Edgar Filing: Village Bank & Trust Financial Corp.

f10qvillage.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

__________

FORM 10-Q

 QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

 TRANSITION REPORT UNDER SECTION 13 OR 15(d)

OF THE EXCHANGE ACT

For the transition period from ______ to ______

____________

Commission file number: 0-50765

VILLAGE BANK AND TRUST FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

Virginia	16-1694602
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

15521 Midlothian Turnpike, Midlothian, Virginia	23113
(Address of principal executive offices)	(Zip code)

804-897-3900
(Registrant’s telephone number, including area code)

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

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

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

Large Accelerated Filer £	Accelerated Filer £
Non-Accelerated Filer £ (Do not check if smaller reporting company)	Smaller Reporting Company x

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

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

4,251,795 shares of common stock, $4.00 par value, outstanding as of August 3, 2012

Village Bank and Trust Financial Corp.

Form 10-Q

TABLE OF CONTENTS

Part I – Financial Information

	Item 1. Financial Statements

	Consolidated Balance Sheets
	June 30, 2012 (unaudited) and December 31, 2011		3

	Consolidated Statements of Operations For the Three and Six Months Ended
	June 30, 2012 and 2011 (unaudited)		4

	Consolidated Statements of Comprehensive Income (Loss)
	For the Three and Six Months Ended June 30, 2012 and 2011 (unaudited)		5

	Consolidated Statements of Stockholders’ Equity For the Six Months Ended
	June 30, 2012 and 2011 (unaudited)		6

	Consolidated Statements of Cash Flows For the Six Months Ended
	June 30, 2012 and 2011 (unaudited)		7

	Notes to Condensed Consolidated Financial Statements (unaudited)		8

	Item 2. Management’s Discussion and Analysis of Financial Condition
		and Results of Operations	33

	Item 3. Quantitative and Qualitative Disclosures About Market Risk		56

	Item 4. Controls and Procedures		56

Part II – Other Information

	Item 1. Legal Proceedings		58

	Item 1A. Risk Factors		58

	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		58

	Item 3. Defaults Upon Senior Securities		58

	Item 4. Mine Safety Disclosures		58

	Item 5. Other Information		58

	Item 6. Exhibits		58

Signatures			59

PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Balance Sheet
June 30, 2012 (Unaudited) and December 31, 2011

	June 30,			December 31,
	2012			2011
Assets
Cash and due from banks	$	23,271,435		$	55,557,541
Federal funds sold		3,834,563			7,228,475
Total cash and cash equivalents		27,105,998			62,786,016
Investment securities available for sale		36,696,282			30,163,292
Loans held for sale		19,729,508			16,168,405
Loans
Outstandings		393,035,350			427,870,716
Allowance for loan losses		(14,865,722	)		(16,071,424	)
Deferred fees and costs		751,748			767,775
		378,921,376			412,567,067
Premises and equipment, net		26,286,493			26,826,524
Accrued interest receivable		1,910,147			2,046,524
Bank owned life insurance		6,159,335			6,065,305
Other real estate owned		17,677,080			9,177,167
Restricted equity securities		2,767,886			2,989,286
Other assets		7,208,307			12,914,733

	$	524,462,412		$	581,704,319

Liabilities and Stockholders' Equity
Liabilities
Deposits
Noninterest bearing demand	$	64,348,408		$	66,534,956
Interest bearing		386,071,500			418,986,096
Total deposits		450,419,908			485,521,052
Federal Home Loan Bank advances		29,000,000			37,750,000
Long-term debt - trust preferred securities		8,764,000			8,764,000
Other borrowings		5,062,344			5,778,661
Accrued interest payable		703,817			592,283
Other liabilities		5,458,402			7,050,681
Total liabilities		499,408,471			545,456,677

Stockholders' equity
Preferred stock, $4 par value, $1,000 liquidation preference		58,952			58,952
1,000,000 shares authorized, 14,738 shares issued and outstanding
Common stock, $4 par value - 10,000,000 shares issued and outstanding
4,251,795 shares issued and outstanding at June 30, 2012
4,243,378 shares issued and outstanding at December 31, 2011		17,007,180			16,973,512
Additional paid-in capital		40,704,021			40,732,178
Retained earnings (deficit)		(33,438,097	)		(21,895,557	)
Preferred stock warrant		732,479			732,479
Discount on preferred stock		(272,921	)		(346,473	)
Accumulated other comprehensive income (loss)		262,327			(7,449	)
Total stockholders' equity		25,053,941			36,247,642

	$	524,462,412		$	581,704,319


See accompanying notes to consolidated financial statements

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Statements of Operations
Three and Six Months Ended June 30, 2012 and 2011
(Unaudited)


	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2012			2011		2012			2011
Interest income
Loans	$	5,614,263		$	6,767,421	$	11,513,471		$	13,808,189
Investment securities		215,196			352,798		365,545			653,124
Federal funds sold		11,621			20,481		32,553			38,804
Total interest income		5,841,080			7,140,700		11,911,569			14,500,117

Interest expense
Deposits		1,245,465			1,905,320		2,604,018			3,944,196
Borrowed funds		244,135			297,158		535,121			579,849
Total interest expense		1,489,600			2,202,478		3,139,139			4,524,045

Net interest income		4,351,480			4,938,222		8,772,430			9,976,072
Provision for loan losses		6,660,000			900,000		8,395,000			1,903,000
Net interest income (loss) after provision
for loan losses		(2,308,520	)		4,038,222		377,430			8,073,072

Noninterest income
Service charges and fees		540,335			498,432		1,047,978			871,382
Gain on sale of loans		2,191,229			1,636,240		3,941,892			3,008,918
Gain (loss) on sale of securities		99,470			19		263,677			63,144
Rental income		182,199			164,620		393,197			299,069
Other		121,896			106,554		211,855			201,072
Total noninterest income		3,135,129			2,405,865		5,858,599			4,443,585

Noninterest expense
Salaries and benefits		3,305,869			3,195,283		6,404,093			6,245,399
Occupancy		579,931			518,712		1,160,800			994,448
Equipment		202,616			224,150		407,980			444,220
Supplies		105,311			109,785		197,213			225,944
Professional and outside services		733,909			523,092		1,369,291			1,089,446
Advertising and marketing		47,983			111,584		124,046			234,423
Expenses related to foreclosed real estate		677,848			361,896		1,796,623			824,212
Other operating expenses		1,027,500			1,010,448		2,030,721			1,877,307
Total noninterest expense		6,680,967			6,054,950		13,490,767			11,935,399

Net income (loss) before income taxes		(5,854,358	)		389,137		(7,254,738	)		581,258
Income tax expense		3,881,914			132,306		3,881,914			241,706

Net income (loss)		(9,736,272	)		256,831		(11,136,652	)		339,552

Preferred stock dividends and amortization of discount		185,449			220,169		405,898			438,227
Net income (loss) available to common
shareholders	$	(9,921,721	)	$	36,662	$	(11,542,550	)	$	(98,675	)

Earnings (loss) per share, basic	$	(2.33	)	$	0.01	$	(2.72	)	$	(0.02	)
Earnings (loss) per share, diluted	$	(2.33	)	$	0.01	$	(2.72	)	$	(0.02	)

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Statements of Comprehensive Income (Loss)
Three and Six Months Ended June 30, 2012 and 2011
(Unaudited)

	For the Three Months Ended June 30,
	2012									2011
				Tax									Tax
				Expense									Expense
	Amount			(Benefit)			Total			Amount			(Benefit)			Total

Net Income (loss)	$	(5,854,358	)	$	3,881,914		$	(9,736,272	)	$	389,137		$	132,306		$	256,831

Other comprehensive income:
Unrealized holding gains arising during the period		1,046,534			355,821			690,712			(692,993	)		(235,618	)		(457,375	)
Reclassification adjustment for gains realized in income		(99,470	)		(33,820	)		(65,650	)		(19	)		(6	)		(13	)
Minimum pension adjustment		3,250			1,105			2,145			3,250			1,105			2,145
Total other comprehensive income		950,314			323,107			627,207			(689,762	)		(234,519	)		(455,243	)

Total comprehensive income (loss)	$	(4,904,044	)	$	4,205,021		$	(9,109,065	)	$	(300,625	)	$	(102,213	)	$	(198,412	)

		For the Six Months Ended June 30,
		2012									2011
				Tax									Tax
				Expense									Expense
	Amount			(Benefit)			Total			Amount			(Benefit)			Total

Net Income (loss)	$	(7,254,738	)	$	3,881,914		$	(11,136,652	)	$	581,258		$	241,706		$	339,552

Other comprehensive income:
Unrealized holding gains arising during the period		665,929			226,416			439,513			1,103,971			375,350			728,621
Reclassification adjustment for gains realized in income		(263,677	)		(89,650	)		(174,027	)		(63,144	)		(21,469	)		(41,675	)
Minimum pension adjustment		6,500			2,210			4,290			6,500			2,210			4,290
Total other comprehensive income		408,752			138,976			269,776			1,047,327			356,091			691,236

Total comprehensive income (loss)	$	(6,845,986	)	$	4,020,890		$	(10,866,876	)	$	1,628,585		$	597,797		$	1,030,788


See accompanying notes to consolidated financial statements

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Statements of Stockholders' Equity
Six Months Ended June 30, 2012 and 2011
(Unaudited)

							Accumulated
			Additional	Retained		Discount on	Other
	Preferred	Common	Paid-in	Earnings		Preferred	Comprehensive
	Stock	Stock	Capital	(Deficit)	Warrant	Stock	Income (loss)	Total

Balance, December 31, 2005		7,418,472	9,191,567	585,416			(43,562)	17,151,893
Issuance of common stock		2,829,880	4,374,314	-			-	7,204,194
Stock based compensation		-	23,007	-			-	23,007
Minimum pension adjustment
(net of income taxes of
$75,112)		-	-	-			(145,806)	(145,806)
Balance, December 31, 2011	$ 58,952	$ 16,973,512	$ 40,732,178	$ (21,895,557)	$ 732,479	$ (346,473)	$ (7,449)	$ 36,247,642
Amortization of preferred stock							-	-
discount	-			(73,552)	-	73,552		-
Preferred stock dividend	-	-		(332,336)	-	-	-	(332,336)
Issuance of common stock	-	33,668	(33,668)	-	-	-	-	-
Stock based compensation			5,511					5,511
Minimum pension adjustment
(net of income taxes of $2,917)	-	-	-	-	-	-	4,290	4,290
Net income (loss)	-	-	-	(11,136,652)	-	-	-	(11,136,652)
Change in unrealized gain on
investment securities available-for-sale,
net of reclassification and tax effect	-	-	-	-	-	-	265,486	265,486

Balance, June 30, 2012	$ 58,952	$ 17,007,180	$ 40,704,021	$ (33,438,097)	$ 732,479	$ (272,921)	$ 262,327	$ 25,053,942

Balance, December 31, 2010	$ 58,952	$ 16,953,664	$ 40,633,581	$ (9,192,552)	$ 732,479	$ (492,456)	$ (373,474)	$ 48,320,194
Amortization of preferred stock							-	-
discount	-			(72,806)	-	72,806		-
Preferred stock dividend	-	-		(365,421)	-	-	-	(365,421)
Issuance of common stock	-	19,848	(19,848)	-	-	-	-	-
Stock based compensation			59,223					59,223
Minimum pension adjustment
(net of income taxes of $2,917)	-	-	-	-	-	-	4,290	4,290
Net income (loss)	-	-	-	339,552	-	-	-	339,552
Change in unrealized gain on
investment securities available-for-sale,
net of reclassification and tax effect	-	-	-	-	-	-	686,946	686,946

Balance, June 30, 2011	$ 58,952	$ 16,973,512	$ 40,672,956	$ (9,291,227)	$ 732,479	$ (419,650)	$ 317,762	$ 49,044,784

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2012 and 2011
(Unaudited)
	Six Months Ended June 30,
	2012			2011
Cash Flows from Operating Activities
Net income (loss)	$	(11,136,652	)	$	339,552
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization		764,926			716,443
Deferred income taxes		(4,290,620	)		(3,710,085	)
Valuation allowance on deferred tax asset		6,281,101			-
Provision for loan losses		8,395,000			1,903,000
Write-down of other real estate owned		943,560			427,237
Gain on securities sold		(263,678	)		(63,144	)
Gain on loans sold		(3,941,892	)		(3,008,918	)
Loss on sale of other real estate owned		43,618			86,824
Stock compensation expense		5,511			59,223
Proceeds from sale of mortgage loans		140,739,661			114,982,327
Origination of mortgage loans for sale		(140,358,872	)		(104,077,018	)
Amortization of premiums and accrection of discounts on securities, net		130,888			56,757
(Increase) decrease in interest receivable		136,377			(231,244	)
Increase in bank owned life insurance		(94,030	)		(100,228	)
Decrease in other assets		5,901,368			4,188,569
Increase in interest payable		111,534			82,335
Decrease in other liabilities		(4,021,112	)		1,176,406
Net cash provided by (used in) operating activities		(653,312	)		12,828,036

Cash Flows from Investing Activities
Purchases of available for sale securities		(36,395,416	)		(62,377,306	)
Proceeds from the sale or calls of available for sale securities		28,804,399			803,100
Proceeds from maturities and principal payments of available for sale securities		1,593,068			62,996,221
Net decrease in loans		14,634,257			5,347,767
Proceeds from sale of other real estate owned		1,129,343			2,382,588
Purchases of premises and equipment		(224,896	)		(579,743	)
Net cash provided by investing activities		9,540,755			8,572,627

Cash Flows from Financing Activities
Net increase (decrease) in deposits		(35,101,144	)		6,964,761
Net increase (decrease) in Federal Home Loan Bank Advances		(8,750,000	)		10,000,000
Net increase (decrease) in other borrowings		(716,317	)		1,568,180
Net cash provided by (used in) financing activities		(44,567,461	)		18,532,941

Net increase (decrease) in cash and cash equivalents		(35,680,018	)		39,933,604
Cash and cash equivalents, beginning of period		62,786,016			12,012,311

Cash and cash equivalents, end of period	$	27,105,998		$	51,945,915

Supplemental Schedule of Non Cash Activities
Real estate owned assets acquired in settlement of loans	$	10,616,434		$	2,850,739
Dividends on preferred stock accrued	$	332,336		$	-

See accompanying notes to consolidated financial statements.

Village Bank and Trust Financial Corp. and Subsidiary

Notes to Condensed Consolidated Financial Statements

Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)

Note 1 - Principles of presentation

Village Bank and Trust Financial Corp. (the “Company”) is the holding company of Village Bank (the “Bank”). The consolidated financial statements include the accounts of the Company, the Bank and the Bank’s three wholly-owned subsidiaries, Village Bank Mortgage Company, Village Insurance Agency, Inc., and Village Financial Services Company. All material intercompany balances and transactions have been eliminated in consolidation.

In the opinion of management, the accompanying condensed consolidated financial statements of the Company have been prepared on the accrual basis in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, all adjustments that are, in the opinion of management, necessary for a fair presentation have been included. The results of operations for the three and six month periods ended June 30, 2012 are not necessarily indicative of the results to be expected for the full year ending December 31, 2012. The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes to financial statements that are presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the Securities and Exchange Commission.

Note 2 - Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheets and statements of income for the period. Actual results could differ significantly from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses and the related provision.

