Annual Report - jsb.bank · 113360_JSB_IntroPages.indd 2 3/22/13 11:23 AM. 35 55 Wayne Goodrich: 35...

2012Annual Report

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Board of DirectorsWilliam E. Knode, Jr.Chairman of the BoardOwned W.H. Knode’s Sons

Albert F. KaveVice Chairman of the BoardRetired Retail Grocer

James M. DavisSecretary of the BoardRetired Secretary and Treasurer of Supertane Gas Corporation

K. Stephen MorrisPresident & Chief Executive Officer of Jefferson Security Bank

Monica W. LingenfelterExecutive Vice President of Shepherd University Foundation, Inc.

Frederick K. ParsonsPresident of Parsons Automotive Group & Parsons Enterprises

Suellen D. MyersOwner and Operatorof Willow Spring Farm

Eric J. Lewis, CPAPartner of Ours, Lawyers, Lewis & Company, PLLC & ManagingMember of The Ranger Group, LLC

John W. SnyderOwner, President & Chief Executive Officer of HBP, Inc.

Front Row: Eric J. Lewis, William E. Knode, Jr., John W. SnyderBack Row: James M. Davis, K. Stephen Morris, Albert F. Kave, Monica W. Lingenfelter, Suellen D. Myers, Frederick K. Parsons

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Letter to the Shareholders

Sincerely,

K. Stephen MorrisPresident & Chief Executive Officer

Dear Shareholder,

This year promises to be another challenging year for our industry. It has been a little more than five years since the “near collapse of the financial industry”. Since the beginning of the recession to this writing, 468 of our brethren have been closed by regulators. We have never before seen regulatory scrutiny at such a high level and the cost of compliance is exorbitant. The magnitude of new laws, rules and regulations is staggering and it has only just begun: Dodd-Frank, The Consumer Financial Protection Bureau and possibly Basel III will change the way we do business forever. We will become less flexible in favor of a “cookie cutter” style to satisfy the regulators and various agencies.

Community banks, such as ours, played no role in the excessive practices that contributed to the recent financial crisis which were the impetus for Dodd-Frank, but we are certainly paying a price. It is important to understand that Dodd-Frank substitutes federal bureaucratic judgment for that of experienced bankers. The issue is especially important to consider since Dodd-Frank does not address the very significant problems associated with Fannie Mae, Freddie Mac and the Federal Housing Administration.

Providing a mortgage is one of the most important connections we have with our customers. In fact, most of our business pertains to making mortgage loans. This business has been slow during the past few years, which has resulted in an historically reduced loan to deposit ratio, but there are signs that the housing market is beginning to pick up. Housing prices are at a very affordable level due to both low home prices and low mortgage rates. It is now cheaper to buy than to rent in many markets. In regard to our business, we are only keeping adjustable rate mortgage loans on our books.

Earnings per share and dividends per share have not recovered to their peak in 2006, but they are at a three year high. We continue to feel the effects of the “great recession” and an extremely slow recovery but book value per share has increased 4% over last year to $70.60 as of December 31, 2012. In the meantime, we continue to be poised to take advantage of a rising rate environment, which we expect to occur when the national unemployment rate approaches 6%.

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Common Stock InformationShares of the Bank’s common stock are listed on the OTC Bulletin Board Market. Trading of the shares is not extensive and has periodically been handled in a limited number of privately negotiated transactions. Based on information available to it, the Bank believes that during 2012 and 2011, the selling price of shares of common stock ranged from $40.00 to $65.00.

2012 2011High Low High Low

First Quarter $65.00 $41.25 $64.00 $43.75 Second Quarter $64.00 $43.50 $64.00 $45.00 Third Quarter $64.00 $45.00 $65.00 $41.25 Fourth Quarter $64.00 $40.00 $65.00 $40.50

As of March 20, 2013, the last known trade of the Bank’s common stock was at $50.00. There may, however, have been other transactions at other prices not known to the Bank. Raymond James & Associates, Inc. is a market maker for Jefferson Security Bank stock. A market maker is a firm that maintains a firm bid and ask price for a given number of shares at a point in time in a given security by standing ready to buy or sell at publicly quoted prices. The Bank’s common stock is not subject to any outstanding options or warrants to purchase granted by the Bank. The Bank has not agreed to register any shares of common stock under the Securities Act for sale by any shareholder nor does the Bank currently have any plans to make a public offering of any Bank stock. Information about sales of Jefferson Security Bank stock is available on the Internet through many of the stock information services using the Bank’s symbol, JFWV. As of March 20, 2013, there were 288,400 shares of common stock outstanding held by approximately 555 shareholders.

During the last two fiscal years, the Bank has declared semi-annual dividends on the common stock as follows:

2012 May $0.50 per share November $0.60 per share

2011 May $0.50 per share November $0.50 per share

The Bank is subject to certain legal restrictions on the amount of dividends it is permitted to pay to its shareholders. In addition, the final determination of the timing, amount and payment of dividends on shares of the Bank’s common stock is at the discretion of the Bank’s Board of Directors and will depend upon the earnings of the Bank, the financial condition of the Bank and other factors, including general economic conditions and applicable governmental regulations and policies.

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Wayne Goodrich: 35 Years of Service

For Albert Kave, 2012 marked 55 years of continuous service as a member of the Board of Directors of Jefferson Security Bank. Mr. Kave is a vital part

of the Bank and has served as Vice Chairman of the Board since January 1997 and a member the Executive Committee for 18 years. A lifelong resident of the Shepherdstown area, Mr. Kave actively served the community through his ownership of Kave’s Market for 30 years, his tenure of more than a decade on the Shepherdstown Town Council and as one of the founding members of the Shepherdstown Men’s Club currently known as the Shepherdstown Community Club. During this time, his service to the Bank included many years of performing inspections and completing appraisals. There is no doubt that Mr. Kave’s impact on the Bank goes beyond his years of ser-

vice. His commitment to employees is shown through his attendance of various employee activities from retirement parties to employee luncheons. While many changes have occurred over the past 55 years, his dedicated service continues to provide institutional continuity and industry knowledge. We want to thank Mr. Kave for his leadership and dedication to our Bank as his involvement over the years has helped us achieve our banking goals.

Albert Kave: 55 Years of Service

In 2012, Wayne Goodrich, Executive Vice President of Lending, retired from Jefferson Security Bank after 35 years of service. Mr. Goodrich served our Bank and com-munity in many ways, including building valuable customer relationships, opening and managing our first branch office in Charles Town, planning and organizing the layout of the Bank’s calendars, working through various system conversions and ensuring that the Jacob Craft clock, displayed in our main office, was always wound properly. Mr. Goodrich’s service to the community expanded beyond the Bank through his involvement in various organizations and community boards. Over the years, he has seen the Bank through some of our brightest moments and our toughest challenges. His hard work, dedication and many efforts made a significant contribution to the quality and standards that are represented by the Bank today. Thank you for 35 years of loyalty, service and dedication. We wish you well in your retirement.

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Executive OfficersK. Stephen MorrisPresident & Chief Executive Officer

Cynthia A. Kitner, CPAExecutive Vice President & Chief Financial Officer

Dennis L. BarronExecutive Vice President & Chief Operations Officer

Karl J. KellerExecutive Vice President of Lending

Mission StatementJefferson Security Bank is committed to remaining a progressive and efficient independent community bank responsive to the needs of the customers and communities it serves. A productive and satisfied staff will deliver long term value to the shareholders by balancing growth and profits within the parameters of safe banking practices.

Jefferson Security Bank OfficesShepherdstown Main Office 105 East Washington Street P.O. Box 35, Shepherdstown, WV 25443 Tel 304.876.9000 Fax 304.876.0671

Barron Office7994 Martinsburg Pike Shepherdstown, WV 25443 Tel 304.876.2800 Fax 304.876.9482

Charles Town Office 873 East Washington Street, Suite 100Charles Town, WV 25414 Tel 304.725.9752 Fax 304.728.7791

Martinsburg Office 1861 Edwin Miller Blvd. Martinsburg, WV 25404 Tel 304.264.0900 Fax 304.262.3160

Inwood Office 277 Mineral Drive, Suite 1 Inwood, WV 25428 Tel 304.229.6000 Fax 304.229.9200

Sharpsburg Office103 West Main Street Sharpsburg, MD 21782 Tel 301.432.3900 Fax 301.432.7058

www.jeffersonsecuritybank.com 24 Hour Account AccessTel 866.255.4190

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INDEPENDENT AUDITOR'S REPORT

To the Shareholders and Board of Directors Jefferson Security Bank Shepherdstown, West Virginia Report on the Financial Statements We have audited the accompanying consolidated financial statements of Jefferson Security Bank which comprise the consolidated balance sheets as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the years ended December 31, 2012, 2011 and 2010 and the related notes to the financial statements. Management’s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audit as of and for the year ended December 31, 2012 in accordance with auditing standards generally accepted in the United States of America. We conducted our audits as of and for the years ended December 31, 2011 and 2010 in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. These procedures include examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Jefferson Security Bank as of December 31, 2012 and 2011, and the results of their operations and their cash flows for the years ended December 31, 2012, 2011 and 2010 in accordance with accounting principles generally accepted in the United States of America.

