form10q_q1.htm

The accompanying notes are an integral part of these consolidated financial statements.

STELLARONE CORPORATION AND SUBSIDIARY
CONSOLIDATED INCOME STATEMENTS
(In thousands, except per share data)
	Three Months Ended
	March 31,
	2012			2011
Interest Income
Loans, including fees	$	26,014		$	27,264
Federal funds sold and deposits in other banks		34			68
Investment securities:
Taxable		1,610			1,721
Tax-exempt		1,300			1,253
Total interest income		28,958			30,306

Interest Expense
Deposits		4,277			5,533
Federal funds purchased and securities sold under agreements to repurchase		6			8
Federal Home Loan Bank advances		438			640
Subordinated debt		341			262
Total interest expense		5,062			6,443
Net interest income		23,896			23,863
Provision for loan losses		850			4,500
Net interest income after provision for loan losses		23,046			19,363

Noninterest Income
Retail banking fees		3,795			3,556
Commissions and fees from fiduciary activities		929			904
Brokerage fee income		414			435
Mortgage banking-related fees		2,184			2,065
Losses on mortgage indemnifications and repurchases		(354	)		(265	)
Losses on sale of premises and equipment		(16	)		-
Gains on sale of securities available for sale		73			10
Losses on sale / impairments on foreclosed assets		(348	)		(128	)
Income from bank owned life insurance		440			319
Other operating income		1,008			774
Total noninterest income		8,125			7,670
Non-interest Expense
Compensation and employee benefits		12,624			12,355
Net occupancy		2,063			2,073
Equipment		2,218			2,020
Amortization of intangible assets		412			413
Marketing		249			327
State franchise taxes		568			598
FDIC insurance		639			877
Data processing		671			636
Professional fees		681			633
Telecommunications		425			376
Other operating expenses		3,007			3,228
Total noninterest expense		23,557			23,536

Income before income taxes		7,614			3,497
Income tax expense		2,114			626
Net income	$	5,500		$	2,871
Dividends and accretion on preferred stock		-			(465	)
Net income available to common shareholders	$	5,500		$	2,406

Basic net income per common share available to common shareholders	$	0.24		$	0.11
Diluted net income per common share available to common shareholders	$	0.24		$	0.11

The accompanying notes are an integral part of these consolidated financial statements.

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STELLARONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME
(In thousands)
	Three months ended March 31,
	2012						2011
Net income				$	5,500					$	2,871
Other comprehensive income, net of tax:
Unrealized holding gains arising during the period (net of tax 2012: $165, 2011: $288)		(307	)					535
Reclassification adjustment (net of tax 2012: $26, 2011: $4)		(47	)					(6	)
Change in post retirement liability (net of tax 2012: $1, 2011: $42)		2						(78	)
Change in cash flow hedge (net of tax 2012: $15, 2011: $11)		(27	)					20
Other comprehensive (loss) income					(379	)					471
Total comprehensive income				$	5,121					$	3,342

The accompanying notes are an integral part of these consolidated financial statements.

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STELLARONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
											Accumulated
											Other
					Additional						Compre-
	Preferred		Common		Paid-In			Retained			hensive
	Stock		Stock		Capital			Earnings			Income			Total
Balance, January 1, 2011	$	28,763	$	22,748	$	270,047		$	101,188		$	3,691		$	426,437
Net income		-		-		-			2,871			-			2,871
Other comprehensive income		-		-		-			-			471			471
Cash dividends paid or accrued:															-
Common ($0.04 per share)		-		-		-			(917	)		-			(917	)
Preferred cumulative 5%		-		-		-			(370	)		-			(370	)
Accretion on preferred stock discount		95		-		-			(95	)		-			-
Stock-based compensation expense (5,831 shares)		-		6		159			-			-			165
Exercise of stock options (21,840 shares)		-		22		190			-			-			212
Balance, March 31, 2011	$	28,858	$	22,776	$	270,396		$	102,677		$	4,162		$	428,869

Balance, January 1, 2012	$	-	$	22,819	$	271,080		$	110,940		$	9,334		$	414,173
Net income		-		-		-			5,500			-			5,500
Other comprehensive loss		-		-		-			-			(379	)		(379	)
Common dividends paid ($0.06 per share)		-		-		-			(1,384	)		-			(1,384	)
Stock-based compensation (benefit) expense (36,708 shares)		-		37		(62	)		-			-			(25	)
Exercise of stock options (3,192 shares)		-		3		32			-			-			35
Balance, March 31, 2012	$	-	$	22,859	$	271,050		$	115,056		$	8,955		$	417,920

The accompanying notes are an integral part of these consolidated financial statements.

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STELLARONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
	Three Months Ended March 31,
	2012			2011
Cash Flows from Operating Activities
Net income	$	5,500		$	2,871
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		1,629			1,680
Amortization of intangible assets		412			413
Provision for loan losses		850			4,500
Deferred tax expense (benefit)		597			(843	)
Stock-based compensation (benefit) expense		(25	)		165
Losses on sale / impairments on foreclosed assets		348			128
Losses on mortgage indemnifications and repurchases		354			265
Losses on sale of premises and equipment		16			-
Gains on sale of securities available for sale		(73	)		(10	)
Mortgage banking-related fees		(2,184	)		(2,065	)
Proceeds from sale of mortgage loans		97,007			121,217
Origination of mortgage loans for sale		(69,854	)		(79,477	)
Amortization of securities premiums and accretion of discounts, net		495			272
Income on bank owned life insurance		(440	)		(319	)
Changes in assets and liabilities:
(Increase) decrease in accrued interest receivable		(53	)		170
Decrease in other assets		927			3,192
Decrease in accrued interest payable		(209	)		(2,278	)
Increase in other liabilities		2,346			4,073
Net cash provided by operating activities	$	37,643		$	53,954

Cash Flows from Investing Activities
Proceeds from maturities, calls and principal payments of securities available for sale	$	25,528		$	33,256
Proceeds from sales of securities available for sale		-			1,085
Purchase of securities available for sale		(72,552	)		(32,634	)
Net (increase) decrease in loans		(6,364	)		28,313
Proceeds from sale of premises and equipment		9			-
Purchase of premises and equipment		(1,672	)		(561	)
Proceeds from sale of foreclosed assets		2,643			2,736
Net cash (used) provided by investing activities	$	(52,408	)	$	32,195

Cash Flows from Financing Activities
Net increase (decrease) in demand, money market and savings deposits	$	31,003		$	(13,047	)
Net decrease in certificates of deposit		(24,686	)		(8,491	)
Principal payments on Federal Home Loan Bank advances		(5,000	)		(25,000	)
Proceeds from exercise of stock options		35			212
Cash dividends paid		(1,384	)		(1,287	)
Net cash used by financing activities	$	(32	)	$	(47,613	)

(Decrease) increase in cash and cash equivalents	$	(14,797	)	$	38,536

Cash and Cash Equivalents
Beginning		99,970			139,886
Ending	$	85,173		$	178,422
Supplemental Schedule of Noncash Activities
Foreclosed assets acquired in settlement of loans	$	1,219		$	1,213

The accompanying notes are an integral part of these consolidated financial statements.

