148 million compared to $1.163 million, or $15 thousand less than the same period in 2010. Revenue from the net gain on sale of securities, and the net amount recorded for other-than-temporary impairments, is considered as non-recurring revenue, therefore noninterest income, excluding these items was $1.188 million for the six months ended June 30, 2011 and $1.136 million for the same period in 2010; an increase of $52 thousand.
 
 
Below is a representation of the changes to the significant components of noninterest income.
 

   
Three months ended
         
Six months ended
       
(Dollars in thousands)
 
June 30,
   
June 30,
   
%
   
June 30,
   
June 30,
   
%
 
   
2011
   
2010
   
Change
   
2011
   
2010
   
Change
 
                                     
Noninterest Income
                                   
   Service charges on deposit accounts
  $ 267     $ 255       4.7 %   $ 506     $ 516       -1.9 %
   Net gain on sales of loans
    13       16       -18.8 %     27       26       3.8 %
   Net gain on sale of securities
    -       23       -100.0 %     -       27       -100.0 %
   Other-than-temporary impairments
    (27 )     -       100.0 %     (7 )     -       100.0 %
   Less:Noncredit portion of OTTI impairments
    13       -       100.0 %     33       -       100.0 %
      Net other-than-temporary impairments
    (40 )     -       100.0 %     (40 )     -       100.0 %
   Income from bank owned life ins.
    75       75       0.0 %     147       143       2.8 %
   ATM fee income
    196       169       16.0 %     377       319       18.2 %
   Other income
    81       68       19.1 %     131       132       -0.8 %
      Total noninterest income
  $ 592     $ 606       -2.3 %   $ 1,148     $ 1,163       -1.3 %
                                                 

·  
Service charges on deposit accounts increased $12 thousand for the three months ended June 30, 2011 to $267 thousand from $255 at June 30, 2010 and decreased 1.9% or $10 thousand for the six months ended June 30 2011 compared to the same period in 2010, chiefly due to changes in the Bank’s customer behavior, revised policies regarding overdraft accounts and the continuing popularity of “totally free” checking products. The revised overdraft policies limited the daily amount of overdraft fees that a customer could be assessed, the automated closure of long-term overdrawn checking accounts, and providing customers’ information on overdraft fees charged to their account in the current cycle and for the year-to-date. Management is also exploring other deposit account changes in response to the effects of Federal regulations.
 
 
 
 
39

 
 
·  
Net gain on sales of loans decreased $3 thousand for the three months ended June 30, 2011 to $13 thousand from $16 thousand at June 30, 2010 and increased 3.8% or $1 thousand for the six months ended June 30 2011 compared to the same period in 2010 as a result of decreased activity in the secondary market.
 
 
·  
Net gain on sale of securities $23 thousand in income was realized in the three months ended June 30, 2010 and $27 thousand was realized in the six months ended June 30, 2010 as a result of Agency securities being called at par value. The Company has not sold securities during the three or six month periods ending June 30, 2011.
 
 
·  
Other-than-temporary impairments At June 30, 2011, management recorded an other-than-temporary impairment relating to what is determined to be a permanent credit loss involving non-agency CMO securities in the amount of $40 thousand.   There was no impairment charge related to credit loss for any of the portfolio securities taken in 2010.   For further discussion on other-than-temporary impairments see “Note 2” earlier in this report.
 
 
·  
ATM fee income increased $27 thousand for the three months ended June 30, 2011 to $196 thousand from $169 thousand at June 30, 2010 and increased 18.2% or $58 thousand for the six months ended June 30, 2011 compared to the same period in 2010 as a result of increased ATM and point of sale transactions by the Bank’s customers and fees received from non-customers using the Bank’s ATMs. A portion of this increase is the result of changes management has made to the existing Bank/interchange relationships.
 
 
·  
Other income increased $13 thousand for the three months ended June 30, 2011 to $81 thousand from $68 thousand at June 30, 2010 and decreased 0.8% or $1 thousand for the six months ended June 30, 2011 compared to the same period in 2010. Other income generally consists of incidental fees and services that tend to be variable in nature.
 