Winchester, Virginia March 21, 2013

JEFFERSON SECURITY BANK AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS

December 31, 2012 and 2011

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2012 2011ASSETS

Cash and due from financial institutions 6,106,176$ 7,261,303$ Interest bearing deposits with depository institutions 8,540,719 3,773,965

Cash and cash equivalents 14,646,895 11,035,268 Securities available for sale, at fair value 128,902,014 108,662,023 Restricted securities, at cost 958,900 1,319,200 Loans, net of allowance for loan losses of $2,063,131 - 2012; $1,848,558 - 2011 131,869,333 136,033,276 Accrued interest receivable 1,104,729 840,338 Premises and equipment, net 6,837,033 6,963,056 Bank owned life insurance 5,232,602 5,064,026 Other real estate owned, net of valuation allowances of $87,000 - 2012; $130,000 - 2011 981,621 1,943,942 Other assets 2,623,878 2,868,451 Total assets 293,157,005$ 274,729,580$

LIABILITIES AND SHAREHOLDERS' EQUITY

LiabilitiesDeposits Interest bearing 218,974,956$ 206,700,630$ Noninterest bearing 50,509,679 44,808,415 Total deposits 269,484,635 251,509,045 Securities sold under agreements to repurchase 641,300 517,340 Accrued interest payable 115,477 126,361 Other accrued expenses and other liabilities 2,554,739 2,988,748 Total liabilities 272,796,151 255,141,494 Shareholders' EquityCommon stock, $10 par value; 300,000 shares authorized; 288,400 shares issued and outstanding 2,884,000 2,884,000 Additional paid-in capital 2,884,000 2,884,000 Retained earnings 16,244,863 15,652,280 Accumulated other comprehensive (loss), net (1,652,009) (1,832,194) Total shareholders' equity 20,360,854 19,588,086 Total liabilities and shareholders' equity 293,157,005$ 274,729,580$

See accompanying notes to consolidated financial statements

JEFFERSON SECURITY BANK AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME

For the Years Ended December 31, 2012, 2011 and 2010

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2012 2011 2010Interest and dividend income

Loans, including fees 6,702,971$ 7,110,836$ 7,685,495$ Securities:

Taxable 1,463,126 1,828,673 1,755,665 Nontaxable 670,028 457,662 900,013

Dividends and other interest 30,686 21,421 24,610 Total interest and dividend income 8,866,811 9,418,592 10,365,783

Interest expenseDeposits 1,610,637 2,149,502 2,469,887 Borrowings 6,913 4,583 5,309

Total interest expense 1,617,550 2,154,085 2,475,196

Net interest income 7,249,261 7,264,507 7,890,587 Provision for loan losses 720,000 2,238,000 1,420,000 Net interest income after provision

for loan losses 6,529,261 5,026,507 6,470,587

Noninterest incomeService charges on deposit accounts 733,347 736,206 924,725 Other service charges, commissions and fees 925,073 967,341 929,479 Net (loss) gain on sale of securities (20) 1,693,230 825,960 Income from bank owned life insurance 168,576 170,367 170,025 Other 123,722 101,025 119,444

Total noninterest income 1,950,698 3,668,169 2,969,633 Noninterest expense

Salaries and employee benefits 4,252,797 4,038,541 4,480,194 Occupancy 994,697 999,199 1,065,097 Advertising and marketing 101,532 129,484 118,983 ATM and debit card fees 352,379 374,694 441,861 Data processing 582,184 600,450 664,590 Postage and stationery supplies 196,153 178,796 205,440 Professional services 252,774 323,962 271,909 FDIC and state assessments 274,268 322,188 498,972 Net (benefit) cost of other real estate owned (201,305) 159,016 198,240 Directors' fees 111,000 114,000 112,800 Other 558,226 564,587 540,449

Total noninterest expense 7,474,705 7,804,917 8,598,535 Income before income tax expense (benefit) 1,005,254 889,759 841,685

Income tax expense (benefit) 95,431 104,978 (23,611) Net income 909,823$ 784,781$ 865,296$ Basic and diluted earnings per common share 3.15$ 2.72$ 3.00$


JEFFERSON SECURITY BANK AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME


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2012 2011 2010

Net income 909,823$ 784,781$ 865,296$ Other comprehensive income (loss), net of tax:

Unrealized holding gains on securities available for sale arising during period ($168,572 - 2012; $734,603 - 2011; $502,107 - 2010) 285,393 1,173,457 802,066 Reclassification adjustment for losses (gains) included in net income ($8 - 2012; ($651,893) - 2011; ($317,995) - 2010) 12 (1,041,337) (507,965) Change in pension benefits, (($34,120) - 2012; ($418,334) - 2011; ($122,942) - 2010) (105,220) (668,248) (196,388)

Total other comprehensive income (loss) 180,185 (536,128) 97,713 Comprehensive income 1,090,008$ 248,653$ 963,009$


JEFFERSON SECURITY BANK AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY


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AccumulatedAdditional Other Total

Common Paid-In Retained Comprehensive Shareholders'Stock Capital Earnings (Loss) Equity

Balance at December 31, 2009 2,884,000$ 2,884,000$ 14,579,003$ (1,393,779)$ 18,953,224$ Net income 865,296 865,296 Other comprehensive income 97,713 97,713

Cash dividends - $1.00 per share (288,400) (288,400) Balance at December 31, 2010 2,884,000$ 2,884,000$ 15,155,899$ (1,296,066)$ 19,627,833$

Net income 784,781 784,781 Other comprehensive loss (536,128) (536,128)


Net income 909,823 909,823 Other comprehensive income 180,185 180,185



JEFFERSON SECURITY BANK AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS


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2012 2011 2010Cash flows from operating activities

Net income 909,823$ 784,781$ 865,296$ Adjustments to reconcile net income to net cash

provided by operating activities:Depreciation 416,231 433,284 501,938 Provision for loan losses 720,000 2,238,000 1,420,000 Provision for other real estate owned - - 103,600 174,100 Deferred income taxes 211,100 (23,445) (235,126) Net (accretion) amortization of securities 338,337 315,193 (16,327) Net (gain) loss on sale of securities 20 (1,693,230) (825,960) Net gain on sale of other real estate owned (247,901) (76,995) (32,572) Net gain on sale of fixed assets - - - - (6,000) Net change in:

Accrued interest receivable (264,391) 54,396 153,563Accrued interest payable (10,884) (69,638) (3,422) Other assets (269,563) (99,812) 744,264 Other accrued expenses and other liabilities (573,349) 132,239 (419,083) Net cash provided by operating activities 1,229,423 2,098,373 2,320,671

Cash flows from investing activitiesNet decrease in loans 3,685,829 1,805,250 1,354,918 Purchase of securities available for sale (50,380,380) (114,225,407) (64,862,828) Purchase of securities held to maturity - - - - (24,842,196) Proceeds from sale of securities available for sale 4,171,286 84,526,487 28,841,618 Proceeds from sale of securities held to maturity - - - - 11,595,884 Proceeds from calls, maturities and principal

paydowns of securities available for sale 26,084,731 22,891,173 25,209,011 Proceeds from calls, maturities and principal

paydowns of securities held to maturity - - - - 2,721,453 Proceeds from the sale of other real estate owned 1,183,410 446,235 125,922 Capital improvements in other real estate owned (215,074) (83,117) - - Proceeds from sale of Federal Home Loan Bank stock 360,300 282,300 80,100 Purchase of bank owned life insurance - - - - (125,761) Property and equipment expenditures, net (290,208) (110,788) (159,732)

Net cash used in investing activities (15,400,106) (4,467,867) (20,061,611) Cash flows from financing activities

Net increase in demand deposits, NOW accounts and savings accounts 16,855,315 13,738,950 12,527,496

Net increase (decrease) in time deposits 1,120,275 (5,446,937) 4,614,921 Net increase (decrease) in securities sold under agreements

to repurchase 123,960 (21,220) 9,304 Dividends paid (317,240) (288,400) (374,920)

Net cash provided by financing activities 17,782,310 7,982,393 16,776,801 Net change in cash and cash equivalents 3,611,627 5,612,899 (964,139) Cash and cash equivalents at beginning of year 11,035,268 5,422,369 6,386,508 Cash and cash equivalents at end of year 14,646,895$ 11,035,268$ 5,422,369$


JEFFERSON SECURITY BANK AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended December 31, 2012, 2011 and 2010 (Continued)

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2012 2011 2010Supplemental disclosures:

Interest paid 1,628,434$ 2,223,723$ 2,478,618$ Income taxes paid 26,881 220,144 114,560 Transfers from loans to other real estate owned 337,970 1,792,751 659,900 Transfers from other real estate owned to loans 579,856 603,137 549,250 Transfer of securities from held to maturity to available for sale - - - - 34,546,057 Change in unrealized gain on available for sale securities 453,985 214,830 478,213 Pension liability adjustment (139,340) (1,086,582) (319,330)