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.	Organization

StellarOne Corporation (“we”) is a Virginia bank holding company headquartered in Charlottesville, Virginia. Our sole banking affiliate is StellarOne Bank headquartered in Christiansburg, Virginia. Additional subsidiaries include VFG Limited Liability Trust and FNB (VA) Statutory Trust II, both of which are associated with our subordinated debt issues and are not subject to consolidation. The consolidated statements include our accounts and those of our wholly-owned banking subsidiary. All significant intercompany accounts have been eliminated. In the opinion of management, the accompanying consolidated financial statements contain all adjustments necessary to present fairly the financial position as of March 31, 2012 and December 31, 2011, and the results of operations and cash flows for the three months ended March 31, 2012 and 2011. The statements should be read in conjunction with the Notes to Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2011. The results of operations for the three month period ended March 31, 2012 are not necessarily indicative of the results to be expected for the full year.

2.	Investment Securities

A summary of the amortized cost and fair value of securities available for sale with gross unrealized gains and losses is presented below (In thousands).

	March 31, 2012									December 31, 2011
			Gross		Gross							Gross		Gross
	Amortized		Unrealized		Unrealized			Fair		Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value		Cost		Gains		Losses			Value
U. S. Government agencies	$	213,007	$	1,270	$	(190	)	$	214,087	$	151,155	$	1,370	$	(58	)	$	152,467
State and municipals		145,554		10,139		(13	)		155,680		148,933		10,582		-			159,515
Corporate bonds		4,808		130		(6	)		4,932		4,478		140		-			4,618
Collateralized mortgage obligations		6,775		204		-			6,979		7,251		221		-			7,472
Agency mortgage backed securities		127,604		5,739		-			133,343		139,330		5,563		-			144,893
Other		8,999		-		-			8,999		8,999		-		-			8,999
Total	$	506,747	$	17,482	$	(209	)	$	524,020	$	460,146	$	17,876	$	(58	)	$	477,964

The book value of securities pledged to secure deposits and for other purposes amounted to $131.1 million and $146.4 million at March 31, 2012 and December 31, 2011, respectively.

Information pertaining to sales and calls of securities available for sale is as follows (In thousands):

	Three Months Ended
	March 31,
	2012		2011

Proceeds from sales/calls	$	2,705	$	10,483
Gross realized gains		73		10

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2012, securities with unrealized losses segregated by length of impairment were as follows (In thousands):

	Less than 12 months					12 months or more				Total
			Unrealized					Unrealized				Unrealized
	Fair Value		Losses			Fair Value		Losses		Fair Value		Losses
Securities Available for Sale
U. S. Government agencies	$	66,515	$	(190	)	$	-	$	-	$	66,515	$	(190	)
State and municipals		2,222		(13	)		-		-		2,222		(13	)
Corporate bonds		1,318		(6	)		-		-		1,318		(6	)
Total temporarily impaired securities	$	70,055	$	(209	)	$	-	$	-	$	70,055	$	(209	)

Declines in the fair value of available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in cost.

As of March 31, 2012, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is not likely that we will have to sell any such securities before a recovery of cost given the current liquidity position. The unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date or re-pricing date or if market yields for such investments decline. Management does not believe such securities are other-than-temporarily impaired due to reasons of credit quality.

The amortized cost and fair value of securities available for sale at March 31, 2012 are presented below by contractual maturity (In thousands).

	Amortized Cost		Fair Value
Due in one year or less	$	47,930	$	48,246
Due after one year through five years		208,574		211,009
Due after five years through ten years		80,891		85,258
Due after ten years		169,351		179,507
Total	$	506,746	$	524,020

Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

3.	Derivative Financial Instruments

We use derivatives to manage exposure to interest rate risk through the use of interest rate swaps, caps and floors to mitigate exposure to interest rate risk and service the needs of our customers.

Interest rate swaps involve the exchange of fixed and variable rate interest payments between two counterparties, based on a common notional principal amount and maturity date with no exchange of underlying principal amounts. During 2010, we entered into a forward start interest rate swap contract on our subordinated debt that qualifies as a cash flow hedge, effective September 2011. The swap was extended for an additional three years, with the new rate to take effect in September 2013 following the maturity of the current swap. Our cash flow hedge effectively modifies our exposure to interest rate risk by converting floating rate subordinated debt to a fixed rate with a maturity in 2016.

On September 30, 2011, we began paying a weighted average fixed rate of 1.245% plus margin, and receive a variable interest rate of three-month LIBOR on a total notional amount of $32.0 million, with quarterly settlements. Beginning in September of 2011, this swap effectively fixed the interest rate on the subordinated debt at 4.11% for the two year swap term (through September 2013). The cash flow hedge was fully effective at March 31, 2012 and therefore the change in fair value on the cash flow hedge was recognized as a component of other comprehensive income, net of deferred income taxes. The swap extension will effectively fix the interest rate on the subordinated debt at 4.81%, starting in September 2013 (through September 2016). At March 31, 2012, the cash flow hedge had a fair value of $845 thousand and is recorded in Other Liabilities. We anticipate that it will continue to be fully effective and changes in fair value will continue to be recognized as a component of other comprehensive income, net of deferred income taxes.

We entered into certain interest rate swap contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which we enter into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each swap transaction, we agree to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, we agree to pay the counterparty the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows our customers to effectively convert a variable rate loan to a fixed rate. Because we act as an intermediary for our customers, changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact our results of operations. The aggregate notional amount of these swap agreements with counterparties was $21.5 million as of March 31, 2012.

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

4.	Loans and Alowance for Loan Losses

Through our banking subsidiary, we grant mortgage, commercial and consumer loans to customers, all of which are considered financing receivables. A substantial portion of the loan portfolio is represented by mortgage loans. The ability of our debtors to honor their contracts is dependent upon the real estate and general economic conditions in our market area.

Loans that we have the intent and ability to hold for the foreseeable future or until maturity or pay-off are generally reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. These amounts are generally being amortized over the contractual life of the loan.