 
Noninterest Expense
 
 
Noninterest expense includes employee compensation and benefits-related costs, occupancy and equipment expense, other real estate owned (“OREO”), data processing and other overhead costs.  Noninterest expense decreased 1.8% for the quarter ended June 30, 2011 to $2.355 million from $2.399 million at June 30, 2010.   For the six months ended June 30, 2011, noninterest expenses increased $15 thousand to $4.782 million as compared to $4.767 million for the comparable period in 2010, or an increase of 0.3%.   The revenues recognized on sales of OREO and the losses incurred from the impairment of OREO are considered non-recurring, therefore noninterest expense, excluding these items was $4.771 million for the six months ended June 30, 2011 and $4.765 million for the same period in 2010; an increase of $6 thousand.
 
 
Management’s strategy is to maintain strict controls over non-interest expenses, and where possible, these efforts are being realized with only moderate increases being seen in noninterest expenses over the previous year.  FDIC insurance and costs associated with loan collection efforts and OREO properties are areas where higher-than-normal increases have occurred.  The following table outlines the changes in significant components:
 

 
40

 

 

 
 
 
Three months ended
         
Six months ended
       
(Dollars in thousands)
 
June 30,
   
June 30,
   
%
   
June 30,
   
June 30,
   
%
 
   
2011
   
2010
   
Change
   
2011
   
2010
   
Change
 
Noninterest Expense
                                   
   Salaries and employee benefits
  $ 1,371     $ 1,347       1.8 %   $ 2,740     $ 2,711       1.1 %
   Net occupancy expense
    151       142       6.3 %     300       295       1.7 %
   Equipment expense
    118       129       -8.5 %     240       260       -7.7 %
   FDIC Insurance
    60       143       -58.0 %     261       299       -12.7 %
   Data Processing
    76       81       -6.2 %     143       158       -9.5 %
   Net (gain) on sale of oreo properties
    (9 )     (13 )     -30.8 %     (16 )     (13 )     23.1 %
   Impairment - oreo properties
    27       15       80.0 %     27       15       80.0 %
   Other operating expense
    561       555       1.1 %     1,087       1,042       4.3 %
      Total noninterest expense
  $ 2,355     $ 2,399       -1.8 %   $ 4,782     $ 4,767       0.3 %
                                                 

 
·  
Salaries and employee benefits increased $24 thousand for the three months ended June 30, 2011 to $1.371 million from $1.347 million at June 30, 2010 and 1.1% or $29 thousand for the first six months of 2011 primarily due to a decline in loan origination cost deferrals and increases related to cost of living salary adjustments.
 
 
·  
Net occupancy expense increased $9 thousand for the three months ended June 30, 2011 to $151 thousand from $142 thousand at June 30, 2010 and 1.7% or $5 thousand for the first six months of 2011 primarily as a result of higher utility costs.
 
 
·  
Equipment expense decreased $11 thousand for the three months ended June 30, 2011 to $118 thousand from $129 thousand at June 30, 2010 and 7.7% or $20 thousand for the year-to-date primarily due to lower depreciation expense as equipment becomes fully depreciated.
 
 
·  
FDIC deposit insurance decreased $83 thousand for the three months ended June 30, 2011 to $60 thousand from $143 thousand at June 30, 2010 and 12.7% or $38 thousand for the first six months of 2011, primarily as a result of the new calculation employed by the FDIC to determine a financial institutions quarterly assessment.
 
 
·  
Data processing expense decreased $5 thousand for the three months ended June 30, 2011 to $76 thousand from $81 thousand at June 30, 2010 and 9.5% or $15 thousand for the first six months of 2010.
 
 
·  
Net (gain) on sale of OREO properties decreased 30.8%or $4 thousand for the three months ended June 30, 2011 and increased 23.1% or $3 thousand for the first six months of 2011.
 