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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Jefferson Security Bank and Subsidiary conform to accounting principles generally accepted in the United States of America and to general practice within the banking industry. The following describes the significant accounting and reporting policies which are employed in the preparation of the financial statements. Basis of Presentation: The consolidated financial statements include the accounts of Jefferson Security Bank and its wholly-owned limited liability company, JSB Financial, LLC. All significant intercompany balances and transactions have been eliminated in consolidation. Nature of Operations, Business Segments and Concentrations of Credit Risk: The Bank provides a full range of banking services to individuals, agricultural businesses and commercial businesses located in its service area. It maintains a diversified loan portfolio, including loans to individuals for home mortgages, automobiles and personal expenditures, and loans to business enterprises for current operations and expansion. The Bank offers a variety of deposit products, including checking, savings, money market, individual retirement accounts and certificates of deposit. While the Bank’s management monitors the revenue stream of various products and services, operations are managed and financial performance is evaluated on a Bank wide basis. Accordingly, all of the Bank’s operations are considered by management to be aggregated into one operating segment. The principal markets for the Bank’s financial services are the West Virginia and Maryland communities in which the Bank is located and the areas immediately surrounding these communities. The Bank serves these markets through its offices located in Jefferson and Berkeley counties in West Virginia and Washington County in Maryland. Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of other real estate owned, deferred tax assets, the fair value of financial instruments, other than temporary impairment of securities and the determination of the pension benefit obligation. Cash and Cash Equivalents: For purposes of the consolidated balance sheets and the consolidated statements of cash flows, cash and cash equivalents includes cash on hand, cash items, amounts due from financial institutions with original maturities less than 90 days and federal funds sold. Amounts due from financial institutions may, at times, exceed federally insured limits. Interest Bearing Deposits with Depository Institutions: Interest bearing deposits mature within 90 days and are carried at cost. Securities: Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Trading securities are recorded at fair value with changes in fair value included in earnings. Securities not classified as held to maturity or trading, including debt and equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Other restricted securities are carried at cost. All investments are classified as available for sale, except for stock in Federal Home Loan Bank and Community Bankers Bank, which are restricted securities. The Bank follows relevant accounting guidance related to recognition and presentation of other than temporary impairment. This accounting guidance specifies that (a) if a company does not have the intent to sell the debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other than temporarily impaired unless there is a credit loss. When the Bank does not intend to sell the security, and it is more likely than not the Bank will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other than temporary impairment of a debt security in earnings and the remaining portion in

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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) other comprehensive income. For held to maturity debt securities, the amount of an other than temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other than temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security. For equity securities, when the Bank has decided to sell an impaired available for sale security and the Bank does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed other than temporarily impaired in the period in which the decision to sell is made. The Bank recognizes an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made. Federal Home Loan Bank Stock: The Bank, as a member of the Federal Home Loan Bank (FHLB) of Pittsburgh, is required to maintain an investment in capital stock of the FHLB. Based on redemption provisions of the FHLB, the stock has no quoted market value and is carried at cost. The quarterly redemption of FHLB stock is subject to certain limitations and conditions. At its discretion, the FHLB may declare dividends on the stock. Management reviews for impairment based on the ultimate recoverability of the cost basis in the FHLB stock. Loans: Loans that management has the intent and ability to hold for the foreseeable future or until payoff or maturity are reported at the principal balance outstanding, net of unearned interest, deferred loan fees or costs and an allowance for loan losses. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using either the interest method or straight-line method. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the estimated loan term. Interest income is not reported when full loan repayment is in doubt, typically when the loan is impaired or payments are past due over 90 days, unless the loan is both well secured and in the process of collection. Payments received on such loans are reported as principal reductions. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. When a loan is not fully collateralized and is in the process of collection, the Bank may charge off the account balance or some portion thereof as a loss. Generally, a delinquency over 90 days past due will be charged off unless the loan is well secured and an acceptable collection plan is in place. All charge offs are approved by the Loan Committee and reported to the Board of Directors. The Bank’s charge off and nonaccrual policies are the same for all classes of loans. Risk characteristics associated with specific segments of the loan portfolio are detailed below: Commercial loans not secured by real estate carry risks associated with the successful operation of a business, and the repayments of these loans depend on the profitability and cash flows of the business. Borrowers may be subject to changes in industry conditions including decreasing demand and increasing material and production cost that cannot be immediately recaptured. Interest rate increases could have an adverse impact on profitability of the business. Additional risk relates to the value of collateral where depreciation occurs and the valuation is less precise. Commercial loans secured by real estate carry risks associated with the profitability of the business and the ability to generate positive cash flows sufficient to service debts. Real estate security diminishes risks only to the extent that a market exists for the collateral. Real estate secured construction loans carry risks that a project will not be completed as scheduled and budgeted and that the value of the collateral may, at any point, be less than the principal amount of the loan. Additional risks may occur if the general contractor, who may not be a loan customer, is unable to finish the project as planned due to financial pressures unrelated to the project. Residential real estate loans carry risks associated with the continued credit worthiness of the borrower and changes in the value of collateral. These loans are subject to adverse employment conditions in the local economy leading to an increase in

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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) default rates. Residential real estate loans are mainly comprised of adjustable rate mortgages. In the event of incremental rate increases, the borrowers’ ability to maintain payments may be impacted. Consumer loans carry risks associated with the continued credit worthiness of the borrower and the value of the underlying collateral. In addition, these loans may be unsecured. Consumer loans are more likely to be immediately affected adversely by unemployment, divorce, illness or personal bankruptcy. Consumer loans are further segmented into credit cards and all other consumer loans. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable and incurred credit losses, which is increased by the provision for loan losses and decreased by charged off loans less recoveries. Management estimates the allowance balance required using historical experience, the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, economic conditions and other factors. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that in management’s judgment, should be charged off. Loan losses are charged against the allowance when management believes the loan to be uncollectible. Subsequent recoveries, if any, are credited to the allowance for loan losses. The allowance consists of specific and general components. The specific component relates to loans that are classified as troubled debt restructurings, doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include, payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The recorded investment in impaired loans is defined as the unpaid principal balance less any partial charge offs. Impairment is evaluated in total for smaller-balance loans of similar nature such as consumer loans and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the fair value of collateral if repayment is expected solely from the collateral. The general component covers non-classified loans and is based on historical loss experience adjusted for six qualitative factors. The first factor is comprised of delinquent loans, accruing watchlist, nonaccrual loans and net charge offs. The factor is applied to each loan segment. The second factor involves economic and industry conditions. Economic and industry conditions are assessed as well as their impact on collateral value to arrive at assigned factor values which are then applied to the loan segment balances. The other four factors are based on the experience of the loan department, the composition of the loan portfolio and external factors. These factors are subjective and the Bank’s management provides input on these factors to determine the factor value to be equally applied to each loan segment. There has not been a significant change to the methodology for the allowance for loan losses calculation during the year ended December 31, 2012. Other Real Estate Owned: Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value, less estimated selling costs, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in noninterest expense from other real estate owned.

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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Concentrations of Credit Risk: Most of the Bank’s activities are with customers located within Berkeley and Jefferson counties of West Virginia and in areas of Washington County, Maryland. Note 4 details the types of lending in which the Bank engages. The Bank does not have any significant concentrations in any one industry or customer. Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method with useful lives ranging from 2 to 40 years for buildings and improvements, and 1 to 35 years for furniture and equipment. Maintenance, repairs and minor alterations are charged to current operations as expenditures are incurred. Major improvements are capitalized. Employee Benefits: A defined benefit pension plan covers employees age 21 and over and completing one year of service, with benefits based on years of service and compensation prior to retirement. A minimum of 1,000 hours is required for each year of service. Contributions to the plan are based on information provided annually by the Bank’s actuary with consideration given to the maximum amount deductible for income tax purposes. A benefit plan with 401(k) features is available to employees age 21 and over with at least one year of service and 1,000 hours per year. The plan allows employee contributions, with matching contributions, to be allocated based on a percentage of the employee salary deferral. Income Taxes: When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the consolidated statements of income. Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized holding gains and losses on securities available for sale and pension benefits. Fair Values of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Dividend Restriction: Bank regulatory agencies restrict, without prior approval, the total dividend payments of a bank in any calendar year to the bank’s retained net income of that year to date, as defined, combined with its retained net income of the preceding two years, less any required transfers to surplus. At December 31, 2012, retained net income, which was free of such restriction, amounted to approximately $1,665,860. Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation. Such reclassifications had no effect on the financial position and results of operations. Financial Instruments with Off-Balance Sheet Risk: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and standby letters of credit issued to meet customer needs. The face amount for these items represents the exposure to loss before considering customer collateral or repayment ability. Such financial instruments are recorded when they are funded.