Our loan portfolio is composed of the following (In thousands):

	March 31,			December 31,
	2012			2011
Construction and land development:
Residential	$	48,478		$	49,995
Commercial		158,753			164,672
Total construction and land development		207,231			214,667
Commercial real estate:
Commercial real estate - owner occupied		317,374			317,976
Commercial real estate - non-owner occupied		421,288			417,658
Farmland		15,851			15,756
Multifamily, nonresidential and junior liens		97,601			93,470
Total commercial real estate		852,114			844,860
Consumer real estate:
Home equity lines		261,851			263,035
Secured by 1-4 family residential, secured by first deeds of trust		451,454			450,667
Secured by 1-4 family residential, secured by second deeds of trust		40,789			42,534
Total consumer real estate		754,094			756,236
Commercial and industrial loans (except those secured by real estate)		199,453			189,887
Consumer and other:
Consumer installment loans		18,754			20,216
Deposit overdrafts		1,213			3,526
All other loans		1,581			1,739
Total consumer and other		21,548			25,481
Total loans		2,034,440			2,031,131
Deferred loan costs		312			299
Allowance for loan losses		(31,615	)		(32,588	)
Net loans	$	2,003,137		$	1,998,842

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2012 and December 31, 2011, the book value of loans pledged as collateral for advances outstanding with the Federal Home Loan Bank of Atlanta totaled $622.9 million and $642.6 million, respectively.

The accrual of interest is generally discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Deposit overdrafts and other loans are typically charged off no later than 120 days past due. Consumer installment loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual at an earlier date if collection of principal or interest is considered doubtful or charged-off if a loss is considered imminent.

All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future collection of principal and interest are reasonably assured.

The following table presents the recorded investment in nonaccrual and loans past due more than 90 days still accruing by portfolio segment (In thousands):

	Nonaccrual				Loans Past Due Over 90 Days Still Accruing
	March 31,		December 31,		March 31,		December 31,
	2012		2011		2012		2011
Construction and land development	$	8,414	$	8,324	$	-	$	-
Commercial real estate		14,378		15,055		-		1,416
Consumer real estate		14,272		14,629		352		-
Commercial and industrial loans (except those secured by real estate)		598		1,141		205		96
Consumer and other		30		25		6		4
Total	$	37,692	$	39,174	$	563	$	1,516

If interest under the accrual method had been recognized on nonaccrual loans, such income would have approximated $351 thousand and $713 thousand for the three months ended March 31, 2012 and 2011, respectively.

The following table presents the aging of the recorded investment in past due loans as of March 31, 2012 and December 31, 2011 by portfolio segment (In thousands):

	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Non-accrual		Total Past Due		Current		Total Loans
March 31, 2012
Construction and land development	$	6,123	$	413	$	-	$	8,414	$	14,950	$	192,281	$	207,231
Commercial real estate		3,869		3,138		-		14,378		21,385		830,729		852,114
Consumer real estate		12,879		4,681		352		14,272		32,184		721,910		754,094
Commercial and industrial loans (except those secured by real estate)		496		783		205		598		2,082		197,371		199,453
Consumer and other		207		89		6		30		332		21,216		21,548
Total loans	$	23,574	$	9,104	$	563	$	37,692	$	70,933	$	1,963,507	$	2,034,440

December 31, 2011
Construction and land development	$	7,268	$	397	$	-	$	8,324	$	15,989	$	198,678	$	214,667
Commercial real estate		5,125		2,856		1,416		15,055		24,452		820,408		844,860
Consumer real estate		14,818		2,661		-		14,629		32,108		724,128		756,236
Commercial and industrial loans (except those secured by real estate)		714		264		96		1,141		2,215		187,672		189,887
Consumer and other		297		59		4		25		385		25,096		25,481
Total loans	$	28,222	$	6,237	$	1,516	$	39,174	$	75,149	$	1,955,982	$	2,031,131

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan balances are charged off against the allowance when management believes a loan balance is confirmed uncollectable. Subsequent recoveries, if any, are credited to the allowance.

We conduct an analysis of the loan portfolio on a regular basis. This analysis is used in assessing the sufficiency of the allowance for loan losses and in the determination of the necessary provision for loan losses. The review process generally begins with the identification of potential problem loans to be reviewed on an individual basis for impairment. When a loan has been identified as impaired, a specific reserve may be established based on our calculation of the loss embedded in the individual loan. In addition to specific reserves on impaired loans, we have a nine point grading system for each non-homogeneous loan in the portfolio to reflect the risk characteristic of the loan. The loans identified and measured for impairment are segregated from risk-rated loans within the portfolio. Loans are then grouped by loan type and, in the case of commercial and construction loans, by risk rating. Each loan type is assigned an allowance factor based on historical loss experience, economic conditions, overall portfolio quality including delinquency rates and commercial real estate loan concentrations. The ALLL is an accounting estimate and as such there is uncertainty associated with the estimate due to the level of subjectivity and judgment inherent in performing the calculation. Management’s evaluation of the ALLL also includes considerations of existing general economic and business conditions affecting our key lending areas, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience in particular segments of the portfolio, duration of the current business cycle, bank regulatory examination results and findings of our outsourced loan review consultants. The total of specific reserves required for impaired classified loans and the calculated reserves comprise the allowance for loan losses.

The look-back period for calculating historical losses is four years. This period was increased to four years in the first quarter of 2012, from three years, as management believes this period more appropriately reflects the current credit cycle and accurately reflects the risk in the loan portfolio. A period of four years includes the higher credit losses beginning in 2008 attributable to the economic downturn. The look-back period was shortened due to the sudden, extreme decline in credit quality. As the economy recovers, we are returning our look-back period to more historical levels. The most current 12 month period continues to be heavily weighted as management considers it to be the most relevant indicator of current economic conditions. An additional soft factor to capture the additional risk associated with the level of nonaccrual consumer real estate loans was also added to the methodology during the current quarter. These refinements to the ALLL calculation were not significant to the provision expense or the overall consolidated financial statements.

While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

Activity in the allowance for loan losses is as follows (In thousands):

	Three Months Ended March 31, 2012
	Construction and Land Development			Commercial Real Estate			Consumer Real Estate			Commercial and Industrial (Except those Secured by Real Estate)			Consumer and Other			Total Loans
Balance, January 1, 2012	$	9,856		$	8,565		$	10,019		$	4,059		$	89		$	32,588
Provision for loan losses		(53	)		395			1,295			(713	)		(74	)		850
Loans charged off		(401	)		(798	)		(886	)		(250	)		(48	)		(2,383	)
Recoveries		14			68			98			268			112			560
Net (charge-offs) recoveries		(387	)		(730	)		(788	)		18			64			(1,823	)
Balance, March 31, 2012	$	9,416		$	8,230		$	10,526		$	3,364		$	79		$	31,615