 
·  
Impairment – other real estate owned increased $12 thousand for the three months ended June 30, 2011 to $27 thousand from $15 thousand at June 30, 2010.   The same increase was recorded for the first six months of 2011.   In accordance with accounting standards ASC 310 and ASC 360, management had certain OREO properties re-appraised and those properties values had declined and this change was reported as an impairment charge.
 
 
·  
Other operating expense increased $6 thousand for the three months ended June 30, 2011 to $561 thousand from $555 thousand at June 30, 2010 and 4.3% or $45 thousand for the first six months of 2011.   Costs related to the Commonwealth’s Franchise Tax, ATM network and collection-related expenses are included in this category.
 
Liquidity
 
 
Liquidity management involves the ability to meet the cash flow requirements of depositors wanting to withdraw funds, of borrowers needing assurance that sufficient funds will be available to meet their credit needs and the Company’s current and future expenditures.  Liquidity can best be demonstrated by an analysis of cash flows.  The primary source of cash flows is from operating activities.  Operating activities provided $3.047 million of liquidity for the six-month period ended June 30, 2011, compared to $2.486 million for the same six months in 2010; or an increase of $561 thousand.  The principal elements of these operating flows are net income, increased for significant non-cash expenses for the provision for loan losses, depreciation and securities amortization.
 
 
 
41

 
Other sources or uses of liquidity come from investing activities and financing activities.  Investing activities required a net use of liquidity totaling $4.965 million that was primarily used to increase the investment securities portfolio by $4.207 million and increase the loan portfolio by $2.502 million for the six months ended June 30, 2011.  For the six months ended June 30, 2011, financing activities required use of liquidity principally due to the net decrease in deposit account balances of $5.341 million.  Financing activities can be sources of liquidity as a result of issuing debt, borrowed funds or the additional issuance of Company stock.
 
 
At June 30, 2011, the Company had $15.371 million in cash and cash equivalents on hand.
 
 
The Company maintains extensive sources of liquidity including blanket collateral borrowing lines with the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Atlanta which had a net availability of $28.1 million at June 30, 2011.  In addition, there are short-term unsecured borrowing lines totaling $27.4 million at June 30, 2011, which are with three correspondent banks.
 
 
As of June 30, 2011 the Bank has the following lines of credit available.
 
Collateralized Lines of Credit
 
Federal Home Loan Bank of Atlanta
 $         29,553,652
Federal Reserve Bank of Richmond
              3,552,143
Less: Outstanding advances
            (5,000,000)
Sub-total Collateralized Lines of Credit
 $         28,105,795
   
Unsecured, Short-term Lines
 
CenterState Bank
 $           6,000,000
Community Bankers Bank
            11,400,000
First Tennessee Bank NA
            10,000,000
Sub-total Unsecured, Short-term Lines
 $         27,400,000
   
Total Available Lines of Credit
 $         55,505,795
   

 
Other borrowings consisted of $5.9 million in short-term borrowings and from balances outstanding in the Investment Sweeps Account product at June 30, 2011; at December 31, 2010 the balance of this product was $5.1 million. The Investment Sweeps Account is an overnight repurchase agreement product, not insured by FDIC, but guaranteed by the Bank with US Government and Federal Agency securities.  This product is offered to commercial customers only.
 
 
The Company monitors its liquidity position on a regular basis and continuously adjusts its assets to maintain adequate liquidity levels.  The Company has established satisfactory liquidity targets and reports its liquidity ratios to the Board of Directors on a monthly basis. The Company considers its sources of liquidity to be sufficient to meet its estimated needs.
 
 
(The remainder of this page left blank, intentionally.)
 

 
42

 

 
Item 4.                                Controls and Procedures
 
 
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our Management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
 
Under the supervision and with the participation of our Management, including our Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this quarterly report.  Based on that evaluation, the Company has concluded that these controls and procedures are effective. In addition, our Management, including our Chief Executive Officer and Chief Financial Officer, is also responsible for establishing and maintaining adequate internal control over financial reporting.
 