Note 3 - Earnings (loss) per common share

The following table presents the basic and diluted earnings per share computations:

	Three Months Ended June 30,					Six Months Ended June 30,
	2012			2011		2012			2011
Numerator
Net income (loss) - basic and diluted	$	(9,736,272	)	$	256,831	$	(11,136,652	)	$	339,552
Preferred stock dividend and accretion		185,449			220,169		405,898			438,227
Net income (loss) available to common
shareholders	$	(9,921,721	)	$	36,662	$	(11,542,550	)	$	(98,675	)

Denominator
Weighted average shares outstanding - basic		4,250,579			4,243,378		4,250,579			4,242,665
Dilutive effect of common stock options and
restricted stock awards		-			-		-			-

Weighted average shares outstanding - diluted		4,250,579			4,243,378		4,250,579			4,242,665

Earnings (loss) per share - basic and diluted
Earnings (loss) per share - basic	$	(2.33	)	$	0.01	$	(2.72	)	$	(0.02	)
Effect of dilutive common stock options		-			-		-			-

Earnings (loss) per share - diluted	$	(2.33	)	$	0.01	$	(2.72	)	$	(0.02	)

Outstanding options and warrants to purchase common stock were considered in the computation of diluted earnings per share for the periods presented. Stock options for 261,530 shares of common stock were not included in computing diluted earnings per share for the three and six months ended June 30, 2012 because their effects were anti-dilutive. Warrants for 499,029 shares of common stock were not included in computing earnings per share in 2012 and 2011 because their effects were also anti-dilutive.

Note 4 – Investment securities available for sale

At June 30, 2012 and December 31, 2011, all of our securities were classified as available-for-sale. The following table presents the composition of our investment portfolio at the dates indicated (dollars in thousands).

					Gross		Gross			Estimated
	Par		Amortized		Unrealized		Unrealized			Fair		Average
	Value		Cost		Gains		Losses			Value		Yield
June 30, 2012

US Government Agencies
More than ten years	$	15,300	$	18,264	$	472	$	-		$	18,736		3.27	%
		15,300		18,264		472		-			18,736		3.27	%
Mortgage-backed securities
One to five years		3		3		-		-			3		0.01	%
More than ten years		11,363		11,961		64		(10	)		12,016		1.51	%
Total		11,366		11,964		64		(10	)		12,019		1.51	%

Municipals
Five to ten years		3,500		4,137		5		-			4,142		2.56	%
More than ten years		1,550		1,784		15		-			1,799		3.52	%
Total		5,050		5,921		20		-			5,941		2.85	%

Total investment securities	$	31,716	$	36,149	$	557	$	(10	)	$	36,696		2.63	%

December 31, 2011

US Government Agencies
More than ten years	$	2,000	$	2,000	$	1	$	-		$	2,001		3.81	%

Mortgage-backed securities
One to five years		11		11		-		-			11		0.01	%
More than ten years		19,870		20,621		220		(49	)		20,792		1.83	%
Total		19,881		20,632		220		(49	)		20,803		1.83	%

Other investments
More than ten years		7,356		7,386		-		(27	)		7,359		0.55	%

Total investment securities	$	29,237	$	30,018	$	221	$	(76	)	$	30,163		1.65	%

Investment securities available for sale that have an unrealized loss position at June 30, 2012 and December 31, 2011 are detailed below (dollars in thousands).

	Securities in a loss					Securities in a loss
	Position for less than					Position for more than
	12 Months					12 Months					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
June 30, 2012	(in Thousands)
Mortgage-backed securities	$	2,331	$	(10	)	$	3	$	-		$	2,334	$	(10	)

Total	$	2,331	$	(10	)	$	3	$	-		$	2,334	$	(10	)

December 31, 2011
US Treasuries	$	7,358	$	(27	)	$	-	$	-		$	7,358	$	(27	)
Mortgage-backed securities		10,221		(47	)		205		(2	)		10,426		(49	)

Total	$	17,579	$	(74	)	$	205	$	(2	)	$	17,784	$	(76	)

Management does not believe that any individual unrealized loss as of June 30, 2012 and December 31, 2011 is other than a temporary impairment. These unrealized losses are primarily attributable to changes in interest rates. As of June 30, 2012, management does not have the intent to sell any of the securities classified as available for sale and management believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.

Note 5 – Loans and allowance for loan losses

The following table presents the composition of our loan portfolio (excluding mortgage loans held for sale) at the dates indicated (dollars in thousands).

	June 30, 2012						December 31, 2011
	Amount			%			Amount			%
Construction and land development
Residential	$	7,442			1.89	%	$	7,906			1.85	%
Commercial		55,828			14.20	%		72,621			16.97	%
Total construction and land development		63,270			16.09	%		80,527			18.82	%
Commercial real estate
Farmland		2,447			0.62	%		2,465			0.58	%
Commercial real estate - owner occupied		100,149			25.48	%		105,592			24.68	%
Commercial real estate - non-owner occupied		55,891			14.22	%		54,059			12.63	%
Multifamily		6,960			1.77	%		6,680			1.56	%
Total commercial real estate		165,447			42.09	%		168,796			39.45	%
Consumer real estate
Home equity lines		28,365			7.22	%		30,687			7.17	%
Secured by 1-4 family residential, secured by first deeds of trust		84,775			21.58	%		93,219			21.79	%
Secured by 1-4 family residential, secured by second deeds of trust		10,095			2.57	%		12,042			2.81	%
Total consumer real estate		123,235			31.37	%		135,948			31.77	%
Commercial and industrial loans (except those secured by real estate)		37,529			9.55	%		37,734			8.82	%
Consumer and other		3,554			0.90	%		4,865			1.14	%

Total Loans		393,035			100.0	%		427,870			100.0	%
Deferred loan cost (unearned income), net		752						768
Less: Allowance for loan losses		(14,866	)					(16,071	)

	$	378,921					$	412,567

The Company assigns risk rating classifications to its loans. These risk ratings are divided into the following groups:

Risk rated 1 to 4 loans are considered of sufficient quality to preclude an adverse rating. 1-4 assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral;

Risk rated 5 loans are defined as having potential weaknesses that deserve management’s close attention;

Risk rated 6 loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any, and;

Risk rated 7 loans have all the weaknesses inherent in substandard loans, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

The following tables provide information on the risk rating of loans at the dates indicated:

	June 30, 2012
	Risk Rated		Risk Rated		Risk Rated		Risk Rated		Total
		1-4		5		6		7	Loans

Construction and land development
Residential	$	6,197,776	$	671,709	$	572,439	$	-	$	7,441,924
Commercial		29,535,994		1,403,600		24,388,336		500,472		55,828,402
Total construction and land development		35,733,770		2,075,309		24,960,775		500,472		63,270,326

Commercial real estate
Farmland		1,397,310				1,049,489		-		2,446,799
Commercial real estate - owner occupied		73,149,268		11,261,166		15,480,900		257,898		100,149,232
Commercial real estate - non-owner occupied		25,607,380		11,142,004		19,141,489		-		55,890,873
Multifamily		4,702,665		1,091,058		1,166,632		-		6,960,355
Total commercial real estate		104,856,623		23,494,228		36,838,510		257,898		165,447,259

Consumer real estate
Home equity lines		22,888,912		2,267,061		3,134,202		75,000		28,365,175
Secured by 1-4 family residential, secured by first deeds of trust		58,547,748		7,258,617		18,968,098		-		84,774,463
Secured by 1-4 family residential, secured by second deeds of trust		8,218,980		419,994		1,456,145		-		10,095,119
Total consumer real estate		89,655,640		9,945,672		23,558,445		75,000		123,234,757

Commercial and industrial loans (except those secured by real estate)		29,206,043		1,732,430		5,740,435		850,305		37,529,213

Consumer and other		3,311,242		182,600		59,953		-		3,553,795

Total Loans	$	262,763,318	$	37,430,239	$	91,158,118	$	1,683,675	$	393,035,350

	December 31, 2011

	Risk Rated		Risk Rated		Risk Rated		Risk Rated		Total
		1-4		5		6		7	Loans

Construction and land development
Residential	$	4,943,061			$	2,963,404	$	-	$	7,906,465
Commercial		44,315,474		-		28,305,063		-		72,620,537
Total construction and land development		49,258,535		-		31,268,467		-		80,527,002

Commercial real estate
Farmland		2,464,981		-		-		-		2,464,981
Commercial real estate - owner occupied		46,958,816		16,352,920		42,280,412		-		105,592,148
Commercial real estate - non-owner occupied		37,581,904		3,036,887		13,440,358		-		54,059,149
Multifamily		5,511,882		-		1,167,446		-		6,679,328
Total commercial real estate		92,517,583		19,389,807		56,888,216		-		168,795,606

Consumer real estate
Home equity lines		26,403,850		1,373,002		2,910,374		-		30,687,226
Secured by 1-4 family residential, secured by first deeds of trust		80,670,887		6,052,128		6,495,783		-		93,218,798
Secured by 1-4 family residential, secured by second deeds of trust		9,960,928		706,484		1,374,651		-		12,042,063
Total consumer real estate		117,035,665		8,131,614		10,780,808		-		135,948,087

Commercial and industrial loans (except those secured by real estate)		31,322,834		4,289,037		2,122,645		-		37,734,516

Consumer and other		3,508,768		384,387		972,350		-		4,865,505

Total Loans	$	293,643,385	$	32,194,845	$	102,032,486	$	-	$	427,870,716

The following table presents the aging of the recorded investment in past due loans and leases as of the dates indicated:

June 30, 2012
													Recorded
					Greater								Investment >
	30-59 Days		60-89 Days		Than		Total Past				Total		90 Days and
	Past Due		Past Due		90 Days		Due		Current		Loans		Accruing


Construction and land development
Residential	$	-	$	-	$	-	$	-	$	7,441,924	$	7,441,924	$	-
Commercial		346,786		509,927		-		856,713		54,971,689		55,828,402		-
Total construction and land development		346,786		509,927		-	$	856,713	$	62,413,613	$	63,270,326		-

Commercial real estate
Farmland		-		-		-		-		2,446,799		2,446,799		-
Commercial real estate - owner occupied		2,873,063		341,526		-		3,214,589		96,934,643		100,149,232		-
Commercial real estate - non-owner occupied		543,138		2,772,366		-		3,315,504		52,575,369		55,890,873		-
Multifamily		-		-		-		-		6,960,355		6,960,355		-
Total commercial real estate		3,416,201		3,113,892		-		6,530,093		158,917,166		165,447,259		-

Consumer real estate
Home equity lines		516,932		427,843		-		944,775		27,420,400		28,365,175		-
Secured by 1-4 family residential, secured by first deeds of trust		1,273,713		600,391		199,380		2,073,484		82,700,979		84,774,463		199,380
Secured by 1-4 family residential, secured by second deeds of trust		-		125,506		-		125,506		9,969,613		10,095,119		-
Total consumer real estate		1,790,645		1,153,740		199,380		3,143,765		120,090,992		123,234,757		199,380

Commercial and industrial loans (except those secured by real estate)		3,202,797		-		-		3,202,797		34,326,416		37,529,213		-

Consumer and other		57,795		6,018		-		63,813		3,489,982		3,553,795		-

Total Loans	$	8,814,224	$	4,783,577	$	199,380	$	13,797,181	$	379,238,169	$	393,035,350	$	199,380

December 31, 2011
													Recorded
					Greater								Investment >
	30-59 Days		60-89 Days		Than		Total Past				Total		90 Days and
	Past Due		Past Due		90 Days		Due		Current		Loans		Accruing


Construction and land development:
Residential	$	575,200	$	251,799	$	-	$	826,999	$	7,079,466	$	7,906,465	$	-
Commercial		1,367,360		408,000		36,770		1,812,130		70,808,407		72,620,537		36,770
Total construction and land development		1,942,560		659,799		36,770	$	2,639,129	$	77,887,873	$	80,527,002		36,770

Commercial real estate:
Farmland		-		-		-		-		2,464,981		2,464,981		-
Commercial real estate - owner occupied		598,006		36,972		-		634,978		104,957,170		105,592,148		-
Commercial real estate - non-owner occupied		55,709		673,561		-		729,270		53,329,879		54,059,149		-
Multifamily		111,571		255,196		-		366,767		6,312,561		6,679,328		-
Total commercial real estate		765,286		965,729		-		1,731,015		167,064,591		168,795,606		-

Consumer real estate:
Home equity lines		323,349		99,494		299,783		722,626		29,964,600		30,687,226		299,783
Secured by 1-4 family residential, secured by first deeds of trust		985,116		1,572,973		624,740		3,182,829		90,035,969		93,218,798		624,740
Secured by 1-4 family residential, secured by second deeds of trust		12,673		132,928		156,026		301,627		11,740,436		12,042,063		156,026
Total consumer real estate		1,321,138		1,805,395		1,080,549		4,207,082		131,741,005		135,948,087		1,080,549

Commercial and industrial loans (except those secured by real estate)		46,392		3,313		54,918		104,623		37,629,893		37,734,516		54,918

Consumer and other		59,697		3,176		-		62,873		4,802,632		4,865,505		-

Total Loans	$	4,135,073	$	3,437,412	$	1,172,237	$	8,744,722	$	419,125,994	$	427,870,716	$	1,172,237

management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired then a specific reserve is established for the amount of impairment. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible. June 30, 2012 and year-end impaired loans are set forth in the following table.

