UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2012

or

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

For the transition period from              to             

Commission File Number: 000-49976

ALLIANCE BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

VIRGINIA	46-0488111
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

14200 Park Meadow Drive, Suite 200 South, Chantilly, Virginia 20151

(Address of principal executive offices) (Zip Code)

(703) 814-7200

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  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  x    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 a 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

As of November 13, 2012, the number of outstanding shares of registrant’s common stock, par value $4.00 per share was: 5,109,969.

ALLIANCE BANKSHARES CORPORATION

INDEX

		Page
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements		3
Consolidated Balance Sheets at September 30, 2012 (Unaudited) and December 31, 2011 (Audited)			3
Consolidated Statements of Operations for the three months ended September 30, 2012 and 2011 (Unaudited)			4
Consolidated Statements of Operations for the nine months ended September 30, 2012 and 2011 (Unaudited)			5
Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2012 and 2011 (Unaudited)			6
Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2012 and 2011 (Unaudited)			7
Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011 (Unaudited)			8
Notes to Consolidated Financial Statements (Unaudited)			9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		39
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		78
Item 4.	Controls and Procedures		81
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings		82
Item 1A.	Risk Factors		82
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		82
Item 3.	Defaults Upon Senior Securities		82
Item 4.	Mine Safety Disclosures		82
Item 5.	Other Information		82
Item 6.	Exhibits		83
SIGNATURES			84

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Alliance Bankshares Corporation

Consolidated Balance Sheets

September 30, 2012 and December 31, 2011

(Dollars in thousands, except share and per share amounts)

	September 30, 2012			December 31, 2011
	(Unaudited)			(Audited)
ASSETS
Cash and due from banks	$	115,515		$	45,837
Federal funds sold		26,594			16,567
Trading security, at fair value		293			596
Investment securities available-for-sale, at fair value		79,411			123,463
Restricted stock, at cost		3,972			4,772
Loans, net of allowance for loan losses of $4,866 and $5,393		283,115			301,483
Premises and equipment, net		1,103			1,415
Other real estate owned, net		3,575			3,748
Deferred tax assets, net		1,601			1,553
Accrued interest and other assets		6,751			7,049
TOTAL ASSETS	$	521,930		$	506,483
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Non-interest bearing deposits	$	145,295		$	112,450
Savings and NOW deposits		84,058			51,475
Money market deposits		18,123			23,370
Time deposits		166,733			193,148
Total deposits	$	414,209		$	380,443
Repurchase agreements		22,558			40,420
Federal Home Loan Bank advances ($30,018 and $29,350 at fair value)		45,018			44,350
Trust Preferred Capital Notes		10,310			10,310
Other liabilities		2,766			2,838
Commitments and contingent liabilities		—			—
Total liabilities		494,861			478,361
SHAREHOLDERS’ EQUITY:
Common stock, $4 par value; 15,000,000 shares authorized; 5,109,969 shares issued and outstanding at September 30, 2012 and December 31, 2011		20,440			20,440
Capital surplus		25,942			25,915
Retained (deficit)		(19,791	)		(18,269	)
Accumulated other comprehensive income, net		478			36
Total shareholders’ equity		27,069			28,122
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	521,930		$	506,483

See Notes to Consolidated Financial Statements (Unaudited).

3

Alliance Bankshares Corporation

Consolidated Statements of Operations

For the Three Months Ended September 30, 2012 and 2011 (Unaudited)

(Dollars in thousands, except per share amounts)

	2012			2011
INTEREST INCOME:
Loans	$	3,973		$	4,574
Investment securities		155			802
Trading security		9			12
Federal funds sold		33			10
Total interest income		4,170			5,398
INTEREST EXPENSE:
Savings and NOW deposits		30			26
Time deposits		629			877
Money market deposits		34			45
Repurchase agreements		11			54
FHLB advances		267			261
Trust preferred capital notes		128			93
Total interest expense		1,099			1,356
Net interest income		3,071			4,042
Provision (recovery of ) for loan losses		(222	)		130
Net interest income after provision for loan losses		3,293			3,912
OTHER (LOSS):
Deposit account service charges		39			39
Net gain on sale of available-for-sale securities		168			2,120
Gain (loss) and fair value adjustments on trading security		58			(43	)
Fair value adjustments on FHLB advance		(459	)		(2,801	)
Other operating income		41			34
Total other (loss)		(153	)		(651	)
OTHER EXPENSES:
Salaries and employee benefits		956			1,197
Professional fees		465			398
Occupancy expense		581			578
Equipment expense		121			163
Other real estate owned expense		245			26
FDIC assessments		202			220
Merger expenses		248			619
Other operating expenses		648			866
Total other expenses		3,466			4,067
(Loss) before income taxes		(326	)		(806	)
Income tax (benefit)		(156	)		(303	)
Net (loss)	$	(170	)	$	(503	)
Net (loss) per common share, basic	$	(0.03	)	$	(0.10	)
Net (loss) per common share, diluted	$	(0.03	)	$	(0.10	)

See Notes to Consolidated Financial Statements (Unaudited)

4

Alliance Bankshares Corporation

Consolidated Statements of Operations

For the Nine Months Ended September 30, 2012 and 2011 (Unaudited)

(Dollars in thousands, except per share amounts)

	2012			2011
INTEREST INCOME:
Loans	$	12,245		$	13,674
Investment securities		810			3,290
Trading security		27			57
Federal funds sold		72			32
Total interest income		13,154			17,053
INTEREST EXPENSE:
Savings and NOW deposits		89			88
Time deposits		2,070			2,845
Money market deposits		95			139
Repurchase agreements		117			194
FHLB advances		803			776
Trust preferred capital notes		359			278
Total interest expense		3,533			4,320
Net interest income		9,621			12,733
Provision for loan losses		228			1,205
Net interest income after provision for loan losses		9,393			11,528
OTHER INCOME (LOSS):
Deposit account service charges		113			115
Net gain on sale of available-for-sale securities		171			3,034
(Loss) and fair value adjustments on trading security		(113	)		(76	)
Fair value adjustments on FHLB advance		(668	)		(2,874	)
Other operating income		119			153
Total other income (loss)		(378	)		352
OTHER EXPENSES:
Salaries and employee benefits		3,277			3,993
Professional fees		1,558			1,239
Occupancy expense		1,704			1,703
Equipment expense		391			486
Other real estate owned expense		340			77
FDIC assessments		633			860
Merger expenses		666			619
Other operating expenses		2,195			2,577
Total other expenses		10,764			11,554
Income (loss) before income taxes		(1,749	)		326
Income tax expense (benefit)		(227	)		70
NET INCOME (LOSS)	$	(1,522	)	$	256
Net income (loss) per common share, basic	$	(0.30	)	$	0.05
Net income (loss) per common share, diluted	$	(0.30	)	$	0.05

See Notes to Consolidated Financial Statements (Unaudited)

5

Alliance Bankshares Corporation

Consolidated Statements of Comprehensive Income (Loss)

For the Three and Nine Months Ended September 30, 2012 and 2011 (Unaudited)

(Dollars in thousands)

	For the Three Months Ended September 30,
	2012			2011
NET (LOSS)	$	(170	)	$	(503	)
Other comprehensive income (loss):
Unrealized holding gains on securities net of taxes of $104 in 2012 and $297 in 2011		202			576
Reclassification adjustment, net of taxes of ($57) in 2012 and ($722) in 2011		(111	)		(1,398	)
Total other comprehensive income (loss)		91			(822	)
TOTAL COMPREHENSIVE (LOSS)	$	(79	)	$	(1,325	)

See Notes to Consolidated Financial Statements (Unaudited)

	For the Nine Months Ended September 30,
	2012			2011
NET INCOME (LOSS)	$	(1,522	)	$	256
Other comprehensive income (loss):
Unrealized holding gains on securities net of taxes of $286 in 2012 and $1,293 in 2011		555			2,509
Reclassification adjustment, net of taxes of ($58) in 2012 and ($1,032) in 2011		(113	)		(2,002	)
Total other comprehensive income		442			507
TOTAL COMPREHENSIVE INCOME (LOSS)	$	(1,080	)	$	763

See Notes to Consolidated Financial Statements (Unaudited)

6

Alliance Bankshares Corporation

Consolidated Statements of Changes in Shareholders’ Equity

For the Nine Months Ended September 30, 2012 and 2011 (Unaudited)

(Dollars in thousands)

	Common Stock		Capital Surplus			Retained Deficit			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
BALANCE, DECEMBER 31, 2010	$	20,427	$	25,857		$	(12,311	)	$	(288	)	$	33,685
Net income		—		—			256			—			256
Other comprehensive income, net of tax		—		—			—			507			507
Exercise of stock options		9		(3	)		—			—			6
Stock-based compensation expense		—		10			—			—			10
BALANCE, September 30, 2011	$	20,436	$	25,864		$	(12,055	)	$	219		$	34,464
BALANCE, DECEMBER 31, 2011	$	20,440	$	25,915		$	(18,269	)	$	36		$	28,122
Net (loss)		—		—			(1,522	)		—			(1,522	)
Other comprehensive income, net of tax		—		—			—			442			442
Stock-based compensation expense		—		27			—			—			27
BALANCE, September 30, 2012	$	20,440	$	25,942		$	(19,791	)	$	478		$	27,069

See Notes to Consolidated Financial Statements (Unaudited)

7

Alliance Bankshares Corporation

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2012 and 2011 (Unaudited)

(Dollars in thousands)

	2012			2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		(1,522	)	$	256
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation, amortization and accretion		2,247			976
Loss on disposal of fixed assets		—			15
Provision for loan losses		228			1,205
Losses and valuation adjustments on other real estate owned		292			15
Stock-based compensation expense		27			10
Net (gain) on sale of securities available-for-sale		(171	)		(3,034	)
Fair value adjustments		780			2,950
Changes in assets and liabilities affecting operations:
Accrued interest and other assets		23			3,710
Other liabilities		(72	)		(752	)
Net cash provided by operating activities		1,832			5,351
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in federal funds sold		(10,027	)		(5,774	)
Purchase of securities available-for-sale		(65,582	)		(79,724	)
Proceeds from sale of securities available-for-sale		85,257			104,642
Paydowns on securities available-for-sale		23,364			9,014
Net change in trading security		190			1,963
Net change in restricted stock		800			1,131
Net change in loan portfolio		17,177			11,575
Proceeds from sale of other real estate owned		845			946
Purchase of premises and equipment		(82	)		(442	)
Net cash provided by investing activities		51,942			43,331
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in cash provided by (expended on):
Non-interest bearing deposits		32,845			1,233
Savings and NOW deposits		32,583			1,712
Money market deposits		(5,247	)		(1,864	)
Time deposits		(26,415	)		(5,693	)
Repurchase agreements		(17,862	)		(657	)
Proceeds from exercise of stock options		—			6
Net cash provided by (used in) financing activities		15,904			(5,263	)
NET INCREASE IN CASH AND CASH EQUIVALENTS		69,678			43,419
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		45,837			24,078
CASH AND CASH EQUIVALENTS, END OF PERIOD		115,515		$	67,497

See Notes to Consolidated Financial Statements (Unaudited)

8

Notes to Consolidated Financial Statements (Unaudited)

1. General

Alliance Bankshares Corporation (Bankshares or Company) is a bank holding company that conducts substantially all its operations through its subsidiaries. Alliance Bank Corporation (the Bank) is state-chartered and a member of the Federal Reserve System. The Bank places special emphasis on serving the needs of individuals, small and medium size businesses and professional concerns in the greater Washington, D.C. Metropolitan region, primarily in the Northern Virginia submarket.

On June 26, 2003, Alliance Virginia Capital Trust I (Trust), a Delaware statutory trust and a subsidiary of Bankshares was formed for the purpose of issuing Bankshares’ trust preferred debt.

On May 3, 2012, WashingtonFirst Bankshares, Inc. (WFBI), Bankshares and the Bank entered into an Agreement and Plan of Reorganization (Merger Agreement), pursuant to which Bankshares will merge with and into WFBI, with WFBI being the surviving corporation (Merger). Each share of Bankshares’ outstanding common stock will be converted into and become the right to receive, subject to proration in accordance with the terms of the Merger Agreement and at the election of each shareholder of Bankshares, either 0.4435 shares of common stock of WFBI or cash in the amount of $5.30, subject in either case to adjustment in the event that Bankshares’ shareholders’ equity (as defined in the Agreement), at the month-end prior to completion of the Merger has declined by more than 10% from the amount of Bankshares’ shareholders’ equity at December 31, 2011, and provided that no more than 20% of the common shares of Bankshares may elect to receive cash. Completion of the Merger is subject to (i) approval of the Merger by the shareholders of each of Bankshares and WFBI, (ii) applicable regulatory approvals, including those of the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Virginia State Corporation Commission, and (iii) other customary closing conditions.

Under the Merger Agreement, Bankshares agreed to conduct its business in the ordinary course while the Merger is pending, and, except as permitted under the Merger Agreement, to generally refrain from, among other things, redeeming, purchasing or otherwise acquiring any shares of its capital stock, amending its articles of incorporation or bylaws, soliciting any third party acquisition proposals and entering into any new line of business, without the consent of WFBI.

Additionally, Bankshares and the Bank are parties to a Memorandum of Understanding (the MOU) with the Federal Reserve Bank of Richmond and the Virginia Bureau of Financial Institutions, which is a regulatory means of seeking correction through informal administrative action from institutions considered to be of supervisory concern, but which have not deteriorated to the point where they warrant formal administrative action. Among the specific concerns cited in the MOU were asset quality, earnings, liquidity, and capital. The MOU imposes restrictions and/or requirements on Bankshares and the Bank, including (i) the requirement to be examined twice yearly by its regulators, (ii) the requirement to provide regular quarterly progress reports to the relevant regulators and (iii) the requirement that Bankshares and the Bank receive regulatory approval to pay dividends, repurchase common stock, and make interest or principal payments on subordinated debt and trust preferred securities. Bankshares has implemented significant improvements in credit policies, loan administration, and liquidity management in its efforts to comply with the terms of the MOU. The MOU also requires Bankshares to maintain a written plan for compliance with the capital adequacy rules applicable to all state member banks under Federal Reserve Board Regulation H (12 CFR Part 208). These rules require all state member banks, including the Bank, to maintain adequate capital consistent with their risk profiles, which takes into account the volume of adversely classified loans, the adequacy of the loan loss reserve, any planned asset growth and the nature and level of asset concentrations, among other things. Given this, it is the policy of federal banking regulators not to specify or confirm that a given capital level will be “adequate” at a future point in time. As a result, federal banking regulators have not, and Bankshares cannot, identify a specific dollar amount of capital required under the MOU. However, Bankshares estimates that it would need $7.5 million to $10 million in new capital to be compliant with applicable capital adequacy rules.

The accompanying unaudited consolidated financial statements reflect the financial condition and results of operations of Bankshares on a consolidated basis and have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial reporting. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications considered necessary to present fairly Bankshares’ financial position as of September 30, 2012 and December 31, 2011, the consolidated results of operations for the three and nine month periods ended September 30, 2012 and 2011, consolidated statements of

9

comprehensive income (loss) for the three and nine month periods ended September 30, 2012 and 2011, changes in shareholders’ equity for the nine month periods ended September 30, 2012 and 2011 and consolidated statements of cash flows for the nine month periods ended September 30, 2012 and 2011. The notes included herein should be read in conjunction with the financial statements and accompanying notes included in Bankshares’ Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission (the SEC).

Operating results for the three and nine month periods ended September 30, 2012 and 2011 are not necessarily indicative of full year financial results.

2. Stock Option Plan

Accounting Standards Codification (ASC) 718-10, “Stock Compensation”, requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options and nonvested shares, based on the fair value of those awards at the date of grant. Compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period.

As of September 30, 2012, there was $55 thousand of total unrecognized compensation expense related to stock options, which will be recognized over the remaining requisite service period which is estimated to be three years or less.

Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for each separately vesting portion of the award. The fair value of each grant is estimated at the grant date using the Black-Scholes option-pricing model. There were no grants of stock options for the first nine months of 2012.

10

Stock option activity for the nine months ended September 30, 2012 is summarized below:

	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Aggregate Intrinsic Value1 (in thousands)
Outstanding at January 1, 2012		257,846		$	8.88
Granted		—			—
Exercised		—			—
Forfeited		(15,700	)		11.29
Expired		(22,690	)		6.12
Outstanding at September 30, 2012		219,456		$	9.00		4.3	$	125
Exercisable at September 30, 2012		173,306		$	10.64		3.4	$	46

¹  Intrinsic value is the difference between the underlying stock’s price and the strike price. If the difference is negative, the intrinsic value is given as zero.

3. Fair Value Measurements

Bankshares uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of Financial Accounting Standards Board (FASB), ASC 820-10, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for Bankshares’ various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

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

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Fair Value Hierarchy

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

• Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets.

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

• Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect Bankshares’ own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

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

The following describes the valuation techniques used by Bankshares to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Trading and Available-for-Sale Securities — Trading and available-for-sale securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). Financial assets and liabilities that are traded infrequently have values based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own view about the assumptions that market participants would use in pricing the asset or liability (Level 3).

FHLB Advances — Under the fair value accounting standards, certain liabilities can be carried at fair value. The designated instruments are recorded on a fair value basis at the time of issuance. As of September 30, 2012, Bankshares had one wholesale liability as a fair value instrument: a long-term Federal Home Loan Bank (FHLB) advance.

Wholesale instruments are designated as either Level 2 or Level 3 under the ASC 820-10 fair value hierarchy. Level 2 liabilities are based on quoted market prices using independent valuation techniques for similar instruments with like characteristics. This

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information is deemed to be observable market data. Level 3 liabilities are financial instruments that are difficult to value due to dysfunctional, distressed markets or lack of actual trading volume. Management gathers certain data to value the instrument including swap curves, conversion swaptions and discounted cash flows. These data points are modeled to reflect the estimate of the fair value of the liability.