	Three Months Ended March 31, 2011
	Construction and Land Development			Commercial Real Estate			Consumer Real Estate			Commercial and Industrial (Except those Secured by Real Estate)			Consumer and Other			Total Loans
Balance, January 1, 2011	$	11,037		$	8,211		$	10,864		$	7,388		$	149		$	37,649
Provisions for loan losses		1,318			1,019			1,319			829			15			4,500
Loans charged off		(962	)		(1,353	)		(936	)		(1,622	)		(106	)		(4,979	)
Recoveries		15			2			58			126			148			349
Net (charge-offs) recoveries		(947	)		(1,351	)		(878	)		(1,496	)		42			(4,630	)
Balance, March 31, 2011	$	11,408		$	7,879		$	11,305		$	6,721		$	206		$	37,519

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method for the periods ended March 31, 2012 and December 31, 2011 were as follows (In thousands):

	Construction and Land Development		Commercial Real Estate		Consumer Real Estate		Commercial and Industrial Loans (Except those Secured by Real Estate)		Consumer and Other		Total Loans
March 31, 2012
Allowance for loan losses:
Individually evaluated for impairment	$	3,673	$	1,201	$	645	$	-	$	-	$	5,519
Collectively evaluated for impairment		5,743		7,029		9,881		3,364		79		26,096
Total ending allowance	$	9,416	$	8,230	$	10,526	$	3,364	$	79	$	31,615

Loans:
Individually evaluated for impairment	$	14,032	$	15,579	$	7,043	$	-	$	-	$	36,654
Collectively evaluated for impairment		193,199		836,535		747,051		199,453		21,548		1,997,786
Total loans	$	207,231	$	852,114	$	754,094	$	199,453	$	21,548	$	2,034,440

December 31, 2011
Allowance for loan losses:
Individually evaluated for impairment	$	4,071	$	1,088	$	562	$	-	$	-	$	5,721
Collectively evaluated for impairment		5,785		7,477		9,457		4,059		89		26,867
Total ending allowance	$	9,856	$	8,565	$	10,019	$	4,059	$	89	$	32,588

Loans:
Individually evaluated for impairment	$	15,218	$	13,730	$	5,325	$	-	$	-	$	34,273
Collectively evaluated for impairment		199,449		831,130		750,911		189,887		25,481		1,996,858
Total loans	$	214,667	$	844,860	$	756,236	$	189,887	$	25,481	$	2,031,131

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A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining whether a loan is impaired include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Additionally, management’s policy is generally to evaluate only those loans greater than $500 thousand for impairment as these are considered to be individually significant in relation to the size of the loan portfolio. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer and residential loans for impairment.

Impaired loans totaled $51.4 million and $52.8 million at March 31, 2012 and December 31, 2011, respectively. Included in these balances were $34.8 million and $38.7 million, respectively, of loans classified as troubled debt restructurings (“TDRs”). A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider. For loans classified as TDRs, we further evaluate the loans as performing or nonperforming. If, at the time of restructure, the loan is not considered non-accrual, it will be classified as performing and will continue to be classified as performing as long as the borrower continues making payments in accordance with the restructured terms. A modified loan will be reclassified to non-accrual if the loan becomes 90 days delinquent or other weaknesses are observed which make collection of principal and interest unlikely. TDRs originally considered non-accrual will be classified as nonperforming, but are able to be reclassified as performing if subsequent to restructure, they experience consecutive six months of payment performance according to the restructured terms. Further, a TDR may be subsequently removed from impaired status in years subsequent to the restructuring if it meets the following criteria:

· At the time of restructure, the loan was made at a market rate of interest

· The loan has shown at least 6 months of payment performance in accordance with the restructured terms.

· The loan has been reported as a TDR in at least one annual filing on Form 10-K.

Quarterly, we review those loans designated as TDRs for compliance with the previously stated criteria as part of our ongoing monitoring of the performance of modified loans.

The following table provides information on performing and nonperforming restructures for the periods presented (In thousands):

	March 31,		December 31,
	2012		2011
Performing restructurings:
Construction and land development	$	8,238	$	9,946
Commercial real estate		4,987		5,029
Consumer real estate (mortgage modification program)		15,421		15,556
Total performing restructurings	$	28,646	$	30,531

Nonperforming restructurings:
Commercial real estate	$	2,796	$	2,832
Consumer real estate (mortgage modification program)		3,338		5,357
Total nonperforming restructurings	$	6,134	$	8,189

Total restructurings	$	34,780	$	38,720

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The following table provides information about TDRs identified during the specified periods and those loans identified as TDRs within the prior 12 month timeframe that subsequently defaulted. Defaults are those TDRs that went greater than 90 days past due, and aligns with our internal definition of default for those loans not identified as TDRs (In thousands, except number of contracts):

	Modifications for the three months ended,
	March 31, 2012

	Number of contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Construction and land development		1	$	2,201	$	2,201
Consumer real estate		2		986		1,275
Total Troubled Debt Restructurings		3	$	3,187	$	3,476

Troubled Debt Restructurings that Subsequently Defaulted
	Number of contracts		Recorded Investment
Troubled Debt Restructurings
Commercial real estate		1	$	1,043
Consumer real estate		14	$	2,360
Commercial and industrial loans (except those secured by real estate)		1		-
Total Troubled Debt Restructurings		16	$	3,403

	Modifications for the three months ended,
	March 31, 2011

	Number of contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Construction and land development		1	$	152	$	156
Commercial real estate		2		445		445
Consumer real estate		19		3,529		3,599
Total Troubled Debt Restructurings		22	$	4,126	$	4,200

Troubled Debt Restructurings that Subsequently Defaulted
	Number of contracts		Recorded Investment
Troubled Debt Restructurings
Construction and land development		2	$	300
Consumer real estate		17		1,573
Total Troubled Debt Restructurings		19	$	1,873

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Modifications of terms for loans and their inclusion as TDRs are based on individual facts and circumstances. Loan modifications that are included as TDRs may involve either an increase or reduction of the interest rate, extension of the term of the loan, or deferral of principal payments, regardless of the period of the modification. The loans included in all loan classes as TDRs at March 31, 2012 and December 31, 2011 had either an interest rate modification or a deferral of principal payments, which we consider to be a concession. All loans designated as TDRs were modified due to financial difficulties experienced by the borrower.

The allowance for loan losses associated with TDRs for every loan class is determined using a discounted cash flow analysis in which the original rate prior to modification is used to discount the modified cash flow stream to its net present value. This value is then compared to the recorded amount to determine the appropriate level of reserve to be included in the allowance for loan losses. In instances where this analysis is deemed ineffective due to rate increases made during modification, a collateral dependent approach is used as a practical alternative. The discounted cash flow analysis is used to calculate the reserve balance for TDRs both evaluated individually and those included within homogenous pools.