 
There was no change in the Company’s internal control over financial reporting that occurred during the three months ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
 

 
43

 

 
Part II.  Other Information
 
 
Item 1.  Legal Proceedings
 
 
There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company, including its subsidiaries, is a party or of which the property of the Company is subject.
 
 
Item 1A. Risk Factors
 
 
Other than as set forth below, there are no material changes to the Company’s risk factors as disclosed in its Annual Report on Form 10-K for the year ended December 31, 2010.
 
 
Concerns regarding downgrade of the U.S. credit rating could have a material adverse effect on our business, financial condition and liquidity.
 
On August 5, 2011, Standard & Poor’s lowered its long term sovereign credit rating on the United States of America from AAA to AA+. On August 8, 2011, Standard & Poor’s downgraded the credit ratings of certain long-term debt instruments issued by Fannie Mae and Freddie Mac and other U.S. government agencies linked to long-term U.S. debt. These downgrades could have a material adverse impact on financial markets and economic conditions in the United States generally, the market value of such instruments and the credit risk associated with State governments such as Virginia that have significant economic relationships with the U.S. government. Debt instruments of this nature are key assets on the balance sheets of financial institutions, including ours. In turn, the market’s anticipation of these impacts could have a material adverse effect on our business, financial condition and liquidity and could exacerbate the other risks to which we are subject, including those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010.
 
 
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
 
The Board of Directors voted to approve continuation of the common stock repurchase plan at their regularly scheduled meeting held on May 26, 2011. The renewed plan period was effective June 1, 2011 and expires November 30, 2011.  Purchases under the plan are limited to an individual six-month total of 40,000 shares and the maximum per share price to be paid is $16.00.  The stock repurchase plan was originally announced on August 20, 2007.
 
 
The Board of Directors reviews the results of the repurchase plan monthly.  The continuation of the repurchase plan is evaluated by the Directors prior to the reauthorization of the repurchase plan for an additional 6-month period.  The Company will consider whether or not it will repurchase additional shares based upon a number of factors including market conditions, the Company’s performance, and other strategic planning considerations.
 
 
The table below indicates the shares that were no repurchased shares during the most recent fiscal quarter:
 
 
Common Stock Repurchase Plan Table
 
               
Total number
   
Maximum number
 
               
of shares
   
of shares that
 
   
Total number
   
Average
   
purchased as
   
may yet be
 
   
of shares
   
price paid
   
part of publicly
   
purchased
 
Period
 
purchased
   
per share
   
announced plan
   
under the plan
 
April 1 to
                       
April 30, 2011
    -       -       0       40,000  
May 1 to
                               
May 31, 2011
    -       -       0       40,000  
June 1 to
                               
June 30, 2011
    -       -       0       40,000  
Total
    0     $ -       0       40,000  
                                 


 
44

 

 
Item 3.  Defaults upon Senior Securities
 
 
None outstanding.
 
 
Item 4.  [Removed and Reserved]
 
 
Item 5.  Other Information
 
 
None.
 
 
Item 6.  Exhibits
 
 
See Exhibit Index.
 

 
45

 

 

 


SIGNATURES

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

  CITIZENS BANCORP OF VIRGINIA, INC.  
       (Registrant)  
       
       
Date:  August 12, 2011
By:
/s/ Joseph D. Borgerding  
    Joseph D. Borgerding  
   
President and Chief Executive Officer
 
 
       

     
       
Date:  August 12, 2011
By:
/s/ Ronald E. Baron  
   
Ronald E. Baron
 
   
Senior Vice President and Chief Financial Officer
 
       

 
 

 
46

 

EXHIBIT INDEX

Exhibit Number


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

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

32.1  
Statement of Principal Executive Officer Pursuant to 18 U.S.C. ss.1350
 
32.2  
Statement of Principal Executive Officer Pursuant to 18 U.S.C. ss.1350