The following tables present the balances of financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011:

	Fair Value Measurements at September 30, 2012
	Carrying Value		Quoted Prices  in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Other Unobservable Inputs (Level 3)		Assets / Liabilities at Fair Value
	(Dollars in thousands)
Assets:
Trading securities - PCMO	$	293		—	$	293		—	$	293
Available-for-sale securities:
U. S. corporations and agencies		18,569		—		18,569		—		18,569
U. S. government CMOs		41,229		—		41,229		—		41,229
U. S. government MBS		9,768		—		9,768		—		9,768
PCMOs		932		—		932		—		932
Municipal securities		8,913		—		8,913		—		8,913
Total assets	$	79,704	$	—	$	79,704		—	$	79,704
Liabilities:
FHLB advance	$	30,018		—		—	$	30,018	$	30,018
Total liabilities	$	30,018		—		—	$	30,018	$	30,018

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	Fair Value Measurements at December 31, 2011
	Carrying Value		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Other Unobservable Inputs (Level 3)		Assets/ Liabilities at Fair  Value
	(Dollars in thousands)
Assets:
Trading securities - PCMO	$	596	$	—	$	596	$	—	$	596
Available-for-sale securities:
U. S. treasuries		71,115		71,115				—		71,115
U. S. corporations and agencies		9,751		—		9,751		—		9,751
U. S. government CMOs		31,038		—		31,038		—		31,038
U. S. government MBS		7,698		—		7,698		—		7,698
PCMOs		950		—		950		—		950
Municipal securities		2,911		—		2,911		—		2,911
Total assets	$	124,059	$	71,115	$	52,944		—	$	124,059
Liabilities:
FHLB advance	$	29,350	$	—	$	—	$	29,350	$	29,350
Total liabilities	$	29,350	$	—	$	—	$	29,350	$	29,350

The following table presents the activity in Level 3 fair value measurements for the three months ended September 30, 2012:

Fair Value Measurements Using Significant Unobservable Inputs (Level 3) (Dollars in thousands)
	FHLB Advance
Beginning balance, July 1, 2012	$	29,559
Realized losses on liabilities		459
Ending balance, September 30, 2012	$	30,018

14

The following tables present the activity in Level 3 fair value measurements for the nine months ended September 30, 2012 and the year ended December 31, 2011:

Fair Value Measurements Using Significant Unobservable Inputs (Level 3) (Dollars in thousands)
	Other Real Estate Owned			FHLB Advances
Beginning balance, January 1, 2012	$	1,473		$	29,350
Transfers out of Level 3		(1,473	)		—
Realized losses on liabilities		—			668
Ending balance, September 30, 2012		—		$	30,018

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
( Dollars in thousands)
	Other Real Estate Owned		FHLB Advances		AFS Securities			Trading Securities
Beginning balance, January 1, 2011	$	—	$	26,208	$	43,611		$	2,075
Transfers into (out of) Level 3		1,473		—		(26,940	)		(596	)
Sales, maturities or calls		—		—		(16,286	)		(1,489	)
Realized gains on assets		—		—		170			10
Realized losses on liabilities		—		3,142		—			—
Unrealized (losses) on assets		—		—		(555	)		—
Ending balance, December 31, 2011	$	1,473	$	29,350	$	—		$	—

For the assets and liabilities selected for fair value accounting where available, management obtained pricing on each instrument from independent third parties who relied upon pricing models using widely available and industry standard yield curves. At December 31, 2011, the securities previously carried at level three were moved to level two due to the fact that the pricing was identical to the normal market price. Management will continue to monitor these instruments. Changes in fair values associated with fluctuations in market values reported above are reported as fair value adjustments on the Consolidated Statements of Operations.

15

The following table displays quantitative information about Level 3 fair value measurements as of September 30, 2012 (Dollars in thousands):

	Fair Value		Valuation Technique	Unobservable Input	Range (Weighted Average)
FHLB advance	$	30,018	Pricing model	Yield curves	1.70% - 1.90% (2.11%)

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

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

Impaired Loans. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the underlying collateral, if any. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered to be Level 3. Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Operations.

Other Real Estate Owned (OREO). OREO is measured at fair value using an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2). However, if an appraisal of the real estate property is over two years old, then the fair value is considered to be Level 3. Any fair value adjustments are recorded in the period recognized as OREO expense in the Consolidated Statements of Operations.

16

The following tables summarize Bankshares’ assets that were measured at fair value on a nonrecurring basis as of the dates indicated.

	Carrying Value at September 30, 2012
Description	Carrying Value		Quoted Prices  in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Other Unobservable Inputs (Level 3)
	(Dollars in thousands)
Assets:
Impaired loans, net of valuation allowance	$	6,371		—	$	6,371		—
OREO	$	3,575		—	$	3,575		—

	Carrying Value at December 31, 2011
Description	Carrying Value		Quoted Prices  in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Other Unobservable Inputs (Level 3)
	(Dollars in thousands)
Assets:
Impaired loans, net of valuation allowance	$	6,760	$	—	$	6,760	$	—
OREO	$	3,748	$	—	$	2,275	$	1,473

The following describes the valuation techniques used by Bankshares to measure certain financial assets and liabilities not previously described in this note that are not recorded at fair value on a recurring basis in the financial statements:

Cash, Due from Banks, and Federal Funds Sold

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Loans Receivable

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

17

Restricted Stock

Restricted investments in correspondent banks are carried at cost based on the underlying redemption provisions of the instruments and therefore are not included in the fair value disclosures.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Deposit Liabilities

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

Short-Term Borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on Bankshares’ current incremental borrowing rates for similar types of borrowing arrangements.

Trust Preferred Capital Notes

The fair value of Bankshares’ Trust Preferred Capital Notes, which is discussed in Note 10, is estimated using discounted cash flow analyses based on Bankshares’ current incremental borrowing rates for similar types of borrowing arrangements.

Off-Balance-Sheet Financial Instruments

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.

18

The following tables reflect the fair value of financial instruments as of September 30, 2012 and December 31, 2011:

Fair Value of Financial Instruments

	Fair Value Measurements at September 30, 2012, Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Balance
	(Dollars in thousands)
Financial assets:
Cash and due from banks	$	115,515	$	115,515		—		—	$	115,515
Federal funds sold		26,594		26,594		—		—		26,594
Trading security		293		—		293		—		293
Available-for-sale securities		79,411		—		79,411		—		79,411
Loans, net		283,115		—		278,970		—		278,970
Accrued interest receivable		1,548		—		1,548		—		1,548
Financial liabilities:
Non-interest bearing deposits	$	145,295		—	$	145,295		—	$	145,295
Interest-bearing deposits		268,914		—		269,456		—		269,456
Short-term borrowings		22,558		—		22,558		—		22,558
FHLB advances		15,000		—		15,000		—		15,000
FHLB advances, at fair value		30,018		—		—		30,018		30,018
Trust Preferred Capital Notes		10,310		—		10,310		—		10,310
Accrued interest payable		1,486		—		1,486		—		1,486

	Fair Value Measurements at December 31, 2011 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Balance
	(Dollars in thousands)
Financial assets:
Cash and due from banks	$	45,837	$	45,837	$	—	$	—	$	45,837
Federal funds sold		16,567		16,567		—		—		16,567
Trading security		596		—		596		—		596
Available-for-sale securities		123,463		—		123,463		—		123,463
Loans, net		301,483		—		297,163		—		297,163
Accrued interest receivable		1,815		—		1,815		—		1,815
Financial liabilities:
Non-interest bearing deposits	$	112,450	$	—	$	112,450	$	—	$	112,450
Interest-bearing deposits		267,993		—		268,691		—		268,691
Short-term borrowings		40,420		—		40,420		—		40,420
FHLB advances		15,000		—		15,000		—		15,000
FHLB advances, at fair value		29,350		—		—		29,350		29,350
Trust Preferred Capital Notes		10,310		—		10,310		—		10,310
Accrued interest payable		1,155		—		1,155		—		1,155

19

4. Trading Security

The following table reflects the single trading security accounted for on a fair value basis and the effective yield of the instrument as of the dates indicated:

	September 30, 2012					December 31, 2011
	Fair Value		Yield			Fair Value		Yield
	(Dollars in thousands)
Trading security:
PCMO	$	293		5.43	%	$	596		5.44	%
Total trading security	$	293		5.43	%	$	596		5.44	%

As of September 30, 2012, trading security portfolio consisted of one PCMO instrument. This PCMO was rated AAA by at least one ratings agency on the purchase date. Currently the security has a rating below investment grade. The instrument is paying as agreed.

At September 30, 2012 and December 31, 2011, the trading security was not pledged.

5. Investment Securities

The amortized cost, unrealized gains and losses, and the fair value of available-for-sale investment securities at September 30, 2012 are summarized as follows:

	September 30, 2012
	Amortized Cost		Unrealized					Fair Value
			Gains		Losses
	(Dollars in thousands)
Available-for-sale securities:
U.S. government corporations and agencies		18,262		307		—			18,569
U.S. government agency CMOs		41,251		193		(215	)		41,229
U.S. government agency MBS		9,535		233		—			9,768
PCMOs		902		30		—			932
Municipal securities		8,732		246		(65	)		8,913
Total available-for-sale securities	$	78,682	$	1,009	$	(280	)	$	79,411

20

The amortized cost, unrealized gains and losses, and the fair value of available-for-sale investment securities at December 31, 2011 are summarized as follows:

	December 31, 2011
	Amortized		Unrealized					Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)
Available-for-sale securities:
U.S. treasuries	$	71,119	$	—	$	(4	)	$	71,115
U.S. government corporations and agencies		9,737		35		(21	)		9,751
U.S. government agency CMOs		30,893		195		(50	)		31,038
U.S. government agency MBS		7,672		26		—			7,698
PCMOs		1,005		—		(55	)		950
Municipal securities		2,982		70		(141	)		2,911
Total available-for-sale securities	$	123,408	$	326	$	(271	)	$	123,463

There were no held-to-maturity investments at September 30, 2012 or December 31, 2011.

21

The following tables present the aggregate amount of unrealized loss in investment securities as of September 30, 2012 and December 31, 2011. The aggregate amount is determined by summation of all the related securities that have a continuous loss at period end, and the length of time that the loss has been unrealized is shown by terms of “less than 12 months” and “12 months or more.” The fair value is the approximate market value as of the period end.

	September 30, 2012
	Less than 12 months					12 months or more				Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
	(Dollars in thousands)
U.S. government agency CMOs		23,845		(215	)		—		—		23,845		(215	)
Municipal securities		617		(65	)		—		—		617		(65	)
Total temporarily impaired investment securities	$	24,462	$	(280	)	$	—	$	—	$	24,462	$	(280	)

	December 31, 2011
	Less than 12 months					12 months or more					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
	(Dollars in thousands)
U.S. treasuries	$	71,115	$	(4	)	$	—	$	—		$	71,115	$	(4	)
U.S. government corporations and agencies		3,327		(21	)		—		—			3,327		(21	)
U.S. government agency CMOs		7,401		(50	)		—		—			7,401		(50	)
PCMOs		—		—			950		(55	)		950		(55	)
Municipal securities		526		(4	)		525		(137	)		1,051		(141	)
Total temporarily impaired investment securities	$	82,369	$	(79	)	$	1,475	$	(192	)	$	83,844	$	(271	)

Bankshares’ investment security portfolio is primarily comprised of U.S. government and fixed rate bonds, whose prices move inversely with interest rates. At the end of any accounting period, the portfolio may have both unrealized gains and losses. Unrealized losses within Bankshares’ portfolio typically occur as market interest rates rise. Such unrealized losses are considered temporary in nature. Under ASC 320-10-35, Debt and Equity Securities Recognition and Presentation of Other-Than-Temporary Impairments, an impairment is considered “other than temporary” if any of the following conditions are met: Bankshares intends to sell the security, it is more likely than not that Bankshares will be required to sell the security before recovery of its amortized cost basis, or Bankshares does not expect to recover the security’s entire amortized cost basis (even if Bankshares does not intend to sell). In the event that a security would suffer impairment for a reason that was “other than temporary,” Bankshares would be expected to write down the security’s value to its new fair value, and the amount of the write-down would be included in earnings as a realized loss. As of September 30, 2012 and December 31, 2011, management does not consider any of the unrealized losses to be other-than-temporarily impaired and no impairment charges have been recorded.

There are a total of 15 investment securities with a total fair value of $24.5 million that have an aggregate unrealized loss of $280 thousand and are considered temporarily impaired as of September 30, 2012. Management believes the unrealized losses noted in the table above are a result of current market conditions and interest rates, and do not reflect on the ability of the issuers to repay the obligations. Approximately $23.8 million or 97.1% of the investment securities with an unrealized loss are backed by U.S. government agencies and other forms of underlying collateral.

22

Bankshares’ investment in FHLB stock totaled $2.6 million at September 30, 2012. FHLB stock is generally viewed as a long term investment and as a restricted investment security which is carried at cost, because there is no market for the stock other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value. Bankshares does not consider this investment to be other than temporarily impaired as of September 30, 2012 and no impairment has been recognized. FHLB stock is included in restricted stock on the Consolidated Balance Sheets.

6. Loans

The following table summarizes the composition of the loan portfolio by dollar amount and percentage as of the dates indicated:

	September 30, 2012						December 31, 2011
	Amount			Percentage			Amount			Percentage
	(Dollars in thousands)
Real estate:
Residential real estate	$	92,443			32.1	%	$	101,248			33.0	%
Commercial real estate		125,602			43.6	%		137,610			44.8	%
Construction / land		41,478			14.4	%		39,176			12.8	%
Total real estate		259,523			90.1	%		278,034			90.6	%
Commercial and industrial		27,076			9.4	%		26,820			8.7	%
Consumer		1,382			0.5	%		2,022			0.7	%
Gross loans		287,981			100.0	%		306,876			100.0	%
Less: allowance for loan losses		(4,866	)					(5,393	)
Net loans	$	283,115					$	301,483

As of September 30, 2012 and December 31, 2011, there were $1 thousand and $25 thousand, respectively, in checking account overdrafts that were reclassified on the Consolidated Balance Sheets as loans.

23

The following tables represent the credit quality of loans by class for September 30, 2012 and December 31, 2011:

	As of September 30, 2012 (Dollars in thousands)
INTERNAL RISK RATING GRADES	Pass		Watch		Special Mention		Substandard		Doubtful		Loss		Total Loans
Risk Rating Number1		1 to 5		6		7		8		9		10
Commercial and industrial	$	24,083	$	787	$	205	$	2,001		—		—	$	27,076
Commercial real estate
Owner occupied		54,391		871		1,982		3,801		—		—		61,045
Non-owner occupied		56,289		4,736		1,731		1,801		—		—		64,557
Construction/land
Residential construction		16,037		792		—		—		559		—		17,388
Other construction & land		14,823		524		165		8,242		336		—		24,090
Residential real estate
Equity lines		27,031		321		99		150		—		—		27,601
Single family		51,801		2,729		2,684		2,235		—		—		59,449
Multifamily		5,393		—		—		—		—		—		5,393
Consumer - non real estate		1,181		8		181		12		—		—		1,382
Totals	$	251,029	$	10,768	$	7,047	$	18,242	$	895		—	$	287,981

	As of December 31, 2011 (Dollars in thousands)
INTERNAL RISK RATING GRADES	Pass		Watch		Special Mention		Substandard		Doubtful		Loss		Total Loans
Risk Rating Number1		1 to 5		6		7		8		9		10
Commercial and industrial	$	23,901	$	927	$	224	$	1,768	$	—	$	—	$	26,820
Commercial real estate
Owner occupied		63,192		625		1,742		2,610		—		—		68,169
Non-owner occupied		60,069		1,231		8,141		—		—		—		69,441
Construction/land
Residential construction		9,356		175		599		3,753		876		—		14,759
Other construction & land		16,018		—		1,662		5,837		900		—		24,417
Residential real estate
Equity lines		27,311		430		718		95		552		—		29,106
Single family		56,134		4,876		—		5,347		—		—		66,357
Multifamily		5,785		—		—		—		—		—		5,785
Consumer - non real estate		1,836		—		186		—		—		—		2,022
Totals	$	263,602	$	8,264	$	13,272	$	19,410	$	2,328	$	—	$	306,876

¹  Internal risk ratings of pass (rating numbers 1 to 5) and watch (rating number 6) are deemed to be unclassified assets. Internal risk ratings of special mention (rating number 7), substandard (rating number 8), doubtful (rating number 9) and loss (rating number 10) are deemed to be classified assets.