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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Advertising Costs: The Bank follows the policy of charging the costs of advertising to expense as incurred. Total advertising expense incurred for 2012, 2011 and 2010 was $19,505, $23,498 and $21,667, respectively. Troubled Debt Restructurings: In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans. Transfers of Financial Assets: Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank – put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Recent Accounting Pronouncements Adoption of New Accounting Standards 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 were 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. The adoption of the new guidance did not have a material impact on the Bank’s 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 International Accounting Standards Board (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 International Financial Reporting Standards (IFRS). The amendments were effective for interim and annual periods beginning after December 15, 2011 with prospective application. The adoption of the new guidance did not have a material impact on the Bank’s consolidated financial statements. In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” The new guidance amends disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (“OCI”) as part of the statement of changes in shareholders’ equity. All changes in OCI must be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The guidance does not change the items that must be reported in OCI. The Bank adopted this guidance effective 2012, and has elected to present two separate but consecutive financial statements. In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or

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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Bank does not expect the adoption of ASU 2011-11 to have a material impact on its consolidated financial statements. In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU clarify the scope for derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements and securities borrowing and securities lending transactions that are either offset or subject to netting arrangements. An entity is required to apply the amendments for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The Bank does not expect the adoption of ASU 2013-01 to have a material impact on its consolidated financial statements. In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this ASU require an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. In addition, the amendments require a cross-reference to other disclosures currently required for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. Companies should apply these amendments for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The Bank is currently assessing the impact that ASU 2011-03 will have on its consolidated financial statements. NOTE 2 – EARNINGS PER SHARE Basic and diluted earnings per common share are calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share include the dilutive effects of additional potential common shares, if present. No such items exist as of December 31, 2012, 2011 and 2010. Therefore, diluted earnings per share equals basic earnings per share for all three years. Basic and diluted earnings per share are calculated based on weighted average common shares outstanding of 288,400 for December 31, 2012, 2011 and 2010. Basic and diluted earnings per common share was $3.15, $2.72 and $3.00 for the years ended December 31, 2012, 2011 and 2010, respectively. NOTE 3 – SECURITIES The primary purposes of the securities portfolio are to generate income, supply collateral for public funds on deposit and meet liquidity needs of the Bank through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with interest rates, as well as variable rate bonds, whose prices correspond directly with interest rates. At the end of any accounting period, the securities portfolio may have both unrealized gains and losses. The Bank monitors the portfolio which is subject to liquidity needs, market rate changes and credit risk changes to determine if adjustments are needed. The Bank currently holds all securities as available for sale to allow for the flexibility to appropriately manage the securities portfolio and adjust financial strategies to compensate for unanticipated market forces. During 2010, management decided to transfer the securities classified as held to maturity to available for sale to allow for more flexibility to appropriately manage the securities portfolio and adjust financial strategies to compensate for unanticipated market forces. In November 2010, a held to maturity security was sold thereby tainting the securities portfolio. The remaining held to maturity securities were transferred to available for sale immediately following the transaction. Management intends to classify future purchases as available for sale until circumstances change that would warrant consideration for a different classification.

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NOTE 3 – SECURITIES (Continued) The Bank began using a more refined approach for amortizing agency mortgage backed securities during the third quarter of 2011. The approach uses actual projected cash flows with consideration given to the actual three month prepayment speeds for projected future cash flows to provide a more objective and accurate amortization calculation. The amortized cost and fair value of securities, with gross unrealized gains and losses, follows:

Gross GrossAmortized Unrealized Unrealized Fair

December 31, 2012 Cost Gains Losses ValueAvailable for Sale U.S. Government and agency 100,948,398$ 902,230$ (232,885)$ 101,617,743$ State and municipal 26,712,882 628,900 (57,511) 27,284,271

127,661,280$ 1,531,130$ (290,396)$ 128,902,014$ December 31, 2011Available for Sale U.S. Government and agency 97,195,983$ 612,498$ (52,270)$ 97,756,211$ State and municipal 10,679,291 248,178 (21,657) 10,905,812

107,875,274$ 860,676$ (73,927)$ 108,662,023$

At December 31, 2012 and 2011, securities were pledged to secure public deposits and for other purposes required or permitted by law. These securities had a fair value of $85,824,585 and $77,192,002, and an amortized cost of $84,735,036 and $76,507,968, at December 31, 2012 and 2011, respectively. The fair value of securities pledged to secure securities sold under agreements to repurchase was $1,599,303 and $712,293, and the amortized cost of these securities was $1,586,470 and $699,021 at December 31, 2012 and 2011, respectively. The amortized cost and fair value of debt securities by contractual maturity at December 31, 2012 follows:

Amortized FairCost Value

Due in less than one year 60,506$ 61,831$ Due from one to five years 51,397 52,121 Due from five to ten years 3,415,870 3,474,216 Due after ten years 124,133,507 125,313,846

127,661,280$ 128,902,014$

Available for Sale

For the years ended December 31, 2012, 2011 and 2010, proceeds from sales of securities available for sale amounted to $4,171,286, $84,526,487 and $28,841,618, respectively. For the years ended December 31, 2012, 2011 and 2010, gross realized gains amounted to $5,208, $1,707,617 and $825,960, respectively, while gross realized losses amounted to $5,228, $14,387 and $0, respectively. The tax provision applicable to these net realized gains and (losses) amounted to ($8), $651,893 and $317,995, for the years ended December 31, 2012, 2011 and 2010, respectively.

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NOTE 3 – SECURITIES (Continued) An impairment is considered “other than temporary” if any of the following conditions are met: the Bank intends to sell the security, it is more likely than not that the Bank will be required to sell the security before the recovery of its amortized cost basis, or the Bank does not expect to recover the security’s entire amortized cost basis, even if the Bank does not intend to sell. The Bank does not have any securities that are considered “other than temporarily impaired” at December 31, 2012 and 2011. The following tables detail all unrealized losses in the Bank’s securities portfolio. At December 31, 2012, thirteen securities had unrealized losses and at December 31, 2011, twelve securities had unrealized losses based on market prices at the respective dates. Unrealized losses were caused by interest rate fluctuations and not due to credit deterioration of the issuers.

Duration of Unrealized LossesDecember 31, 2012

Fair ValueUnrealized

Losses Fair ValueUnrealized


Losses

U.S. Government and agency 24,514,904$ (232,885)$ - -$ - -$ 24,514,904$ (232,885)$ State and municipal 5,115,521 (57,511) - - - - 5,115,521 (57,511)

29,630,425$ (290,396)$ - -$ - -$ 29,630,425$ (290,396)$

TotalLess than 12 months 12 months or longer

Duration of Unrealized LossesDecember 31, 2011

Fair ValueUnrealized



Losses

U.S. Government and agency 32,861,266$ (52,270)$ - -$ - -$ 32,861,266$ (52,270)$ State and municipal 1,879,552 (21,657) - - - - 1,879,552 (21,657)

34,740,818$ (73,927)$ - -$ - -$ 34,740,818$ (73,927)$

TotalLess than 12 months 12 months or longer

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NOTE 4 – LOANS Loans are shown on the consolidated balance sheets net of the allowance for loan losses. Interest is computed by methods that result in level rates of return on principal. Loans are charged off when, in the opinion of management, they are deemed to be uncollectable after taking into consideration such factors as the current financial condition of the customer and the underlying collateral and guarantees. A summary of the balances of loans follows:

2012 2011Loans secured by real estate:Commercial real estate:

Construction 11,162,539$ 12,243,872$ Owner occupied 18,548,547 20,094,773 Non-owner occupied 17,185,803 17,181,384

Residential real estate:Construction 2,893,512 1,129,175 Home equity 16,140,754 16,910,187 Other 62,646,846 63,638,715

Total loans secured by real estate 128,578,001 131,198,106 Commercial 2,937,162 3,746,318 Consumer:

Credit cards 235,394 245,968 Revolving credit plan 254,415 306,823 Other 2,091,679 2,527,479

134,096,651 138,024,694 Net deferred loan fees and costs (164,187) (142,860) Allowance for loan losses (2,063,131) (1,848,558)

Loans, net 131,869,333$ 136,033,276$

December 31,

NOTE 5 – ALLOWANCE FOR LOAN LOSSES Management’s evaluation of the adequacy of the allowance for loan losses is based on historical experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions. An analysis of the allowance for loan losses follows for the years ended December 31, 2012, 2011 and 2010:

2012 2011 2010

Beginning balance 1,848,558$ 2,510,908$ 1,803,674$ Loans charged off (519,237) (2,995,758) (735,512) Recoveries 13,810 95,408 22,746 Provision for loan losses 720,000 2,238,000 1,420,000 Ending balance 2,063,131$ 1,848,558$ 2,510,908$

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NOTE 5 – ALLOWANCE FOR LOAN LOSSES (Continued)

Commercial Real Estate

Residential Real Estate Commercial Consumer Total

Beginning balance 972,960$ 783,641$ 48,268$ 43,689$ 1,848,558$ Loans charged off (365,236) (9,373) (73,771) (70,857) (519,237) Recoveries 9,216 1,251 - - 3,343 13,810 Provision for loan losses 154,121 447,632 73,878 44,369 720,000 Ending balance 771,061$ 1,223,151$ 48,375$ 20,544$ 2,063,131$

Ending balance: individuallyevaluated for impairment 397,844$ 573,112$ 25,000$ - -$ 995,956$

Ending balance: collectivelyevaluated for impairment 373,217$ 650,039$ 23,375$ 20,544$ 1,067,175$

Ending balance 46,896,889$ 81,681,112$ 2,937,162$ 2,581,488$ 134,096,651$ Ending balance: individually

evaluated for impairment 3,786,274$ 2,145,182$ 130,569$ - -$ 6,062,025$ Ending balance: collectively

evaluated for impairment 43,110,615$ 79,535,930$ 2,806,593$ 2,581,488$ 128,034,626$

December 31, 2012Allowance for loan losses:

Loans:

Commercial Real Estate

Residential Real Estate Commercial Consumer Total

Beginning balance 1,510,980$ 864,354$ 79,532$ 56,042$ 2,510,908$ Loans charged off (2,383,609) (556,617) (40,122) (15,410) (2,995,758) Recoveries 83,096 4,165 5,090 3,057 95,408 Provision for loan losses 1,762,493 471,739 3,768 - - 2,238,000 Ending balance 972,960$ 783,641$ 48,268$ 43,689$ 1,848,558$

Ending balance: individuallyevaluated for impairment 576,954$ 137,837$ 30,000$ - -$ 744,791$

Ending balance: collectivelyevaluated for impairment 396,006$ 645,804$ 18,268$ 43,689$ 1,103,767$