	June 30, 2012
			Unpaid
	Recorded		Principal		Related
	Investment		Balance		Allowance

With no related allowance recorded

Construction and land development
Residential	$	489,503	$	978,503	$	-
Commercial		15,051,292		19,436,447		-
Total construction and land development		15,540,795		20,414,950		-
Commercial real estate
Farmland		1,049,489		1,049,489		-
Commercial real estate - owner occupied		6,872,799		6,903,383		-
Commercial real estate - non-owner occupied		8,374,527		8,549,256		-
Multifamily		941,632		941,632		-
Total commercial real estate		17,238,447		17,443,760		-
Consumer real estate
Home equity lines		1,725,387		1,887,187		-
Secured by 1-4 family residential, secured by first deeds of trust		10,988,639		13,033,493		-
Secured by 1-4 family residential, secured by second deeds of trust		836,754		1,012,754		-
Total consumer real estate		13,550,780		15,933,434		-
Commercial and industrial loans (except those secured by real estate)		1,071,027		1,789,527		-
Consumer and other		36,987		36,987		-
	$	47,438,036	$	55,618,658	$	-

With an allowance recorded

Construction and land development:
Residential	$	-	$	-	$	-
Commercial		6,509,162		8,711,930		1,133,647
Total construction and land development		6,509,162		8,711,930		1,133,647
Commercial real estate:
Farmland		-		-		-
Commercial real estate - owner occupied		7,020,688		7,277,790		1,852,684
Commercial real estate - non-owner occupied		5,008,676		5,008,676		1,338,605
Multifamily		-		-		-
Total commercial real estate		12,029,364		12,286,466		3,191,289
Consumer real estate:
Home equity lines		418,936		467,220		154,665
Secured by 1-4 family residential, secured by first deeds of trust		4,426,370		4,598,717		719,908
Secured by 1-4 family residential, secured by second deeds of trust		117,322		117,322		105,997
Total consumer real estate		4,962,628		5,183,259		980,570
Commercial and industrial loans (except those secured by real estate)		1,515,187		1,852,776		831,471
Consumer and other		-		-		-
	$	25,016,341	$	28,034,431	$	6,136,977

Total
Construction and land development
Residential	$	489,503	$	978,503	$	-
Commercial		21,560,454		28,148,377		1,133,647
Total construction and land development		22,049,957		29,126,880		1,133,647
Commercial real estate
Farmland		1,049,489		1,049,489		-
Commercial real estate - owner occupied		13,893,487		14,181,173		1,852,684
Commercial real estate - non-owner occupied		13,383,203		13,557,932		1,338,605
Multifamily		941,632		941,632		-
Total commercial real estate		29,267,811		29,730,226		3,191,289
Consumer real estate
Home equity lines		2,144,323		2,354,407		154,665
Secured by 1-4 family residential, secured by first deeds of trust		15,415,009		17,632,210		719,908
Secured by 1-4 family residential, secured by second deeds of trust		954,076		1,130,076		105,997
Total consumer real estate		18,513,408		21,116,693		980,570
Commercial and industrial loans (except those secured by real estate)		2,586,214		3,642,303		831,471
Consumer and other		36,987		36,987		-
	$	72,454,377	$	83,653,089	$	6,136,977

	December 31, 2011
			Unpaid
	Recorded		Principal		Related
	Investment		Balance		Allowance

With no related allowance recorded

Construction and land development
Residential	$	624,651	$	712,243	$	-
Commercial		9,722,132		11,094,408		-
Total construction and land development		10,346,783		11,806,651		-
Commercial real estate
Farmland		-		-		-
Commercial real estate - owner occupied		6,414,362		6,414,362		-
Commercial real estate - non-owner occupied		7,146,531		7,146,531		-
Multifamily		2,019,675		2,019,675		-
Total commercial real estate		15,580,568		15,580,568		-
Consumer real estate
Home equity lines		702,338		702,338		-
Secured by 1-4 family residential, secured by first deeds of trust		6,319,837		6,792,837		-
Secured by 1-4 family residential, secured by second deeds of trust		336,257		336,257		-
Total consumer real estate		7,358,432		7,831,432		-
Commercial and industrial loans (except those secured by real estate)		1,194,913		1,494,913		-
Consumer and other		143,241		143,241		-
	$	34,623,937	$	36,856,805	$	-

With an allowance recorded

Construction and land development
Residential	$	587,235	$	587,235	$	320,250
Commercial		14,885,541		15,785,541		3,913,820
Total construction and land development		15,472,776		16,372,776		4,234,070
Commercial real estate
Farmland		-		-		-
Commercial real estate - owner occupied		9,508,393		9,652,393		2,031,740
Commercial real estate - non-owner occupied		1,719,690		1,719,690		450,000
Multifamily		-		-		-
Total commercial real estate		11,228,083		11,372,083		2,481,740
Consumer real estate
Home equity lines		756,892		756,892		233,606
Secured by 1-4 family residential, secured by first deeds of trust		4,224,325		4,749,325		1,007,155
Secured by 1-4 family residential, secured by second deeds of trust		167,523		167,523		119,524
Total consumer real estate		5,148,740		5,673,740		1,360,285
Commercial and industrial loans (except those secured by real estate)		818,597		818,597		452,773
Consumer and other		267,166		267,166		266,178
	$	32,935,362	$	34,504,362	$	8,795,046

Total
Construction and land development
Residential	$	1,211,886	$	1,299,478	$	320,250
Commercial		24,607,673		26,879,949		3,913,820
Total construction and land development		25,819,559		28,179,427		4,234,070
Commercial real estate
Farmland		-		-		-
Commercial real estate - owner occupied		15,922,755		16,066,755		2,031,740
Commercial real estate - non-owner occupied		8,866,221		8,866,221		450,000
Multifamily		2,019,675		2,019,675		-
Total commercial real estate		26,808,651		26,952,651		2,481,740
Consumer real estate
Home equity lines		1,459,230		1,459,230		233,606
Secured by 1-4 family residential, secured by first deeds of trust		10,544,162		11,542,162		1,007,155
Secured by 1-4 family residential, secured by second deeds of trust		503,780		503,780		119,524
Total consumer real estate		12,507,172		13,505,172		1,360,285
Commercial and industrial loans (except those secured by real estate)		2,013,510		2,313,510		452,773
Consumer and other		410,407		410,407		266,178
	$	67,559,299	$	71,361,167	$	8,795,046

The following is a summary of average recorded investment in impaired loans with and without

a valuation allowance and interest income recognized on those loans for the three and six months ended June 30, 2012.

	For the Three Months				For the Six Months
	Ended June 30, 2012				Ended June 30, 2012

	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized

Impaired loans with no related allowance recorded

Construction and land development
Residential	$	1,301,243	$	7,401	$	978,503	$	11,741
Commercial		17,785,898		55,716		21,838,440		181,033
Total construction and land development		19,087,141		63,117		22,816,943		192,774
Commercial real estate
Farmland		524,745		15,405		1,049,489		15,405
Commercial real estate - owner occupied		9,571,973		73,330		9,609,792		225,959
Commercial real estate - non-owner occupied		8,599,009		110,449		9,118,068		240,093
Multifamily		777,933		27,298		942,216		27,298
Total commercial real estate		19,473,659		226,482		20,719,565		508,755
Consumer real estate
Home equity lines		1,639,963		27,955		1,887,350		32,979
Secured by 1-4 family residential, secured by first deeds of trust		11,593,774		125,304		13,101,708		230,755
Secured by 1-4 family residential, secured by second deeds of trust		754,922		10,430		1,021,578		18,112
Total consumer real estate		13,988,659		163,689		16,010,636		281,846
Commercial and industrial loans (except those secured by real estate)		1,524,274		13,297		1,792,752		21,909
Consumer and other		199,919		445		38,578		1,093
	$	54,273,651	$	467,030	$	61,378,474	$	1,006,377

Impaired loans with an allowance recorded

Construction and land development:
Residential	$	-	$	-	$	-	$	-
Commercial		5,092,484		9,016		9,656,982		9,016
Total construction and land development		5,092,484		9,016		9,656,982		9,016
Commercial real estate:
Farmland
Commercial real estate - owner occupied		6,864,617		31,174		7,438,497		46,386
Commercial real estate - non-owner occupied		3,406,420		21,158		5,043,459		35,586
Multifamily		-		-		-		-
Total commercial real estate		10,271,037		52,332		12,481,956		81,972
Consumer real estate:
Home equity lines		434,976		3,995		472,476		4,151
Secured by 1-4 family residential, secured by first deeds of trust		3,555,198		27,332		4,656,755		44,009
Secured by 1-4 family residential, secured by second deeds of trust		58,710		508		117,420		1,684
Total consumer real estate		4,048,884		31,835		5,246,651		49,844
Commercial and industrial loans (except those secured by real estate)		1,873,540		25,072		1,873,540		32,588
Consumer and other		-		-		-		-
	$	21,285,944	$	118,255	$	29,259,129	$	173,420

Total
Construction and land development
Residential	$	1,301,243	$	7,401	$	978,503	$	11,741
Commercial		22,878,382		64,732		31,495,422		190,049
Total construction and land development		24,179,624		72,133		32,473,925		201,790
Commercial real estate
Farmland		524,745		15,405		1,049,489		15,405
Commercial real estate - owner occupied		16,436,590		104,504		17,048,289		272,345
Commercial real estate - non-owner occupied		12,005,429		131,607		14,161,527		275,679
Multifamily		777,933		27,298		942,216		27,298
Total commercial real estate		29,744,696		278,814		33,201,521		590,727
Consumer real estate
Home equity lines		2,074,939		31,950		2,359,826		37,130
Secured by 1-4 family residential, secured by first deeds of trust		15,148,972		152,636		17,758,463		274,764
Secured by 1-4 family residential, secured by second deeds of trust		813,632		10,938		1,138,998		19,796
Total consumer real estate		18,037,542		195,524		21,257,287		331,690
Commercial and industrial loans (except those secured by real estate)		3,397,814		38,369		3,666,292		54,497
Consumer and other		199,919		445		38,578		1,093
	$	75,559,595	$	585,285	$	90,637,603	$	1,179,797

Included in impaired loans are loans classified as troubled debt restructurings (TDRs). A

modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrowers financial difficulties that it would not otherwise consider. For loans classified as impaired TDRs, the Company further evaluates the loans as performing or nonperforming. If, at the time of restructure, the loan is not considered nonaccrual, it will be classified as performing. TDRs originally classified as nonperforming are able to be reclassified as performing if, subsequent to restructure, they experience six months of payment performance according to the restricted terms. The following table provides certain information concerning TDRs as of June 30, 2012.

	Three Months Ended June 30, 2012
							Specific
							Valuation
	Total		Performing		Nonaccrual		Allowance

Construction and land development:
Commercial	$	625,764		-	$	625,764		-
Total construction and land development		625,764		-		625,764		-
Commercial real estate:
Commercial real estate - owner occupied		1,398,661		-		1,398,661		196,000
Commercial real estate - non-owner occupied		2,626,306		-		2,626,306		663,570
Total commercial real estate		4,024,967		-		4,024,967		859,570
Consumer real estate:
Secured by 1-4 family residential, secured by first deeds of trust		416,598		-		416,598		50,713
Total consumer real estate		416,598		-		416,598		50,713
	$	5,067,329	$	-	$	5,067,329	$	910,283

	Six Months Ended June 30, 2012
							Specific
							Valuation
	Total		Performing		Nonaccrual		Allowance

Construction and land development:
Residential	$	360,343	$	-	$	360,343	$	-
Commercial		14,540,256		3,785,942		10,754,314		996,602
Total construction and land development		14,900,599		3,785,942		11,114,657		996,602
Commercial real estate:
Farmland		-		-		-		-
Commercial real estate - owner occupied		10,580,554		537,029		10,043,525		1,025,656
Commercial real estate - non-owner occupied		9,068,618		4,475,603		4,593,015		753,170
Multifamily		575,679		575,679		-		-
Total commercial real estate		20,224,851		5,588,311		14,636,540		1,778,826
Consumer real estate:
Home equity lines		349,192		-		349,192		96,569
Secured by 1-4 family residential, secured by first deeds of trust		6,614,202		1,478,043		5,136,159		579,444
Secured by 1-4 family residential, secured by second deeds of trust		69,815		-		69,815		-
Total consumer real estate		7,033,209		1,478,043		5,555,166		676,013
Commercial and industrial loans (except those secured by real estate)		269,659		6,552		263,107		83,400
Consumer and other		-		-		-		-
	$	42,428,318	$	10,858,848	$	31,569,470	$	3,534,841

The following table provides information about TDRs identified during the current period:

	Three Months Ended
	June 30, 2012
			Pre-		Post-
			Modification		Modification
	Number of		Recorded		Recorded
	Loans		Balance		Balance

Construction and land development:
Residential		-	$	-	$	-
Commercial		4		625,764		625,764
Total construction and land development		4		625,764		625,764
Commercial real estate:
Farmland				-		-
Commercial real estate - owner occupied		1		1,398,661		1,398,661
Commercial real estate - non-owner occupied		1		2,626,306		2,626,306
Multifamily		-		-		-
Total commercial real estate		2		4,024,967		4,024,967
Consumer real estate:
Home equity lines		-		-		-
Secured by 1-4 family residential, secured by first deeds of trust		2		416,598		416,598
Secured by 1-4 family residential, secured by second deeds of trust		-		-		-
Total consumer real estate		2		416,598		416,598
Commercial and industrial loans (except those secured by real estate)		-		-		-
Consumer and other		-		-		-
		8		5,067,329		5,067,329

There were no loans in default for the three month period ended June 30, 2012.

	Six Months Ended						Year Ended
	June 30, 2012						December 31, 2011
			Pre-		Post-				Pre-		Post-
			Modification		Modification				Modification		Modification
	Number of		Recorded		Recorded		Number of		Recorded		Recorded
	Loans		Balance		Balance		Loans		Balance		Balance

Construction and land development:
Residential		5	$	360,343	$	360,343			$	-	$	-
Commercial		17		4,890,578		4,890,578		11		6,604,400		6,604,400
Total construction and land development		22		5,250,921		5,250,921		11	$	6,604,400		6,604,400
Commercial real estate:												-
Farmland				-		-						-
Commercial real estate - owner occupied				-		-		9		9,748,062		9,748,062
Commercial real estate - non-owner occupied		3		5,185,649		5,185,649		5		4,031,868		4,031,868
Multifamily		-		-		-				-		-
Total commercial real estate		3		5,185,649		5,185,649		14		13,779,930		13,779,930
Consumer real estate:
Home equity lines		1		349,192		349,192				-		-
Secured by 1-4 family residential, secured by first deeds of trust		36		3,578,561		3,578,561		2		1,422,772		1,422,772
Secured by 1-4 family residential, secured by second deeds of trust		1		69,815		69,815				-		-
Total consumer real estate		38		3,997,568		3,997,568		2		1,422,772		1,422,772
Commercial and industrial loans (except those secured by real estate)		6		269,659		269,659		3		159,073		159,073
Consumer and other		-		-		-		1		128,419		128,419
		69	$	14,703,797	$	14,703,797		31	$	21,966,175	$	21,966,175

	Six Months Ended						Year Ended
	June 30, 2012						December 31, 2011
	Number of		Recorded				Number of		Recorded
Defaults on TDRs	Loans		Balance				Loans		Balance
Construction and land development:
Residential		4		357,843
Commercial		18		6,295,206				8		11,389,291
Total construction and land development		22		6,653,049				8		11,389,291
Commercial real estate:
Farmland		-		-
Commercial real estate - owner occupied		3		537,029				2		2,202,688
Commercial real estate - non-owner occupied		1		1,200,035						-
Multifamily		4		1,737,064				2		2,202,688
Total commercial real estate
Consumer real estate:
Home equity lines		1		343,937
Secured by 1-4 family residential, secured by first deeds of trust		31		3,910,895				2		1,422,772
Secured by 1-4 family residential, secured by second deeds of trust		1		69,815						-
Total consumer real estate		33		4,324,647				2		1,422,772
Commercial and industrial loans (except those secured by real estate)		5		263,107				2		151,790
Consumer and other		-		-				1		128,419
Total		64	$	12,977,867				15	$	15,294,960

Activity in the allowance for loan losses is as follows for the periods indicated:

	Construction and			Construction and						Commercial			Commercial
	land development			land development						Real estate			Real estate
	Residential			Commercial			Farmland			owner occupied			non-owner occupied			Multifamily
Six months ended June 30, 2012
Beginning balance	$	704,728		$	6,798,177		$	-		$	1,496,466		$	1,548,899		$	406,635
Provision for loan losses		688,712			1,536,857			-			1,333,927			164,343			(313,907	)
Charge-offs		(794,786	)		(3,773,205	)		-			(309,486	)		(313,354	)		-
Recoveries		900			500			-			-			205			-
Ending balance		599,554			4,562,330			-			2,520,907			1,400,093			92,728

Loans Individually Evaluated for Impairment		2,244,282			37,911,902			1,397,461			71,103,069			43,283,999			5,068,253
Loans collectively Evaluated for Impairment		5,197,642			17,916,500			1,049,338			29,046,163			12,606,874			1,892,102
	$	7,441,924		$	55,828,402		$	2,446,799		$	100,149,232		$	55,890,873		$	6,960,355