24

The following tables set forth aging and non-accrual loans by class as of the dates indicated:

	Aging and Non-accrual Loans by Class
	As of September 30, 2012
	(Dollars in thousands)
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		90-days Past Due and Still Accruing		Non- accrual Loans
Commercial & industrial	$	1,518	$	28	$	269		1,815	$	25,261		792	$	1,547
Commercial real estate
Owner occupied		355		99		2,475		2,929		58,116		—		2,475
Non-owner occupied		—		1,801		—		1,801		62,756		—		—
Construction/land
Residential construction		—		—		1,351		1,351		16,037		—		559
Other construction & land		165		983		4,866		6,014		18,076		—		5,849
Residential real estate
Equity lines		285		292		150		727		26,874		—		150
Single family		623		1,315		261		2,199		57,250		—		261
Multifamily		—		—		—		—		5,393		—		—
Consumer-non real estate		—		—		12		12		1,370		—		12
Total loans	$	2,946	$	4,518	$	9,384	$	16,848	$	271,133		792	$	10,853

25

	Aging and Non-accrual Loans By Class
	As of December 31, 2011
	(Dollars in thousands)
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		90-days Past Due and Still Accruing		Non- accrual Loans
Commercial and industrial	$	1,228	$	367	$	—	$	1,595	$	25,225	$	—	$	977
Commercial real estate
Owner occupied		121		—		2,610		2,731		65,438		—		2,610
Non-owner occupied		—		992		—		992		68,449		—		—
Construction/land
Residential construction		—		—		540		540		14,219		—		540
Other construction & land		—		1,225		5,988		7,213		17,204		—		7,139
Residential real estate
Equity lines		304		33		184		521		28,585		—		236
Single family		74		29		1,733		1,836		64,521		—		1,762
Multifamily		—		—		—		—		5,785		—		—
Consumer-non real estate		186		—		—		186		1,836		—		—
Total loans	$	1,913	$	2,646	$	11,055	$	15,614	$	291,262	$	—	$	13,264

26

7. Allowance for Loan Losses

The following table summarizes the activity in the allowance for loan losses for the periods presented:

	Nine Months Ended September 30, 2012			Year Ended December  31, 2011			Nine Months Ended September 30, 2011
	(Dollars in thousands)
Allowance for Loan Losses
Balance, beginning of period	$	5,393		$	5,281		$	5,281
Provision for loan losses		228			1,549			1,205
Loans charged off		(894	)		(1,702	)		(1,556	)
Recoveries of loans charged off		139			265			248
Net (charge offs)		(755	)		(1,437	)		(1,308	)
Balance, end of period	$	4,866		$	5,393		$	5,178

The following tables represent the allocation of allowance for loan losses by segment as of the dates indicated:

	September 30, 2012
	(Dollars in thousands)
	Commercial and Industrial			Commercial Real Estate			Construction Land		Residential Real Estate			Consumer			Total
Beginning Balance:	$	210		$	1,508		$	1,808	$	1,826		$	41		$	5,393
Charge-offs		—			—			—		(894	)		—			(894	)
Recoveries		—			—			—		139			—			139
Provision		(56	)		(53	)		68		282			(13	)		228
Ending Balance:	$	154		$	1,455		$	1,876	$	1,353		$	28		$	4,866
Individually evaluated for impairment	$	109		$	—		$	1,520	$	78			4		$	1,711
Collectively evaluated for impairment	$	45		$	1,455		$	356	$	1,275		$	24		$	3,155
Loans:
Ending Balance:	$	27,076		$	125,602		$	41,478	$	92,443		$	1,382		$	287,981
Individually evaluated for impairment	$	1,546		$	2,475		$	6,409	$	971			12		$	11,413
Collectively evaluated for impairment	$	25,530		$	123,127		$	35,069	$	91,472		$	1,370		$	276,568

27

Allowance for Loan Losses

As of December 31, 2011

(Dollars in thousands)

	Commercial and Industrial			Commercial Real Estate			Construction Land			Residential Real Estate			Consumer			Total
	(Dollars in thousands)
Beginning Balance:	$	463		$	1,420		$	700		$	2,613		$	85		$	5,281
Charge-offs		(10	)		(173	)		(404	)		(1,044	)		(71	)		(1,702	)
Recoveries		116			9			—			134			6			265
Provision		(359	)		252			1,512			123			21			1,549
Ending Balance:	$	210		$	1,508		$	1,808		$	1,826		$	41		$	5,393
Individually evaluated for impairment	$	—		$	135		$	1,376		$	760		$	—		$	2,271
Collectively evaluated for impairment	$	210		$	1,373		$	432		$	1,066		$	41		$	3,122
Loans:
Ending Balance:	$	26,820		$	137,610		$	39,176		$	101,248		$	2,022		$	306,876
Individually evaluated for impairment	$	977		$	2,610		$	7,678		$	1,999		$	—		$	13,264
Collectively evaluated for impairment	$	25,843		$	135,000		$	31,498		$	99,249		$	2,022		$	293,612

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Impaired loans and non-accrual loans are summarized as follows as of the dates indicated:

	September 30, 2012		December 31, 2011
	(Dollars in thousands)
Impaired loans without a valuation allowance	$	3,331	$	4,233
Impaired loans with a valuation allowance		8,082		9,031
Total impaired loans	$	11,413	$	13,264
Valuation allowance related to impaired loans	$	1,711	$	2,271
Total loans past due 90 days and still accruing, not included in total impaired loans	$	232	$	—
Average investment in impaired loans	$	12,017	$	13,538
Interest income recognized on impaired loans	$	45	$	234
Interest income recognized on a cash basis on impaired loans	$	45	$	234

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The following tables represent specific allocation for impaired loans by class as of the dates indicated:

	Specific Allocation for Impaired Loans By Class
	As of September 30, 2012
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
	(Dollars in thousands)
With no related allowance:
Commercial & industrial	$	896	$	1,005		—	$	1,018		—
Commercial real estate
Owner occupied		—		—		—		—		—
Non-owner occupied		—		—		—		—		—
Construction/land
Residential		—		—		—		—		—
Other construction & land		2,285		2,293		—		2,293
Residential real estate		—		—		—		—		—
Single family		150		150		—		150		—
With an allowance recorded:
Commercial & industrial		650		659		109		675		18
Commercial real estate
Owner occupied		2,475		2,634		1		2,648		—
Non-owner occupied		—		—		—		—		—
Construction/land
Residential construction		559		565		285		558		—
Other construction & land		3,565		3,821		1,235		3,835		—
Residential real estate
Single family		821		825		77		826		26
Consumer		12		12		4		14		1
Total:	$	11,413	$	11,964	$	1,711	$	12,017	$	45

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	Specific Allocation for Impaired Loans By Class
	As of December 31, 2011
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
	(Dollars in thousands)
With no related allowance:
Commercial & Industrial	$	977	$	1,033	$	—	$	1,037	$	15
Commercial Real Estate
Owner occupied		—		—		—		—		—
Non-owner occupied		—		—		—		—		—
Construction/Land
Residential		—		—		—		—		—
Other construction & land		2,293		2,293		—		2,199		87
Residential Real Estate
Single Family		963		963		—		968		37
Consumer		—		—		—
Other
With an allowance Recorded:
Commercial & Industrial		—		—		—
Commercial Real Estate
Owner occupied		2,610		2,669		135		2,311		20
Non-owner occupied		—		—		—		—		—
Construction/Land
Residential		540		546		259		546		—
Commercial		4,845		5,049		1,118		5,436		53
Residential Real Estate
Single Family		1,036		1,039		759		1,041		22
Total:	$	13,264	$	13,592	$	2,271	$	13,538	$	234

There were no non-accrual loans excluded from impaired loan disclosures as of September 30, 2012 and December 31, 2011. No additional funds are committed to be advanced in connection with impaired loans.

At September 30, 2012, there were $897 thousand in troubled debt restructured loans. At December 31, 2011, there were $956 thousand in troubled debt restructured loans.

There were no loans modified as TDRs and no TDR defaults during the three and nine months ended September 30, 2012.

For purposes of this disclosure, a TDR payment default occurs when, within 12 months of the original TDR modification, either the TDR is placed in non-accrual status or a charge-off has occurred.

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8. Other Real Estate Owned (OREO)

The table below reflects changes in OREO for the periods indicated:

	Nine Months Ended September 30, 2012			Twelve Months Ended December 31, 2011
	(Dollars in thousands)
Balance, beginning of period	$	3,748		$	4,627
Properties acquired at foreclosure		963			434
Sales of foreclosed properties		(905	)		(959	)
Valuation adjustments		(231	)		(354	)
Balance, end of period	$	3,575		$	3,748

The table below reflects expenses applicable to OREO for the periods indicated:

	Nine Months September 30, 2012		Twelve Months December 31, 2011		Nine Months September 30, 2011
	(Dollars in thousands)
Loss on sales of OREO	$	61	$	12	$	15
Valuation adjustments		231		354		—
Operating expenses, net of rental income		48		88		62
Total OREO expense	$	340	$	454	$	77

9. Federal Home Loan Bank Advances

Bankshares has two advances from the FHLB: one fixed rate advance and one floating rate advance.

At September 30, 2012 and December 31, 2011, the FHLB advance accounted for on a fair value basis had a value of $30.0 and $29.4 million, respectively, and matures in 2021. The weighted average interest rate on the long-term FHLB advance accounted for on a fair value basis was 3.985% at September 30, 2012 and December 31, 2011. The par value of the FHLB advance accounted for on a fair value basis was $25.0 million at September 30, 2012 and December 31, 2011.

At September 30, 2012 and December 31, 2011, there was one FHLB advance accounted for on a cost basis. Bankshares renewed this floating rate advance in the first quarter of 2012 for $15.0 million. The advance matures in 2013 and the interest rate at September 30, 2012 was 0.320% and at December 31, 2011 was 0.379%. The weighted average interest rate for both FHLB advances outstanding is 2.61%.

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10. Trust Preferred Capital Notes of Subsidiary Trust

On June 30, 2003, Bankshares’ wholly-owned Delaware statutory business trust privately issued $10.0 million face amount of the Trust’s floating rate trust preferred capital securities (Trust Preferred Capital Notes) in a pooled trust preferred capital securities offering. The trust issued $310 thousand in common equity to Bankshares. Simultaneously, the trust used the proceeds of the sale to purchase $10.3 million principal amount of Bankshares’ floating rate junior subordinated debentures due 2033 (Subordinated Debentures). Both the Trust Preferred Capital Notes and the Subordinated Debentures are callable at any time. The Subordinated Debentures are an unsecured obligation of Bankshares and are junior in right of payment to all present and future senior indebtedness of Bankshares. The Trust Preferred Capital Notes are guaranteed by Bankshares on a subordinated basis. The Trust Preferred Capital Notes are presented in the Consolidated Balance Sheets of Bankshares under the caption “Trust Preferred Capital Notes.” Bankshares records distributions payable on the Trust Preferred Capital Notes as an interest expense in its Consolidated Statements of Operations. The interest rate associated with the Trust Preferred Capital Notes is three month LIBOR plus 3.15% subject to quarterly interest rate adjustments. Under the indenture governing the Trust Preferred Capital Notes, Bankshares has the right to defer payments of interest for up to twenty consecutive quarterly periods. Beginning with the quarter ended September 30, 2009 and through September 30, 2012, Bankshares elected to defer the interest payments as permitted under the indenture. The interest deferred under the indenture compounds quarterly at the interest rate then in effect. As of September 30, 2012, the total amount of deferred and compounded interest owed under the indenture is $1.3 million. The base interest rate as of September 30, 2012 was 3.54% and as of December 31, 2011 was 3.70%. All or a portion of the Trust Preferred Capital Notes may be included in the regulatory computation of capital adequacy as Tier 1 capital. Under the current guidelines, Tier 1 capital may include up to 25% of shareholders’ equity excluding accumulated other comprehensive income (loss) in the form of Trust Preferred Capital Notes. At September 30, 2012 and December 31, 2011, $8.9 million and $9.4 million were considered Tier 1 capital.

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11. Net Income (Loss) Per Share

The following tables show the weighted average number of shares used in computing net income (loss) per share and the effect on weighted average number of shares of potential dilutive common stock. Potential dilutive common stock had no effect on income (loss) available to common shareholders for the periods presented.

Three Months Ended September 30,
	2012						2011
	Shares			Per Share Amount			Shares			Per Share Amount
Basic net (loss) per share		5,109,969		($	0.03	)		5,108,969		($	0.10	)
Effect of dilutive securities, stock options		—						—
Diluted net (loss) per share		5,109,969		($	0.03	)		5,108,969		($	0.10	)
Net (loss) utilized in the earnings per share calculations above (in thousands)	$	(170,000	)				$	(503,000	)

Nine Months Ended September 30,
	2012						2011
	Shares			Per Share Amount			Shares		Per Share Amount
Basic net income (loss) per share		5,109,969		($	0.30	)		5,108,616	$	0.05
Effect of dilutive securities, stock options		—						20,695
Diluted net income (loss) per share		5,109,969		($	0.30	)		5,129,311	$	0.05
Net income (loss) utilized in the earnings per share calculations above (in thousands).	$	(1,522,000	)				$	256,000

All average shares have been excluded from the calculation for the nine months ended September 30, 2012. Average shares of 167,306 have been excluded from the calculation for the nine months ended September 30, 2011, because their effects were anti-dilutive.

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12. Supplemental Cash Flow Information

Supplemental disclosures of cash flow information for the nine months ended September 30, 2012 and 2011:

	September 30, 2012		September 30, 2011
	(Dollars in thousands)
Supplemental Disclosures of Cash Flow Information:
Interest paid during the nine months	$	3,202	$	4,243
Income taxes paid during the nine months		—	$	—
Supplemental Disclosures of Non-cash Activities:
Fair value adjustment for securities	$	670	$	767
Transfer of loans to foreclosed assets	$	963	$	434

13. Income Taxes

Allocation of federal and state income taxes between current and deferred portions is as follows for the nine months ended September 30, 2012.

	September 30, 2012
	(Dollars in thousands)
Current	$	—
Deferred tax		(227	)
Income tax expense	$	(227	)

The reasons for the differences between the statutory federal income tax rate and the effective tax rate are summarized as follows:

	September 30, 2012
	(Dollars in thousands)
Computed at the expected statutory rate	$	(595	)
Tax exempt income, net		(54	)
Other		299
Change in valuation allowance		123
Income tax expense	$	(227	)

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Deferred Taxes. In accordance with ASC 740-10, Income Taxes (formerly SFAS No. 109, Accounting for Income Taxes), deferred tax assets are to be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The future realization of the tax benefit generated by net operating losses depends upon the existence of sufficient taxable income within the applicable carryback and carry forward periods. Bankshares periodically assesses the need to establish, increase, or decrease a valuation allowance for deferred tax assets.

Bankshares performed an analysis to determine if a valuation allowance for deferred tax assets was necessary. Bankshares’ analyzed and reviewed various forms of positive and negative evidence in determining whether a valuation allowance is necessary and if so to what degree a valuation allowance is warranted. The three year cumulative loss position of Bankshares is considered negative evidence when determining if a valuation allowance is necessary. Bankshares considered positive evidence such as previous earnings patterns, multiyear business projections and the potential realization of net operating loss (NOL) carry forwards within the prescribed time periods. In addition, Bankshares considered tax planning strategies that would impact the timing and extent of taxable income. Based on the analysis and the guidance in the relevant accounting literature, it is not considered more likely than not that Bankshares will be able to realize all its deferred tax assets. A valuation allowance of $5.3 million related to the deferred tax assets was recorded at December 31, 2011. The valuation allowance at September 30, 2012 related to the deferred tax assets was $5.5 million.

Bankshares evaluated the DTA related to the fair value adjustment of an FHLB advance separately from other DTAs. As the future taxable income implicit in the recovery of the book basis of the fair value adjustment offsets any potential future deductions underlying the DTA, Bankshares determined that no valuation allowance was necessary for this DTA. Bankshares has the ability and intent to retain the FHLB advance until such time as it recovers in value, which could be maturity.

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The components of the net deferred tax assets and liabilities are as follows:

	September 31, 2012
	(Dollars in thousands)
Deferred tax assets:
Bad debt expense	$	1,654
Deferred rent		14
Deferred data processing costs		111
Other real estate owned		1,107
Net operating loss carryforward		2,522
Other		457
Fair value adjustment		1,607
		7,472
Deferred tax liabilities:
Unrealized gain on available-for-sale securities		248
Deferred loan costs, net		128
Depreciation and amortization		34
Other		7
		417
Net deferred tax assets		7,055
Valuation allowance		(5,454	)
Deferred tax assets		1,601

14. Mergers and Acquisitions

On May 3, 2012, WFBI, Bankshares and the Bank entered into the Merger Agreement with respect to the Merger and a related bank merger agreement by and between the Bank and WashingtonFirst Bank (WF Bank), WFBI’s wholly owned subsidiary bank (Bank Merger). The consummation of the Merger and the Bank Merger are conditioned upon, among other things, approvals of applicable regulatory agencies and the shareholders of each of Bankshares and WFBI.

The consideration to be received by the shareholders of Bankshares in the Merger is a combination of stock and cash. Pursuant to the Merger Agreement, each share of Bankshares’ outstanding common stock will be converted into and become the right to receive, subject to proration in accordance with the terms of the Merger Agreement and at the election of each shareholder of Bankshares, either 0.4435 shares of common stock of WFBI or cash in the amount of $5.30, subject in either case to adjustment in the event that Bankshares’ shareholders’ equity (as defined in the Agreement), at the month-end prior to completion of the Merger has declined by more than 10% from amount of Bankshares’ shareholders’ equity at December 31, 2011, and provided that no more than 20% of the common shares of Bankshares may elect to receive cash.

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The Merger is expected to close in the fourth quarter of 2012, pending approval of the shareholders of each of Bankshares and WFBI and the receipt of all required regulatory approvals, as well as other customary conditions as described in the Current Report on Form 8-K previously filed on May 8, 2012.

15. Subsequent Events

Bankshares evaluated subsequent events that occurred after the balance sheet date, but before the financial statements are issued. There are two types of subsequent events: (1) recognized, or those that provide additional evidence about conditions that existed at the date of the balance sheet, including estimates inherent in the process of preparing financial statements, and (2) nonrecognized, or those that provided evidence about conditions that did not exist at the date of the balance sheet but arose after that date. As of the report date there were no subsequent events that would cause adjustments to or disclosures in the financial statements.

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

The following discussion is intended to assist readers in understanding and evaluating the financial condition and results of operations of Bankshares and the Bank on a consolidated basis. This discussion and analysis should be read in conjunction with Bankshares’ Annual Report on Form 10-K for the year ended December 31, 2011, and the unaudited consolidated financial statements and accompanying notes included elsewhere in this report.

Internet Access to Corporate Documents

Information about Bankshares can be found on the Bank’s website at www.alliancebankva.com. Under “Documents / SEC Filings” in the Investor Relations section of the website, Bankshares posts its annual reports, quarterly reports, current reports, definitive proxy materials and any amendments to those reports as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (SEC). All such filings are available free of charge.

The information available on the Bank’s website is not part of the Quarterly Report on Form 10-Q or any other report filed by Bankshares with the SEC.

Forward-Looking Statements

Some of the matters discussed below and elsewhere in this report include forward-looking statements. Forward-looking statements often use words such as “believe,” “expect,” “plan,” “may,” “will,” “should,” “project,” “contemplate,” “anticipate,” “forecast,” “intend” or other words of similar meaning. Forward-looking statements in this report may include, but are not limited to, statements regarding the proposed merger (the Merger) of Bankshares and WashingtonFirst Bankshares, Inc., estimated capital requirements under the MOU to be compliant with applicable capital adequacy rules, profitability, liquidity, Bankshares’ loan portfolio, adequacy of the allowance for loan losses and provisions for loan losses, trends regarding net charge-offs, trends regarding levels of non-performing assets, interest rates and yields, interest rate sensitivity, market risk, regulatory developments, capital requirements, business strategy, the effects of Bankshares’ efforts to reposition its business and other goals or objectives.