Ending balance 49,520,029$ 81,678,077$ 3,746,318$ 3,080,270$ 138,024,694$ Ending balance: individually

evaluated for impairment 3,812,255$ 1,483,344$ 136,325$ - -$ 5,431,924$ Ending balance: collectively

evaluated for impairment 45,707,774$ 80,194,733$ 3,609,993$ 3,080,270$ 132,592,770$

December 31, 2011Allowance for loan losses:

Loans:

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NOTE 5 – ALLOWANCE FOR LOAN LOSSES (Continued) Impaired loans at December 31, 2012 and 2011 were as follows:

December 31, 2012Recorded

Investment

Unpaid Principal Balance

Related Allowance

Average Recorded

Investment

Interest Income

RecognizedWith no related allowance recorded: Commercial real estate: Construction 2,349,752$ 2,349,752$ - -$ 2,273,473$ 90,760$ Owner occupied - - - - - - - - - - Non-owner occupied 199,070 199,070 - - 198,300 9,936 Residential real estate: Construction 130,458 130,458 - - 98,368 889 Home equity - - - - - - - - - - Other 263,305 263,305 - - 265,718 13,986 Commercial 99,293 99,293 - - 99,476 1,200 With an allowance recorded: Commercial real estate: Construction 132,618 132,618 73,000 262,314 19,448 Owner occupied 906,697 906,697 300,844 908,411 25,152 Non-owner occupied 198,137 198,137 24,000 199,008 11,868 Residential real estate: Construction - - - - - - - - - - Home equity 143,968 143,968 126,798 145,103 3,259 Other 1,607,451 1,607,451 446,314 1,623,354 75,847 Commercial 31,276 31,276 25,000 34,175 2,580 Total 6,062,025$ 6,062,025$ 995,956$ 6,107,700$ 254,925$

December 31, 2011Recorded

Investment

Unpaid Principal Balance

Related Allowance

Average Recorded

Investment

Interest Income

RecognizedWith no related allowance recorded: Commercial real estate: Construction 1,649,002$ 1,649,002$ - -$ 2,423,938$ 72,564$ Owner occupied 147,319 147,319 - - 211,485 5,890 Non-owner occupied 200,663 200,663 - - 196,041 10,807 Residential real estate: Construction - - - - - - - - - - Home equity - - - - - - - - - - Other 288,255 288,255 - - 373,019 15,003 Commercial 100,493 100,493 - - 100,809 - - With an allowance recorded: Commercial real estate: Construction 895,053 895,053 332,000 887,848 13,012 Owner occupied 920,218 920,218 244,954 925,749 31,298 Non-owner occupied - - - - - - - - - - Residential real estate: Construction - - - - - - - - - - Home equity - - - - - - - - - - Other 1,195,089 1,195,089 137,837 1,176,770 57,685 Commercial 35,832 35,832 30,000 37,814 2,971 Total 5,431,924$ 5,431,924$ 744,791$ 6,333,473$ 209,230$

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NOTE 5 – ALLOWANCE FOR LOAN LOSSES (Continued) The following tables present the aging of past due loans including nonaccrual loans as of December 31, 2012 and 2011 by class of loans:

December 31, 201230-59 Days Past Due

60-89 Days Past Due

90 Days

and Greater

Total Past Due Current Total Loans

Recorded Investment > 90 Days and

Accruing

Commercial real estate:Construction 159,948$ 18,654$ 1,742,847$ 1,921,449$ 9,241,090$ 11,162,539$ 1,496,034$ Owner occupied - - - - 818,853 818,853 17,729,694 18,548,547 - - Non-owner occupied 198,137 - - - - 198,137 16,987,666 17,185,803 - -

Residential real estate:Construction 130,458 - - - - 130,458 2,763,054 2,893,512 - - Home equity 229,278 - - 19,798 249,076 15,891,678 16,140,754 - - Other 862,340 283,774 244,561 1,390,675 61,256,171 62,646,846 244,561

Commercial - - - - 99,293 99,293 2,837,869 2,937,162 - - Consumer:

Credit cards 2,534 - - - - 2,534 232,860 235,394 - - Revolving credit plans - - - - - - - - 254,415 254,415 - - Other 19,015 - - 31,928 50,943 2,040,736 2,091,679 - -

Total 1,601,710$ 302,428$ 2,957,280$ 4,861,418$ 129,235,233$ 134,096,651$ 1,740,595$

December 31, 201130-59 Days Past Due

60-89 Days Past Due

90 Days

and Greater

Total Past Due Current Total Loans

Recorded Investment > 90 Days and

Accruing

Commercial real estate:Construction 24,576$ - -$ 856,739$ 881,315$ 11,362,557$ 12,243,872$ - -$ Owner occupied 231,035 - - 976,582 1,207,617 18,887,156 20,094,773 - - Non-owner occupied - - - - - - - - 17,181,384 17,181,384 - -

Residential real estate:Construction - - - - - - - - 1,129,175 1,129,175 - - Home equity - - - - - - - - 16,910,187 16,910,187 - - Other 100,042 191,515 159,247 450,804 63,187,911 63,638,715 25,295

Commercial - - - - 100,493 100,493 3,645,825 3,746,318 - - Consumer:

Credit cards - - - - - - - - 245,968 245,968 - - Revolving credit plans - - - - - - - - 306,823 306,823 - - Other 6,947 - - - - 6,947 2,520,532 2,527,479 - -

Total 362,600$ 191,515$ 2,093,061$ 2,647,176$ 135,377,518$ 138,024,694$ 25,295$

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NOTE 5 – ALLOWANCE FOR LOAN LOSSES (Continued) The following table displays the types of loans that comprised nonaccruals at December 31, 2012 and 2011:

2012 2011Commercial real estate:

Construction 496,989$ 856,739$ Owner occupied 818,853 976,582 Non-owner occupied - - - -

Residential real estate:Construction - - - - Home equity 143,968 - - Other 253,910 133,951

Commercial 99,293 100,493 Consumer:

Credit cards - - - - Revolving credit plans - - - - Other 31,928 - -

Total 1,844,941$ 2,067,765$

Every loan is assessed and assigned a risk rating by the loan officer prior to approval of the credit. The loan review policy dictates which portions of the loan portfolio will be periodically reassessed and graded and that the risk rating of each loan will be reviewed and changed as necessary. Loans are rated on a scale from pass to doubtful. The grade considers and reflects the creditworthiness, documentation and credit file completeness as well as legal and policy compliance. Each grade is described below. Pass Loans graded as pass are strong borrowers. The Bank will likely not incur a loss on loans graded as pass. Any inadequacies evident in financial performance and/or management sufficiency are offset by other features such as adequate collateral, good guarantors with liquid assets and/or cash flow capacity to repay the debt. Generally loans classified as pass meet the terms of repayment but may be susceptible to deterioration if adverse factors are encountered. Special Mention Loans are graded as special mention when the borrower's character, credit, capacity or collateral is questionable. These weaknesses may, if not checked or corrected, weaken the asset or inadequately protect the Bank's credit position at some future date. Circumstances warrant more than normal monitoring, as these borrowers reflect the risks described in the following categories. These loans should be placed on the Bank's watchlist, and are considered adversely classified. These credits are considered bankable assets with no apparent loss of principal or interest envisioned but may require a higher level of management attention. Assets are currently protected but potentially weak. Potential weaknesses include declining trends in operating earnings and cash flows and/or reliance on the secondary source of repayment. Credits subject to economic, industry, or management factors having an adverse impact upon the credit's prospects for timely payment may also be classified as special mention. Substandard Loans graded as substandard are inadequately protected by the net worth and/or cash flow capacity of the borrower or of the collateral pledged. Loans graded as substandard have a borrower whose character has become suspect. The source of repayment is considered conditional, problematic or marginal. Substandard loans would include unsecured or partially secured loans to financially weak borrowers with a strong guarantor or endorser who did not benefit from the loan and without a curtailment in over one year. Some of the loans are workout loans with potential loss consideration. The credit risk in this situation relates to the possibility of some loss of principal and/or interest if the deficiencies are not corrected.