				Consumer Secured			Consumer Secured			Commercial and
	Consumer			by 1-4 family residential			by 1-4 family residential			Industrial (except those
	Home equity lines			first deeds of trust			second deeds of trust			secured by real estate)			consumer and other			Total

Beginning balance	$	860,307		$	1,881,470		$	397,504		$	1,655,713		$	321,525		$	16,071,424
Provision for loan losses		206,929			2,666,051			170,024			1,710,826			231,238			8,395,000
Charge-offs		(291,820	)		(2,589,378	)		(196,609	)		(1,155,782	)		(402,305	)		(9,826,725	)
Recoveries		1,317			80,804			4,633			134,488			3,175			226,023
Ending balance		776,732			2,038,947			375,552			2,345,245			153,633			14,865,722

Loans Individually Evaluated for Impairment		1,416,634			14,559,314			565,686			16,350,363			-			193,900,963
Loans collectively Evaluated for Impairment		26,948,541			70,215,149			9,529,433			21,178,850			3,553,795			199,134,387
	$	28,365,175		$	84,774,463		$	10,095,119		$	37,529,213		$	3,553,795		$	393,035,350


	Construction and			Construction and						Commercial			Commercial
	land development			land development						Real estate			Real estate
	Residential			Commercial			Farmland			owner occupied			non-owner occupied			Multifamily
Three months ended June 30, 2012
Beginning balance	$	629,376		$	6,279,552		$	-		$	1,846,730		$	762,385		$	91,775
Provision for loan losses		705,264			508,282			-			954,663			860,313			953
Charge-offs		(735,536	)		(2,226,005	)		-			(280,486	)		(222,605	)		-
Recoveries		450			500			-			-			-			-
Ending balance		599,554			4,562,330			-			2,520,907			1,400,093			92,728

Loans Individually Evaluated for Impairment		2,244,282			37,911,902			1,397,461			71,103,069			43,283,999			5,068,253
Loans collectively Evaluated for Impairment		5,197,642			17,916,500			1,049,338			29,046,163			12,606,874			1,892,102
	$	7,441,924		$	55,828,402		$	2,446,799		$	100,149,232		$	55,890,873		$	6,960,355

				Consumer Secured			Consumer Secured			Commercial and
	Consumer			by 1-4 family residential			by 1-4 family residential			Industrial (except those
	Home equity lines			first deeds of trust			second deeds of trust			secured by real estate)			consumer and other			Total

Beginning balance	$	770,598		$	1,341,501		$	335,352		$	2,181,803		$	122,881		$	14,361,953
Provision for loan losses		174,830			2,301,071			41,730			951,701			161,192			6,660,000
Charge-offs		(169,321	)		(1,623,629	)		(5,970	)		(895,380	)		(132,510	)		(6,291,441	)
Recoveries		625			20,004			4,440			107,121			2,070			135,210
Ending balance		776,732			2,038,947			375,552			2,345,245			153,633			14,865,721

Loans Individually Evaluated for Impairment		1,416,634			14,559,314			565,686			16,350,363			-			193,900,963
Loans collectively Evaluated for Impairment		26,948,541			70,215,149			9,529,433			21,178,850			3,553,795			199,134,387
	$	28,365,175		$	84,774,463		$	10,095,119		$	37,529,213		$	3,553,795		$	393,035,350

	Construction and			Construction and					Commercial			Commercial
	land development			land development					Real estate			Real estate
	Residential			Commercial		Farmland			owner occupied			non-owner occupied			Multifamily
Three months ended June 30, 2011
Beginning balance	$	629,376		$	2,340,000	$	-		$	150,000		$	26,174		$	(82,501	)
Provision for loan losses		(143,333	)		792,119		-			(71,555	)		-			-
Charge-offs		-			-		-			-			-			-
Recoveries		-			10,000		-			-			-			-
Ending balance		493,841			3,142,119		-			78,445			26,174			(82,501	)

Loans Individually Evaluated for Impairment		3,841,792			31,093,945		-			90,826,298			50,843,899			7,559,912
Loans collectively Evaluated for Impairment		5,516,724			44,650,193		2,174,778			10,486,423			5,870,224			872,835
	$	9,358,516		$	75,744,138	$	2,174,778		$	101,312,721		$	56,714,123		$	8,432,747

				Consumer Secured		Consumer Secured			Commercial and
	Consumer			by 1-4 family residential		by 1-4 family residential			Industrial (except those
	Home equity lines			first deeds of trust		second deeds of trust			secured by real estate)			consumer and other			Total

Beginning balance		770,598			1,703,207		500,000			1,046,967			350,462			7,434,283
Provision for loan losses		321,998			-		-			-			771			900,000
Charge-offs		(923,824	)		-		(35,152	)		(119,019	)		(10,661	)		(1,088,656	)
Recoveries		725			-		-			-			262			10,987
Ending balance		169,497			1,703,207		462,249			927,948			335,635			7,256,614

Loans Individually Evaluated for Impairment		4,150,919			11,490,868		1,559,932			15,964,672			2,116,151		$	219,448,388
Loans collectively Evaluated for Impairment		30,746,189			85,113,770		11,554,541			23,955,772			2,619,519			223,560,968
	$	34,897,108		$	96,604,638	$	13,114,473		$	39,920,444		$	4,735,670		$	443,009,356


	Construction and			Construction and					Commercial			Commercial
	land development			land development					Real estate			Real estate
	Residential			Commercial		Farmland			owner occupied			non-owner occupied			Multifamily
Six months ended June 30, 2011
Beginning balance	$	293,841		$	2,832,119	$	-		$	78,445		$	20,477		$	-
Provision for loan losses		200,000			300,000		-			-			250,000			-
Charge-offs		-					-			-			(244,303	)		(82,501	)
Recoveries		-			10,000		-			-			-			-
Ending balance		493,841			3,142,119		-			78,445			26,174			(82,501	)

Loans Individually Evaluated for Impairment		3,841,792			31,093,945		-			90,826,298			50,843,899			7,559,912
Loans collectively Evaluated for Impairment		5,516,724			44,650,193		2,174,778			10,486,423			5,870,224			872,835
	$	9,358,516		$	75,744,138	$	2,174,778		$	101,312,721		$	56,714,123		$	8,432,747

				Consumer Secured		Consumer Secured			Commercial and
	Consumer			by 1-4 family residential		by 1-4 family residential			Industrial (except those
	Home equity lines			first deeds of trust		second deeds of trust			secured by real estate)			consumer and other			Total

Beginning balance	$	641,975		$	1,403,207	$	297,401		$	1,315,582		$	428,665		$	7,311,712
Provision for loan losses		450,000			300,000		200,000			203,000			-		$	1,903,000
Charge-offs		(923,824	)		-		(35,152	)		(592,634	)		(93,472	)		(1,971,886	)
Recoveries		1,346			-		-			2,000			442			13,788
Ending balance		169,497			1,703,207		462,249			927,948			335,635			7,256,614

Loans Individually Evaluated for Impairment		4,150,919			11,490,868		1,559,932			15,964,672			2,116,151		$	219,448,388
Loans collectively Evaluated for Impairment		30,746,189			85,113,770		11,554,541			23,955,772			2,619,519			223,560,968
	$	34,897,108		$	96,604,638	$	13,114,473		$	39,920,444		$	4,735,670		$	443,009,356


	Construction and			Construction and						Commercial			Commercial
	land development			land development						Real estate			Real estate
	Residential			Commercial			Farmland			owner occupied			non-owner occupied			Multifamily
Year ended December 31, 2011
Beginning balance	$	293,841		$	2,832,119		$	-		$	78,445		$	20,477		$	-
Provision for loan losses		467,187			8,249,320			-			1,568,052			1,871,804			489,136
Charge-offs		(65,500	)		(4,293,262	)		-			(150,031	)		(343,382	)		(82,501	)
Recoveries		9,200			10,000			-			-			-			-
Ending balance		704,728			6,798,177			-			1,496,466			1,548,899			406,635

Loans Individually Evaluated for Impairment		1,831,478			30,292,460			-			91,008,321			45,529,918			5,625,490
Loans collectively Evaluated for Impairment		6,074,987			42,328,077			2,464,981			14,583,827			8,529,231			1,053,838
	$	7,906,465		$	72,620,537		$	2,464,981		$	105,592,148		$	54,059,149		$	6,679,328

				Consumer Secured			Consumer Secured			Commercial and
	Consumer			by 1-4 family residential			by 1-4 family residential			Industrial (except those
	Home equity lines			first deeds of trust			second deeds of trust			secured by real estate)			consumer and other			Total

Beginning balance	$	641,975		$	1,403,207		$	297,401		$	1,315,582		$	428,665		$	7,311,712
Provision for loan losses		1,447,272			1,571,813			462,634			2,496,729			140,349			18,764,296
Charge-offs		(1,232,153	)		(1,129,509	)		(362,531	)		(2,159,669	)		(249,526	)		(10,068,063	)
Recoveries		3,213			35,959			-			3,070			2,037			63,479
Ending balance		860,307			1,881,470			397,504			1,655,713			321,525			16,071,424

Loans Individually Evaluated for Impairment		4,314,190			13,105,245			1,692,944			14,343,224			3,501,524			211,244,794
Loans collectively Evaluated for Impairment		26,373,036			80,113,553			10,349,119			23,391,292			1,363,981			216,625,922
	$	30,687,226		$	93,218,798		$	12,042,063		$	37,734,516		$	4,865,505		$	427,870,716

Note 6 – Deposits

Deposits as of June 30, 2012 and December 31, 2011 were as follows:

	June 30, 2012					December 31, 2011
	Amount		%			Amount		%

Noninterest bearing demand	$	64,348,408		14.29	%	$	66,534,956		13.70	%
Interest checking accounts		43,542,588		9.67	%		40,237,146		8.29	%
Money market accounts		65,933,468		14.64	%		75,487,907		15.55	%
Savings accounts		18,688,852		4.15	%		15,166,012		3.12	%
Time deposits of $100,000 and over		117,110,398		26.00	%		129,436,270		26.66	%
Other time deposits		140,796,194		31.25	%		158,658,761		32.68	%

Total	$	450,419,908		100.00	%	$	485,521,052		100.00	%

Note 7 – Trust preferred securities

During the first quarter of 2005, Southern Community Financial Capital Trust I, a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable securities. On February 24, 2005, $5.2 million of Trust Preferred Capital Notes were issued through a pooled underwriting. The securities have a LIBOR-indexed floating rate of interest (three-month LIBOR plus 2.15%) which adjusts, and is payable, quarterly. The interest rate at June 30, 2012 was 2.62%. The securities were redeemable at par beginning on March 15, 2010 and each quarter after such date until the securities mature on March 15, 2035. No amounts have been redeemed at June 30, 2012 and there are no plans to do so. The principal asset of the Trust is $5.2 million of the Company’s junior subordinated debt securities with like maturities and like interest rates to the Trust Preferred Capital Notes.

During the third quarter of 2007, Village Financial Statutory Trust II, a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable securities. On September 20, 2007, $3.6 million of Trust Preferred Capital Notes were issued through a pooled underwriting. The securities have a five year fixed interest rate of 6.29% payable quarterly, converting after five years to a LIBOR-indexed floating rate of interest (three-month LIBOR plus 1.40%) which adjusts, and is also payable, quarterly. The securities may be redeemed at par at any time commencing in December 2012 until the securities mature in 2037. The principal asset of the Trust is $3.6 million of the Company’s junior subordinated debt securities with like maturities and like interest rates to the Trust Preferred Capital Notes.

The Trust Preferred Capital Notes may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion. The portion of the Trust Preferred Capital Notes not considered as Tier 1 capital may be included in Tier 2 capital.

The obligations of the Company with respect to the issuance of the Trust Preferred Capital Notes constitute a full and unconditional guarantee by the Company of the Trust’s obligations with respect to the Trust Preferred Capital Notes. Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on the junior subordinated debt securities, which would result in a deferral of distribution payments on the related Trust Preferred Capital Notes and require a deferral of common dividends. In consideration of our agreements with our regulators, which require regulatory approval to make interest payments on these securities, the Company has deferred interest payments on the junior subordinated debt securities of $461,100 at June 30, 2012; the Company has been deferring interest payments since June 2011. Although we elected to defer payment of the interest due, the amount has been accrued and is included in interest expense.

Note 8 – Stock incentive plan

The Company has a stock incentive plan which authorizes the issuance of up to 455,000 shares of common stock to assist the Company in recruiting and retaining key personnel.

The following table summarizes stock options outstanding under the stock incentive plan at the indicated dates:

	Six Months Ended June 30,
	2012								2011
				Weighted							Weighted
				Average							Average
				Exercise		Fair Value		Intrinsic			Exercise		Fair Value		Intrinsic
	Options			Price		Per Share		Value	Options		Price		Per Share		Value

Options outstanding,
beginning of period		264,980		$	9.48	$	4.70			310,205	$	9.48	$	4.73
Granted		-			-		-			-		-		-
Forfeited		(3,450	)		4.98		3.12			-		-		-
Exercised		-			-		-			-		-		-
Options outstanding,
end of period		261,530		$	9.71	$	4.73	$ -		310,205	$	9.48	$	4.73	$ -
Options exercisable,
end of period		261,530								291,350

During the first quarter of 2009, we granted to certain officers 26,592 restricted shares of common stock with a weighted average fair market value of $4.60 at the date of grant. These restricted stock awards have three-year graded vesting. Prior to vesting, these shares are subject to forfeiture to us without consideration upon termination of employment under certain circumstances. The total number of shares underlying non-vested restricted stock and performance share awards was 6,271 and 14,881 at June 30, 2012 and 2011, respectively.

The fair value of the stock is calculated under the same methodology as stock options and the expense is recognized over the vesting period. Unamortized stock-based compensation related to nonvested share based compensation arrangements granted under the Incentive Plan as of June 30, 2012 and 2011 was $1,666 and $65,556 respectively. The time based unamortized compensation of $1,666 is expected to be recognized over a weighted average period of 0.25 years.

Stock-based compensation expense was $5,511 and $59,223 for the six months ended June 30, 2012 and 2011, respectively.

Note 9 — Fair value

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transaction involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are independent, knowledgeable, able to transact and willing to transact.

FASB Codification Topic 820: Fair Value Measurements and Disclosures establishes a hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair values hierarch is as follows:

Level 1 Inputs — Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 Inputs — Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 Inputs- Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods to determine the fair value of each type of financial instrument:

Securities: Fair values for securities available-for-sale are obtained from an independent pricing service. The prices are not adjusted. The independent pricing service uses industry-standard models to price U.S. Government agency obligations and mortgage backed securities that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating. Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace (Levels 1 and 2).

Impaired loans: The fair values of impaired loans are measured for impairment using the fair value of the collateral for collateral-dependent loans on a nonrecurring basis. Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable. The vast majority of the Company’s collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than two years old, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal if deemed significant using observable market data. Likewise, values for inventory and account receivables collateral are based on financial statement balances or aging reports (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Real Estate Owned: Real estate owned assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, real estate owned assets are carried at net realizable value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring level 3.