You can also identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. The forward-looking statements Bankshares makes in this report are subject to significant risks, assumptions and uncertainties, including among other things, the following important factors that could affect the actual outcome of future events:

• Changes in the strength of the national economy in general and the local economies in Bankshares market areas that adversely affect Bankshares’ customers and their ability to transact profitable business with us, including the ability of Bankshares’ borrowers to repay their loans according to their terms or a change in the value of the related collateral;

• Retention of existing employees;

• Maintaining and developing well established and valuable client relationships and referral source relationships;

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• Changing trends in customer profiles and behavior;

• Direct and substantive competition from other financial services companies targeting certain key business lines;

• Other competitive factors within the financial services industry;

• Changes in the availability of funds resulting in increased costs or reduced liquidity;

• Changes in accounting policies, rules and practices;

• Changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and disruption of the capital and credit markets, and soundness of other financial institutions Bankshares does business with;

• The timing of and value realized upon the sale of Other Real Estate Owned (OREO) property;

• Changes in the assumptions underlying the establishment of reserves for possible loan losses and other estimates;

• Fiscal and governmental policies of the United States federal government;

• Reactions in financial markets related to potential or actual downgrades in the sovereign credit rating of the United States and the budget deficit or national debt of the United States government;

• The impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act, related regulatory rulemaking processes and other legislative and regulatory initiatives on the regulation and supervision of financial institutions, specifically depository institutions;

• The impact of changes to capital requirements that apply to financial institutions and depository institutions, including changes related to the proposed Basel III capital standards;

• Changes in Bankshares’ and the Bank’s risk profile that cause the amount of new capital necessary for compliance with applicable capital adequacy rules to be materially different from Bankshares’ estimate;

• Changes in the way the FDIC insurance premiums are assessed;

• Changes in interest rates and market prices, which could reduce Bankshares’ net interest margins, asset valuations and expense expectations;

• Timing and implementation of certain balance sheet strategies;

• Impairment concerns and risks related to Bankshares’ investment portfolio, and the impact of fair value accounting, including income statement volatility;

• Assumptions used within our Asset Liability Management (ALM) process and Net Interest Income (NII) and Economic Value of Equity (EVE) models;

• Changes in tax laws and regulations;

• Bankshares’ ability to recognize future tax benefits;

• Impacts of implementing various accounting standards;

• Deposit attrition, operating costs, customer losses and business disruption in connection with the Merger, including adverse effects on relationships with employees, may be greater than expected;

• The ability to complete the Merger as expected and within the expected timeframe;

• The possibility that required regulatory and shareholder approvals of the Merger may not be obtained, or one or more of the other conditions to the completion of the Merger may not be satisfied;

• The expected growth opportunities or cost savings from the Merger may not be fully realized or may take longer to realize than expected; and

• Other factors described from time to time in our SEC filings.

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In addition, Bankshares’ business and financial performance could be impacted as the financial industry restructures in the current environment, both by changes in the creditworthiness and performance of Bankshares’ counterparties and by changes in the regulatory and competitive landscape. Additionally, other risks that could cause actual results to differ from predicted results are set forth in Item 1A of Bankshares’ Annual Report on Form 10-K for the year ended December 31, 2011.

Because of these and other uncertainties, Bankshares’ actual results and performance may be materially different from results indicated by these forward-looking statements. In addition, Bankshares’ past results of operations are not necessarily indicative of future performance.

Bankshares cautions you that the above list of important factors is not exclusive. These forward-looking statements are made as of the date of this report, and Bankshares may not undertake steps to update these forward-looking statements to reflect the impact of any circumstances or events that arise after the date the forward-looking statements are made.

Critical Accounting Policies

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

Allowance for Loan Losses. The allowance for loan losses is an estimate of the losses that may be sustained in Bankshares’ loan portfolio. The allowance is based on two basic principles of accounting: (1) ASC 450-10-05, Contingencies which requires that losses be accrued when they are probable of occurring and estimable, and (2) ASC 310-10-35, Receivables which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The allowance for loan losses has two basic components: the general allowance and the specific allowance.

The general allowance is developed following the accounting principles contained in ASC 450-10-05, Contingencies and represents the largest component of the total allowance. It is determined by aggregating unclassified loans and unimpaired loans by loan type based on common purpose, collateral, repayment source or other credit characteristics and then applying factors which in the judgment of management represent the expected losses inherent in the portfolio. In determining these factors, Bankshares considers the following: (1) delinquencies and overall risk ratings, (2) loss history, (3) trends in volume and terms of loans, (4) effects of changes in lending policy, (5) the experience and depth of the borrowers’ management, (6)

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national and local economic trends, (7) concentrations of credit by individual credit size and by class of loans, (8) quality of loan review system and (9) the effect of external factors (e.g., competition and regulatory requirements).

ASC 310-10-35, Receivables is the basis upon which Bankshares determines specific reserves on individual loans which comprise the specific allowance. Specific loans to be evaluated for impairment are identified based on the borrower’s loan size and the loan’s risk rating, collateral position and payment history. If it is determined that it is likely that the Bank will not receive full payment in a timely manner, the loan is determined to be impaired. Each such identified loan is then evaluated to determine the amount of reserve that is appropriate based on ASC 310-10-35. This standard also requires that losses be accrued based on the differences between the value of collateral, present value of expected future cash flows or values that are observable in the secondary market and the loan balance.

Share-Based Compensation. ASC 718-10, Stock Compensation, requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options and nonvested shares, based on the fair value of those awards at the date of grant. Compensation cost has been measured using the Black-Scholes model to estimate fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period.

Deferred Tax Asset. Bankshares routinely evaluates the likelihood of the recognition of deferred tax assets. The analysis is used to determine if a valuation allowance for deferred tax assets is necessary. Bankshares reviews and analyzes various forms of positive and negative evidence in determining whether a valuation allowance is necessary and if so to what degree a valuation allowance is warranted.

At December 31, 2011, Bankshares performed an analysis to determine if a valuation allowance for deferred tax assets was necessary. Its analysis reviewed various forms of positive and negative evidence in determining whether a valuation allowance is necessary and if so to what degree a valuation allowance is warranted. The three year cumulative loss position of Bankshares is considered negative evidence when determining if a valuation allowance is necessary. Bankshares considered positive evidence such as previous earnings patterns, multiyear business projections and the potential realization of net operating loss (NOL) carry forwards within the prescribed time periods. In addition, Bankshares considered tax planning strategies that would impact the timing and extent of taxable income. Based on the analysis and the guidance in the relevant accounting literature, it was considered more likely than not, that Bankshares will not be able to realize all its deferred tax assets. As of September 30, 2012, the net deferred tax asset was $1.6 million, compared to $1.5 million as of December 31, 2011.

Overview

On May 3, 2012, WashingtonFirst Bankshares, Inc. (WFBI), Bankshares and the Bank entered into an Agreement and Plan of Reorganization (Merger Agreement), pursuant to which Bankshares will merge with and into WFBI, with WFBI being the surviving corporation. Under the Merger Agreement, Bankshares agreed to conduct its business in the ordinary course while the Merger is pending, and, except as permitted under the Merger Agreement, to generally

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refrain from specific actions without the consent of WFBI. Completion of the Merger is subject to approval by the shareholders of each of Bankshares and WFBI, applicable regulatory approval and customary closing conditions.

On May 31, 2012, in contemplation of the pending Merger and after consulting with Washington First Bank, Bankshares exercised its’ early termination clause in the lease agreement with Carr Properties on the Corporate Headquarters location in Chantilly, Virginia. This event triggered a payment of $675 thousand which is recorded in the financial statements as other assets according to the guidance outlined in ASC 805 and 420.

Notwithstanding the Merger Agreement, Bankshares’ primary long-term goals continue to be maximizing earnings and deploying capital in profit driven initiatives that will enhance shareholder value in a sustainable fashion. In pursuit of these goals, Bankshares’ current emphasis is on optimizing profitability in the near term and strengthening its financial performance, while also transitioning its operations to focus more closely on traditional banking activities and to reposition Bankshares for the future. Bankshares’ transitional strategies include, among others, continuing the following initiatives:

• Diversifying the loan portfolio by increasing Bankshares’ focus on commercial loans and loans secured by owner occupied commercial real estate, while continuing to be an active lender in attractive aspects of the residential and commercial real estate markets.

• Reducing the investment securities portfolio and eliminating the trading assets portfolio.

• Continuing to attentively manage the level of non-performing assets by addressing problem loans on a timely basis.

• Increasing low cost deposits by local commercial and retail customers, while working to reduce Bankshares’ brokered deposit and repurchase agreement portfolios.

• Reducing Bankshares’ operating and funding costs.

Additionally, Bankshares and the Bank are parties to a Memorandum of Understanding (the MOU) with the Federal Reserve Bank of Richmond and the Virginia Bureau of Financial Institutions, which is a regulatory means of seeking correction through informal administrative action from institutions considered to be of supervisory concern, but which have not deteriorated to the point where they warrant formal administrative action. Among the specific concerns cited in the MOU were asset quality, earnings, liquidity, and capital. The MOU imposes restrictions and/or requirements on Bankshares and the Bank, including (i) the requirement to be examined twice yearly by its regulators, (ii) the requirement to provide regular quarterly progress reports to the relevant regulators and (iii) the requirement that Bankshares and the Bank receive regulatory approval to pay dividends, repurchase common stock, and make interest or principal payments on subordinated debt and trust preferred securities. Bankshares has implemented significant improvements in credit policies, loan administration, and liquidity management in its efforts to comply with the terms of the MOU. The MOU also requires Bankshares to maintain a written plan for compliance with the capital adequacy rules applicable to all state member banks under Federal Reserve Board Regulation H (12 CFR Part 208). These rules require all state member banks, including the Bank, to maintain adequate capital consistent with their risk profiles, which takes into account the volume of adversely classified loans, the adequacy of the loan loss reserve, any planned asset growth and the nature and level of asset concentrations, among other things. Given this, it is the policy of federal banking regulators not to specify or confirm that a given capital level will be “adequate” at a future point in time. As a result, federal banking regulators have not, and Bankshares cannot, identify a specific dollar amount of capital required under the MOU. However, Bankshares estimates that it would need $7.5 million to $10 million in new capital to be compliant with applicable capital adequacy rules.

Performance Highlights

• The net loss for the quarter ended September 30, 2012 was $170 thousand compared to a net loss of $503 thousand for the same period in 2011, an improvement of $333 thousand. The net loss was $1.5 million for the nine months ended September 30, 2012 compared to net income of $256 thousand for the nine months ended September 30, 2011, a decrease of $1.8 million. Loss per common share, basic and diluted, amounted to $0.30 for the nine months ended September 30, 2012, compared to earnings per share of $0.05 for the nine months ended September 30, 2011. Earnings for the nine months ended September 30, 2012, were negatively affected by merger related expenses of $666 thousand, the negative fair value adjustment on the FHLB advance of $668 thousand and a reduction in interest income of $3.9 million, from $17.1 million for the nine months ended September 30, 2011 to $13.2 million for the nine months ended September 30, 2012. Due to the improvement in the overall risk profile of the loan portfolio and the lower level of total loans, Alliance released $223 thousand of reserves into income and also did not recognized a provision expense during the quarter, this has positively affected net income for the period. The reduction in interest income is comprised of a $1.4 million decrease in the loan interest income and a $2.5 million decrease in the interest income from investment securities.

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• Total assets were $521.9 million at September 30, 2012, an increase of $15.4 million from total assets of $506.5 million at December 31, 2011. The increase in total assets is directly related to a $69.7 million increase in cash and due from banks, with such increase being offset by $18.9 million decrease in the loan portfolio related to the payoff of a number of loan relationships as well as a $44.1 million reduction in Bankshares’ investment portfolio. The increase in cash relates to the cyclical nature of the business of Bankshares’ title and escrow clients.

• Total loans were $288.0 million at September 30, 2012, a decrease of $18.9 million, or 6.2% from the December 31, 2011 balance of $306.9 million. The decrease in total loans results from a combination of strategic repositioning of lending activities, normal amortization and payoffs, the total of which offset new loan production during the period. Each loan segment as a percentage of total loans at September 30, 2012 is nearly unchanged from the percentages at December 31, 2011.

• Demand deposits were $145.3 million at September 30, 2012, or 35.1% of total deposits. This compares to the December 31, 2011 level of $112.5 million, or 29.6% of total deposits.

• The composition of non-performing assets as of September 30, 2012 was primarily comprised of $10.9 million of non-accrual loans, $3.6 million of OREO, $897 thousand of troubled debt restructured loans, compared to the composition of non-performing assets as of December 31, 2011, which was $13.3 million of non-accrual loans, $3.7 million of OREO and $956 thousand of troubled debt restructured loans for a total of $18.0 million. The non-performing assets balance decreased by $2.0 million at September 30, 2012 compared to December 31, 2011. The change resulted from the following: the charge off of six loans secured by residential real estate, totaling $838 thousand; the foreclosure and purchase into OREO of a residential property valued at $963 thousand; the full repayment of a commercial loan secured by land with a prior balance of $899 thousand; the movement back to accrual status of two loans secured by land totaling $325 thousand; and , the receipt of ongoing payments from a borrower with three outstanding loans secured by land and construction equipment totaling $4.4 million that are carried in non-accrual status; such payments reduced Bankshares’ carrying balance by $85 thousand during 2012. Since December 31, 2011, six loans totaling $1.1 million have been added to the non-accrual and impaired loan list. Of these six loans, 95% are secured by residential real estate.

• The investment securities portfolio totaled $79.4 million at September 30, 2012. This compares to $123.5 million of investments as of December 31, 2011, a decrease of $44.1 million. This decrease is attributable to management’s strategy to reduce the investment portfolio by taking some opportunistic gains to mitigate some of the losses realized in the CMO portfolio and to improve the overall yield. In addition, the investment securities portfolio contains mortgage oriented products (CMO, PCMO, and MBS) and SBA securities. When prepayments on these instruments occur at a faster rate than anticipated, principal is paid down earlier than expected. During the nine months ended September 30, 2012, the Bank experienced greater than expected prepayments on a variety of investment securities.

• The net interest margin for the quarter ended September 30, 2012 was 3.02% compared to 3.61% for the same 2011 period, a decrease of 59 basis points. For the nine months ended September 30, 2012, the net interest margin of 3.10% was 64 basis points lower than the net interest margin of 3.74% for the nine months ended September 30, 2011.

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For the nine months ended September 30, 2012, Bankshares experienced early prepayments on a number of CMO’s and PCMO’s securities. When prepayments on these instruments occur at a faster rate than anticipated, premium amortization increases which adversely impacts the portfolio yield, the Bank experiences greater than expected prepayments on a variety of investment securities.

• Deposits were $414.2 million at September 30, 2012, an increase of $33.8 million from the December 31, 2011 balance of $380.4 million. Strong growth in the title agency-related deposit coupled with a strategic shift of funding from repurchase agreements into deposits, contributed to the increase in overall deposit balance. Savings and NOW accounts increased by $32.6 million from $51.5 million at December 31, 2011 to $84.1 million at September 30, 2012 and non-interest bearing deposits increased by $32.8 million, from $112.5 million at December 31, 2011 to $145.3 million at September 30, 2012. These increases were offset by decreases in money market deposits of $5.3 million, from $23.4 million at December 31, 2011 to $18.1 million at September 30, 2012, and time deposits of $26.4 million, from $193.1 million at December 31, 2011 to $166.7 million at September 30, 2012.

• Non-interest expense for the three months ended September 30, 2012 amounted to $3.5 million compared to $4.1 million for the same period in 2011 a reduction of $601 thousand. For the nine months ended September 30, 2012, non-interest expense amounted to $10.8 million compared to $11.6 million in 2011, a reduction of $800 thousand. The non-interest expense for the nine months ended September 30, 2012, include merger related expenses of $666 thousand, consultant expenses related to contract employees of $445 thousand and OREO expenses including valuation adjustments of $340 thousand.

45

Financial Performance Measures. Bankshares’ net loss for the three month period ended September 30, 2012 was $170 thousand, an improvement of $333 thousand over the third quarter of 2011 net loss of $503 thousand. The net loss of $170 thousand for the quarter ended September 30, 2012 includes net interest income of $3.1 million compared to $4.0 million for the same period last year, a decrease of $900 thousand. Results during the quarter ended September 30, 2012 were primarily impacted by reduced interest income, merger-related expenses, OREO expenses and valuation write-downs, and a negative adjustment to the $25 million FHLB advance recorded at fair value, the total of which offset gains on the sale of investment securities and favorable reductions in non-interest expenses and interest expenses. Due to the improvement in the overall risk profile of the loan portfolio and a lower level of total loans, In addition, Alliance released reserves into income and also did not recognize a provision expense during the quarter. For the three months ended September 30, 2012, total interest expense was $1.1 million compared to $1.4 million for the three months ended September 30, 2011. These factors led to $0.03 basic and diluted loss per share for the quarter ended September 30, 2012, compared to $0.10 basic and diluted loss per share for the quarter ended September 30, 2011. Weighted average basic shares outstanding were 5,109,969 for the three months ended September 30, 2012 and 5,108,969 for the three months ended September 30, 2011. Weighted average diluted shares outstanding were 5,109,969 for the three months ended September 30, 2012 and 5,108,969 for the three months ended September 30, 2011.

For the nine month period ended September 30, 2012, Bankshares had a net loss of $1.5 million compared to net income of $256 thousand for the same period in the prior year, a decline of $1.8 million. The net loss of $1.5 million for the nine months ended September 30, 2012 includes net interest income of $9.6 million compared to $12.7 million for the same period last year, a decrease of $3.1 million. The decrease is due primarily to a decrease in interest income in the amount of $3.9 million, from $17.1 million for the nine months ended September 30, 2011, to $13.2 million for the same period in 2012, and the lower average yield on the investment portfolio and the lower average balances on the loan portfolio. The decrease was partially offset by a reduction of $787 thousand in the cost of funds. For the nine months ended September 30, 2012, total interest expense was $3.5 million compared to $4.3 million for the nine months ended September 30, 2011. These factors led to a $0.30 basic and diluted loss per share for the nine months ended September 30, 2012. The basic and diluted earnings per share for the nine months ended September 30, 2011 was $0.05. Weighted average basic shares outstanding were 5,109,969 for the nine months ended September 30, 2012 and 5,108,616 for the nine months ended September 30, 2011. Weighted average diluted shares outstanding were 5,109,969 and 5,129,311 for the nine months ended September 30, 2012 and September 30, 2011, respectively.

The net interest margin decreased to 3.02% for the three months ended September 30, 2012 compared to 3.61% for the three months ended September 30, 2011, a decrease of 59 basis points. The net interest margin was 3.10% for the nine months ended September 30, 2012

46

compared to 3.74% for the nine months ended September 30, 2011, a decrease of 64 basis points. For the first nine months of 2012 the net interest margin continues to be negatively affected by the decrease in the yield on interest earning assets. Targeted efforts to strategically restructure Bankshares’ balance sheet in anticipation of the merger with Eagle during 2011 led to shifts in Bankshares’ investment portfolio mix and the overall reduced balance and yield on the portfolio, and the unexpected prepayments on the CMO instruments in the portfolio. Yield on the investment portfolio for the nine months ended September 31, 2012 was 1.09% compared to 3.57% for the same period in 2011. Total interest income reversal relating to non-accrual loans for the nine months ended September 30, 2012 was $355 thousand compared to $461 thousand for the nine months ended September 30, 2011.