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NOTE 5 – ALLOWANCE FOR LOAN LOSSES (Continued) Doubtful Loans graded as doubtful are inadequately protected by the net worth of the borrower or by the collateral pledged and repayment in full is improbable on the basis of existing facts, values and conditions. These loans may include those over two months past due that are not adequately secured or are in the process of collection. The probability of some loss is high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the facility, its classification as an estimated loss is deferred until a more exact status may be determined. Loss Loans graded as loss are considered uncollectible and continuance as an acceptable asset is not warranted. A loan classified as a loss is generally charged off. Performing and Nonperforming Nonperforming loans include nonaccrual loans, on which no interest is currently accruing, and loans for which principal or interest has been in default for a period of ninety days or more and still accruing interest. All other loans are performing. The following tables display loans by credit quality indicators at December 31, 2012 and 2011:

December 31, 2012 Pass Special Mention Substandard Doubtful Total

Commercial real estate:Construction 6,381,283$ 2,939,125$ 1,709,513$ 132,618$ 11,162,539$ Owner occupied 13,984,619 3,657,231 906,697 - - 18,548,547 Non-owner occupied 10,410,823 6,576,843 198,137 - - 17,185,803

Residential real estate:Construction 2,763,054 - - 130,458 - - 2,893,512 Home equity 15,411,653 709,303 19,798 - - 16,140,754 Other 56,311,569 4,332,590 1,981,999 20,688 62,646,846

Commercial 2,420,017 386,577 130,568 - - 2,937,162 Consumer:

Credit cards 235,394 - - - - - - 235,394 Revolving credit plans 237,657 16,758 - - - - 254,415 Other 2,059,751 31,928 - - - - 2,091,679

Total 110,215,820$ 18,650,355$ 5,077,170$ 153,306$ 134,096,651$

26

NOTE 5 – ALLOWANCE FOR LOAN LOSSES (Continued)

December 31, 2011 Pass Special Mention Substandard Doubtful Total

Commercial real estate:Construction 7,253,306$ 2,446,511$ 2,239,188$ 304,867$ 12,243,872$ Owner occupied 14,914,255 4,112,982 1,067,536 - - 20,094,773 Non-owner occupied 11,775,338 5,406,046 - - - - 17,181,384

Residential real estate:Construction 1,129,175 - - - - - - 1,129,175 Home equity 16,419,352 490,835 - - - - 16,910,187 Other 58,566,462 3,822,391 1,249,862 - - 63,638,715

Commercial 3,096,226 513,768 136,324 - - 3,746,318 Consumer:

Credit cards 245,968 - - - - - - 245,968 Revolving credit plans 301,701 5,122 - - - - 306,823 Other 2,469,549 57,930 - - - - 2,527,479

Total 116,171,332$ 16,855,585$ 4,692,910$ 304,867$ 138,024,694$ Loans are classified as troubled debt restructurings (TDR) when, for economic or legal reasons related to the borrower’s financial position, management grants a concession to the borrower that would not have otherwise been considered. At December 31, 2012 and 2011, the Bank had a total of $1,795,968 and $1,826,071, respectively, in loans classified as troubled debt restructurings. Troubled debt restructurings are considered subsequently defaulted once the loan is past due greater than 90 days. During the year ended December 31, 2012, the Bank had one residential real estate loan in the amount of $351,736 that had subsequently defaulted during the period within the twelve months of modification. During the year ended December 31, 2011, the Bank had no loans that subsequently defaulted during the period within twelve months of modification. The following tables detail the additions to troubled debt restructurings during the years ended December 31, 2012 and 2011:

December 31, 2012Number of Contracts

Pre-Modification Outstanding

Recorded Investment

Post-Modification Outstanding

Recorded Investment

Residential real estate:Other 1 351,736$ 351,736$

Consumer:Other 2 14,911 14,514

Total 3 366,647$ 366,250$

December 31, 2011Number of Contracts

Pre-Modification Outstanding

Recorded Investment

Post-Modification Outstanding

Recorded Investment

Residential real estate:Other 1 155,652$ 154,304$

Consumer:Other 1 16,107 13,170

Total 2 171,759$ 167,474$

27

NOTE 6 – PREMISES AND EQUIPMENT A summary of the cost and accumulated depreciation of premises and equipment follows:

2012 2011

Land 1,580,761$ 1,580,761$ Buildings and improvements 8,153,490 8,140,538 Furniture and equipment 3,919,772 3,941,214

Total cost 13,654,023 13,662,513 Less accumulated depreciation (6,816,990) (6,699,457) Premises and equipment, net 6,837,033$ 6,963,056$

December 31,

Depreciation expense for the years ended December 31, 2012, 2011 and 2010 was $416,231, $433,284 and $501,938, respectively. NOTE 7 – DEPOSITS The Bank makes every effort to obtain deposits to fund loan growth or the growth of the securities portfolio. The Bank had three deposit relationships that represented 26.48% and 25.35% of total deposits at December 31, 2012 and 2011, respectively. The aggregate amount of time deposit accounts in denominations of $100,000 or more at December 31, 2012 and 2011 was $39,298,030 and $35,118,679, respectively. At December 31, 2012, the scheduled maturities of time deposits were as follows:

2013 54,546,040$ 2014 11,696,615 2015 4,381,234 2016 5,590,534 2017 5,174,533

81,388,956$ NOTE 8 – BORROWINGS

Securities Sold Under Agreements to Repurchase Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected as the amount of cash received in connection with the transaction. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. Pledged securities related to securities sold under agreements to repurchase are discussed in Note 3. Securities sold under agreements to repurchase amounted to $641,300 and $517,340 at December 31, 2012 and 2011, respectively. Federal Home Loan Bank Advances The Bank is a member of the Federal Home Loan Bank of Pittsburgh (“FHLB”) which allows for participation in FHLB borrowing programs. At December 31, 2012, the Bank had a maximum borrowing capacity with the FHLB in excess of $57,898,000 of which seventy-five percent is unrestricted and would not require the Bank to pledge securities or make other commitments. The Bank has a secured line of credit with the FHLB in the amount of $35,000,000 related to this

28

NOTE 8 – BORROWINGS (Continued) borrowing capacity. Under the terms of the agreement, advances with the FHLB are collateralized by one-to-four family mortgage loans totaling approximately $71,912,000 and $74,338,000 at December 31, 2012 and 2011, respectively, and Federal Home Loan Bank stock. This line has no scheduled maturity date. Borrowings have a variable rate of interest that is subject to change daily. The Bank had no outstanding advances from the FHLB at December 31, 2012 and 2011. Available Lines of Credit At December 31, 2012, the Bank had lines of credit available with various financial institutions totaling $12,000,000 for the purchase of federal funds. As of December 31, 2012 and 2011, there were no outstanding borrowings against these lines. The Bank has an agreement with the Federal Reserve Bank to borrow from the discount window, which is classified as a short term borrowing. In order to borrow funds under this agreement, the Bank must pledge securities to the Federal Reserve Bank. As of December 31, 2012 and 2011, the Bank had no borrowings from the discount window. NOTE 9 – EMPLOYEE BENEFIT PLANS Pension Plan

The Bank provides pension benefits for eligible employees through a defined benefit pension plan. Employees participate in the retirement plan on a non-contributory basis after attaining the age of 21 and completing one year of service. A minimum of 1,000 hours is required for each year of service. Employees are fully vested after five years of service. The pension plan’s funded status as of December 31, 2012, December 31, 2011 and December 31, 2010 follows. The amounts shown below are recognized in the Bank’s consolidated balance sheets as of December 31, 2012, 2011 and 2010.

2012 2011 2010Change in benefit obligation:

Beginning benefit obligation 7,678,776$ 6,307,771$ 5,596,588$ Service cost 298,153 257,342 283,182 Interest cost 385,468 342,349 331,823 Actuarial loss 575,292 892,782 334,119 Benefits paid (192,452) (121,468) (237,941) Ending benefit obligation 8,745,237$ 7,678,776$ 6,307,771$

Change in plan assets, at fair value:Beginning plan assets 5,556,718$ 5,539,160$ 4,659,481$ Actual return on plan assets 674,095 139,026 367,620 Employer contribution 1,000,000 - - 750,000 Benefits paid (192,452) (121,468) (237,941) Ending plan assets 7,038,361$ 5,556,718$ 5,539,160$

Funded status (1,706,876)$ (2,122,058)$ (768,611)$ Accrued benefit liability recognized on the

consolidated balance sheets at December 31 (1,706,876)$ (2,122,058)$ (768,611)$ Amounts recognized in accumulated other

comprehensive loss:Net loss 3,905,267$ 3,755,948$ 2,659,393$ Prior service cost - - 9,979 19,952

Net amount recognized 3,905,267$ 3,765,927$ 2,679,345$

The accumulated benefit obligation for the defined benefit plan was $7,802,064, $6,895,038 and $5,638,032 at December 31, 2012, 2011 and 2010, respectively.

29

NOTE 9 – EMPLOYEE BENEFIT PLANS (Continued) At December 31, 2012, 2011 and 2010, the assumptions used to determine the benefit obligation are as follows:

2012 2011 2010Discount rate 4.39% 5.09% 5.50%Expected rate of return on plan assets 7.40% 7.58% 8.00%Rate of compensation increase 2.00% (1) 2.00% 2.00% (1) 2.00% grading up by 0.25% per year to an ultimate rate of 3.00% The components of net periodic benefit cost, other amounts recognized in other comprehensive loss and the assumptions used to determine net periodic pension cost are as follows:

2012 2011 2010

Components of net periodic benefit cost:

Service cost 298,153$ 257,342$ 283,182$ Interest cost 385,468 342,349 331,823 Expected return on plan assets (492,875) (483,708) (443,484) Net amortization and deferral 254,732 150,882 90,652

Net periodic benefit cost 445,478 266,865 262,173

Other changes in plan assets and benefit obligations recognized in other comprehensive loss:

Net actuarial loss at December 31 394,072 1,237,464 409,983 Amortization of prior service cost (9,979) (9,973) (9,973) Amortization of net loss (244,753) (140,909) (80,679)

Total recognized in other comprehensive loss 139,340 1,086,582 319,331 Total recognized in net periodic benefit cost and

other comprehensive loss 584,818$ 1,353,447$ 581,504$

Discount rate 5.09% 5.50% 6.00%Expected rate of return on plan assets 8.00% 8.00% 8.00%Rate of compensation increase 2.00% 2.00% 3.00%

The estimated net loss and prior service cost for the defined benefit pension plan that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year are $308,333 and $0, respectively.