Assets and liabilities measured at fair value under Topic 820 on a recurring and non-recurring basis are summarized below for the indicated dates:

	Fair Value Measurement
	at June 30, 2012 Using
	(In thousands)
			Quoted Prices
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets - Recurring
US Government Agencies	$	18,736	$	-	$	18,736	$	-
MBS		12,019		-		12,019		-
Municipals		5,941		4,816		1,125		-
Residential loans held for sale		17,192		-		17,192		-
						-
Financial Assets - Non-Recurring
Impaired loans		72,454		-		57,754		14,700
Real estate owned		17,677		-		11,212		6,465


	Fair Value Measurement
	at December 31, 2011 Using
	(in thousands)
			Quoted Prices
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets - Recurring
US Government Agencies	$	2,001	$	-	$	2,001	$	-
MBS		20,803		2,849		17,954		-
Small Business Administration		7,359		7,359		-		-
Residential loans held for sale		16,168		-		16,168		-

Financial Assets - Non-Recurring
Impaired loans		64,655		-		51,868		12,787
Real estate owned		9,177		-		874		8,303

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value at June 30, 2012:

					Range
	Fair Value		Valuation	Unobservable	(Weighted
	Estimate		Techniques	Input	Average)
	(In thousands)

Impaired Loans -Real Estate Secured		11,035	Appraisal (1) or Internal Valuation (2)	Appraisal Adjustments Liquidation Expenses (3)		10%-30	%
Impaired Loans - Non-Real Estate Secured		3,665	Appraisal (1) or Discounted Cash Flow	Appraisal Adjustments Liquidation Expenses (3)		10%-20	%
Real Estate Owned		6,465	Appraisal (1) or Internal Valuation (2)	Appraisal Adjustments Liquidation Expenses (3)		7%-30	%

(1) Fair Value is generally determined through independent appraisals of the underlying collateral, which generally
included various level 3 inputs which are not identifiable
(2) Internal valuations may be conducted to determine Fair Value for assets with nominal carrying balances
(3) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated
liquidation expenses

The following table presents the changes in the Level 3 fair value category for the six months ended June 30, 2012.

	Impaired		Real Estate
	Loans		Owned			Total Assets
	(In thousands)

Balance at December 31, 2011	$	12,787	$	8,030		$	20,817
Total realized and unrealized gains (losses)
Included in earnings		-		(43	)		(43	)
Included in other comprehensive income		-		-			-
Net transfers in and/or out of Level 3		1,913		(1,522	)		391

Balance at June 30, 2012	$	14,700	$	6,465		$	21,165

In general, fair value of securities is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon market prices determined by an outside, independent entity that primarily uses as inputs, observable market-based parameters. Fair value of loans held for sale is based upon internally developed models that primarily use as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly and or quarter valuation process.

Cash and cash equivalents – The carrying amount of cash and cash equivalents approximates fair value.

Investment securities – The fair value of investment securities available-for-sale is estimated based on bid quotations received from independent pricing services for similar assets. The carrying amount of other investments approximates fair value.

Loans – For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. For all other loans, fair values are calculated by discounting the contractual cash flows using estimated market discount rates which reflect the credit and interest rate risk inherent in the loans, or by using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits – The fair value of deposits with no stated maturity, such as demand, interest checking and money market, and savings accounts, is equal to the amount payable on demand at year-end. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using the rates currently offered for deposits of similar remaining maturities.

Borrowings – The fair value of borrowings is based on the discounted value of contractual cash flows using the rates currently offered for borrowings of similar remaining maturities

Accrued interest – The carrying amounts of accrued interest receivable and payable approximate fair value.

Village Bank
Fair Value - Financial Instruments Summary
June 30, 2012

		June 30,				December 31,
		2012				2011
	Level in Fair
	Value	Carrying		Estimated		Carrying		Estimated
	Hierarchy	Value		Fair Value		Value		Fair Value

Financial assets
Cash	Level 1	$	23,271,435	$	23,271,435	$	55,557,541	$	55,557,541
Cash equivalents	Level 2		3,834,563		3,834,563		7,228,475		7,228,475
Investment securities available for sale	Level 1		4,816,213		4,816,213		10,207,805		10,207,805
Investment securities available for sale	Level 2		31,880,069		31,880,069		19,955,487		19,955,487
Federal Home Loan Bank stock	Level 2		2,396,600		2,396,600		2,647,000		2,647,000
Loans held for sale	Level 2		19,729,508		19,729,508		16,168,405		16,168,405
Loans	Level 2		306,467,001		305,208,432		353,186,646		353,349,981
Impaired loans	Level 2		57,753,817		57,753,817		51,867,625		51,867,625
Impaired loans	Level 3		14,700,558		14,700,558		12,787,473		12,787,473
Other real estate owned	Level 2		11,212,437		11,212,437		874,246		874,246
Other real estate owned	Level 3		6,464,625		6,464,625		8,302,921		8,302,921
Bank owned life insurance	Level 3		6,159,335		6,159,335		6,065,305		6,065,305
Accrued interest receivable	Level 2		1,910,147		1,910,147		2,046,524		2,046,524

Financial liabilities
Deposits	Level 2		450,419,908		454,971,918		485,521,052		487,915,609
FHLB borrowings	Level 2		29,000,000		29,167,554		37,750,000		37,963,672
Trust preferred securities	Level 2		8,764,000		8,764,000		8,764,000		8,764,000
Other borrowings	Level 2		5,062,344		5,062,344		5,778,661		5,778,661
Accrued interest payable	Level 2		703,817		703,817		592,283		592,283

Note 10 – Capital Purchase Program

On May 1, 2009, as part of the Capital Purchase Program established by the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008 (“EESA”), the Company entered into a Letter Agreement and Securities Purchase Agreement—Standard Terms (collectively, the “Purchase Agreement”) with the Treasury, pursuant to which the Company sold (i) 14,738 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $4.00 per share, having a liquidation preference of $1,000 per share (the “Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 499,029 shares of the Company’s common stock at an initial exercise price of $4.43 per share, subject to certain anti-dilution and other adjustments, for an aggregate purchase price of $14,738,000 in cash. The fair value of the preferred stock was estimated using discounted cash flow methodology at an assumed market equivalent rate of 13%, with 20 quarterly payments over a five year period. The fair value of the warrant was estimated using the Black-Scholes option pricing model, with assumptions of 25% volatility, a risk-free rate of 2.03%, a yield of 6.162% and an estimated life of 5 years. The value attributed to the warrant is being accreted as a discount on the preferred stock using the effective interest rate method over five years.

The Preferred Stock qualifies as Tier 1 capital and pays cumulative dividends at a rate of 5% per annum for the first five years, and thereafter at a rate of 9% per annum. The Preferred Stock is generally non-voting, other than on certain matters that could adversely affect the Preferred Stock.

In consideration of our agreements with our regulators, which require regulatory approval to make dividend payments on our preferred stock, the Company notified the U.S. Treasury in May 2011 that the Company was going to defer the payment of the quarterly cash dividend of $184,225 due on May 16, 2011, and subsequent quarterly payments, on the Preferred Stock. The total arrearage on such preferred stock as of June 30, 2012 was $982,533. In June 2012 as a result of the unpaid dividends, Treasury requested that an observer appointed by Treasury be allowed to attend the Company’s meetings of its board of directors.

The Bank is subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. See further discussion of capital requirements under Capital Resources in Management’s Discussion and Analysis of Financial Condition and Results of Operations following.

Note 11 – Commitments and contingencies

Off-balance-sheet risk – The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized in the financial statements. The contract amounts of these instruments reflect the extent of involvement that the Company has in particular classes of instruments.

The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, and to potential credit loss associated with letters of credit issued, is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for loans and other such on-balance sheet instruments.

The Company had outstanding the following approximate off-balance-sheet financial instruments whose contract amounts represent credit risk at the dates indicated:

	June 30,		December 31,
	2012		2011

Undisbursed credit lines	$	38,378,000	$	40,661,000
Commitments to extend or originate credit		23,276,000		18,214,000
Standby letter of credit		7,217,000		3,719,000

Total commitments to extend credit	$	68,871,000	$	62,594,000

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Historically, many commitments expire without being drawn upon; therefore, the total commitment amounts shown in the above table are not necessarily indicative of future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, as deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the customer. Collateral held varies but may include personal or income-producing commercial real estate, accounts receivable, inventory and equipment.

Concentrations of credit risk – All of the Company’s loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Company’s market area. Although the Company is building a diversified loan portfolio, a substantial portion of its clients’ ability to honor contracts is reliant upon the economic stability of the Richmond, Virginia area, including the real estate markets in the area. The concentrations of credit by type of loan are set forth in Note 5. The distribution of commitments to extend credit approximates the distribution of loans outstanding.

Consent Order – In February 2012, the Bank entered into a Stipulation and Consent to the Issuance of a Consent Order (“Consent Agreement”) with the Federal Deposit Insurance Corporation and the Virginia Bureau of Financial Institutions (the “Supervisory Authorities”), and the Supervisory Authorities have issued the related Consent Order (the “Order”) effective February 3, 2012. The description of the Consent Agreement and the Order is set forth below:

Management. The Order requires that the Bank have and retain qualified management, including at a minimum a chief executive officer, senior lending officer and chief operating officer, with qualifications and experience commensurate with their assigned duties and responsibilities within 90 days from the effective date of the order. Within 30 days of the effective date of the Order, the Bank must retain a bank consultant to develop a written analysis and assessment of the Bank’s management and staffing needs for the purpose of providing qualified management for the Bank. Within 30 days from receipt of the consultant’s management report, the Bank must formulate a written management plan that

incorporates the findings of the management report, a plan of action in response to each recommendation contained in the management report, and a timeframe for completing each action.

Capital Requirements. Within 90 days from the effective date of the Order and during the life of the Order, the Bank must have Tier 1 capital equal to or greater than 8 percent of its total assets, and total risk-based capital equal to or greater than 11 percent of the Bank’s total risk-weighted assets. Within 90 days from the effective date of the Order, the Bank must submit a written capital plan to the Supervisory Authorities. The capital plan must include a contingency plan in the event that the Bank fails to maintain the minimum capital ratios required in the Order, submit a capital plan that is acceptable to the Supervisory Authorities, or implement or adhere to the capital plan.

Charge-offs. The Order requires the Bank to eliminate from its books, by charge-off or collection, all assets or portions of assets classified “Loss” and 50 percent of those classified “Doubtful”. If an asset is classified “Doubtful”, the Bank may, in the alternative, charge off the amount that is considered uncollectible in accordance with the Bank’s written analysis of loan or lease impairment. The Order also prevents the Bank from extending, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, on whole or in part, “loss” or “doubtful” and is uncollected. The Bank may not extend, directly or indirectly, any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been classified “substandard.” These limitations do not apply if the Bank’s failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.

Asset Growth. While the Order is in effect, the Bank must notify the Supervisory Authorities at least 60 days prior to undertaking asset growth that exceeds 10% or more per year or initiating material changes in asset or liability composition. The Bank’s asset growth cannot result in noncompliance with the capital maintenance provisions of the Order unless the Bank receives prior written approval from the Supervisory Authorities.

Restriction on Dividends and Other Payments. While the Order is in effect, the Bank cannot declare or pay dividends, pay bonuses, or pay any form of payment outside the ordinary course of business resulting in a reduction of capital without the prior written approval of the Supervisory Authorities. In addition, the Bank cannot make any distributions of interest, principal, or other sums on subordinated debentures without prior written approval of the Supervisory Authorities.

Brokered Deposits. The Order provides that the Bank may not accept, renew, or roll over any brokered deposits unless it is in compliance with the requirements of the FDIC regulations governing brokered deposits. These regulations prohibit undercapitalized institutions from accepting, renewing, or rolling over any brokered deposits and also prohibit undercapitalized institutions from soliciting deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the institution’s market area. An “adequately capitalized” institution may not accept, renew, or roll over brokered deposits unless it has applied for and been granted a waiver by the FDIC.

Written Plans and Other Material Terms. Under the terms of the Order, the Bank is required to prepare and submit the following written plans or reports to the FDIC and the Commissioner:

			·Plan to improve liquidity, contingency funding, interest rate risk, and asset liability management
			·Plan to reduce assets of $250,000 or greater classified “doubtful” and “substandard”
			·Revised lending and collection policy to provide effective guidance and control over the Bank’s lending and credit administration functions

·Effective internal loan review and grading system

·Policy for managing the Bank’s other real estate

·Business/strategic plan covering the overall operation of the Bank

·Plan and comprehensive budget for all categories of income and expense for the year 2011

·Policy and procedures for managing interest rate risk

·Assessment of the Bank’s information technology function

Under the Order, the Bank’s board of directors has agreed to increase its participation in the affairs of the Bank, including assuming full responsibility for the approval of policies and objectives for the supervision of all of the Bank’s activities. The Bank must also establish a board committee to monitor and coordinate compliance with the Order.

The Order will remain in effect until modified or terminated by the Supervisory Authorities.

While subject to the Consent Order, we expect that our management and board of directors will be required to focus considerable time and attention on taking corrective actions to comply with the terms. In addition, certain provisions of the Consent Order described above could adversely impact the Company’s businesses and results of operations.

Written Agreement – In June 2012, the Company entered into a written agreement (“Written Agreement”) with the Federal Reserve Bank of Richmond (“Reserve Bank”). Under the terms of the Written Agreement, the Company has agreed to develop and submit to the Reserve Bank for approval within the time periods specified therein written plans to maintain sufficient capital and correct any violations of section 23A of the Federal Reserve Act and Regulation W. In addition, the Company will submit a written statement of its planned sources and uses of cash for debt service, operation expenses, and other purposes.

The Company also has agreed that it will not, without prior regulatory approval:

pay or declare any dividends;

take any other form of payment representing a reduction in Bank’s capital;

make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities;

incur, increase or guarantee any debt;

purchase or deem any shares of its stock.

In June 2012 the Treasury asked to allow an observer at the Company’s meetings of its board

of directors. The observer will start attending board meetings commencing in August 2012. The Treasury has the contractual right to nominate up to two members to the board of directors upon the Company’s sixth missed dividend payment. The Company has deferred five dividend payments as of June 30, 2012 and expects to defer its sixth dividend payment due August 15, 2012.

Note 12 – Income Taxes

The net deferred tax asset is included in other assets on the balance sheet. Accounting Standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. Management considers both positive and negative evidence and analyzes changes in near-term market conditions as well as other factors which may impact future operating results. In making such judgments, significant weight is given to evidence that can be objectively verified. The deferred tax assets are analyzed quarterly for changes affecting realization. Management determined that as of June 30, 2012, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance for all of the net deferred tax asset of approximately $10,210,000.

Note 13 – Recent accounting pronouncements

In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The Company adopted ASU 2011-04, which generally aligns the principles of fair value measurements with International Financial Reporting Standards (IFRSs), in its consolidated financial statements in the first quarter 2012. The provisions of ASU 2011-04 clarify the application of existing fair value measurement requirements, and expand the disclosure requirements for fair value measurements. The increased provisions of ASU 2011-04 did not have a material effect on the Company’s financial condition and results of operations.

In June 2011, The FASB issued ASU No. 2011-05, Presentation of Comprehensive Income, Topic 220. This ASU eliminates the option of presenting the components of other comprehensive income (OCI) as part of the statement of changes in stockholders’ equity. The ASU instead permits an entity to present the total of comprehensive income, the components of net income, and the components of OCI either in a single continuous statement of comprehensive income or in two separate but consecutive statements. With either format, the entity is required to present each component of net income along with total net income, each component of OCI along with the total for OCI, and a total amount for comprehensive income. Also, the ASU requires entities to present, for either format, reclassification adjustments for items that are reclassified from OCI to net income in the statement(s) where the components of net income and the components of OCI are presented. This ASU is to be applied retrospectively. The Company adopted ASU-2011-05 in the first quarter of 2012. The provisions of ASU 22011-05 did not have a material effect on the Company’s financial condition and results of operations.