Results of Operations

Net Interest Income. Net interest income (on a fully tax equivalent basis) for the three months ended September 30, 2012 was $3.1 million compared to $4.0 million for the same period in 2011. Interest income on earning assets was $1.2 million lower for the three months ended September 30, 2012, compared to the third quarter of 2011, while interest expense decreased $257 thousand during the same time period.

Net interest income for the nine months ended September 30, 2012 was $9.6 million compared to $12.8 million for the same period in 2011. Interest income on earning assets was $3.9 million lower for the nine months ended September 30, 2012, compared to the first nine months of 2011. Of the $3.9 million decrease in interest income, $1.1 million is attributable to the $27.5 million lower average balance in loans. The reduction in the average balance in the investment securities portfolio was $17.3 million and contributed $2.5 million to the reduction in interest income. This was offset by the decrease in interest expense of $787 thousand. The average balance of interest bearing deposits decreased by $18.0 million and contributed $818 thousand to the reduction in interest expense.

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The following table illustrates average balances of total interest-earning and non-interest earning assets as well as total interest-bearing and non-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.

Average Balances, Interest Income and Expense and Average Yield and Rates⁽¹⁾

	Three Months Ended September 30,
	2012								2011
	Average Balance			Income / Expense		Yield / Rate 1			Average Balance			Income / Expense		Yield / Rate 1
	(Dollars in thousands)
Assets
Interest-earning assets:
Loans (2)	$	288,421		$	3,973		5.48	%	$	320,004		$	4,574		5.67	%
Trading securities		276			9		12.97	%		639			12		7.45	%
Investment securities		98,950			182		0.73	%		117,771			823		2.77	%
Federal funds sold		19,876			33		0.66	%		7,674			10		0.52	%
Total interest earning assets		407,523			4,197		4.10	%		446,088			5,419		4.82	%
Non-interest earning assets:
Cash and due from banks		61,100								24,594
Premises and equipment		1,179								1,613
Other real estate owned (OREO)		3,821								4,150
Other assets		8,446								14,596
Less: allowance for loan losses		(5,162	)							(5,655	)
Total non-interest earning assets		69,384								39,298
Total Assets	$	476,907							$	485,386
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing demand deposits	$	60,271		$	29		0.19	%	$	40,475		$	25		0.25	%
Money market deposit accounts		17,649			34		0.77	%		24,612			45		0.73	%
Savings accounts		4,703			1		0.08	%		3,152			1		0.13	%
Time deposits		168,722			629		1.48	%		197,008			877		1.77	%
Total interest-bearing deposits		251,345			693		1.10	%		265,247			948		1.42	%
FHLB advances(3)		44,564			267		2.38	%		41,311			261		2.51	%
Other borrowings		37,210			139		1.49	%		50,871			147		1.15	%
Total interest-bearing liabilities		333,119			1,099		1.31	%		357,429			1,356		1.51	%
Non-interest-bearing liabilities:
Demand deposits		113,770								89,101
Other liabilities		2,775								2,571
Total liabilities		449,664								449,101
Shareholders’ Equity		27,243								36,285
Total Liabilities and Shareholders’ Equity	$	476,907							$	485,386
Interest Spread (4)							2.79	%							3.31	%
Net Interest Margin (5)				$	3,098		3.02	%				$	4,063		3.61	%

⁽¹⁾  The rates and yields are on a fully tax equivalent basis assuming a 34% federal tax rate.

⁽²⁾ The Bank had average non-accrual loans of $11.4 million and $10.8 million in the third quarter of 2012 and 2011. The 2012 and 2011 interest income on non-accrual loans excluded from the loans above was $171 thousand and $150 thousand, respectively.

⁽³⁾  The Bank had two FHLB advances during the periods presented: a $15.0 million floating rate advance accounted for on a cost basis and a $25.0 million par value fixed rate advance accounted for on a fair value basis. The average fair value of the fixed rate FHLB advance for the second quarter of 2012 and 2011 was $30.0 million and $29.3 million, respectively. As of September 30, 2012, the fair value of the fixed rate FHLB advance was $30.0 million.

⁽⁴⁾ Interest spread is the average yield earned on earning assets, less the average rate incurred on interest-bearing liabilities.

⁽⁵⁾ Net interest margin is net interest income expressed as a percentage of average earning assets.

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Average loan balances were $288.4 million for the three months ended September 30, 2012 compared to $320.0 million for the same period in 2011. The $31.6 million decline is average loan balances is concentrated in a $10 million decline in C&I loan balances centered in the loss of two large lines of credit; $9.5 million reduction in Owner-occupied Commercial Mortgages where borrowers refinanced with other lenders and a $9 million decline in Residential Investment Mortgage Loans, primarily due to reduced activity with our larger Residential Flippers who buy and sell properties within a 12 month time frame.”

Bankshares longer-term strategy is to grow small business commercial loans and owner occupied commercial real estate, and focus on Bankshares’ geographical area. The related interest income from loans was $4.0 million in the three months ended September 30, 2012 compared to $4.6 million in the same period in 2011. The average yield on loans of 5.48% during the three months ended September 30, 2012 was 19 basis points lower than the yield of 5.67% in the third quarter of 2011. Interest rates are established for classes of loans that include variable rates based on Wall Street Journal Prime or other identifiable bases while others carry fixed rates with terms out to 15 years. Most new variable rate originations include minimum start rates and/or floors.

For the three months ended September 30, 2012, Bankshares held one security in its trading portfolio with an average balance of $276 thousand, compared to $639 thousand for the three months ended September 30, 2011. The trading security interest income for the three months ended September 30, 2012 was $9 thousand compared to $12 thousand for the three months ended September 30, 2011. At September 30, 2012, the carrying value of the security was $293 thousand.

Investment securities averaged $99.0 million for the quarter ended September 30, 2012 compared to $117.8 million for the same quarter in 2011. Investment securities income (on a fully tax equivalent basis) was $182 thousand for the three months ended September 30, 2012 compared to $823 thousand for the three months ended September 30, 2011. The tax equivalent average yield on investment securities for the three months ended September 30, 2012, was 0.73% compared to 2.77% for the three months ended September 30, 2011. The reduction in the average balance of the investment securities portfolio reflects management’s targeted efforts to strategically restructure Bankshares’ balance sheet in anticipation of the merger during 2011 that led to shifts in Bankshares’ investment portfolio mix, the reduction in the portfolio and the reduction in the overall yield. During the second quarter and continuing into the third quarter of 2012, the Bank experienced greater than expected prepayments on a variety of investment securities which impacted the yield on the portfolio. When repayments occur at a faster rate than anticipated, premium amortization increases and adversely impact the portfolio yield.

Short-term investments in federal funds sold contributed $33 thousand to interest income in the three month period ended September 30, 2012, compared to $10 thousand for the same period in 2011. The average balance for the three months ended September 30, 2012 was $19.9 million, a $12.2 million increase from the prior year average balance of $7.7 million. The increase in federal funds sold is due to the increase in the Title and Escrow businesses accounts during the quarter.

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The average balance of cash and due from banks was $61.1 million and $24.6 million for the three months ended September 30, 2012 and 2011, respectively.

Total average interest earning assets yielded 4.10% for the three months ended September 30, 2012 compared to the yield of 4.82% for the same period in 2011. Total interest income was $4.2 million for the three months ended September 30, 2012 compared to $5.4 million for the three months ended September 30, 2011. As discussed above, interest income decreased in the third quarter of 2012 compared to the third quarter of 2011 due to the smaller average loans and securities balances, which are a product of Bankshares’ strategies to reposition its balance sheet, and lower yields generated by Bankshares’ interest-earning assets in the low interest rate environment, coupled with the unexpected prepayments on the CMO instruments in the investment portfolio.

Total average interest-bearing liabilities were $333.1 million in the third quarter of 2012, or $24.3 million lower than the third quarter of 2011 level of $357.4 million. A key driver of the decline was the decrease in average time deposits. The average balance of time deposits for the third quarter of 2012 was $168.7 million compared to the third quarter of 2011 average balance of $197.0 million, a decrease of $28.3 million. Interest expense for all interest-bearing liabilities amounted to $1.1 million for the three months ended September 30, 2012 compared to $1.4 million for the three months ended September 30, 2011, or a decrease of $257 thousand. The average cost of interest-bearing liabilities for the third quarter of 2012 was 1.31% or 20 basis points lower than the third quarter of 2011 level of 1.51%. The lower interest rate environment allowed for competitive repricing of interest bearing demand accounts, money market accounts, savings accounts and title client based time deposits. The benefits of the repricing are seen in the lower time deposit cost of 1.48% during the third quarter of 2012 compared to 1.77% during the same period of 2011.

For the three months ended September 30, 2012, the brokered certificate of deposit portfolio carried an average coupon rate of 1.24% compared to an average coupon rate of 1.71% at September 30, 2011. When maturing wholesale deposits mature and are replaced, Bankshares is able to secure new brokered deposits at lower rates.

Non-interest bearing demand deposits averaged $113.8 million for the third quarter of 2012, $24.7 million more than the third quarter of 2011 level of $89.1 million. This increase is due to the cyclical fluctuation in the title and escrow customer business and the growth in the title agency-related deposits, coupled with a strategic shift of funding from repurchase agreements into deposits.

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Average Balances, Interest Income and Expense and Average Yield and Rates⁽¹⁾

	Nine Months Ended September 30,
	2012								2011
	Average Balance			Income / Expense		Yield / Rate  1			Average Balance			Income / Expense		Yield / Rate  1
	(Dollars in thousands)
Assets
Interest-earning assets:
Loans (2)	$	294,498		$	12,245		5.55	%	$	321,981		$	13,674		5.68	%
Trading securities		424			27		8.51	%		1,066			57		7.15	%
Investment securities		108,597			888		1.09	%		125,859			3,365		3.57	%
Federal funds sold		13,751			72		0.70	%		8,641			32		0.50	%
Total interest earning assets		417,270			13,232		4.24	%		457,547			17,128		5.00	%
Non-interest earning assets:
Cash and due from banks		43,409								21,343
Premises and equipment		1,276								1,599
Other real estate owned (OREO)		3,995								4,367
Other assets		9,576								16,548
Less: allowance for loan losses		(5,132	)							(5,507	)
Total non-interest earning assets		53,124								38,350
Total Assets	$	470,394							$	495,897
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing demand deposits	$	49,278		$	86		0.23	%	$	41,646		$	83		0.27	%
Money market deposit accounts		16,690			95		0.76	%		24,769			139		0.75	%
Savings accounts		4,376			3		0.09	%		4,238			5		0.16	%
Time deposits		180,343			2,070		1.53	%		197,999			2,845		1.92	%
Total interest-bearing deposits		250,687			2,254		1.20	%		268,652			3,072		1.53	%
FHLB advances(3)		44,999			803		2.38	%		41,192			776		2.52	%
Other borrowings		44,584			476		1.43	%		59,292			472		1.06	%
Total interest-bearing liabilities		340,270			3,533		1.39	%		369,136			4,320		1.56	%
Non-interest bearing liabilities:
Demand deposits		98,038								89,369
Other liabilities		2,540								2,553
Total liabilities		440,848								461,058
Shareholders’ Equity		29,546								34,839
Total Liabilities and Shareholders’ Equity	$	470,394							$	495,897
Interest Spread (4)							2.85	%							3.44	%
Net Interest Margin (5)				$	9,699		3.10	%				$	12,808		3.74	%

⁽¹⁾  The rates and yields are on a fully tax equivalent basis assuming a 34% federal tax rate.

⁽²⁾ The Bank had average non-accrual loans of $11.4 million and $11.0 million for the first nine months of 2012 and 2011, respectively. The 2012 and 2011 interest income on non-accrual loans excluded from the loans above was $355 thousand and $311 thousand, respectively.

⁽³⁾ The Bank had two FHLB advances during the periods presented: a $15.0 million floating rate advance accounted for on a cost basis and a $25.0 million par value fixed rate advance accounted for a fair value basis. The average fair value of the fixed rate FHLB advance for the first nine months of 2012 and 2011 was $ 29.3 million and $26.2 million, respectively. As of September 30, 2012, the fair value of the fixed rate FHLB advance was $30.0 million.

⁽⁴⁾ Interest spread is the average yield earned on earning assets, less the average rate incurred on interest-bearing liabilities.

⁽⁵⁾ Net interest margin is net interest income expressed as a percentage of average earning assets.

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For the nine months ended September 30, 2012, average loan balances were $294.5 million compared to $322.0 million for the same period in 2011, a decrease of $27.5 million. Interest income from loans was $12.2 million in the first nine months of 2012 compared to $13.7 million in the same period of 2011, with the average yield decreasing to 5.55% from 5.68%. The lower average balance contributed $1.1 thousand and lower rates contributed $302 thousand to the $1.4 million decrease in interest income on loans.

For the nine months ended September 30, 2012, Bankshares held one security in its trading portfolio with an average balance of $424 thousand, compared to $1.1 million for the nine months ended September 30, 2011. The trading security interest income for the nine months ended September 30, 2012 was $27 thousand compared to $57 thousand for the nine months ended September 30, 2011. The reduction in average trading securities reflects management’s business strategy to eliminate the trading securities portfolio as Bankshares repositions the balance sheet and led to the reduction in associated interest income. At September 30, 2012, the carrying value of the security was $293 thousand.

Investment securities averaged $108.6 million for the nine months ended September 30, 2012 compared to $125.9 million for the same period in 2011. Investment securities income was $888 thousand for the nine months ended September 30, 2012 compared to $3.4 million for the nine months ended September 30, 2011. The average tax equivalent yields on investment securities for the nine months ended September 30, 2012 and 2011 were 1.09% and 3.57% respectively. The reduction in average investment securities reflects management’s targeted efforts to strategically restructure our balance sheet in anticipation of the merger during 2011 which led to shifts in the portfolio mix and reduction the investment portfolio’s balance. During the second quarter and continuing into the third quarter of 2012, the Bank experienced greater than expected prepayments on a variety of investment securities which impacted the yield on the portfolio. When repayments occur at a faster rate than anticipated, premium amortization increases which adversely impacts the portfolio yield.

Short-term investments in federal funds sold contributed $72 thousand to interest income in the nine month period ended September 30, 2012 compared to $32 thousand in the nine month period ended September 30, 2011.

The average balance of cash and due from banks was $43.4 million and $21.3 million for the nine months ended September 30, 2012 and 2011 respectively.

Total average earning assets yielded 4.24% for the nine months ended September 30, 2012 or 76 basis points lower than the yield of 5.00% for the same period in 2011. Total interest income (on a fully tax equivalent basis) was $13.2 million for the nine months ended September 30, 2012 compared to $17.1 million for the nine months ended September 30, 2011.

Total average interest-bearing liabilities were $340.3 million in the first nine months of 2012 or $28.8 million less than the first nine months of 2011 level of $369.1 million. The average balance of time deposits was $17.7 million lower than the same period last year. For the nine months ended September 30, 2012, interest expense was $3.5 million compared to $4.3 million for the nine months ended September 30, 2011. The average cost of interest-bearing

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liabilities for the first nine months of 2012 was 1.39% or 17 basis points lower than the 2011 level of 1.56%. Many of the larger wholesale deposits have matured and new brokered deposits were issued at lower interest rates.

For the nine months ended, September 30, 2012, the brokered certificate of deposit portfolio carried an average coupon rate of 1.48% compared to an average coupon rate of 1.85% at September 30, 2011.

Non-interest bearing demand deposits averaged $98.0 million for the first nine months of 2012, or $8.6 thousand more than the first nine months of 2011 level of $89.4 million. These balances are subject to seasonal changes.

The following table describes the impact on Bankshares’ tax equivalent interest income and expense resulting from changes in average balances and average rates for the periods indicated. The change in interest income due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

	Volume and Rate Analysis Nine Months Ended September 30, 2012 compared to 2011
	Change Due To:
	(Decrease)			Volume			Rate
	(Dollars in thousands)
Interest Earning Assets:
Loans	$	(1,429	)	$	(1,127	)	$	(302	)
Trading securities		(30	)		(44	)		14
Investment securities		(2,477	)		(396	)		(2,081	)
Federal funds sold		40			24			16
Total (decrease) in interest income		(3,896	)		(1,543	)		(2,353	)
Interest-Bearing Liabilities:
Interest-bearing deposits		(818	)		(266	)		(552	)
Borrowed funds		31			58			(27	)
Total (decrease) in interest expense		(787	)		(208	)		(579	)
(Decrease) in net interest income	$	(3,109	)	$	(1,335	)	$	(1,774	)

For the nine months ended, September 30, 2012, due to improvement in the overall risk profile of the loan portfolio and a lower level of total loans, the Company released reserves into income of $223 thousand, and did not recognize a provision expense for the period.

Non-interest Income (Other Income). Non-interest income amounted to a loss of $153 thousand during the three months ended September 30, 2012, an increase of $498 thousand from a loss of $651 thousand of non-interest income for the same period of 2011.

Fair value adjustments on the FHLB advance and the trading security recorded for the three months ended September 30, 2012 resulted in a net loss of $401 thousand, compared to a net loss of $2.8 million for the same period in 2011, a decrease of $2.4 million. The net loss of $170 thousand for the three months ended September 30, 2012 is primarily driven by a negative fair value adjustment of $459 thousand on the FHLB advance, and gains of $171 thousand on the sale of investment securities

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Non-interest Expense. Non-interest expense for the three months ended September 30, 2012, amounted to $3.5 million compared to $4.1 million for the same period in 2011, a decrease of $600 thousand. The key components of non-interest expenses are salary and employee benefits, merger related expenses, occupancy expenses and professional fees. Salary and employee benefits expenses for the quarter ended September 30, 2012 were $956 million, compared to the third quarter of 2011 level of $1.2 million, a decrease of $241 thousand. Professional fees for the quarter ended September 30, 2012 were $465 thousand, compared to the third quarter of 2011 level of $398 thousand, an increase of $67 thousand, which is due to the use of contract employees in the Human Resources, Information Technology and Accounting departments. Merger expenses were $248 thousand for the three months ended September 30, 2012, compared to $619 thousand for the same period in 2011. Occupancy expenses and equipment expenses collectively totaled $702 thousand for the quarter ended September 30, 2012 compared to the 2011 level of $741 thousand, a decrease of $39 thousand.