30

NOTE 9 – EMPLOYEE BENEFIT PLANS (Continued) Determination of Expected Long-term Rate of Return The expected long-term rate of return for the plan’s total assets is based on the expected return of each of the below categories, weighted based on the median of the target allocation for each class. The Bank’s pension plan weighted average asset allocations at December 31, 2012 and 2011 follows:

Asset Category 2012 2011

Equity Securities 62% 48%Debt Securities 36% 50%Cash 2% 2% Total 100% 100%

Percentage of PlanAssets at December 31,

The following tables present the balance of plan assets measured at fair value on a recurring basis as of December 31, 2012 and 2011:

Fair Value Measurements at Reporting Date Using

DescriptionBalance as of

December 31, 2012

Quoted Prices in Active Markets

for Identical Assets (Level 1)

Significant Other Observable

Inputs (Level 2)

Significant Other Unobservable

Inputs (Level 3)

Cash 105,945$ 105,945$ - -$ - -$ Equity Securities U.S. large cap 3,093,120 3,093,120 - - - - U.S. small cap funds 370,672 370,672 - - - - International 909,389 909,389 - - - - Fixed Income Securities Core fixed income 2,380,036 - - 2,380,036 - - International 179,199 - - 179,199 - - Total 7,038,361$ 4,479,126$ 2,559,235$ - -$

31

NOTE 9 – EMPLOYEE BENEFIT PLANS (Continued)



December 31, 2011



Significant Other Observable

Inputs (Level 2)


Inputs (Level 3)

Cash 127,736$ 127,736$ - -$ - -$ Equity Securities U.S. large cap 2,075,831 2,075,831 - - - - U.S. small cap funds 162,447 162,447 - - - - International 452,978 452,978 - - - - Fixed Income Securities Core fixed income 2,575,668 - - 2,575,668 - - International 162,058 - - 162,058 - - Total 5,556,718$ 2,818,992$ 2,737,726$ - -$

Investment Policy and Strategy The policy, as established by the Pension Committee, is to invest assets in a diversified portfolio per target allocations. The assets will be reallocated periodically to meet the target allocations of 60% equity securities and 40% debt securities. The investment policy will be reviewed periodically, under the advisement of a registered investment advisor. The overall investment objective is to provide for long-term growth of capital through participation in the equity markets with a moderate level of income. The investment time horizon is estimated at five to ten years. The investment return objective is to achieve a return greater than a blended mix of stated indices tailored to the same asset mix of the plan assets by 0.5% after fees over the rolling five-year moving average basis. Allowable assets include cash equivalents, taxable bonds, U.S. equity securities, international equity securities, institutional mutual funds and guaranteed investment contracts (GICs). In order to achieve a prudent level of portfolio diversification, the securities of any one company should not exceed more than 10% of the total plan assets, and no more than 25% of total plan assets should be invested in any one industry (other than securities of the U.S. Government or Agencies). Additionally, no more than 20% of the plan assets shall be invested in foreign securities (both equity and fixed). While no minimum contributions are required for 2013, the Bank contributed $1,000,000 to the plan on February 1, 2013. Estimated future benefit payments, which reflect expected future service, are as follows: 2013 238,656$ 2014 296,178 2015 383,647 2016 419,881 2017 466,282 2018 to 2022 2,539,652

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NOTE 9 – EMPLOYEE BENEFIT PLANS (Continued) 401(k) Plan

The Bank has a 401(k) Plan whereby employees age 21 and over with at least one year of service and 1,000 hours per year may participate in the Plan. The Bank makes matching contributions equal to 25 percent of the first five percent of an employee’s compensation contributed to the Plan. Matching contributions vest to the employee over a five-year period based on a tiered schedule. For the years ended December 31, 2012, 2011 and 2010, expense attributable to the Plan amounted to $17,484, $18,263 and $20,769, respectively. NOTE 10 – INCOME TAXES The Bank files income tax returns in the U.S. federal jurisdiction and the states of West Virginia and Maryland. With few exceptions, the Bank is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2009.

Allocation of federal and state income taxes between current and deferred portions is as follows for the years ended December 31, 2012, 2011 and 2010:

2012 2011 2010Federal

Current (111,548)$ 131,388$ 173,762$ Deferred 179,479 (35,396) (221,190)

67,931 95,992 (47,428) State

Current (4,121) (2,965) 37,753 Deferred 31,621 11,951 (13,936)

27,500 8,986 23,817

Income tax expense (benefit) 95,431$ 104,978$ (23,611)$

Effective tax rates differ from the statutory federal income tax rate due to the following:

2012 2011 2010

Federal statutory rate 34.0% 34.0% 34.0%Increase (decrease) resulting from: Tax-exempt income (27.7) (22.7) (36.9) State taxes, net of federal income tax effect 0.9 0.3 0.9 Nondeductible expenses and other, net 2.3 0.2 (0.8)

9.5% 11.8% (2.8%)

Under the provisions of the Internal Revenue Code, the Bank has $594,206 of net operating loss carryforwards which can be offset against future taxable income. The carryforwards expire through December 31, 2032. The full realization of tax benefits associated with carryforwards depends predominately upon the recognition of ordinary income during the carryforward period.

33

NOTE 10 – INCOME TAXES (Continued) The components of the net deferred tax asset, included in other assets, are as follows:

2012 2011Deferred tax assets:

Allowance for loan losses 401,656$ 357,528$ Allowance for other real estate owned 80,560 96,900 Tax basis adjustment for other real estate owned 23,085 76,177 Other real estate owned expenses 56,373 76,205 Deferred real estate gains 25,229 45,039 Deferred loan fees 62,391 54,286 Nonaccrual loan income 57,779 114,729 Home equity expenses 3,120 8,552 Pension benefits 648,612 825,212 Supplemental retirement plans 157,707 152,276 Alternative minimum tax credit 398,514 400,687 Net operating loss carryforwards 91,468 - - Other 11,599 6,459

2,018,093 2,214,050

Deferred tax liabilities:Fixed assets, net (41,842) (58,091) Net unrealized gain on available for sale securities (471,479) (302,898) Accretion on investment securities (5,239) (7,967)

(518,560) (368,956) Net deferred tax asset 1,499,533$ 1,845,094$

December 31,

NOTE 11 – RELATED PARTY TRANSACTIONS The Bank had, and may be expected to have in the future, banking transactions in the ordinary course of business with directors, executive officers, their immediate families and affiliated companies in which they are principal shareholders (commonly referred to as related parties), on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others. Loans to these parties totaled $1,650,131 and $1,814,064 at December 31, 2012 and 2011, respectively. During 2012, total principal additions were $198,053 and total principal payments were $324,819. Deposits from related parties held by the Bank at December 31, 2012 and 2011 amounted to $1,498,135 and $1,348,677, respectively. In 2012, there was a change in related party relationships. NOTE 12 – COMMITMENTS, OFF-BALANCE SHEET RISK AND CONTINGENCIES There are various contingent liabilities that are not reflected in the consolidated financial statements, including claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material effect on the financial condition or results of operations of the Bank. Some financial instruments are used in the normal course of business to meet the financing needs of customers and to reduce exposure to interest rate changes. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements.

34

NOTE 12 – COMMITMENTS, OFF-BALANCE SHEET RISK AND CONTINGENCIES (Continued) Exposure to credit loss, if the other party does not perform, is represented by the contractual amount of these commitments to extend credit and standby letters of credit. The same credit policies are used for commitments and conditional obligations as are used for loans. A summary of the notional or contractual amounts of financial instruments with off-balance sheet risk at year-end follows:

2012 2011Commitments to extend credit 1,841,000$ 286,000$ Unfunded commitments 23,565,000$ 20,857,000$ Standby letters of credit 439,000$ 1,408,000$

December 31,

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being used, the total commitments do not necessarily represent future cash requirements. Unfunded commitments under commercial lines-of-credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are collateralized as deemed necessary and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Bank is committed. Standby letters of credit are conditional lending commitments issued by the Bank to guarantee the performance of a customer to a third party. Letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral supporting these commitments. The amount of collateral obtained, if deemed necessary, is based upon management’s credit evaluation of the customer. The Bank is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2012 and 2011, reserve balances amounted to $969,000 and $1,087,000, respectively. NOTE 13 – FAIR VALUE MEASUREMENTS The Bank follows Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. ASC 820 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Bank’s market assumptions. The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:

Level 1 – Valuation is based on quoted prices in active markets for identical assets and liabilities. Level 2 – Valuation is based on observable inputs including quoted prices in active markets for similar assets and

liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-basedvaluation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.