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

Caution about forward-looking statements

In addition to historical information, this report may contain forward-looking statements. For this purpose, any statement, that is not a statement of historical fact may be deemed to be a forward-looking statement. These forward-looking statements may include statements regarding profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy and financial and other goals. Forward-looking statements often use words such as “believes,” “expects,” “plans,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends” or other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements.

There are many factors that could have a material adverse effect on the operations and future prospects of the Company including, but not limited to:

the inability of the Bank to comply with the requirements of agreements with its regulators;

the inability to reduce nonperforming assets consisting of nonaccrual loans and foreclosed real estate;

our inability to improve our regulatory capital position;

the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;

changes in assumptions underlying the establishment of allowances for loan losses, and other estimates;

changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and disruption of the capital and credit markets, soundness of other financial institutions we do business with;

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

changes in operations of Village Bank Mortgage Corporation as a result of the activity in the residential real estate market;

legislative and regulatory changes, including the Dodd-Frank Act Wall Street Reform and Consumer Protection Act and other changes in banking, securities, and tax laws and regulations and their application by our regulators, and changes in scope and cost of FDIC insurance and other coverages;

exposure to repurchase loans sold to investors for which borrowers failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;

the effects of future economic, business and market conditions;

governmental monetary and fiscal policies;

changes in accounting policies, rules and practices;

maintaining capital levels adequate to remain well capitalized;

reliance on our management team, including our ability to attract and retain key personnel;

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

demand, development and acceptance of new products and services;

problems with technology utilized by us;

changing trends in customer profiles and behavior; and

other factors described from time to time in our reports filed with the SEC.

These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made. In addition, past results of operations are not necessarily indicative of future results.

General

The Company’s primary source of earnings is net interest income, and its principal market risk exposure is interest rate risk. The Company is not able to predict market interest rate fluctuations and its asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on the Company’s results of operations and financial condition.

Although we endeavor to minimize the credit risk inherent in the Company’s loan portfolio, we must necessarily make various assumptions and judgments about the collectability of the loan portfolio based on our experience and evaluation of economic conditions. If such assumptions or judgments prove to be incorrect, the current allowance for loan losses may not be sufficient to cover loan losses and additions to the allowance may be necessary, which would have a negative impact on net income. Over the last three years, the Company has recorded record provisions for loan losses due primarily to deteriorating quality of loans collateralized by real estate located in its principal market area.

There is intense competition in all areas in which the Company conducts its business. The Company competes with banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions. Many of these competitors have substantially greater resources and lending limits and provide a wider array of banking services. To a limited extent, the Company also competes with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies. Competition is based on a number of factors, including prices, interest rates, services, availability of products and geographic location.

Given current economic uncertainty as well as stress on our capital ratios resulting from operating losses, the Company has adopted a balance sheet reduction plan that focuses on the reduction of nonperforming assets and higher risk-weighted assets that will help increase capital ratios in three ways. First, the lower overall asset size affords the Company's capital reserves to support a smaller balance sheet. Second, the reduced risk profile of the Company's ensuing loan portfolio requires less capital support during times of economic stress. Third, a reduced infrastructure reduces general and administrative expenses, which in turn reduces the need for additional capital.

Given the asset growth restriction in the Consent Order, as well as the Company's current weakened financial position, the Company does not anticipate undertaking growth via acquisition or de novo branching during the foreseeable future.

The Company's objective is to continue decreasing assets by loan and deposit attrition.

Results of operations

The following represents management’s discussion and analysis of the financial condition of the Company at June 30, 2012 and December 31, 2011 and the results of operations for the Company for the three and six months ended June 30, 2012 and 2011. This discussion should be read in conjunction with the Company’s condensed consolidated financial statements and the notes thereto appearing elsewhere in this Quarterly report.

Income Statement Analysis

Summary

For the three months ended June 30, 2012, the Company had a net loss of $(9,736,000) and net loss available to common shareholders of $(9,922,000), or $(2.33) per fully diluted share, compared to net income of $257,000 and net income available to common shareholders of $37,000, or $0.01 per fully diluted share, for the same period in 2011. For the six months ended June 30, 2012, the Company had a net loss totaling $(11,137,000) and a net loss available to common shareholders of $(11,543,000), or $(2.72) per fully diluted share, compared to net income totaling $340,000 and a net loss available to common shareholders of $(99,000), or $(0.02) per share on a fully diluted share, for the same period in 2011. This represents decreases in net income before payment of dividends of $(9,993,000) and $(11,476,000), for the three and six month periods, respectively.

The components of these decreases in net income before payment of dividends are presented following:

	Three Months			Six Months
	Ended			Ended
	June 30, 2012			June 30, 2012

Decrease in net interest income	$	(586,000	)	$	(1,204,000	)
Increase in provision for loan losses		(5,760,000	)		(6,492,000	)
Increase in noninterest income		729,000			1,415,000
Increase in noninterest expense		(626,000	)		(1,555,000	)
Increase in tax expense		(3,750,000	)		(3,640,000	)

	$	(9,993,000	)	$	(11,476,000	)

Our profitability continues to be negatively affected by the continued stress on our borrowers and real estate values from the recessionary economy. As a result, asset quality continues to be a concern and management is devoting substantial resources to problem asset resolution. The increase in the provision for loan losses is discussed further under Asset quality and provision for loan losses.

Our cost of deposits declined from 1.74% for the second quarter of 2011 to 1.31% for the second quarter of 2012. This decline in cost of deposits is a result of the repricing of higher cost certificates of deposit during low interest rate environment that has existed for the last three years as well as an effort to change our deposit mix so that we are not so dependent on higher cost deposits. Our mortgage company’s profit increased in the first six months of 2012 compared to the same period of 2011 by $805,000 due to the mortgage company closing $140,359,000 in mortgage loans for the first two quarters of 2012 compared to $104,077,000 for the same period in 2011.

Net interest income

Net interest income, which represents the difference between interest earned on interest-earning assets and interest incurred on interest-bearing liabilities, is the Company’s primary source of earnings. Net interest income can be affected by changes in market interest rates as well as the level and composition of assets, liabilities and shareholder’s equity. Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. The net yield on interest-earning assets (“net interest margin”) is calculated by dividing tax equivalent net interest income by average interest-earning assets. Generally, the net interest margin will exceed the net interest spread because a portion of interest earning assets are funded by various noninterest-bearing sources, principally noninterest-bearing deposits and shareholders’ equity.

Net interest income for the second quarter of $4,351,000 represents a decrease of $(586,000), or 12%, compared to the second quarter of 2011, and a decrease of $70,000, or 2%, compared to the first quarter of 2012.

Compared to the second quarter of 2011, average interest-earning assets for the second quarter of 2012 decreased by $54,559,000 or 10%. The decrease in interest-earning assets was due primarily to decreases in portfolio loans of $34,106,000, investment securities of $19,655,000 and federal funds sold of $6,144,000, offset by increases in loans held for sale of $5,347,000. The primary reason for the decline in our portfolio loans that are interest-earning was loan charge-offs as well as loans placed on nonaccrual status. In addition to the decline in interest-earning assets, the average yield on interest-earning assets decreased to 4.89% for the second quarter of 2012 compared to 5.37% for the second quarter of 2011. These declines resulted in a decline in interest income from the second quarter of 2011 to the second quarter of 2012 of $3,588,000, or 18%.

Average interest-bearing liabilities for the second quarter of 2012 decreased by $58,175,000 or 12%, compared to the second quarter of 2011. The decrease in interest-bearing liabilities was due primarily to declines in average deposits of $57,207,000. The average cost of interest-bearing liabilities decreased to 1.41% for the six months ended 2012 from 1.80% for the six months ended 2011. The principal reason for the decrease in liability costs was the maintenance of short-term interest rates by the Federal Reserve. The continuing low interest rates have allowed us to reduce our cost of funds as certificates of deposit and borrowings mature. See our discussion of interest rate sensitivity below for more information.

The Company’s net interest margin is not a measurement under accounting principles generally accepted in the United States, but it is a common measure used by the financial services industry to determine how profitably earning assets are funded. Our net interest margin over the last several quarters is provided in the following table:

	Net
	Interest
Quarter Ended	Margin

June 30, 2011		3.65	%
September 30, 2011		3.63	%
December 31, 2011		3.38	%
March 31, 2012		3.53	%
June 30, 2012		3.65	%

The net interest margin declined during 2011, primarily as a result of increasing nonaccrual loans. Additionally our margin was compressed as our deposits generally do not reprice as quickly as our loans. The improvement in net interest margin for the second quarter of 2012 compared to the first quarter of 2012 is a result of utilizing lower interest-earning assets, primarily federal funds sold, to fund a decrease in interest-bearing liabilities of $22,234,000. As a result higher yielding loans represented 85% of total interest-bearing assets as compared to 83% for the first quarter of 2012. However, given the continued depressed economy and the potential impact on interest income from new nonaccrual loans, no assurance can be provided that increases in the net interest margin will continue to occur.

The following table illustrates average balances of total interest-earning assets and total interest-bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, shareholders' equity and related income, expense and corresponding weighted-average yields and rates. The average balances used in these tables and other statistical data were calculated using daily average balances. We had no tax exempt assets for the periods presented.

Average Balance Sheets
(in thousands)

	Three Months Ended June 30, 2012								Three Months Ended June 30, 2011
				Interest		Annualized						Interest		Annualized
	Average			Income/		Yield			Average			Income/		Yield
	Balance			Expense		Rate			Balance			Expense		Rate


Loans net of deferred fees	$	405,173		$	5,448		5.39	%	$	443,722		$	6,648		6.01	%
Loans held for sale		16,122			166		4.13	%		9,728			119		4.91	%
Investment securities		36,243			215		2.38	%		51,464			353		2.75	%
Federal funds and other		20,060			12		0.24	%		37,527			20		0.21	%
Total interest earning assets		477,598			5,841		4.91	%		542,441			7,140		5.28	%

Allowance for loan losses and deferred fees		(14,161	)							(7,709	)
Cash and due from banks		13,796								13,577
Premises and equipment, net		26,428								27,386
Other assets		37,444								32,547

Total assets	$	541,105							$	608,242

Interest bearing deposits
Interest checking	$	42,711		$	36		0.34	%	$	37,513		$	69		0.74	%
Money market		68,860			70		0.41	%		89,978			167		0.74	%
Savings		17,752			22		0.50	%		12,073			22		0.73	%
Certificates		262,106			1,118		1.71	%		317,615			1,647		2.08	%
Total		391,429			1,246		1.28	%		457,179			1,905		1.67	%
Borrowings		44,941			244		2.18	%		52,499			297		2.27	%
Total interest bearing liabilities		436,370			1,490		1.37	%		509,678			2,202		1.73	%
Noninterest bearing deposits		64,405								46,130
Other liabilities		5,295								3,501
Total liabilities		506,070								559,309
Equity capital		35,034								48,933
Total liabilities and capital	$	541,104							$	608,242

Net interest income before provision for loan losses				$	4,351							$	4,938

Interest spread - average yield on interest
earning assets, less average rate on
interest bearing liabilities							3.54	%							3.55	%

Annualized net interest margin (net
interest income expressed as
percentage of average earning assets)							3.65	%							3.65	%

Average Balance Sheets
(in thousands)

	Six Months Ended June 30, 2012								Six Months Ended June 30, 2011
				Interest		Annualized						Interest		Annualized
	Average			Income/		Yield			Average			Income/		Yield
	Balance			Expense		Rate			Balance			Expense		Rate


Loans net of deferred fees	$	412,503		$	11,217		5.47	%	$	446,609		$	13,567		6.13	%
Loans held for sale		14,616.52			297		4.08	%		9,270			241		5.24	%
Investment securities		33,775			366		2.18	%		53,430			653		2.47	%
Federal funds and other		29,358			32		0.22	%		35,502			39		0.22	%
Total interest earning assets		490,253			11,912		4.89	%		544,811			14,500		5.37	%

Allowance for loan losses and deferred fees		(13,020.42	)							(7,510	)
Cash and due from banks		14,553								6,826
Premises and equipment, net		26,569								27,420
Other assets		35,348								32,516

Total assets	$	553,703							$	604,063

Interest bearing deposits
Interest checking	$	42,439		$	76		0.36	%	$	35,469		$	133		0.75	%
Money market		71,141			146		0.41	%		91,479			371		0.82	%
Savings		16,969			43		0.51	%		11,658			41		0.71	%
Certificates		269,564			2,339		1.74	%		318,714			3,400		2.15	%
Total		400,114			2,604		1.31	%		457,321			3,944		1.74	%
Borrowings		47,180			535		2.28	%		48,148			580		2.43	%
Total interest bearing liabilities		447,294			3,139		1.41	%		505,469			4,524		1.80	%
Noninterest bearing deposits		63,808								45,187
Other liabilities		4,423								5,174
Total liabilities		515,525								555,830
Equity capital		38,177								48,234
Total liabilities and capital	$	553,703							$	604,064

Net interest income before provision for loan losses				$	8,773							$	9,976

Interest spread - average yield on interest
earning assets, less average rate on
interest bearing liabilities							3.48	%							3.57	%

Provision for loan losses

The provision for loan losses for the three months ended June 30, 2012 amounted to $6,660,000 compared to $900,000 for the three months ended June 30, 2011. The provision for loan losses for the six months ended June 30, 2012 was $8,395,000 compared to $1,903,000 for the six months ended June 30, 2011. These increases reflect the continued stress on our borrowers from the recessionary economy as well as recognition of declines in real estate values evidenced by current appraisals. Asset quality continues to be a concern as there continues to be uncertainty in the economy.

Additionally, a significant portion of the provision for loan losses is based upon loan charge-off history over the last two years. As charge-offs increased significantly during this period, the provision for loan losses based upon this history has significantly increased.

Noninterest income

Noninterest income increased from $2,406,000 for the three months ended June 30, 2011 to $3,135,000 for the three months ended June 30, 2012, an increase of $729,000, or 30%. The increase in noninterest income is primarily a result of increases in gain on sale of loans of $555,000 and a gain on sale of securities of $99,000. Noninterest income also increased from $4,443,000 for the first six months of 2011 to $5,858,000 for the first six months of 2012, an increase of $1,415,000, or 32%. The increase in noninterest income is primarily a result of higher gains on sale of loans of $933,000 and gain on sale of securities of $201,000.

Noninterest expense

Noninterest expense for the three months ended June 30, 2012 was $6,681,000 compared to $6,055,000 for the three months ended June 30, 2011, an increase of $626,000, or 10%. The more significant increases in noninterest expense occurred in expenses related to foreclosed real estate of $316,000 and salaries and benefits of $111,000.

Noninterest expense for the six months ended June 30, 2012 totaled $13,491,000, an increase of $1,555,000, or 13%, from $11,935,000 for the six months ended June 30, 2011. Expenses related to foreclosed real estate increased by $972,000, salaries and benefits increased by $159,000, occupancy expense increased by $166,000 and loan underwriting expense increased by $170,000.