For the nine months ended September 30, 2012, non-interest expense was $10.8 million compared to $11.6 million for the 2011 period, a decrease of $800 thousand. Salaries and employee benefits expenses decreased by $716 thousand, occupancy and equipment expenses decreased by $94 thousand, merger related expenses increased by $47 thousand, and professional fees increased by $319 thousand. This increase in professional fees is due to the use of contract employees to fill open positions in the Human Resources, Information Technology, and Accounting departments. OREO expenses for the nine months ended excluding valuation allowance was $109 thousand and $77 thousand for the nine months ended September 30, 2012 and 2011 respectively. FDIC assessments decreased by $227 thousand, and there was a decrease of $382 thousand in other operating expenses. There were also merger related expenses of $666 thousand.

Income Taxes. Bankshares recorded an income tax benefit of $156 thousand and $227 thousand related to the FHLB fair value adjustment for the three and nine months ended September 30, 2012 and 2011 respectively. This income tax benefit was an increase of $297 thousand over the nine months ended, September 30, 2011 and a decrease of $333 thousand for three months ended September 30, 2011.

At December 31, 2011, Bankshares performed an analysis to determine if a valuation allowance for deferred tax assets was necessary. Its analysis reviewed various forms of positive and negative evidence in determining whether a valuation allowance is necessary and if so to what degree a valuation allowance is warranted. The three year cumulative loss position of Bankshares is considered negative evidence when determining if a valuation allowance is necessary. Bankshares considered positive evidence such as previous earnings patterns, multiyear business projections and the potential realization of net operating loss (NOL) carry forwards within the prescribed time periods. In addition, Bankshares considered tax planning strategies that would impact the timing and extent of taxable income. Based on the analysis and the guidance in the relevant accounting literature, it was considered more likely than not, that Bankshares will not be able to realize all of its deferred tax assets. As of September 30, 2012, the net deferred tax asset was $1.6 million, compared to $1.5 million as of December 31, 2011. The change in the net asset is due to fair value changes relating to the FHLB advance.

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Analysis of Financial Condition

Trading Security. At September 30, 2012 and December 31, 2011, the trading portfolio consisted of one PCMO security with a fair value of $293 thousand and $596 thousand respectively. The current effective portfolio yield is 5.43%.

The following table reflects Bankshares’ trading assets and effective yield on the instruments as of the dates indicated:

ALLIANCE BANKSHARES CORPORATION

Consolidated Statistical Information

Trading Asset Summary

	Trading Security
	September 30, 2012					December 31, 2011
	Fair Value		Yield			Fair Value		Yield
	(Dollars in thousands)
PCMO (1)	$	293		5.43	%	$	596		5.44	%
Totals	$	293		5.43	%	$	596		5.44	%

⁽¹⁾  As of September 30, 2012, trading security portfolio consisted of one PCMO instrument. This PCMO was rated AAA by at least one ratings agency on the purchase date. Currently the security has a rating below investment grade.

The instrument is paying as agreed.

Investment Securities - Available-for-Sale.

Bankshares actively manages its portfolio duration and composition with changing market conditions and changes in balance sheet risk management needs. Additionally, the securities are pledged as collateral for certain borrowing transactions and repurchase agreements. The total amount of the investment securities accounted for under available-for-sale accounting was $79.4 million September 30, 2012 compared to $123.5 million at December 31, 2011. Targeted efforts to strategically restructure the balance sheet in 2011 led to shifts in the investment portfolio mix and reduced the investment securities portfolio balance at September 30, 2012.

On September 30, 2012, the investment portfolio contained callable and non-callable U.S. government corporations and agencies securities, U.S. government collateralized mortgage obligations (CMOs), U.S. government mortgage backed securities (MBS), PCMOs, and municipal securities.

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On September 30, 2012, U.S. corporations and agencies were $18.6 million or 23.4% of the portfolio, PCMOs, CMOs and MBS were $51.9 million, or 65.4% of the portfolio, and municipal securities were $8.9 million, or 11.2% of the portfolio.

The yield on the investment securities portfolio as of September 30, 2012 was 2.53%. During the third quarter of 2012, the Bank earned $182 thousand on the investment securities portfolio or an effective tax equivalent yield of 0.73%. The investment securities portfolio contains mortgage oriented products (CMO, PCMO, and MBS) and SBA securities. Bankshares is experiencing lower yields on the portfolio in 2012 on a number of instruments. When prepayments on these instruments occur at a faster rate than anticipated, premium amortization increases which adversely impacts the portfolio yield. During the second quarter and continuing into the third quarter of 2012, the Bank experienced greater than expected prepayments on a variety of investment securities. The U. S. treasuries matured during the first nine months of 2012 and were re-invested in higher yielding securities.

	Investment Securities- Available-for-Sale
	September 30, 2012								December 31, 2011
	Fair Value		Yield			% of Total			Fair Value		Yield			% of Total
	(Dollars in thousands)
U.S. treasuries	$	—		—			—		$	71,115		0.01	%		57.6	%
U.S. government corporations and agencies		18,569		2.37	%		23.4	%		9,751		2.63	%		7.9	%
U.S. government agency CMOs		41,229		2.26	%		51.9	%		31,038		2.16	%		25.1	%
U.S. government agency MBS		9,768		2.14	%		12.3	%		7,698		2.01	%		6.2	%
PCMOs		932		2.87	%		1.2	%		950		2.82	%		0.8	%
Municipal securities		8,913		4.47	%		11.2	%		2,911		5.06	%		2.4	%
Total Investment Securities Available-for-Sale	$	79,411		2.53	%		100.0	%	$	123,463		1.02	%		100.0	%

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The following table summarizes the contractual maturity of the investment securities on an amortized cost basis and their weighted average yield as of September 30, 2012:

	Contractual Maturities of Investment Securities September 30, 2012
	(Dollars in thousands)
	Within One Year					After One Year but Within Five Years					After Five Years but Within Ten Years					After Ten Years
	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Total (4,5)
Available-For-Sale Securities
U.S. government corporations and agencies		—		0.00	%		—		0.00	%		—		0.00	%		18,262		2.36	%		18,262
U.S. government agency CMOs (1)		—		0.00	%		—		0.00	%		2,744		1.95	%		38,507		2.26	%		41,251
U.S. government agency MBS (1)		—		0.00	%		—		0.00	%		—		0.00	%		9,535		2.15	%		9,535
PCMOs(1)		—		0.00	%		—		0.00	%		—		0.00	%		902		2.87	%		902
Municipal securities (2)		—		0.00	%		—		0.00	%		3,771		3.30	%		4,961		4.79	%		8,732
	$	—		0.00	%	$	—		0.00	%	$	6,515		2.73	%	$	72,167		2.45	%	$	78,682
Total Available-For-Sale Securities (3)

(1) Contractual maturities of CMOs, PCMOs and MBS are not reliable indicators of their expected life because mortgage borrowers have the right to prepay mortgages at any time.

(2) Municipal securities yield is on a fully tax equivalent basis assuming a 34% federal tax rate.

(3) Bankshares did not have any held-to-maturity securities as of September 30, 2012.

(4) Total above is amortized cost and does not include unrealized gains of $729 thousand.

(5) The fair value of the contractual maturities listed in the total above amounts to $79.4 million.

Restricted Securities.

Bankshares’ securities portfolio contains restricted securities that are required to be held as part of the Company’s banking operations. These include stock of the Federal Reserve Bank, the FHLB and Community Bankers Bank (CBB). The following table summarizes the balances of restricted stock at the dates indicated:

	Restricted Stock
	September 30, 2012		December 31, 2011
	(Dollars in thousands)
Federal Reserve Bank Stock	$	1,201	$	1,201
FHLB stock		2,565		3,365
CBB stock		206		206
Total Restricted Stock	$	3,972	$	4,772

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Loan Portfolio.

In its lending activities, Bankshares seeks to develop substantial relationships with clients whose business and individual banking needs will grow with the Bank. Bankshares has made significant efforts to be responsive to the lending needs in the markets served, while maintaining sound asset quality and credit practices. Bankshares grants credit to commercial business, commercial real estate, real estate construction, residential real estate and consumer borrowers in the normal course of business. The loan portfolio net of discounts and fees was $288.0 million as of September 30, 2012, or $18.9 million lower than the December 31, 2011 level of $306.9 million.

The following table summarizes the composition of the loan portfolio by dollar amount and each segment as a percentage of the total loan portfolio as of the dates indicated:

	Loan Portfolio
	September 30, 2012					December 31, 2011
	Amount		Percent			Amount		Percent
	(Dollars in thousands)
Residential real estate	$	92,443		32.1	%	$	101,248		33.0	%
Commercial real estate		125,602		43.6	%		137,610		44.8	%
Construction/land		41,478		14.4	%		39,176		12.8	%
Commercial and industrial		27,076		9.5	%		26,820		8.7	%
Consumer - non real estate		1,382		0.5	%		2,022		0.7	%
Total Loans	$	287,981		100	%	$	306,876		100	%

Substantially all loans are initially underwritten based on identifiable cash flows and supported by appropriate advance rates on collateral, which is independently valued. Commercial loans are generally secured by accounts receivable, equipment and business assets. Commercial real estate is secured by owner-occupied or non-owner occupied commercial properties of all types. Real estate construction loans are supported by projects which generally require an appropriate level of pre-sales or pre-leasing. Generally, all commercial and real estate loans have full recourse to the owners and/or sponsors. Residential real estate is secured by first or second trusts on both owner-occupied and investor-owned residential properties.

As noted in the table above, loans secured by various types of real estate constitute a significant portion of total loans. Commercial real estate loans represent the largest dollar exposure. Substantially all of these loans are secured by properties in the Metropolitan Washington, D.C. area with the heaviest concentration in Northern Virginia and Fairfax County in particular. Risk is managed through diversification by sub-market, property type, and loan size. Risk is further managed by seeking investment property loans with multiple tenants and by emphasizing owner-occupied loans. The average loan size in this portfolio is $582 thousand as of September 30, 2012.

The table also shows a modest increase in the construction/land portion of the portfolio, which represented 14.4% of the portfolio at September 30, 2012 and 12.8% of the portfolio at December 31, 2011. The current levels of construction/land loans are a product of management’s efforts to moderate this type of lending in recent years. New originations in this

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segment are being underwritten in the context of current market conditions and are particularly focused in sub-markets which appear to be the strongest in the region. Legacy loans, particularly in the land portion of this portfolio, have been largely converted to amortizing loans with regular principal and interest payments. Bankshares expects to see further reductions in its land exposure offset by potential increases in certain residential construction activities as market conditions improve.

Loans secured by residential real estate have declined 8.7% since December 31, 2011, with reductions across most relevant loan classes to include both owner-occupied and investment residential categories. All loans in these categories represent loans underwritten by Bankshares, (Bankshares does not purchase loans in this portfolio) to customers with whom it has had direct contact in the local communities it serves. Bankshares believes that its underwriting criteria reflect current market conditions. The portfolio of first mortgage loans had an average size per housing unit of $331 thousand as of September 30, 2012. Bankshares’ subordinate trust loans averaged $99 thousand per property as of September 30, 2012. While Bankshares recognizes that the Metropolitan Washington, D.C. residential real estate market continues to be a nascent recovery, Bankshares believes that its current underwriting standards, its emphasis on serving the sub-markets it knows, the granularity of its portfolio, and the continued reduction of its subordinate trust portfolio represent the appropriate risk management strategies for this portfolio.

The following table presents the maturities or repricing periods of selected loans outstanding at September 30, 2012:

	As of September 30, 2012
	One Year or Less		After One Year Through Five Years		After Five Years		Total
	(Dollars in thousands)
Commercial and industrial	$	18,483	$	7,795	$	799	$	27,076
Construction/land		23,138		14,562		3,778		41,478
Total	$	41,620	$	22,357	$	4,577	$	68,554
Loans with:
Fixed rates	$	62,448	$	77,093	$	70,515	$	210,056
Variable rates		31,814		41,665		4,446		77,925
Total	$	94,262	$	118,758	$	74,961	$	287,981

Asset Quality

Bankshares segregates loans meeting the criteria for special mention, substandard, doubtful and loss from non-classified, or pass rated loans. Bankshares reviews the characteristics of each rating at least annually, generally during the first quarter of each year. The characteristics of these ratings are as follows:

Pass and watch rated loans (risk ratings 1 to 6) are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service

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the existing loans, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that the borrower will maintain this type of payment history. Routinely, acceptable personal guarantors support these loans.

Special mention loans (risk rating 7) have a specific defined weakness in the borrower’s operations and/or the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history is characterized by late payments. Bankshares’ risk exposure to special mention loans is mitigated by collateral supporting the loan. The collateral is considered to be well-managed, well maintained, accessible and readily marketable.

Substandard loans (risk rating 8) are considered to have specific and well-defined weaknesses that jeopardize the viability of Bankshares’ credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantors to pay the loan may not adequately protect Bankshares. There is a distinct possibility that Bankshares will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet Bankshares’ definition of an impaired loan unless the loan is significantly past due and the borrower’s performance and financial condition provide evidence that it is probable Bankshares will be unable to collect all amounts due.

Substandard non-accrual loans have the same characteristics as substandard loans. However these loans have a non-accrual classification generally because the borrower’s principal or interest payments are 90 days or more past due.

Doubtful rated loans (risk rating 9) have all the weakness inherent in a loan that is classified as substandard but with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable based upon current existing facts, conditions, and values. The possibility of loss related to doubtful rated loans is extremely high.

Loss (risk rating 10) rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.

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The table below represents Bankshares’ loan portfolio by risk rating, classification, and loan portfolio segment as of September 30, 2012.

	(Dollars in thousands)
INTERNAL RISK RATING GRADES	Pass		Watch		Special Mention		Substandard		Doubtful		Loss		Total Loans
Risk Rating Number1	1 to 5		6		7		8		9		10
Commercial and industrial	$	24,083	$	787	$	205	$	2,001	$	—	$	—	$	27,076
Commercial real estate
Owner occupied		54,391		871		1,982		3,801		—		—		61,045
Non-owner occupied		56,289		4,736		1,731		1,801		—		—		64,557
Construction/land
Residential construction		16,037		792		—		—		559		—		17,388
Other construction & land		14,823		524		165		8,242		336		—		24,090
Residential real estate
Equity lines		27,031		321		99		150		—		—		27,601
Single family		51,801		2,729		2,684		2,235		—		—		59,449
Multifamily		5,393		—		—		—		—		—		5,393
Consumer - non real estate		1,181		8		181		12		—		—		1,382
Totals	$	251,029	$	10,768	$	7,047	$	18,242	$	895	$	—	$	287,981

¹  Internal risk ratings of pass (rating numbers 1 to 5) and watch (rating number 6) are deemed to be unclassified assets. Internal risk ratings of special mention (rating number 7), substandard (rating number 8), doubtful (rating number 9) and loss (rating number 10) are deemed to be classified assets.

As part of Bankshares’ normal credit risk management practices, it regularly monitors the payment performance of its borrowers. Substantially all loans require some form of payment on a monthly basis, with a high percentage requiring regular amortization of principal. However, certain HELOCs, commercial and industrial lines of credit, and construction loans generally require only monthly interest payments.

When payments are 90 days or more in arrears or when Bankshares determines that it is no longer prudent to recognize current interest income on a loan, Bankshares classifies the loan as non-accrual. The decrease in non-accrual loans from $13.3 million at December 2011 to $10.9 million at September 30, 2012 is attributed to the following factors: Six non-accrual/impaired loans totaling $838 thousand secured by residential real estate were charged off during the period, one loan for $963 thousand was secured by a residential property in Fairfax County, Virginia which was foreclosed into Bankshares’ OREO; and a commercial loan totaling $899 thousand secured by land in Fairfax County, Virginia was paid in full. Four other non-accrual loans continue to receive ongoing payments which are applied to reduce Bankshares’ carrying value for these loans.

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The following table sets forth the aging and non-accrual loans by class, as of September 30, 2012:

	Aging and Non-accrual Loans By Class As of September 30, 2012
	(Dollars in thousands)
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current 1		90-days Past Due and Still Accruing		Nonaccrual Loans
Commercial and industrial	$	1,518	$	28	$	269	$	1,815	$	25,261	$	792	$	1,547
Commercial real estate
Owner occupied		355		99		2,475		2,929		58,116		—		2,475
Non-owner occupied		—		1,801		—		1,801		62,756		—		—
Construction/land
Residential construction		—		—		1,351		1,351		16,037		—		559
Other construction & land		165		983		4,866		6,014		18,076		—		5,849
Residential real estate
Equity lines		285		292		150		727		26,874		—		150
Single family		623		1,315		261		2,199		57,250		—		261
Multifamily		—		—		—		—		5,393		—		—
Consumer -non real estate		—		—		12		12		1,370		—		12
Total loans	$	2,946	$	4,518	$	9,384	$	16,848	$	271,133	$	792	$	10,853

¹  For the purposes of this table only, loans 1-29 days past due are included in the balance of current loans.

Allowance for Loan Losses

The allowance for loan losses is an estimate of losses that may be sustained in Bankshares’ loan portfolio. The allowance is based on two basic principles of accounting: (1) ASC 450-10-05, Contingencies which requires that losses be accrued when they are probable of occurring and estimable, and (2) ASC 310-10-35, Receivables which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows, or values that are observable in the secondary market and the loan balance.

The allowance for loan losses was $4.9 million at September 30, 2012, or 1.69 % of loans outstanding, compared to $5.4 million or 1.76% of loans outstanding, at December 31, 2011. Bankshares has allocated $1.7 million at September 30, 2012 compared to $2.3 million at December 31, 2011 for specific non-performing loans. For the first nine months of 2012, Bankshares had net charge-offs of $755 thousand compared to net charge-offs of $1.3 million in the same period of 2011.

As part of its routine credit administration process, Bankshares engages an outside consulting firm to review its loan portfolio periodically. The information from these reviews is used to monitor individual loans as well as to evaluate the overall adequacy of the allowance for loan losses.