Interest is not typically accrued on impaired loans, but is accrued for performing TDRs. The following table shows interest income recognized on impaired loans (In thousands):

	Three Months Ended March 31
	Interest income recognized		Cash-basis interest income
2012
Construction and land development	$	114	$	147
Commercial real estate		62		64
Consumer real estate		45		43
Total	$	221	$	254

2011
Construction and land development	$	35	$	45
Commercial real estate		79		87
Consumer real estate		49		48
Commercial and industrial loans (except those secured by real estate)		53		38
Total	$	216	$	218

Cash basis interest income illustrates income that would have been recognized solely based on cash payments received. Interest income recognized differs from the cash basis due to the movement of loans between performing and nonperforming status during the periods presented. Other than these TDRs, no interest income has been recognized on impaired loans subsequent to their classification as impaired.

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In order to measure the amount of impairment, we evaluate loans either individually or in collective pools. Collective pools consist of smaller balance, homogenous loans that are not subject to a restructuring agreement. Of the $51.4 million of impaired loans at March 31, 2012, $14.7 million, consisting solely of TDRs, was collectively evaluated for impairment and $36.7 million was individually evaluated for impairment. The detail of loans individually evaluated for impairment, which includes $20.1 million of TDRs, is presented below (In thousands):

	Recorded investment		Unpaid contractual principal balance		Allocated allowance		Average recorded investment
March 31, 2012
Loans without a specific valuation allowance:
Construction and land development	$	3,074	$	3,120	$	-	$	3,713
Commercial real estate		8,334		8,388		-		7,581
Consumer real estate		3,510		5,105		-		2,961
Loans with a specific valuation allowance:
Construction and land development		10,958		12,944		3,673		10,912
Commercial real estate		7,245		7,548		1,201		7,074
Consumer real estate		3,533		3,549		645		3,223
Total	$	36,654	$	40,654	$	5,519	$	35,464

As of December 31, 2011, we had $52.8 million of impaired loans, with $18.5 million, consisting solely of TDRs, collectively evaluated for impairment. The other $34.3 million individually evaluated for impairment, which includes $20.2 million of TDRs, is presented below (In thousands):

	Recorded investment		Unpaid contractual principal balance		Allocated allowance		Average recorded investment
December 31, 2011
Loans without a specific valuation allowance:
Construction and land development	$	4,351	$	4,351	$	-	$	3,772
Commercial real estate		6,827		7,105		-		4,484
Consumer real estate		2,412		3,990		-		2,146
Commercial and industrial loans (except those secured by real estate)		-		-		-		517
Loans with a specific valuation allowance:
Construction and land development		10,867		10,867		4,071		10,235
Commercial real estate		6,903		6,927		1,088		7,494
Consumer real estate		2,913		2,913		562		2,295
Commercial and industrial loans (except those secured by real estate)		-		-		-		2,638
Total	$	34,273	$	36,153	$	5,721	$	33,581

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Credit Quality Indicators

We categorize all business and commercial purpose loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We analyze loans individually by setting the risk grade at the inception of a loan through the approval process. The definitions used were last updated in early 2010 and are reviewed for applicability annually. The risk grades are formally affirmed quarterly by loan officers. In addition, a certain percentage of loan dollars is reviewed each year through our loan review process. The risk rating process is inherently subjective and based upon management’s evaluation of the specific facts and circumstances for individual borrowers. As such, the assigned risk ratings are subject to change based upon changes in borrower status and changes in the external environment affecting the borrower. We use the following definitions for risk ratings:

· Risk Grade 1 – Prime Risk. Loss potential is rated as none or extremely low. Loans fully secured by deposit accounts at our subsidiary bank will also be rated as Risk Grade 1.

· Risk Grade 2 – Excellent Risk. Loss potential is demonstrably low. Loans have liquid financial statements or are secured by marketable securities or other liquid collateral.

· Risk Grade 3 – Good Risk. Loss potential is low. Asset quality and liquidity are considered good. Overall leverage and liquidity measures are better than the industry in which the borrower operates and they are stable.

· Risk Grade 4 – Average Risk. Loss potential is low, but evidence of risk exists. Margins and cash flow generally equal or exceed industry norm and policy guidelines, but some inconsistency may be evident. Asset quality is average with liquidity comparable to industry norms. Leverage may be slightly higher than the industry, but is stable.

· Risk Grade 5 – Marginal Risk. Loss potential is variable, but there is potential for deterioration. Asset quality is marginally acceptable. Leverage may fluctuate and is above normal for the industry. Cash flow is marginally adequate.

· Risk Grade 6 – Special Mention. Loss potential moderate if corrective action not taken. Evidence of declining revenues or margins, inadequate cash flow, and possibly high leverage or tightening liquidity.

· Risk Grade 7 – Substandard. Distinct possibility of loss to the bank. Repayment ability of borrower is weak and the loan may have exhibited excessive overdue status, extension, or renewals.

· Risk Grade 8 – Doubtful. Loss potential is extremely high. Ability of the borrower to service the debt is weak, constant overdue status, loan has been placed on non-accrual status and no definitive repayment schedule exists.

· Risk Grade 9 – Loss. Loans are considered fully uncollectible and charged off.

We utilize our nine point grading system in order to evaluate the level of inherent risk in the loan portfolio as part of our allowance for loan losses methodology. Loans graded 5 or worse are assigned an additional reserve factor stated in basis points in order to account for the added inherent risk. Additional basis points are applied as a reserve factor to the loan balances as the corresponding loan grades indicate additional risk and increase from grade 5 to grade 8.

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Loans listed as not rated are either commercial loans less than $25 thousand, consumer purpose loans, construction loans to individuals for single-family owner-occupied construction, or are included in groups of homogenous loans. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows (In thousands):

			Risk Grade
	Not Graded			1		2		3		4		5		6		7		8
March 31, 2012
Construction and land development	$	45,031	$	-	$	148	$	1,264	$	72,647	$	46,801	$	5,347	$	32,617	$	3,376
Commercial real estate		-		-		9,306		84,756		417,676		215,338		50,680		72,645		1,713
Consumer real estate		-		-		1		8,425		100,061		68,630		12,504		32,019		950
Commercial and industrial loans (except those secured by real estate)		-		867		3,889		44,452		101,999		35,188		5,024		8,034		-
Consumer and other		-		-		-		-		-		-		-		-		-
Total	$	45,031	$	867	$	13,344	$	138,897	$	692,383	$	365,957	$	73,555	$	145,315	$	6,039

December 31, 2011
Construction and land development	$	46,724	$	-	$	-	$	1,402	$	72,138	$	47,681	$	3,285	$	40,044	$	3,393
Commercial real estate		-		-		3		89,878		411,433		228,360		37,091		77,424		671
Consumer real estate		-		-		4		9,723		100,501		72,386		13,157		29,540		950
Commercial and industrial loans (except those secured by real estate)		-		790		4,218		46,413		92,000		33,088		4,859		8,482		37
Consumer and other		-		-		-		-		-		-		-		-		-
Total	$	46,724	$	790	$	4,225	$	147,416	$	676,072	$	381,515	$	58,392	$	155,490	$	5,051

We consider the performance of the loan portfolio and its impact on the allowance for loan losses. For smaller-balance homogenous residential and consumer loans, we also evaluate credit quality based on the aging status of the loan and by payment activity. The following table presents the recorded investment in residential and consumer loans based on payment activity (In thousands):

	Consumer real estate				Consumer and other
	March 31, 2012		December 31, 2011		March 31, 2012		December 31, 2011
Performing	$	522,628	$	521,175	$	21,518	$	25,456
Nonperforming		8,876		8,800		30		25
Total	$	531,504	$	529,975	$	21,548	$	25,481

Purchased Loans

We evaluate all mortgage loans at the time of repurchase for evidence of deteriorated credit quality. All loans are recorded at estimated realizable value at the time of purchase.