Income taxes

Certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate.

changes affecting realization. Management determined that as of December 31, 2011, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance on its net deferred tax asset of approximately $3,900,000. At June 30, 2012, management continues to believe that the objective negative evidence represented by the Company’s continued losses in the second quarter outweighed the more subjective positive evidence and, as a result, recognized an addition to the valuation allowance on its net deferred tax asset of approximately $5,871,000. The net operating losses available to offset future taxable income amounted to $11,600,000 at June 30, 2012 and expire through 2030.

Commercial banking organizations conducting business in Virginia are not subject to Virginia income taxes. Instead, they are subject to a franchise tax based on bank capital. The Company recorded a franchise tax expense of $82,000 and $169,000 for the six months ended June 30, 2012 and 2011, respectively.

Balance Sheet Analysis

Our total assets decreased to $524,462,000 at June 30, 2012 from $581,704,000 at December 31, 2011, a decrease of $57,242,000, or 10%. During the second quarter of 2012, liquid assets (cash and due from banks, federal funds sold and investment securities available for sale) decreased by $29,147,000, loans held for sale increased by $3,561,000, net portfolio loans decreased by $33,646,000, and other real estate owned increased by $8,500,000.

Loans

A management objective is to maintain the quality of the loan portfolio. The Company seeks to achieve this objective by maintaining rigorous underwriting standards coupled with regular evaluation of the creditworthiness of and the designation of lending limits for each borrower. The portfolio strategies include seeking industry and loan size diversification in order to minimize credit exposure and originating loans in markets with which the Company is familiar.

The Company’s real estate loan portfolios, which represent approximately 73% of all loans, are secured by mortgages on real property located principally in the Commonwealth of Virginia. Sources of repayment are from the borrower’s operating profits, cash flows and liquidation of pledged collateral. The Company’s commercial loan portfolio represents approximately 9% of all loans. Loans in this category are typically made to individuals, small and medium-sized businesses and range between $250,000 and $2.5 million. Based on underwriting standards, commercial and industrial loans may be secured in whole or in part by collateral such as liquid assets, accounts receivable, equipment, inventory, and real property. The collateral securing any loan may depend on the type of loan and may vary in value based on market conditions. The remainder of our loan portfolio is in consumer loans which represent .9% of the total.

The following table presents the composition of our loan portfolio (excluding mortgage loans held for sale) at the dates indicated.

Loan Portfolio, Net
(In thousands)

	June 30, 2012						December 31, 2012
	Amount			%			Amount			%
Construction and land development:
Residential	$	7,442			1.89	%	$	7,906			1.85	%
Commercial		55,828			14.20	%		72,621			16.97	%
Total construction and land development		63,270			16.09	%		80,527			18.82	%
Commercial real estate:
Farmland		2,447			0.62	%		2,465			0.58	%
Commercial real estate - owner occupied		100,149			25.48	%		105,592			24.68	%
Commercial real estate - non-owner occupied		55,891			14.22	%		54,059			12.63	%
Multifamily		6,960			1.77	%		6,680			1.56	%
Total commercial real estate		165,447			42.09	%		168,796			39.45	%
Consumer real estate:
Home equity lines		28,365			7.22	%		30,687			7.17	%
Secured by 1-4 family residential, secured by first deeds of trust		84,775			21.58	%		93,219			21.79	%
Secured by 1-4 family residential, secured by second deeds of trust		10,095			2.57	%		12,042			2.81	%
Total consumer real estate		123,235			31.37	%		135,947			31.77	%
Commercial and industrial loans (except those secured by real estate)		37,529			9.55	%		37,734			8.82	%
Consumer and other		3,554			0.90	%		4,865			1.14	%

Total Loans		393,035			100.0	%		427,869			100.0	%
Deferred loan cost (unearned income), net		752						768
Less: Allowance for loan losses		(14,866	)					(16,071	)

	$	378,921					$	412,566

The decline in our total loan portfolio is part of management’s strategy to decrease our level of assets to improve our regulatory capital ratios as well as reduce our overhead expenses. In addition, loans totaling $12,098,000 were foreclosed on and $9,772,000 were charged-off.

The Company assigns risk rating classifications to its loans. These risk ratings are divided into the following groups:

Risk rated 5 loans are defined as having potential weaknesses that deserve management’s close attention;

Risk rated 6 loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any, and;

Loans are considered impaired when, based on current information and events it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Allowance for loan losses

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

The allowance reflects management’s best estimate of probable losses within the existing loan portfolio and of the risk inherent in various components of the loan portfolio, including loans identified as impaired as required by FASB Codification Topic 310: Receivables. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.

Loans are grouped by similar characteristics, including the type of loan, the assigned loan classification and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon historical net charge-off rates, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans is adjusted for relevant environmental factors and other conditions of the portfolio of loans and leases, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

The amounts of estimated impairment for individually evaluated loans and groups of loans are added together for a total estimate of loan losses. This estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. We recognize the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the financial statements.

The allowance for loan losses at June 30, 2012 was $14,866,000, compared to $16,071,000 at December 31, 2011. The ratio of the allowance for loan losses to gross portfolio loans (net of unearned income and excluding mortgage loans held for sale) at June 30, 2012 and December 31, 2011 was 3.78% and 3.75%, respectively. The decrease in the allowance for loan losses for the first six months of 2012 was primarily a result of significant charge-offs recognized during the quarter for which specific provisions for loan losses had been previously provided. We believe the amount of the allowance for loan losses at June 30, 2012 is adequate to absorb the losses that can reasonably be anticipated from the loan portfolio at that date.

The following table presents an analysis of the changes in the allowance for loan losses for the periods indicated (in thousands).

	Six Months Ended
	June 30,
	2012			2011

Beginning balance	$	16,071		$	7,312
Provision for loan losses		8,395			1,903
Charge-offs
Construction and land development
Residential		(795	)		-
Commercial		(3,773	)		-
Commercial real estate
Commercial real estate - owner occupied		(309	)
Commercial real estate - non-owner occupied		(313	)		(244	)
Multifamily					(83	)
Consumer real estate
Home equity lines		(292	)		(924	)
Secured by 1-4 family residential, secured by first deeds of trust		(2,589	)
Secured by 1-4 family residential, secured by second deeds of trust		(197	)		(35	)
Commercial and industrial loans (except those secured by real estate)		(1,156	)		(593	)
Consumer and other		(402	)		(93	)
		(9,827	)		(1,972	)
Recoveries
Construction and land development
Residential		1
Commercial		1			10
Consumer real estate
Home equity lines		1			1
Secured by 1-4 family residential, secured by first deeds of trust		81
Secured by 1-4 family residential, secured by second deeds of trust		5
Commercial and industrial loans (except those secured by real estate)		134			2
Consumer and other		3			-
		226			13
Net charge-offs		(9,601	)		(1,959	)

Ending balance	$	14,866		$	7,256

Loans outstanding at end of period(1)	$	393,787		$	443,710
Ratio of allowance for loan losses as
a percent of loans outstanding at
end of period		3.78	%		1.64	%

Average loans outstanding for the year(1)	$	405,173		$	446,609
Ratio of net charge-offs to average loans
outstanding for the period		2.37	%		0.44	%

(1) Loans are net of unearned income.

The allowance for loan losses as a percentage of net loans increased from 1.64% at June 30, 2011 to 3.78% at June 30, 2012 primarily as a result of a decline in asset quality caused by the continued recessionary economy.

Asset quality

The following table summarizes asset quality information at the dates indicated (dollars in thousands).

	June 30,			December 31,			June 30,
	2012			2011			2011

Nonaccrual loans	$	56,632		$	48,097		$	17,901
Foreclosed properties		17,677			9,177			11,982
Total nonperforming assets	$	74,309		$	57,274		$	29,883

Restructured loans still accruing	$	12,655		$	16,411		$	25,130

Loans past due 90 days and still accruing
(not included in nonaccrual loans above)	$	199		$	1,172		$	843

Nonperforming assets to loans at end of period(1)		18.9	%		13.4	%		6.7	%

Nonperforming assets to total assets		14.1	%		9.8	%		4.9	%

Allowance for loan losses to nonaccrual loans		26.3	%		33.4	%		40.5	%

(1) Loans are net of deferred fees and costs.

The following table presents an analysis of the changes in nonperforming assets for the six months ended June 30, 2012 (dollars in thousands).

	Nonaccrual
	Loans			OREO			Total

Balance December 31, 2011	$	48,097		$	9,177		$	57,274
Additions, net		34,133			-			34,133
Transfers to OREO		(12,098	)		12,098			-
Repayments		(3,728	)		-			(3,728	)
Charge-offs		(9,772	)		(2,417	)		(12,189	)
Sales		-			(1,181	)		(1,181	)

Balance June 30, 2012	$	56,632		$	17,677		$	74,309

The significant increase in nonaccrual loans during the first quarter of 2012 was a result of defaults and restructuring of larger real estate loans related to acquisition, construction, land development and commercial real estate. Until a nonperforming restructured loan has performed in accordance with its restructured terms for a minimum of six months, it will remain on nonaccrual status.

Interest is accrued on outstanding loan principal balances, unless the Company considers collection to be doubtful. Commercial and unsecured consumer loans are designated as non-accrual when the Company considers collection of expected principal and interest doubtful. Mortgage loans and most other types of consumer loans past due 90 days or more may remain on accrual status if management determines that concern over our ability to collect principal and

interest is not significant. When loans are placed in non-accrual status, previously accrued and unpaid interest is reversed against interest income in the current period and interest is subsequently recognized only to the extent cash is received. Interest accruals are resumed on such loans only when in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.

Of the total nonaccrual loans of $56,632,000 at June 30, 2012 that were considered impaired, 48 loans totaling $21,890,000 had specific allowances for loan losses totaling $6,106,000. This compares to $48,097,000 in nonaccrual loans at December 31, 2011 of which 47 loans totaling $30,034,000 had specific allowances for loan losses of $5,034,000.

Cumulative interest income that would have been recorded had nonaccrual loans been performing would have been approximately $2,018,000 and $2,015,000 for the six months ended June 30, 2012 and 2011, respectively.

Deposits

Deposits as of June 30, 2012 and December 31, 2011 were as follows:

	June 30, 2012					December 31, 2011
	Amount		%			Amount		%

Noninterest bearing demand	$	64,348,408		14.29	%	$	66,534,956		13.70	%
Interest checking accounts		43,542,588		9.67	%		40,237,146		8.29	%
Money market accounts		65,933,468		14.64	%		75,487,907		15.55	%
Savings accounts		18,688,852		4.15	%		15,166,012		3.12	%
Time deposits of $100,000 and over		117,110,398		26.00	%		129,436,270		26.66	%
Other time deposits		140,796,194		31.25	%		158,658,761		32.68	%

Total	$	450,419,908		100.00	%	$	485,521,052		100.00	%

Total deposits decreased by $35,101,000, or 7.2%, from $485,521,000 at December 31, 2011 to $450,410,000 at June 30, 2012, as compared to an increase of $6,965,000, or 1.4%, during the first six months of 2011. Checking and savings accounts increased by $4,642,000, money market accounts decreased by $9,554,000 and time deposits decreased by $30,188,000. The decline in time deposits was a direct result of repricing maturing time deposits at rates below market for noncore depositors. The cost of our interest-bearing deposits declined to 1.31% for the first six months of 2012 compared to 1.74% for the first six months of 2011.

While the mix of our deposits continues to be weighted toward time deposits, such deposits represent only 57% of total deposits at June 30, 2012 and 59% at December 31, 2011. As our branch network has increased and is more convenient to a larger segment of our targeted customer base, we have experienced a move to a higher percentage of our deposits in checking accounts.

The variety of deposit accounts that we offer has allowed us to be competitive in obtaining funds and has allowed us to respond with flexibility to, although not to eliminate, the threat of disintermediation (the flow of funds away from depository institutions such as banking institutions into direct investment vehicles such as government and corporate securities). Our ability to attract and retain deposits, and our cost of funds, has been, and is expected to continue to be, significantly affected by money market conditions.

Borrowings

We utilize borrowings to supplement deposits when they are available at a lower overall cost to us or they can be invested at a positive rate of return.

As a member of the Federal Home Loan Bank of Atlanta (“FHLB”), the Bank is required to own capital stock in the FHLB and is authorized to apply for borrowings from the FHLB. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB may prescribe the acceptable uses to which the advances may be put, as well as on the size of the advances and repayment provisions. Borrowings from the FHLB were $29,000,000 and $37,750,000 at June 30, 2012 and December 31, 2011 respectively. The FHLB advances are secured by the pledge of residential mortgage loans, investment securities and our FHLB stock.

Capital resources

Stockholders’ equity at June 30, 2012 was $25,054,000, compared to $36,248,000 at December 31, 2011. On May 1, 2009, the Company received a $14,738,000 investment by the United States Department of the Treasury under its Capital Purchase Program (the TARP Program). The TARP Program is a voluntary program designed to provide capital for healthy banks to improve the flow of funds from banks to their customers. Under the TARP Program, the Company issued to the Treasury $14,738,000 of preferred stock and warrants to purchase 499,030 shares of the Company’s common stock at a purchase price of $4.43 per share. The preferred stock issued by the Company under the TARP Capital Purchase Program carries a 5% dividend for each of the first 5 years of the investment, and 9% thereafter, unless the shares are redeemed by the Company. The $(7,312,000) decrease in equity during the first six months of 2012 was primarily due to the net loss of $(7,255,000).

During the first quarter of 2005, the Company issued $5.2 million in Trust Preferred Capital Notes to increase its regulatory capital and to help fund its expected growth in 2005. During the third quarter of 2007, the Company issued $3.6 million in Trust Preferred Capital Notes to partially fund the construction of an 80,000 square foot building completed in 2008. The Trust Preferred Capital Notes may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion.

The Company is currently prohibited by its Written Agreement with the Reserve Bank from making dividend or interest payments on the TARP program preferred stock or trust preferred capital notes without prior regulatory approval. In addition, the Consent Order with the FDIC and BFI provides that the Bank will not pay any dividends, pay bonuses or make any other form of payment outside the ordinary course of business resulting in a reduction in capital, without regulatory approval. At June 30, 2012, the Company’s total accrued but deferred payment on TARP dividend payments was $982,533 and interest payments on trust preferred capital notes was $449,376.

In June 2012 as a result of the unpaid dividends, Treasury requested that an observer appointed by Treasury be allowed to attend the Company’s meetings of its board of directors. The observer will start attending board meetings commencing in August 2012. Treasury has the contractual right to nominate up to two members to the board of directors upon the Company’s sixth deferred dividend payment. The Company has deferred five dividend payments as of June 30, 2012 and expects to defer its sixth dividend payment due August 15, 2012. However, Treasury has not indicated at this time it will nominate two directors to our

board if we missed the sixth dividend payment date.

The following table presents the composition of regulatory capital and the capital ratios for the Company at the dates indicated (dollars in thousands).