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In reviewing the adequacy of the allowance for loan losses at each period, management takes into consideration the historical loan losses experienced by Bankshares, current economic conditions affecting the borrowers’ ability to repay, the volume of loans, trends in delinquent, non-accruing, and potential problem loans, and the quality of collateral securing loans. Loan losses are charged against the allowance when Bankshares believes that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. After charging off all known losses incurred in the loan portfolio, management considers on a quarterly basis whether the allowance for loan losses remains adequate to cover its estimate of probable future losses, and establishes a provision for loan losses as appropriate. Because the allowance for loan losses is an estimate, as the loan portfolio and allowance for loan losses review process continues to evolve, there may be changes to this estimate and elements used in the methodology that may have an effect on the overall level of allowance maintained.

Over the past several quarters, we have experienced a reduction in our loan portfolio and in the losses we have previously experienced. Net loans outstanding decreased $5.5 million from June 30, 2012 to September 30, 2012, due to the payoffs from several large commercial borrowers, coupled with a reduction in activities from our residential real estate investors. Due to these events coupled with the improvement in our risk profile of the loan portfolio reflected in the ASC450-10-05 portion of the Allowance for Loan Losses model, and lower level of loans, Alliance released $222 thousand of previous recorded reserves into income and did not recognized a provision expense during the quarter ended September 30, 2012.

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The following table represents an analysis of the allowance for loan losses for the periods presented:

	Nine Months Ended  September 30, 2012			Twelve Months Ended  December 31, 2011			Nine Months Ended September 30, 2011
	(Dollars in thousands)
Balance, beginning of period	$	5,393		$	5,281		$	5,281
Provision for loan losses		228			1,549			1,205
Chargeoffs:
Commercial and industrial		—			(10	)		(10	)
Construction/land		—			(404	)		(404	)
Residential real estate		(894	)		(1,044	)		(898	)
Commercial real estate		—			(173	)		(173	)
Consumer - non real estate		—			(71	)		(71	)
Total chargeoffs		(894	)		(1,702	)		(1,556	)
Recoveries:
Commercial and industrial		—			116			116
Construction/land		—			—			—
Residential real estate		139			134			118
Commercial real estate		—			9			9
Consumer - non real estate		—			6			5
Total recoveries		139			265			248
Net (chargeoffs)		(755	)		(1,437	)		(1,308	)
Balance, end of period	$	4,866		$	5,393		$	5,178
Allowance for loan losses to total loans		1.69	%		1.76	%		1.62	%
Allowance for loan losses to nonaccrual loans		.45X			0.41X			0.49X
Allowance for loan losses to non-performing assets		30.63	%		29.58	%		0.34X
Non-performing assets to total assets		3.04	%		3.55	%		2.85X
Net chargeoffs to average loans		0.26	%		0.45	%		0.54	%

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The following table provides a breakdown of the allocation of the allowance for loan losses by loan type. However, management does not believe that the allowance for loan losses can be fragmented by category with any precision that would be useful to investors. As such, the entire allowance is available for losses in any particular category, notwithstanding this allocation. The breakdown of the allowance for loan losses is based primarily upon those factors discussed above in computing the allowance for loan losses as a whole. Because all of these factors are subject to change, the allocation and actual results are not necessarily indicative of the exact category of potential loan losses.

	Allowance for Loan Losses
	As of September 30, 2012
	(Dollars in thousands)
	Commercial and  Industrial			Commercial Real Estate			Construction Land		Residential Real  Estate			Consumer			Total
Allowance for Loan Losses:
Beginning Balance	$	210		$	1,508		$	1,808	$	1,826		$	41		$	5,393
Charge-offs		—			—			—		(894	)		—		$	(894	)
Recoveries		—			—			—		139			—		$	139
Provision		(56	)		(53	)		68		282			(13	)	$	228
Ending Balance:	$	154		$	1,455		$	1,876	$	1,353		$	28		$	4,866
Individually evaluated for impairment	$	109		$	—		$	1,520	$	78			4		$	1,711
Collectively evaluated for impairment	$	45		$	1,455		$	356	$	1,275		$	24		$	3,155
Loans:
Ending Balance:	$	27,076		$	125,602		$	41,478	$	92,443		$	1,382		$	287,981
Individually evaluated for impairment	$	1,546		$	2,475		$	6,409	$	971			12		$	11,413
Collectively evaluated for impairment	$	25,530		$	123,127		$	35,069	$	91,472		$	1,370		$	276,568

Non-performing Assets

Non-accrual Loans. A loan may be placed on non-accrual status when the loan is specifically determined to be impaired or when principal or interest is delinquent 90 days or more. Bankshares closely monitors individual loans, and relationship officers are charged with working with customers to resolve potential credit issues in a timely manner with minimum exposure to Bankshares. Bankshares maintains a policy of adding an appropriate amount to the allowance for loan losses to ensure an adequate reserve based on the portfolio composition, specific credit extended by the Bank, general economic conditions and other factors and external circumstances identified during the process of estimating probable losses in the Company’s loan portfolio.

On September 30, 2012, there was $10.9 million in loans on non-accrual status compared to $13.3 million at December 31, 2011. The $10.9 million non-accrual loan balance consists mostly of loans secured by residential and commercial real estate in the Northern Virginia area. The specific allowance for impaired loans as of September 30, 2012 is $1.7 million.

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Non-accruals for the nine months ended September 30, 2012 were $10.9 million, compared to $10.7 for the same period in 2011. Non-accrual loans continue to represent transactions originated in 2006 and prior.

Total Non-performing Assets. As of September 30, 2012, Bankshares had $15.9 million of non-performing assets on the balance sheet compared to $18.0 million as of December 31, 2011, a decrease of $2.1 million. This decrease is primarily comprised of the charge off of six loans, secured by residential real estate, totaling $838 thousand; the foreclosure and purchase into OREO of a residential property valued at $963 thousand; the full repayment of a commercial loan secured by land with a prior balance of $899 thousand; the movement back to accrual status of two loans secured by land totaling $325 thousand. Since December 31, 2011, six loans totaling $1.1 million have been added to the non-accrual and impaired loan list. Of these six loans, 95% are secured by residential real estate. The ratio of non-performing assets to total assets decreased to 3.04% as of September 30, 2012 from 3.55% as of December 31, 2011, a 51 basis points decrease.

The following table provides information regarding credit quality at the dates presented:

	September 30, 2012			December 31, 2011
Credit Quality Information	(Dollars in thousands)
Non-performing assets:
Non-accrual loans		10,853			13,264
OREO		3,575			3,748
Other impaired loans		560			—
Troubled debt restructurings		897			956
Total non-performing assets	$	15,885		$	17,968
Specific reserves associated with impaired loans	$	1,711		$	2,271
Non-performing assets to total assets		3.04	%		3.55	%

Specific Reserves. As of September 30, 2012, Bankshares had $1.7 million in specific reserves for non-performing loans, compared to $2.3 million at December 31, 2011.

Other Real Estate Owned (OREO). As of September 30, 2012, Bankshares had $3.6 million classified as OREO on the balance sheet, compared to $3.7 million as of December 31, 2011. The OREO balance includes $951 thousand which relates to residential acreage in the Stephens City, Virginia, $790 thousand which relates to acreage in Woodstock, Virginia, and $720 thousand which relates to a farm property in Charles Town, West Virginia, and $851 thousand which relates to residential property in Northern Virginia. The remainder is made up of five additional properties totaling $263 thousand at September 30, 2012.

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The table below reflects the OREO activity in the periods presented:

	Nine Months Ended September 30, 2012			Twelve Months Ended  December 31, 2011
	(Dollars in thousands)
Balance, beginning of period	$	3,748		$	4,627
Properties acquired at foreclosure		963			434
Sales of foreclosed properties		(905	)		(959	)
Valuation adjustments		(231	)		(354	)
Balance, end of period	$	3,575		$	3,748

Deposits. Bankshares seeks deposits within its market area by offering high-quality customer service, using technology to deliver deposit services effectively and paying competitive interest rates. A significant portion of its client base and deposits are directly related to home sales and refinancing activity, including those from title and escrow agency customers.

At September 30, 2012, the deposit portfolio was $414.2 million, an increase of $33.8 million compared to the December 31, 2011 level of $380.4 million. The average cost of interest-bearing deposits was 1.20% for the nine months ended September 30, 2012, or 33 basis points less than the nine months ended September 30, 2011 average cost of 1.53%. As key interest rates declined over the past year, Bankshares repriced deposits at lower levels.

At September 30, 2012, Bankshares’ savings and NOW deposits were $84.1 million compared to $51.5 million at December 31, 2011, a $32.6 million increase. Average non-interest bearing demand deposits were $98.0 million for the nine months ended September 30, 2012 compared to average non-interest bearing demand deposits of $89.4 million for the nine months ended September 30, 2011, an increase of $8.6 million. The disparity between the September 30, 2012 balance of non-interest bearing deposits of $145.3 million and the average balance for the first nine months of 2012 of non-interest bearing deposits of $98.0 million is directly related to seasonal and cyclical changes in the business activities of Bankshares’ title and escrow agency client base. Frequently, Bankshares’ title and escrow agency clients experience strong deposit growth around the end of a month or quarter.

Bankshares currently uses wholesale brokered deposits. Bankshares believes these types of funds offer a reliable, stable source of funds for the Bank. Frequently the interest rates associated with wholesale brokered deposits are significantly lower than general customer rates in its markets. As market conditions warrant and balance sheet needs dictate, Bankshares may continue to participate in the wholesale brokered certificate of deposit market. As with any deposit product, Bankshares has potential risk for non-renewal by the customer and/or broker.

As of September 30, 2012, Bankshares had $100.5 million of wholesale brokered certificates of deposit which is $21.9 million lower than the December 31, 2011 level of $122.4 million. This decrease is due to management’s decision not to renew a certificate of deposit that matured during the first nine months of 2012.

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The following table shows the maturity distribution and coupon rate of wholesale brokered certificate of deposits at September 30, 2012:

Maturity Distribution of Brokered Deposits by Year
Maturity Year	Amount		Average Coupon Rate
	(Dollars in thousands)
2013		68,044		1.03	%
2014		22,423		1.58	%
2015		10,000		1.91	%
	$	100,467		1.24	%

Purchased Funds and Other Borrowings. Purchased funds and other borrowings include repurchase agreements (repos), which Bankshares offers to commercial customers and affluent individuals, federal funds purchased and treasury, tax and loan balances. The bulk of purchased funds are made up of the following four categories: customer repos, outstanding federal funds purchased, the Trust Preferred Capital Notes and FHLB advances. Customer repos amounted to $22.6 million at September 30, 2012, compared to $40.4 million at December 31, 2011, a decrease of 17.8 million. The decrease in the Customer repurchase portfolio resulted from management’s decision to reduce the balance in repositioning the balance sheet and the investment portfolio. The Trust Preferred Capital Notes were $10.3 million for all periods presented.

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	Purchased Funds Distribution
	Nine Months September 30, 2012			Twelve Months Ended  December 31, 2011
	(Dollars in thousands)
At Period End
FHLB long-term advances, at fair value	$	30,018		$	29,350
FHLB advances		15,000			15,000
Customer repos		22,558			40,420
Purchased funds and other borrowings		—			—
Trust Preferred Capital Notes		10,310			10,310
Total at period end	$	77,886		$	95,080
Average Balances
FHLB long-term advances, at fair value	$	29,269		$	26,922
FHLB long-term advances		15,730			15,000
Customer repos		33,099			36,666
Purchased funds and other borrowings		1,175			11,773
Trust Preferred Capital Notes		10,310			10,310
Total average balance	$	89,583		$	100,671
Average rate paid on all borrowed funds, end of period		1.95	%		2.00	%
Average rate paid on all borrowed funds, during the period		1.91	%		1.65	%
Maximum outstanding during period	$	99,328		$	108,431

Customer repurchase agreements are standard commercial banking transactions that involve a Bank customer instead of a wholesale bank or broker. Bankshares offers this product as an accommodation to larger retail and commercial customers and affluent individuals that request safety for their funds beyond the FDIC deposit insurance limits. Bankshares believes this product offers it a stable source of financing at a reasonable market rate of interest. Bankshares does not use or have any open repurchase agreements with any broker-dealers.

The FHLB is a key source of funding for the Bank. During the periods presented, Bankshares has used overnight advances (daily rate credit) to support its short-term liquidity needs. On a longer term basis, Bankshares augments its funding portfolio with its two FHLB advances, one of which is accounted for on a fair value basis, and one of which is accounted for on a cost basis.

At September 30, 2012 and December 31, 2011, the FHLB long-term advance accounted for on a fair value basis had a value of $30.0 million and $29.4 million respectively, and matures in 2021. The weighted average interest rate on the long-term FHLB advance accounted for on a fair value basis was 3.99% for all periods presented. The par value of the FHLB advance was $25.0 million at September 30, 2012 and December 31 2011.

At September 30, 2012, there was one FHLB advance accounted for on a cost basis. Bankshares entered into this floating rate advance in the first quarter of 2012 for $15.0 million. The advance matures in 2013 and the interest rate at September 30, 2012 was 0.32%. The weighted average interest rate for both FHLB advances at September 30, 2012 is 2.61%.

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Fair Value of Liability Classified as Level 3. Beginning in the third quarter of 2008 and continuing through the present time, portions of the investment and debt markets have experienced a period of significant distress and dysfunction, and market values for certain financial instruments may not be readily available. Although certain portions of the investment and debt markets have improved, the fair value of an instrument is not the same as a liquidation value. In evaluating the fair value of funding instruments, Bankshares determined that the typical valuation techniques did not take into account the distressed investment and debt markets. As such, Bankshares considered other factors such as typical spreads for the instruments, conversion swaptions, swap curves, discounted cash flow models, previously observable non-distressed valuations and bond issuance rates and spreads for investment and non-investment grade instruments. As of September 30, 2012 and December 31, 2011, the fair value of the long-term FHLB advance accounted for on a fair value basis was $30.0 million and $29.4 million respectively.

The following table reflects the fair value of liabilities accounted for under ASC 820-10 as of the dates indicated:

	September 30, 2012							December 31, 2011
	Par Value		Fair Value		Yield			Par Value		Fair Value		Yield
	(Dollars in thousands)
FHLB long-term advance	$	25,000	$	30,018		3.99	%	$	25,000	$	29,350		3.99	%

Liquidity. Bankshares specifically focuses on liquidity management to meet the demand for funds from its depositors and lending clients as well as expenses that it incurs in the operation of its business. Bankshares has a formal liquidity management policy and a contingency funding policy used to assist management in executing the liquidity strategies necessary for the Bank. Similar to other banking organizations, the Bank monitors the need for funds to support depositor activities and funding of loans. Bankshares’ client base includes a significant number of title and escrow businesses which have more deposit inflows and outflows than a traditional commercial business relationship. The Bank maintains additional liquidity sources to support the needs of this client base. As noted in the risk factors section of Bankshares’ Annual Report on Form 10-K for the year ended December 31, 2011 and the forward-looking statement section of this Quarterly Report on Form 10-Q, loss of relationship officers or clients could have a material impact on Bankshares’ liquidity position through a reduction in average deposits.

Bankshares’ Chief Financial Officer monitors its overall liquidity position daily. Bankshares can and will draw upon federal funds lines with correspondent banks, draw upon reverse repurchase agreement lines with correspondent banks and use FHLB advances as needed. Bankshares’ deposit customers frequently have lower deposit balances in the middle of the month, and balances generally rise toward the end of each month. As such, Bankshares uses wholesale funding techniques to support its balance sheet and asset portfolios, although its longer term plan is to increase deposits from its local retail and commercial deposits and maintain available wholesale funding sources as additional liquidity.

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As of September 30, 2012, Bankshares had $115.5 million in cash and due from banks to support the business activities and deposit flows of its clients. The Bank maintains credit lines at the FHLB and other correspondent banks. At September 30, 2012, the Bank had a total credit line of $101.4 million with the FHLB with an unused portion of $61.4 million. Borrowings with the FHLB have certain collateral requirements and are subject to disbursement approval by the FHLB. At September 30, 2012, the Bank had $30.0 million in secured borrowing capacity and $4.0 million in unsecured borrowing capacity (both reverse repurchase agreements and federal funds purchased) from other correspondent banks. As of September 30, 2012, the Bank did not have any outstanding borrowings from its other correspondent banks. All borrowings from correspondent banks are subject to disbursement approval. The Bank is also eligible to borrow from the Federal Reserve Discount Window subject to the collateral requirements and other terms and conditions that may exist. In addition to the borrowing capacity described above, Bankshares and the Bank may sell investment securities, loans and other assets to generate additional liquidity. Bankshares anticipates maintaining sufficient liquidity to protect depositors, provide for business growth and comply with regulatory requirements.

Capital

Both Bankshares and the Bank are considered “well capitalized” under the risk-based capital guidelines adopted by the federal banking regulatory agencies. Capital adequacy is an important measure of financial stability. Maintaining a “well capitalized” regulatory position is paramount for each organization. Both Bankshares and the Bank monitor the capital positions to ensure appropriate capital for the respective risk profile of each organization, as well as sufficient levels to promote depositor and investor confidence in the respective organizations.

Total shareholders’ equity was $27.1 million as of September 30, 2012 compared to the December 31, 2011 level of $28.1 million. The change in equity is primarily attributable to Bankshares’ net loss for the first nine months of 2012 of $1.5 million and unrealized gains on securities of $442 thousand. Book value per common share was $5.30 as of September 30, 2012, compared to $5.50 as of December 31, 2011. The net unrealized gain on available-for-sale securities amounted to $478 thousand, net of tax, as of September 30, 2012, compared to a net unrealized gain on available-for-sale securities of $36 thousand, net of tax, as of December 31, 2011.

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The following table reflects the components of shareholders equity on a book value per share basis.

	Nine Months Ended September 30, 2012			Twelve Months Ended  December 31, 2011			Nine Months Ended September 30, 2011
	(Dollars in thousands)
Book value per share, beginning of the period	$	5.50		$	6.60		$	6.60
Net income (loss) per common share		(0.30	)		(1.17	)		0.05
Effects of other changes in other comprehensive income 1		0.10			0.07			0.10
Book value per share, end of the period	$	5.30		$	5.50		$	6.75

¹  Other comprehensive income represents the unrealized gains or losses associated with available-for-sale securities and related reclassification adjustments.