Concentrations of Credit

Most of our lending activity occurs within Richmond, Central Virginia and Southwest Virginia. The majority of our loan portfolio consists of consumer and commercial real estate loans. As of March 31, 2012 and December 31, 2011, there were no concentrations of loans related to any single industry in excess of 10% of total loans.

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5. Earnings Per Share

The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock for the three month periods ended March 31, 2012 and 2011. Potential dilutive stock had no effect on income available to common shareholders for the three month periods (In thousands, except share and per share amounts).

	March 31,
	2012		2011
Earnings per common share
Net income	$	5,500	$	2,871
Preferred stock dividends and accretion		-		(465	)
Net income available to common shareholders		5,500		2,406
Weighted average common shares issued and outstanding		23,064,048		22,835,761
Earnings per common share	$	0.24	$	0.11

Diluted earnings per common share
Weighted average common shares issued and outstanding		23,064,048		22,835,761
Incentive stock options		116		1,615
Stock options		-		10,057
Total diluted weighted average common shares issued and outstanding		23,064,164		22,847,433
Diluted earnings per common share	$	0.24	$	0.11

The preferred stock dividends and accretion in 2011 arose from our participation in the U.S. Treasury Capital Purchase Program, which ceased on December 31, 2011 when we completed our repurchase of the preferred stock.

In 2012 and 2011, stock options representing 257,336 and 431,045 shares, respectively, were not included in the three month calculation of earnings per share, as their effect would have been anti-dilutive.

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6. Stock-Based Compensation

Stock-based compensation expense included within compensation and employee benefits expense totaled $218 thousand and $165 thousand during the three months ended March 31, 2012 and 2011, respectively.

A summary of the stock option plan at March 31, 2012 and 2011 and changes during the periods ended on those dates are as follows:

	2012					2011
	Number of Shares			Weighted Average Exercise Price		Number of Shares			Weighted Average Exercise Price

Outstanding at January 1,		291,196		$	21.58		498,174		$	19.98
Forfeited		(6,228	)		19.29		(9,841	)		19.04
Expired		(29,538	)		22.57		(7,304	)		19.90
Exercised		-			-		(21,840	)		9.71
Outstanding at March 31,		255,430		$	21.53		459,189		$	20.50

Exercisable at March 31,		224,206					400,059

There was no aggregate intrinsic value associated with options outstanding and exercisable as of March 31, 2012. The aggregate intrinsic value represents the total pre-tax intrinsic value (the difference between our closing stock price on the last trading day of the quarter ended March 30, 2012 and the exercise price, multiplied by the number of options outstanding). The weighted average remaining contractual life is 2.2 years for exercisable options at March 31, 2012.

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The following table summarizes non-vested restricted shares outstanding as of March 31, 2012 and the related activity during the period:


Nonvested Shares	Number of Shares			Weighted Average Grant-Date Fair Value		Total Intrinsic Value
						(In thousands)

Nonvested at January 1, 2012		201,799		$	12.34	$	2,296
Granted		67,542			12.27
Vested and exercised		(36,708	)		10.80	$	461
Forfeited		(11,532	)		13.59
Nonvested at March 31, 2012		221,101		$	12.51	$	2,624

The estimated unamortized compensation expense, net of estimated forfeitures, related to non-vested stock and stock options issued and outstanding as of March 31, 2012 that will be recognized in future periods is as follows (In thousands):

	Stock Options		Nonvested Restricted Stock		Total

For the remaining nine months of 2012	$	34	$	634	$	668
For year ending December 31, 2013		17		770		787
For year ending December 31, 2014		1		502		503
For year ending December 31, 2015		-		234		234
For year ending December 31, 2016		-		51		51
For year ending December 31, 2017		-		1		1
Total	$	52	$	2,192	$	2,244

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7. Fair Value of Financial Instruments and Interest Rate Risk

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability (an exit price) in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, we utilize valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. FASB ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

We group assets and liabilities 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. An adjustment to the pricing method used within either Level 1 or Level 2 inputs could generate a fair value measurement that effectively falls in a lower level in the hierarchy. These levels are:

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

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

Level 3: Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value. The determination of where an asset or liability falls in the hierarchy requires significant judgment. We evaluate our hierarchy disclosures each quarter and based on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. However, we expect changes in classifications between levels will be rare. There were no transfers between levels in 2012 and 2011.

Assets and Liabilities Measured on a Recurring Basis

Securities: Investment securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Level 1 securities include those traded on nationally recognized securities exchanges, U.S. Treasury securities, and money market funds. Level 2 securities include U.S. Agency securities, mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Deferred compensation plans: Liabilities associated with deferred compensation plans are recorded at fair value on a recurring basis as Level 1 based on the fair value of the underlying securities. Fair value measurement is based upon the fair value of the securities as described above.

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Assets and liabilities measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011 are summarized below (In thousands):

			Fair Value Measurements at
			March 31, 2012
			Using
			Level 1		Level 2		Level 3
	Total		(Quoted Prices)		(Significant Other Observable Inputs)		(Significant Unobservable Inputs)
Investment securities available-for-sale
U. S. Government agencies	$	214,087	$	-	$	214,087	$	-
State and municipals		155,680		-		155,680		-
Corporate bonds		4,932		-		4,932		-
Collateralized mortgage obligations		6,979		-		6,979		-
Agency mortgage backed securities		133,343		-		133,343		-
Certificates of deposit		8,999		-		8,999		-
Other assets 1		2,846		2,846		-		-
Total assets at fair value	$	526,866	$	2,846	$	524,020	$	-

Cash flow hedge	$	845	$	-	$	845	$	-
Other liabilities 1		2,896		2,896		-		-
Total liabilities at fair value	$	3,741	$	2,896	$	845	$	-

1 Includes assets and liabilities associated with deferred compensation plans

			Fair Value Measurements at
			December 31, 2011
			Using
			Level 1		Level 2		Level 3
	Total		(Quoted Prices)		(Significant Other Observable Inputs)		(Significant Unobservable Inputs)
Investment securities available-for-sale
U. S. Government agencies	$	152,467	$	-	$	152,467	$	-
State and municipals		159,515		-		159,515		-
Corporate bonds		4,618		-		4,618		-
Collateralized mortgage obligations		7,472		-		7,472		-
Agency mortgage backed securities		144,893		-		144,893		-
Certificates of deposit		8,999		-		8,999		-
Other assets 1		2,711		2,711		-		-
Total assets at fair value	$	480,675	$	2,711	$	477,964	$	-

Cash flow hedge	$	804	$	-	$	804	$	-
Other liabilities 1		2,711		2,711		-		-
Total liabilities at fair value	$	3,515	$	2,711	$	804	$	-

1 Includes assets and liabilities associated with deferred compensation plans

The change in the balance sheet carrying values associated with company determined market priced assets measured at fair value on a recurring basis during the three months ended March 31, 2012 was not significant and there were no transfer between Levels 1, 2 or 3 during the three months ended March 31, 2012.