	June 30,			December 31,
	2012			2011

Tier 1 capital
Preferred stock	$	59		$	59
Common stock		17,007			16,974
Additional paid-in capital		40,704			40,732
Retained earnings (deficit)		(33,438	)		(21,896	)
Warrant Surplus		732			732
Discount on preferred stock		(273	)		(346	)
Qualifying trust preferred securities		8,764			8,764
Less intangible assets		(442	)		(491	)
Disallowed Deferred tax asset		(186	)		(2,125	)
Total equity		32,927			42,403
Total Tier 1 capital		32,927			42,403

Tier 2 capital
Allowance for loan losses		5,375			5,629
Total Tier 2 capital		5,375			5,629

Total risk-based capital		38,302			48,032

Risk-weighted assets	$	420,480		$	439,873

Average assets	$	535,938		$	578,330

Capital ratios
Leverage ratio (Tier 1 capital to
average assets)		6.14	%		7.33	%
Tier 1 capital to risk-weighted assets		7.83	%		9.64	%
Total capital to risk-weighted assets		9.11	%		10.92	%
Equity to total assets		4.78	%		6.23	%

The following table presents the composition of regulatory capital and the capital ratios for the Bank at the dates indicated (dollars in thousands).

	June 30,			December 31,
	2012			2011

Tier 1 capital
Common stock		6,849			6,849
Additional paid-in capital		53,905			53,899
Retained earnings (deficit)		(29,954	)		(20,436	)
Less intangible assets		(442	)		(491	)
Disallowed Deferred tax asset		-			(846	)
Total equity		30,358			38,975
Total Tier 1 capital		30,358			38,975

Tier 2 capital
Allowance for loan losses		5,351			5,555
Total Tier 2 capital		5,351			5,555

Total risk-based capital		35,709			44,530

Risk-weighted assets	$	418,540		$	433,892

Average assets	$	532,850		$	603,758

Capital ratios
Leverage ratio (Tier 1 capital to
average assets)		5.70	%		6.46	%
Tier 1 capital to risk-weighted assets		7.25	%		8.98	%
Total capital to risk-weighted assets		8.53	%		10.26	%

Federal regulatory agencies are required by law to adopt regulations defining five capital tiers: well capitalized, adequately capitalized, under capitalized, significantly under capitalized, and critically under capitalized. The Bank met the criteria to be categorized as an “adequately capitalized” institution as of June 30, 2012 and “well capitalized” as of December 31, 2011. However, due to the minimum capital ratios required by the Consent Order, the Bank currently is considered “adequately capitalized”. The Consent Order requires the Bank to maintain a leverage ratio of at least 8% and a total capital to risk-weighted assets ratio of at least 11%. At June 30, 2012, the Bank’s leverage ratio was 5.70% and the total capital to risk weighted assets ratio was 8.53%. As required by the Consent Order, the Bank has provided a capital plan to the FDIC and BFI that demonstrates how the Bank will come into compliance with the required minimum capital ratios set forth in the Consent Order. When capital falls below the “well capitalized” requirement, consequences can include: new branch approval could be withheld; more frequent examinations by the FDIC; brokered deposits cannot be renewed without a waiver from the FDIC; and other potential limitations as described in FDIC Rules and Regulations sections 337.6 and 303, and FDIC Act section 29. In addition, the FDIC insurance assessment increases when an institution falls below the “well capitalized” classification.

Liquidity

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day

cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

At June 30, 2012, our liquid assets, consisting of cash, cash equivalents and investment securities available for sale totaled $63,802,000, or 12% of total assets. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. However, approximately $5,553,000 of these securities are pledged against retail sweep accounts. Therefore, the related borrowings would need to be repaid prior to the securities being sold in order for these securities to be converted to cash. Liquid assets declined by approximately $29,147,000 during the six months ended June 30, 2012 primarily as a result of the decline in deposits discussed previously.

Our holdings of liquid assets plus the ability to maintain and expand our deposit base and borrowing capabilities serve as our principal sources of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, and from additional borrowings. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. We maintain two federal funds lines of credit with correspondent banks totaling $22 million for which there were no borrowings against the lines at June 30, 2012.

At June 30, 2012, we had commitments to originate $68,871,000 of loans. Fixed commitments to incur capital expenditures were less than $25,000 at June 30, 2012. Certificates of deposit scheduled to mature in the 12-month period ending June 30, 2013 totaled $114,048,000. We believe that a significant portion of such deposits will remain with us. We further believe that deposit growth, loan repayments and other sources of funds will be adequate to meet our foreseeable short-term and long-term liquidity needs.

Interest rate sensitivity

An important element of asset/liability management is the monitoring of our sensitivity to interest rate movements. In order to measure the effects of interest rates on our net interest income, management takes into consideration the expected cash flows from the securities and loan portfolios and the expected magnitude of the repricing of specific asset and liability categories. We evaluate interest sensitivity risk and then formulate guidelines to manage this risk based on management’s outlook regarding the economy, forecasted interest rate movements and other business factors. Our goal is to maximize and stabilize the net interest margin by limiting exposure to interest rate changes.

Contractual principal repayments of loans do not necessarily reflect the actual term of our loan portfolio. The average lives of mortgage loans are substantially less than their contractual terms because of loan prepayments and because of enforcement of due-on-sale clauses, which gives us the right to declare a loan immediately due and payable in the event, among other things, the borrower sells the real property subject to the mortgage and the loan is not repaid. In addition, certain borrowers increase their equity in the security property by making payments in excess of those required under the terms of the mortgage.

The sale of fixed rate loans is intended to protect us from precipitous changes in the general level of interest rates. The valuation of adjustable rate mortgage loans is not as directly

dependent on the level of interest rates as is the value of fixed rate loans. As with other investments, we regularly monitor the appropriateness of the level of adjustable rate mortgage loans in our portfolio and may decide from time to time to sell such loans and reinvest the proceeds in other adjustable rate investments.

The data in the following table reflects repricing or expected maturities of various assets and liabilities at June 30, 2012. The gap analysis represents the difference between interest-sensitive assets and liabilities in a specific time interval. Interest sensitivity gap analysis presents a position that existed at one particular point in time, and assumes that assets and liabilities with similar repricing characteristics will reprice at the same time and to the same degree.

Village Bank and Trust Financial Corp.
Interest Rate Sensitivity GAP Analysis
June 30, 2012
(In thousands)


	Within 3			3 to 6			6 to 12			13 to 36			More than
	Months			Months			Months			Months			36 Months			Total
Interest Rate Sensitive Assets
Loans (1)
Fixed rate	$	20,998		$	11,810		$	11,613		$	30,277		$	82,176		$	156,874
Variable rate		79,103			7,171			17,620			32,825			99,442			236,161
Investment securities		-			3						-			36,693			36,696
Loans held for sale		19,730			-			-			-			-			19,730
Federal funds sold		3,835			-			-			-			-			3,835

Total rate sensitive assets		123,666			18,984			29,233			63,102			218,311			453,296
Cumulative rate sensitive assets		123,666			142,650			171,883			234,985			453,296

Interest Rate Sensitive Liabilities
Interest checking (2)		-			-			-			43,543			-			43,543
Money market accounts		65,933			-			-			-			-			65,933
Savings (2)		-			-			-			18,689			-			18,689
Certificates of deposit		23,913			53,193			36,942			82,454			61,405			257,907
FHLB advances		1,000			-			5,000			20,000			3,000			29,000
Trust Preferred Securities		-			-			-						8,764			8,764
Other borrowings		5,062			-			-			-			-			5,062

Total rate sensitive liabilities		95,908			53,193			41,942			164,686			73,169			428,898
Cumulative rate sensitive liabilities		95,908			149,101			191,043			355,729			428,898

Rate sensitivity gap for period	$	27,758		$	(34,209	)	$	(12,709	)	$	(101,584	)	$	145,142		$	24,398
Cumulative rate sensitivity gap	$	27,758		$	(6,451	)	$	(19,160	)	$	(120,744	)	$	24,398

Ratio of cumulative gap to total assets		5.3	%		(1.2	)%		(3.7	)%		(23.0	)%		4.7	%
Ratio of cumulative rate sensitive
assets to cumulative rate sensitive
liabilities		128.9	%		95.7	%		90.0	%		66.1	%		105.7	%
Ratio of cumulative gap to cumulative
rate sensitive assets		22.4	%		(4.5	)%		(11.1	)%		(51.4	)%		5.4	%



(1) Includes nonaccrual loans of approximately $56,632,000, which are spread throughout the categories.
(2) Management believes that interest checking and savings accounts are generally not sensitive to changes in interest
rates and therefore has placed such deposits in the "13 to 36 months" category.

At June 30, 2012, our balance sheet is asset sensitive for the first three months, meaning that our assets reprice more quickly than our liabilities during that period, and liability sensitive

for the next thirty-three months, meaning that our liabilities will reprice more quickly than our assets during that period, with a ratio of cumulative gap to total assets ranging from a positive gap of 5.3% for the first three months to a negative gap of (23.0)% for thirteen to thirty six month period. A negative gap can adversely affect earnings in periods of increasing interest rates. Given the Federal Reserve’s recent announcement that it will maintain short-term interest rates at current levels until the end of 2014, we do not expect interest rates to increase in the foreseeable future. However, we believe our balance sheet should be asset sensitive and, accordingly, we have adopted pricing policies to lengthen the maturities/repricing of our liabilities relative to the maturities/pricing of our assets.

Critical accounting policies

The accounting and reporting policies of the Company and its subsidiary are in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and conform to general practices within the banking industry. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities, and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations.

The more critical accounting and reporting policies include the Company’s accounting for the allowance for loan losses, real estate acquired in settlement of loans, goodwill and income taxes. The Company’s accounting policies are fundamental to understanding the Company’s consolidated financial position and consolidated results of operations. Accordingly, the Company’s significant accounting policies are discussed in detail in Note 1 of the Notes to Consolidated Financial Statements.

The following is a summary of the Company’s critical accounting policies that are highly dependent on estimates, assumptions, and judgments.

Allowance for loan losses

Loans are grouped by similar characteristics, including the type of loan, the assigned loan classification and the general collateral type. A loss rate reflecting the expected loss inherent in

a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans is adjusted for relevant environmental factors and other conditions of the portfolio of loans and leases, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

The amounts of estimated impairment for individually evaluated loans and groups of loans are added together for a total estimate of loan losses. This estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses. We recognize the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the financial statements.

Troubled debt restructurings

A loan is accounted for as a troubled debt restructuring if we, for economic or legal reasons, grant a concession to a borrower considered to be experiencing financial difficulties that we would not otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or balance of the loan, a reduction of accrued interest, an extension of the maturity date or renewal of the loan at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions. Troubled debt restructurings can be in either accrual or nonaccrual status. Nonaccrual troubled debt restructurings are included in nonperforming loans. Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected. Troubled debt restructurings generally remain categorized as nonperforming loans and leases until a six-month payment history has been maintained.

In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition, considered to be impaired loans. Impairment for these loans is measured on a loan-by-loan basis similar to other impaired loans as described above under Allowance for loan losses. Certain loans modified as troubled debt restructurings may have been previously measured for impairment under a general allowance methodology (i.e., pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the difference between the results of these two measurement methodologies. Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.

Real estate acquired in settlement of loans

Real estate acquired in settlement of loans represent properties acquired through foreclosure or physical possession. Write-downs to fair value less cost to sell of foreclosed assets at the time of transfer are charged to allowance for loan losses. Subsequent to foreclosure, the Company periodically evaluates the value of foreclosed assets held for sale and records an impairment charge for any subsequent declines in fair value less selling costs. Subsequent declines in value are charged to operations. Fair value is based on an assessment of information available at the end of a reporting period and depends upon a number of factors, including historical experience, economic conditions, and issues specific to individual properties. The evaluation of these factors involves subjective estimates and judgments that may change.

Income taxes

The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance may be established. Management considers the determination of this valuation allowance to be a critical accounting policy due to the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change. A valuation allowance for deferred tax assets may be required if the amounts of taxes recoverable through loss carry backs decline, or if management projects lower levels of future taxable income. Management determined that as of December 31, 2011 and June 30, 2012, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance of $3,929,000 and $10,277,000 on its net deferred tax asset respectively.

New accounting standards

Impact of inflation and changing prices

The Company’s consolidated financial statements included herein have been prepared in accordance with generally accepted accounting principles in the United States, which require the Company to measure financial position and operating results primarily in terms of historical dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond the control of the Company, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable.

ITEM 4 – CONTROLS AND PROCEDURES

The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of June 30, 2012. Based on that evaluation, management concluded that the Company’s disclosure controls and procedures were not effective as of June 30, 2012 due to insufficient time to test the policies and procedures described below which were implemented during the quarter to remediate the material weakness disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.

As disclosed in its Annual Report on Form 10-K for the year ended December 31, 2011, the Company’s internal control over financial reporting was not effective as of December 31, 2011 as a result of a material weakness related to the Company’s allowance for loan and lease losses.

During the first quarter of 2012, the Company implemented certain changes in its internal controls to address the material weakness. Specifically, during the first quarter of 2012, management took the following steps to remediate the material weakness:

Replaced the Chief Lending Officer with an individual who has substantial experience with assessing a borrowers’ ability to repay their obligations to the Company.

Hired a new senior vice president with substantial experience to direct the disposition of problem loans and foreclosed real estate.

Established a Special Assets committee including management and outside members of the board of directors to meet two times a month to address the resolution of problem loans and foreclosed real estate.

Reorganized the credit department to ensure appropriate separation of duties and developed expanded training for the Bank’s lenders.

Changed the Bank’s credit policy to require identification of concentrations of risk, analysis of our customer’s global cash flows, reappraisal and re-evaluation of collateral, more accurate and timely credit-risk rating procedures and improved underwriting processes and standards.

Engaged qualified outside consultants to assist in re-evaluating our methodology for assessing the adequacy of the allowance for loan and lease losses.

Improved the processes for identifying problem loans and the determination of the amount of impairment.

The Company’s management believes the control enhancements described above are sufficient to remediate the material weakness identified. However, as noted above, insufficient time to test the remediation has not yet occurred and therefore management is unable to conclude they are effective at June 30, 2012. Other than the remedial measures noted above, there were no changes in internal control over financial reporting during the quarter ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II – OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS

Not applicable.

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

Not applicable.

ITEM 3 – DEFAULTS UPON SENIOR SECURITIES

ITEM 4 – MINE SAFETY DISCOLOSURES

None

ITEM 5 – OTHER INFORMATION

Not applicable.

ITEM 6 – EXHIBITS

10.1

Written Agreement by and between Village Bank and Trust Financial Corp. and the Federal Reserve Bank of Richmond, dated June 26, 2012 (attached as Exhibit 10.1 to the Company’s current report on Form 8-K filed July 2, 2012 and incorporated by reference herein).

	31.1		Certification of Chief Executive Officer

	31.2		Certification of Chief Financial Officer

	32.1		Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

	101		The following materials from the Village Bank and Trust Financial Corp. Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Stockholders' Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.

SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

		VILLAGE BANK AND TRUST FINANCIAL CORP.
		(Registrant)


Date:	August 14, 2012	By:	/s/ Thomas W. Winfree
			Thomas W. Winfree
			President and
			Chief Executive Officer


Date:	August 14, 2012	By:	/s/ C. Harril Whitehurst, Jr.
			C. Harril Whitehurst, Jr.
			Senior Vice President and
			Chief Financial Officer

Exhibit Index

Exhibit Number	Document

10.1	Written Agreement by and between Village Bank and Trust Financial Corp. and the Federal Reserve Bank of Richmond, dated June 26, 2012 (attached as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed July 2, 2012 and incorporated by reference herein).

31.1	Certification of Chief Executive Officer

31.2	Certification of Chief Financial Officer

32.1	Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

101	The following materials from the Village Bank and Trust Financial Corp. Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Stockholders' Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.