Payment of dividends is at the discretion of Bankshares’ Board of Directors and is subject to various federal and state regulatory limitations. It is Bankshares’ current policy to retain earnings to support its banking operations and its business risk profile. In addition, the terms of the Merger Agreement restrict Bankshares from declaring, setting aside or paying any dividends or other distributions on any class of its capital stock without the consent of WFBI while the Merger is pending.

On September 30, 2003, Bankshares’ wholly-owned Delaware statutory business trust (the Trust), privately issued $10.0 million face amount of the trust’s floating rate trust preferred capital securities (Trust Preferred Capital Notes) in a pooled trust preferred capital securities offering. The Trust issued $310 thousand in common equity to Bankshares. Simultaneously, the Trust used the proceeds of the sale to purchase $10.3 million principal amount of Bankshares’ floating rate junior subordinated debentures due 2033 (Subordinated Debentures). Both the Trust Preferred Capital Notes and the Subordinated Debentures are callable at any time. The Subordinated Debentures are an unsecured obligation of Bankshares and are junior in right of payment to all present and future senior indebtedness of Bankshares. The Trust Preferred Capital Notes are guaranteed by Bankshares on a subordinated basis. The Trust Preferred Capital Notes are presented in the Consolidated Balance Sheets of Bankshares under the caption “Trust Preferred Capital Notes.” Bankshares records distributions payable on the Trust Preferred Capital Notes as an interest expense in its Consolidated Statements of Operations. The interest rate associated with the Trust Preferred Capital Notes is three month LIBOR plus 3.15% subject to quarterly interest rate adjustments. Under the indenture governing the Trust Preferred Capital Notes, Bankshares has the right to defer payments of interest for up to twenty consecutive quarterly periods. Beginning with the quarter ended September 30, 2009 and through September 30, 2012, Bankshares elected to defer the interest payments as permitted under the indenture. The interest deferred under the indenture compounds quarterly at the interest rate then in effect. As of September 30, 2012, the total amount of deferred and compounded interest owed under the indenture is $1.3 million. The base interest rate as of September 30, 2012 was 3.54% and as of December 31, 2011 was 3.70%.

All or a portion of Trust Preferred Capital Notes may be included in the regulatory computation of capital adequacy as Tier 1 capital. Under the current guidelines, Tier 1 capital may include up to 25% of shareholders’ equity excluding accumulated other comprehensive income (loss) in the form of Trust Preferred Capital Notes. At September 30, 2012 and

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December 31, 2011, $8.9 and $9.4 was considered Tier 1 capital. Management does not expect the restrictions on Tier 1 capital treatment of trust preferred securities that were enacted by the Dodd-Frank Act to impact the Tier 1 capital status of the Trust Preferred Capital Notes, as the Dodd-Frank Act’s restrictions generally do not apply to trust preferred securities issued prior to enactment by institutions with fewer than $15 billion in assets.

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Bankshares is considered “well capitalized” as of September 30, 2012 and December 31, 2011, based on regulatory risk based capital guidelines. The following table shows Bankshares’ capital categories, capital ratios and the minimum capital ratios currently required by bank regulators:

	Risk Based Capital Analysis
	September 30, 2012			December 31, 2011
	(Dollars in thousands)
Tier 1 Capital:
Common stock	$	20,440		$	20,440
Capital surplus		25,942			25,915
Retained (deficit)		(19,791	)		(18,269	)
Less: disallowed assets		—			—
Add: Qualifying Trust Preferred Securities		8,864			9,353
Total Tier 1 capital		35,455			37,439
Tier 2 Capital:
Qualifying allowance for loan losses		3,541			3,828
Qualifying Trust Preferred Securities		1,136			647
Total Tier 2 capital		4,677			4,475
Total Risk Based Capital	$	40,131		$	41,914
Risk weighted assets	$	292,381		$	304,676
Quarterly average assets	$	476,908		$	506,050

	September 30. 2012			December 31, 2011			Regulatory Minimum
Capital Ratios:
Tier 1 risk based capital ratio		12.1	%		12.3	%		4.0	%
Total risk based capital ratio		13.7	%		13.8	%		8.0	%
Leverage ratio		7.4	%		7.4	%		4.0	%

The regulatory risk based capital guidelines establish minimum capital levels for the Bank to be deemed “well capitalized.” The guidelines for “well capitalized” call for a leverage ratio of 5.0%, tier 1 risk based capital ratio of 6.0% and total risk based capital ratio of 10.0%. As of September 30, 2012, the Company had capital ratios of 7.4%, 12.1% and 13.7%, respectively, all in excess of the regulatory minimums to be “well capitalized.” The Bank and Bankshares continuously monitor the capital levels and the risk profile of the entities to determine if capital levels are sufficient for the risk profiles of the organization. The MOU also requires Bankshares to maintain a written plan for compliance with the capital adequacy rules applicable to all state member banks under Federal Reserve Board Regulation H (12 CFR Part 208). These rules require all state member banks, including the Bank, to maintain adequate capital consistent with their risk profiles, which takes into account the volume of adversely classified loans, the adequacy of the loan loss reserve, any planned asset growth and the nature and level of asset concentrations, among other things. Given this, it is the policy of federal banking regulators not to specify or confirm that a given capital level will be “adequate” at a future point in time. As a result, federal banking regulators have not, and Bankshares cannot, identify a specific dollar amount of capital required under the MOU. However, Bankshares estimates that it would need $7.5 million to $10 million in new capital to be compliant with applicable capital adequacy rules.

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The ratio of net income to average assets and average equity and certain other ratios are as follows for the periods indicated:

	Three Months Ended September 30, 2012			Nine Months Ended September 30, 2012			Twelve Months  Ended December 31, 2011
	(Dollars in thousands)
Average total assets	$	476,907		$	470,394		$	497,953
Average shareholders’ equity	$	27,243		$	29,546		$	34,778
Net (loss)	$	(170	)	$	(1,522	)	$	(5,958	)
Return on average assets (annualized)		–0.14	%		–0.43	%		–1.20	%
Return on average shareholders’ equity (annualized)		–2.48	%		–6.88	%		–17.13	%
Average shareholders’ equity to average total assets		5.71	%		6.28	%		6.98	%

Concentrations. Substantially all of Bankshares’ loans, commitments and standby letters of credit have been granted to customers located in the greater Washington, D.C. Metropolitan region, primarily in the Northern Virginia area. Bankshares’ overall business includes a significant focus on real estate activities, including real estate lending, title companies and real estate settlement businesses. As of September 30, 2012, commercial real estate loans were 43.6% and residential real estate loans were 32.1% of the total gross loan portfolio. In addition, a substantial portion of our non-interest bearing deposits is generated by our title and escrow company clients. As of September 30, 2012, the non-interest bearing deposits were 35.1% of total deposits. The impact of the title and escrow company concentration can create more volatility in our funding mix, especially during periods of declines in the real estate market, which can have an impact on organizational profitability.

Off-Balance Sheet Activities

Bankshares and the Bank enter into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of customers. These off-balance sheet arrangements include commitments to extend credit, standby letters of credit and financial guarantees which would impact the overall liquidity and capital resources to the extent customers accept and/or use these commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. With the exception of these off-balance sheet arrangements, we have no off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

As of September 30, 2012, there are no material changes to the off-balance sheet arrangements disclosed in Bankshares’ Annual Report on Form 10-K for the year ended December 31, 2011.

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Recent Accounting Pronouncements

In July 2012, the FASB issued ASU 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” The amendments in this ASU apply to all entities that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. The amendments in this ASU provide an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The amendments also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset’s fair value when testing an indefinite-lived intangible asset for impairment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption was permitted. The adoption of the new guidance did not have a material impact on Bankshares’ consolidated financial statements.

In October 2012, the FASB issued ASU 2012-06, “Business Combinations (Topic 805): Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution.” The amendments in this ASU clarify the applicable guidance for subsequently measuring an indemnification asset recognized as a result of a government-assisted acquisition of a financial institution. In addition, the amendments should resolve current diversity in practice on the subsequent measurement of these types of indemnification assets. The amendments are effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. Early adoption is permitted. The amendments should be applied prospectively to any new indemnification assets acquired after the date of adoption and to indemnification assets existing as of the date of adoption arising from a government-assisted acquisition of a financial institution. The adoption of the new guidance will not have a material impact on Bankshares’ consolidated financial statements

In January 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2011-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2011-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures became effective for fiscal years beginning after December 15, 2011 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on Bankshares’ consolidated financial statements.

In July 2011, the FASB issued ASU 2011-20, “Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into an entity’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending on or after December 15, 2011. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures were required for periods beginning on or after December 15,

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2011. Bankshares has included the required disclosures in its consolidated financial statements and the disclosures did not have a material impact on Bankshares’ consolidated financial statements.

In December 2011, the FASB issued ASU 2011-28, “Intangible – Goodwill and Other (Topic 350) – When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this ASU became effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption was not permitted. The adoption of the new guidance did not have a material impact on Bankshares’ consolidated financial statements.

In December 2011, the FASB issued ASU 2011-29, “Business Combinations (Topic 805) – Disclosure of Supplementary Pro Forma Information for Business Combinations.” The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2011-29 became effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2011. Early adoption was permitted. The adoption of the new guidance did not have a material impact on Bankshares’ consolidated financial statements.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Asset Liability Management (ALM) Risk Management. Bankshares engages a consulting firm to model its short-term and long-term interest rate risk profile. The model includes basic business assumptions, interest rates, repricing information and other relevant market data necessary to project Bankshares’ interest rate risk. The Board of Directors has established interest rate risk limits for both short-term and long-term interest rate exposure. On a periodic basis, management reports to the Board of Directors on Bankshares’ base interest rate risk profile and expectations of changes in the profiles based on certain interest rate shocks.

Net Interest Income Sensitivity (Short-term Interest Rate Risk). Bankshares’ ALM process evaluates the effect of upward and downward changes in market interest rates on future net interest income. This analysis involves shocking the interest rates used in determining net interest income over the next twelve months. The resulting percentage change in net interest income in various rate scenarios is an indication of Bankshares’ shorter-term interest rate risk. This analysis is accomplished by assuming a static balance sheet over a period of time with maturing and repayment dollars being rolled back into like instruments for new terms at current market rates. Additional assumptions are applied to modify volumes and pricing under various rate scenarios. These assumptions include prepayments, the sensitivity of non-maturity deposit rates, and other factors deemed significant by Bankshares.

The ALM model results for September 30, 2012 are shown in the table below. Assuming an immediate upward shift in market interest rates of 100 basis points, the results indicate Bankshares would expect net interest income to increase over the next twelve months by 3.00%. Assuming a shift downward of 100 basis points, Bankshares would expect net interest income to decrease over the next twelve months by 4.4%.

Economic Value of Equity (Long-term Interest Rate Risk). The economic value of equity process models the cashflows of financial instruments to maturity. The model incorporates growth and pricing assumptions to develop a baseline Economic Value of Equity (EVE). The interest rates used in the model are then shocked for an immediate increase or decrease in interest rates. The results of the shocked model are compared to the baseline results to determine the percentage change in EVE under the various scenarios. The resulting percentage change in EVE is an indication of the longer term repricing risk and options embedded in the balance sheet.

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The table below shows as of September 30, 2012, ALM model results under various interest rate shocks:

	September 30, 2012
Interest Rate Shocks	NII			EVE
–200 bp		–9.3	%		–4.1	%
–100 bp		–4.4	%		–1.3	%
+100 bp		3.0	%		0.7	%
+200 bp		6.3	%		–0.1	%

All results above are within Bankshares’ current interest rate risk policy guidelines.

Interest Rate Gap. In addition to the NII and EVE models, management reviews Bankshares’ “static” gap position. The cumulative gap position within one year was $12.0 million, or 2.3% of total assets, at September 30, 2012. While this measurement technique is common in the financial services industry, it has limitations and is not Bankshares’ sole tool for measuring interest rate sensitivity. Bankshares does not believe this model accurately reflects its true short-term and long-term interest rate exposure. As an example, $78.3 million of the investment and trading securities at September 30, 2012 are classified as greater than five years due to the contractual maturity of the instruments. Investment and trading securities are easily marketed and can be liquidated in a short period of time. As a result, it is reasonable to consider a portion of, or perhaps all of, the $78.3 million of investment and trading securities as the “within three month” category, which further suggests a more balanced short-term interest rate position for Bankshares.

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The following table reflects our September 30, 2012 “static” interest rate gap position:

	September 30, 2012
	Maturing or Repricing
	Within 3 Months			4-12 Months			1-5 Years			Over 5 Years			Total
	(Dollars in thousands)
Interest earning assets:
Investment securities	$	1,121		$	—		$	—		$	78,290		$	79,411
Trading securities		—			—			293			—			293
Loans*		44,897			44,961			112,720			74,550			277,128
Interest-bearing deposits		113,817			—			—			—			113,817
Federal funds sold		26,594			—			—			—			26,594
Total interest earning assets		186,429			44,961			113,013			152,840			497,243
Interest-bearing liabilities:
Interest-bearing demand deposits		79,893			—			—			—			79,893
Money market deposit accounts		18,123			—			—			—			18,123
Savings accounts		4,165			—			—			—			4,165
Time deposits		11,748			82,230			72,755			—			166,733
Total interest-bearing deposits		113,929			82,230			72,755			—			268,914
FHLB long term advances, at fair value		—			—			—			30,018			30,018
FHLB long term advances		15,000			—			—			—			15,000
Customer repurchase agreements		22,558			—			—			—			22,558
Trust Preferred Capital Notes		10,310			—			—			—			10,310
Total interest-bearing liabilities		161,797			82,230			72,755			30,018			346,800
Period Gap	$	24,632		$	(37,269	)	$	40,258		$	122,822		$	150,443
Cumulative Gap	$	24,632		$	(12,637	)	$	27,621		$	151,443		$	150,443
Cumulative Gap / Total Assets		4.7	%		–2.4	%		5.3	%		28.8	%		28.8	%

* Excludes nonaccrual assets of $ 10.9 million.

Interest Rate Risk Management Summary. As part of its interest rate risk management, Bankshares typically uses the trading and investment portfolio and its wholesale funding instruments to balance its interest rate exposure. There is no guarantee that the risk management techniques and balance sheet management strategies Bankshares employs will be effective in periods of rapid rate movements or extremely volatile periods. Bankshares believes its strategies are prudent and within its policy guidelines in the base case of its modeling efforts as of September 30, 2012.

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Item 4. Controls and Procedures

Bankshares has disclosure controls and procedures to ensure that the information required to be disclosed in the reports that Bankshares files or submits under the Securities Exchange Act of 1934, as amended (the Exchange Act) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and regulations, and that such information is accumulated and communicated to management, including Bankshares’ Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Bankshares’ management evaluated, with the participation of Bankshares’ Chief Executive Officer and Chief Financial Officer, the effectiveness of Bankshares’ disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, Bankshares’ Chief Executive Officer and Chief Financial Officer concluded that Bankshares’ disclosure controls and procedures are effective as of September 30, 2012.

Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that Bankshares’ disclosure controls and procedures will detect or uncover every situation involving the failure of persons within Bankshares to disclose material information required to be set forth in Bankshares’ periodic reports.

No changes in Bankshares’ internal control over financial reporting occurred during the quarter ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, Bankshares’ internal controls over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, Bankshares may be involved in litigation relating to claims arising in the normal course of its business. In the opinion of management, there are no pending or threatened legal matters which would have a material adverse effect on Bankshares’ financial condition or results of operations.

Item 1A. Risk Factors

There have been no material changes to the risk factors disclosed in Item 1A. “Risk Factors” of Bankshares’ Annual Report on Form 10-K for the year ended December 31, 2011 and its Quarterly Report on Form 10-Q for the quarter ended March 31, 2012. Risks and uncertainties identified in Bankshares’ Forward-Looking Statements contained in this Quarterly Report on Form 10-Q or those that are presently unforeseen could result in significant adverse effects on Bankshares’ financial condition, results of operations and cash flows. See “Forward-Looking Statements” contained in Item 2 of Part I, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” within this Quarterly Report on Form 10-Q.

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

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

On November 9, 2012, certain unaudited selected financial information for the quarter ended September 30, 2012 (Financial Information) about Bankshares, on a consolidated basis, was included as part of Amendment No. 3 to Form S-4 (File No. 333-183255) (Registration Statement) filed by WFBI with the SEC in connection with the Merger. A copy of the excerpt from the Registration Statement containing the Financial Information is attached as Exhibit 99.1 to this quarterly report on Form 10-Q.

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Item 6. Exhibits

2.1	Agreement and Plan of Reorganization between Alliance Bankshares Corporation and Alliance Bank Corporation, dated as of May 22, 2002 (incorporated by reference to Exhibit 2.0 to Form 8-K12g-3 filed August 21, 2002).
2.4	Stock Purchase Agreement between Alliance Bank Corporation, as the seller, and Thomas P. Danaher and Oswald H. Skewes, as the purchasers, dated as of December 29, 2010 (incorporated by reference to Exhibit 2.4 to Form 10-K filed May 28, 2010).
2.5	Agreement and Plan of Reorganization, dated as of May 3, 2012, by and among WashingtonFirst Bankshares, Inc., Alliance Bankshares Corporation, and Alliance Bank Corporation (incorporated by reference to Exhibit 2.5 to Form 8-K filed May 8, 2012).
3.1	Articles of Incorporation of Alliance Bankshares Corporation (as amended July 6, 2006) (incorporated by reference to Exhibit 3.1 to Form 10-Q filed August 14, 2006).
3.2	Bylaws of Alliance Bankshares Corporation (amended and restated as of December 19, 2007) (incorporated by reference to Exhibit 3.2 to Form 8-K filed December 27, 2007).
31.1	Certification of CEO pursuant to Rule 13a-14(a).
31.2	Certification of CFO pursuant to Rule 13a-14(a).
32	Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350.
99.1	Excerpt from Amendment No. 3 to Registration Statement on Form S-4 (File No. 183255) filed by WashingtonFirst Bankshares, Inc. on November 9, 2012.
101	The following materials from Alliance Bankshares Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, formatted in XBRL (Extensible Business Reporting Language), furnished herewith: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.

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SIGNATURES

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

ALLIANCE BANKSHARES CORPORATION

(Registrant)

November 14, 2012	/s/ William E. Doyle, Jr.
Date	William E. Doyle, Jr.
	President & Chief Executive Officer
	(Principal Executive Officer)
November 14, 2012	/s/ Jean S. Houpert
Date	Jean S. Houpert
	Executive Vice President &
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

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