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Assets and Liabilities Measured on a Nonrecurring Basis

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with USGAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.

Loans held for sale: The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. Those loans with a quoted price are recorded as Level 2. If no such quoted price exists, the fair value of a loan is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that loan. These loans are recorded as Level 3.

Loans: We do not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value, and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2012 and December 31, 2011, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the impaired loan as nonrecurring Level 3.

Foreclosed assets: Foreclosed assets are initially recorded at fair value less costs to sell upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or net realizable value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. As such, we record the foreclosed asset as nonrecurring Level 3.

Assets measured at fair value on a nonrecurring basis as of March 31, 2012 and December 31, 2011 are included in the table below (In thousands):

			Fair Value Measurements at
			March 31, 2012
			Using
			Level 1		Level 2		Level 3
	Total		(Quoted Prices)		(Significant Other Observable Inputs)		(Significant Unobservable Inputs)
Impaired loans	$	51,360	$	-	$	23,938	$	27,422
Loans held for sale - mortgage		17,058		-		17,058		-
Foreclosed assets		6,836		-		-		6,836
Total assets at fair value	$	75,254	$	-	$	40,996	$	34,258

			Fair Value Measurements at
			December 31, 2011
			Using
			Level 1		Level 2		Level 3
	Total		(Quoted Prices)		(Significant Other Observable Inputs)		(Significant Unobservable Inputs)
Impaired loans	$	52,756	$	-	$	26,839	$	25,917
Loans held for sale - mortgage		42,027		-		42,027		-
Loans held for sale - other assets		213		-		-		213
Foreclosed assets		8,575		-		-		8,575
Total assets at fair value	$	103,571	$	-	$	68,866	$	34,705

The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The estimated fair value approximates carrying value for cash and cash equivalents, accrued interest and the cash surrender value of life insurance policies. The methodologies for other financial assets and financial liabilities are discussed below:

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Loans: For variable-rate loans that re-price frequently and with no significant changes in credit risk, fair values are based on carrying values. The fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered. An overall valuation adjustment is made for specific credit risks as well as general portfolio credit risk. These loans are considered Level 3, as the valuation is determined using discounted cash flow methodology.

Deposit Liabilities: The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. Deposits are considered Level 3, as the valuation is determined using discounted cash flow methodology.

Federal Home Loan Bank Advances: The fair values of our Federal Home Loan Bank advances are provided by the Federal Home Loan Bank of Atlanta and represent mathematical approximations of market values derived from their proprietary models as of the close of business on the last business day of the quarter. We consider these advances Level 3, as the values are estimated fair values and not actual market prices.

Subordinated Debt: The values of our subordinated debt are variable rate instruments that re-price on a quarterly basis; therefore, carrying value is adjusted for the three month re-pricing lag in order to approximate fair value. Subordinated debt is Level 3, as the valuation is determined using discounted cash flow methodology.

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 stand-by 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. At March 31, 2012 and December 31, 2011, the fair value of loan commitments and stand-by letters of credit was immaterial.

The estimated fair values of our financial instruments are as follows (In thousands):

	March 31, 2012			December 31, 2011
	Carrying		Fair	Carrying		Fair
	Amount		Value	Amount		Value
Financial assets:
Cash and cash equivalents	$	85,173	85,173	$	99,970	99,970
Investment securities		524,020	524,020		477,964	477,964
Mortgage loans held for sale		17,058	17,058		42,027	42,027
Loans, net		2,003,137	1,848,357		1,998,842	1,839,635
Accrued interest receivable		8,961	8,961		8,908	8,908

Financial liabilities:
Deposits	$	2,401,917	2,415,636	$	2,395,600	2,409,959
Federal Home Loan Bank advances		55,000	59,172		60,000	64,395
Subordinated debt		32,991	32,932		32,991	32,930
Accrued interest payable		1,913	1,913		2,122	2,122

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

8. Restricted Investment in FHLB Stock

Restricted stock, which represents a required investment in the common stock of a correspondent bank, is carried at cost and, as of March 31, 2012 and December 31, 2011, consisted of the common stock of the Federal Home Loan Bank (“FHLB”) of Atlanta, which is included in Other assets.

We evaluate the restricted stock for impairment in accordance with authoritative accounting guidance under ASC Topic 320, “Investments – Debt and Equity Securities.” Our determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of the cost of an investment is influenced by criteria such as (1) the significance of the decline in net assets of the issuing bank as compared to the capital stock amount for that bank and the length of time this situation has persisted, (2) commitments by the issuing bank to make payments required by law or regulation and the level of such payments in relation to the operating performance of that bank, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the issuing bank.

The FHLB of Atlanta neither provides dividend guidance prior to the end of each quarter, nor conducts repurchases of excess activity-based stock on a daily basis, instead making such determinations quarterly. The FHLB of Atlanta announced on March 23, 2012, that it approved a dividend at the rate of 1.23% for the fourth quarter of 2011. The FHLB did not repurchase any capital stock in the first quarter of 2012, leaving a remaining balance of $2.5 million in excess FHLB capital stock as of March 31, 2012.

Based on evaluation of criteria under ASC Topic 320, we believe that no impairment charge in respect of the restricted stock is necessary as of March 31, 2012.

9.	Segment Information

We operate in three business segments, organized around the different products and services offered:

·	Commercial Banking

·	Mortgage Banking

·	Wealth Management

Commercial Banking includes commercial, business and retail banking. This segment provides customers with products such as commercial loans, small business loans, real estate loans, business financing and consumer loans. In addition, this segment provides customers with several choices of deposit products including demand deposit accounts, savings accounts and certificates of deposit. Mortgage Banking engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best-efforts basis. Wealth Management provides investment and financial advisory services to businesses and individuals, including financial planning, retirement planning, estate planning, trust and custody services, investment management, escrows, and retirement plans.