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

35

NOTE 13 – FAIR VALUE MEASUREMENTS (Continued) The following describes the valuation techniques used by the Bank to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the consolidated financial statements: Securities Available for Sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). The following tables present the balance of financial assets measured at fair value on a recurring basis as of December 31, 2012 and 2011:



December 31, 2012



Significant Other Observable Inputs

(Level 2)


Inputs (Level 3)

Securities Available for SaleU.S. Government and agency 101,617,743$ - -$ 101,617,743$ - -$ State and municipal 27,284,271 - - 27,284,271 - -

128,902,014$ - -$ 128,902,014$ - -$



December 31, 2011




(Level 2)


Inputs (Level 3)

Securities Available for SaleU.S. Government and agency 97,756,211$ - -$ 97,756,211$ - -$ State and municipal 10,905,812 - - 10,905,812 - -

108,662,023$ - -$ 108,662,023$ - -$

Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets. The following describes the valuation techniques used by the Bank to measure certain financial assets recorded at fair value on a nonrecurring basis in the consolidated financial statements: Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreements 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. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Bank’s collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal, of one year or less, conducted by an independent, licensed appraiser using observable market data (Level 2). However, if the collateral is a house or building in

36

NOTE 13 – FAIR VALUE MEASUREMENTS (Continued) the process of construction or if an appraisal of the property is more than one year old and not solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income. Other Real Estate Owned: Loans are transferred to other real estate owned when the collateral securing them is foreclosed upon. The measurement of loss associated with other real estate owned is based on the fair value of the collateral compared to the unpaid loan balance and anticipated costs to sell the property and initial losses are charged against the allowance for loan losses at the time of the transfer. Subsequent to transfer, fair values are determined in a similar manner to impaired loans secured by real estate previously discussed. Any additional fair value adjustments to other real estate owned are recorded in the period incurred and expensed against current earnings. The following tables present the balances of financial assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2012 and 2011:



December 31, 2012




(Level 2)


Inputs (Level 3)

Impaired Loans 2,024,191$ - -$ - -$ 2,024,191$ Other Real Estate Owned 981,621$ - -$ - -$ 981,621$



December 31, 2011




(Level 2)


Inputs (Level 3)

Impaired Loans 2,301,401$ - -$ - -$ 2,301,401$ Other Real Estate Owned 1,943,942$ - -$ - -$ 1,943,942$

The following table displays quantitative information about Level 3 Fair Value Measurements for December 31, 2012 (dollars in thousands):

AssetsFair

Value Valuation Technique Unobservable InputRange

(Weighted Average)

Impaired Loans 2,024$ Discounted appraised value Discount for lack of marketability and age of appraisal 8% - 86% (30%)

Other Real Estate Owned 982$ Discounted appraised value Selling cost 5% - 18% (10%) Discount for lack of marketability

and age of appraisal 0% - 63% (14%)

Quantitative information about Level 3 Fair Value Measurements for December 31, 2012

37

NOTE 13 – FAIR VALUE MEASUREMENTS (Continued) The following methods and assumptions were used to estimate fair values for financial instruments:

Carrying amount is considered to estimate fair value for cash and due from financial institutions, interest bearing deposits with depository institutions, restricted securities, accrued interest receivable, noninterest bearing deposits, securities sold under agreements to repurchase, accrued interest payable and variable rate loans or deposits that re-price frequently.

Securities fair values are based on quoted market prices or, if no quotes are available, on the rate and term of the security, on information about the issuer and third party pricing models.

Fixed rate loans and variable rate loans with infrequent repricing or repricing limits, are estimated using discounted cash flow analyses or underlying collateral values, where applicable. See above for valuation of impaired loans.

The fair value of demand and savings deposits is the amount payable on demand. The fair value of certificates of deposit is estimated using the rates currently offered for deposits with similar maturities.

Bank owned life insurance represents insurance policies on past and current officers and directors of the Bank. The cash values of the polices are estimates using information provided by insurance carriers. These policies are carried at their cash surrender value which approximates fair value.

Fair value of other financial instruments and off-balance sheet items are not considered significant to this presentation.

While these estimates of fair value are based on management’s judgment of the most appropriate factors, there is no assurance that if the Bank had disposed of such items at December 31, 2012 and 2011, the estimated fair values would have been achieved. Market values may differ depending on various circumstances not taken into consideration in this methodology. The estimated fair values at December 31, 2012 and 2011 should not necessarily be considered to apply at subsequent dates. The following table shows the estimated fair values and the related carrying values of the Bank’s financial instruments at December 31, 2012 and 2011 (in thousands):


Carrying Amount

Estimated Fair Value

Quoted Prices in Active Markets for

Identical Assets (Level 1)


(Level 2)

Significant Other Unobservable Inputs

(Level 3)Financial assets:

Cash and due from financial institutions 6,106$ 6,106$ 6,106$ - -$ - -$

Interest bearing deposits with depository instituions 8,541 8,541 8,541 - - - -

Securities available for sale 128,902 128,902 - - 128,902 - - Restricted securities 959 959 - - 959 - - Loans, net 131,869 128,812 - - - - 128,812 Accrued interest receivable 1,105 1,105 1,105 - - - - Bank owned life insurance 5,233 5,233 5,233 - - - -

Financial liabilities:Deposits 269,485$ 269,976$ 188,096$ - -$ 81,880$ Securities sold under

agreements to repurchase 641 641 641 - - - - Accrued interest payable 115 115 115 - - - -

December 31, 2012

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NOTE 13 – FAIR VALUE MEASUREMENTS (Continued)


Carrying Amount

Estimated Fair Value

Quoted Prices in Active Markets for

Identical Assets (Level 1)


(Level 2)

Significant Other Unobservable Inputs

(Level 3)Financial assets:

Cash and due from financial institutions 7,261$ 7,261$ 7,261$ - -$ - -$

Interest bearing deposits with depository instituions 3,774 3,774 3,774 - - - -

Securities available for sale 108,662 108,662 - - 108,662 - - Restricted securities 1,319 1,319 - - 1,319 - - Loans, net 136,033 133,289 - - - - 133,289 Accrued interest receivable 840 840 840 - - - - Bank owned life insurance 5,064 5,064 5,064 - - - -

Financial liabilities:Deposits 251,509$ 251,876$ 171,240$ - -$ 80,636$ Securities sold under

agreements to repurchase 517 517 517 - - - - Accrued interest payable 126 126 126 - - - -

December 31, 2011

The Bank assumes interest rate risk, the risk that general interest rate levels will change, as a result of its normal operations. As a result, the fair values of the Bank’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Bank. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment 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 Bank’s overall interest rate risk. NOTE 14 – REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2012 and 2011, that the Bank met all capital adequacy requirements to which it is subject.

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NOTE 14 – REGULATORY MATTERS (Continued) As of December 31, 2012, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since the notification that management believes have changed the Bank’s category. The Bank’s actual capital amounts (in thousands) and ratios as of December 31, 2012 and 2011 are also presented in the following table.

Minimum

Amount Ratio Amount Ratio Amount Ratio2012Total capital (to risk weighted assets) 24,076$ 14.5% 13,322$ 8.0% 16,653$ 10.0%Tier 1 capital (to risk weighted assets) 22,013$ 13.2% 6,661$ 4.0% 9,992$ 6.0%Tier 1 capital (to average assets) 22,013$ 7.6% 11,619$ 4.0% 14,524$ 5.0%

2011Total capital (to risk weighted assets) 23,269$ 14.5% 12,814$ 8.0% 16,018$ 10.0%Tier 1 capital (to risk weighted assets) 21,420$ 13.4% 6,407$ 4.0% 9,611$ 6.0%Tier 1 capital (to average assets) 21,420$ 7.7% 11,081$ 4.0% 13,852$ 5.0%

Actual Adequacy PurposesFor Capital

Minimum To Be Well Capitalized Under Prompt

Corrective Action Provisions

NOTE 15 – CONCENTRATION RISK

The Bank maintains its cash accounts in several correspondent banks. As of December 31, 2012, cash balances in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) were $25,589. Most of the Bank’s activities are with customers located within its local market areas. As of December 31, 2012, the Bank had three deposit relationships totaling $71,365,650 with each relationship holding more than 5% of total deposits. Significant changes in these accounts are monitored on an ongoing basis. As of December 31, 2012, real estate loans represented 96.0% of the loan portfolio. A detailed schedule is provided in Note 4, Notes to Consolidated Financial Statements. The Bank does not have any significant concentrations to any one customer.

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NOTE 16 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Changes in each component of accumulated other comprehensive loss were as follows:

Adjustments AccumulatedNet Unrealized Related to OtherGains (Losses) Pension Comprehensiveon Securities Benefits (Loss)

Balance at December 31, 2009 57,630$ (1,451,409)$ (1,393,779)$ Unrealized holding gains on securities available for sale

securities, net of tax $502,107 802,066 - - 802,066 Reclassification adjustment, net of tax ($317,995) (507,965) - - (507,965) Change in pension benefits, net of tax ($122,942) - - (196,388) (196,388) Balance at December 31, 2010 351,731$ (1,647,797)$ (1,296,066)$ Unrealized holding gains on securities available for sale

securities, net of tax $734,603 1,173,457 - - 1,173,457 Reclassification adjustment, net of tax ($651,893) (1,041,337) - - (1,041,337) Change in pension benefits, net of tax ($418,334) - - (668,248) (668,248) Balance at December 31, 2011 483,851$ (2,316,045)$ (1,832,194)$ Unrealized holding gains on securities available for sale

securities, net of tax $168,572 285,393 - - 285,393 Reclassification adjustment, net of tax $8 12 - - 12 Change in pension benefits, net of tax ($34,120) - - (105,220) (105,220)

Balance at December 31, 2012 769,256$ (2,421,265)$ (1,652,009)$

NOTE 17 – SUBSEQUENT EVENTS The Bank evaluated subsequent events that have occurred after the balance sheet date, but before the consolidated financial statements are issued. There are two types of subsequent events (1) recognized, or those that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements, and (2) nonrecognized, or those that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Subsequent events have been considered through March 21, 2013, the date the financial statements were available to be issued. Based on the evaluation, the Bank did not identify any recognized or nonrecognized subsequent events that would have required adjustment to or disclosure in the consolidated financial statements.

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