Information about the reportable segments and reconciliation of this information to the consolidated financial statements at and for the three months ended March 31, 2012 and 2011 is as follows (In thousands):

At and for the Three Months Ended March 31, 2012

	Commercial		Mortgage		Wealth					Intersegment
	Banking		Banking		Management		Other			Elimination			Consolidated
Net interest income	$	23,992	$	245	$	-	$	(341	)	$	-		$	23,896
Provision for loan losses		850		-		-		-			-			850
Noninterest income		6,125		1,811		1,393		27			(1,231	)		8,125
Noninterest expense		21,725		1,740		1,135		188			(1,231	)		23,557
Provision for income taxes		2,123		95		77		(181	)		-			2,114
Net income (loss)	$	5,419	$	221	$	181	$	(321	)	$	-		$	5,500

Total Assets	$	2,900,980	$	17,383	$	506	$	455,548		$	(448,503	)	$	2,925,914
Average Assets	$	2,865,457	$	24,988	$	461	$	454,809		$	(448,091	)	$	2,897,624

At and for the Three Months Ended March 31, 2011
	Commercial		Mortgage		Wealth					Intersegment
	Banking		Banking		Management		Other			Elimination			Consolidated
Net interest income	$	23,879	$	245	$	-	$	(261	)	$	-		$	23,863
Provision for loan losses		4,500		-		-		-			-			4,500
Noninterest income		5,644		1,875		1,339		26			(1,214	)		7,670
Noninterest expense		21,555		1,906		1,093		196			(1,214	)		23,536
Provision for income taxes		645		64		74		(157	)		-			626
Net income (loss)	$	2,823	$	150	$	172	$	(274	)	$	-		$	2,871

Total Assets	$	2,876,655	$	12,613	$	498	$	465,231		$	(456,601	)	$	2,898,396
Average Assets	$	2,875,584	$	24,683	$	485	$	464,309		$	(454,819	)	$	2,910,242

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides management’s analysis of the consolidated financial results of operations, financial condition, liquidity and capital resources of StellarOne Corporation and our affiliates. This discussion and analysis should be read in conjunction with the financial statements and footnotes appearing elsewhere in this report.

Results of Operations

Our first quarter 2012 earnings were $5.5 million or $0.24 net income per diluted common share. This represents a 44.9% increase over net income of $2.9 million or $0.11 net income per diluted common share during the same quarter in the prior year, and a 92% increase over net income of $3.8 million or $0.17 net income per diluted common share recognized for the fourth quarter of 2011. Continuing improvements in asset quality, solid non-interest income growth and reduced operating expenses contributed to the growth in recurring earnings.

Operating Segment Results

Revenue from the mortgage banking segment totaled $2.2 million for the first quarter of 2012, or down $439 thousand or 16.7% compared to $2.6 million for the fourth quarter of 2011 and up $119 thousand or 5.8% when compared to the same quarter in 2011. The sequential quarter decrease was primarily volume driven and not margin related as loans sold in the first quarter of 2012 totaled $95 million or down $29 million or 23.4% from the $124 million sold during the fourth quarter of 2011.

Retail banking fee income remained relatively flat at $3.8 million for the first quarter of 2012, a decrease of $81 thousand or 2.1% compared to $3.9 million for the fourth quarter of 2011 and an increase of $239 thousand or 6.7% compared to $3.6 million for the first quarter of 2011. This sequential quarter decrease was attributable to a decrease of $150 thousand in non-sufficient fund revenue offset by an increase in interchange income of $58 thousand. The increase over the same period in the prior year was due to a $172 thousand increase in interchange income, $43 thousand in DDA analysis income and a $40 thousand increase in non-sufficient fund revenue.

Wealth management revenues from trust and brokerage fees for the first quarter of 2012 were $1.3 million or up $284 thousand or 26.8% on a sequential quarter basis and flat compared to the first quarter of 2011. The sequential quarter revenue increase was attributable to both higher assets under management and higher fee realizations. Fiduciary assets increased $19.1 million sequentially to $459.4 million, compared to $440.3 million at December 31, 2011.

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Net Interest Income

Net interest income on a tax-equivalent basis amounted to $24.6 million for the first quarter of 2012, a $438 thousand or 1.7% decrease from the fourth quarter of 2011 and flat to the first quarter of 2011. The net interest margin was 3.85% for the first quarters of 2012 and 2011, compared to 3.79% for the fourth quarter of 2011. The average yield on earning assets for the current quarter increased slightly to 4.64% on a sequential basis as a result of loans representing a higher percentage of earning assets when compared to the preceding quarter. A 6 basis point improvement in the cost of interest bearing liabilities was noted sequentially, moving from 1.00% during the fourth quarter of 2011 to 0.94% during the first quarter of 2012. Both investment yields and loan yields contracted 13 basis points and 5 basis points, respectively, on a sequential basis. Investment yields continue to contract due to lower yields realized on the recent investment of excess liquidity in the current low rate environment. Loan yields continue to contract slightly due to re-pricing within the current portfolio and reduced yields on new production. Though margin improved, a decrease in earning assets resulted in a reduction in net interest income on a tax-equivalent basis which amounted to $24.6 million for the first quarter of 2012. This represents a decrease of $438 thousand from $25.1 in the fourth quarter of 2011, and essentially flat compared to the same period in the prior year. Net interest margin will likely compress moderately going forward as strategic options to continue lowering funding costs become more limited while yields continue to be pressured by pricing competition for quality loan opportunities, lower investment yields, and the flattening yield curve.

CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES (UNAUDITED)
(Dollars in thousands)
	For the Three Months Ended March 31,
	2012							2011
	Average		Interest		Average			Average		Interest		Average
	Balance		Inc/Exp		Rates			Balance		Inc/Exp		Rates
Assets
Loans receivable, net (1)	$	2,054,830	$	26,040		5.10	%	$	2,104,031	$	27,303		5.26	%
Investment securities
Taxable		322,372		1,610		1.98	%		229,709		1,720		3.00	%
Tax exempt (1)		138,864		2,000		5.70	%		129,318		1,928		5.96	%
Total investments		461,236		3,610		3.10	%		359,027		3,648		4.06	%

Interest bearing deposits		37,156		20		0.21	%		77,042		36		0.19	%
Federal funds sold		22,167		14		0.28	%		51,390		32		0.25	%
		520,559		3,644		2.77	%		487,459		3,716		3.05	%

Total earning assets		2,575,389	$	29,684		4.64	%		2,591,490	$	31,019		4.85	%

Total nonearning assets		322,235							318,752

Total assets	$	2,897,624						$	2,910,242

Liabilities and Stockholders' Equity
Interest-bearing deposits
Interest checking	$	585,017	$	396		0.27	%	$	559,393	$	533		0.39	%
Money market		412,739		544		0.53	%		420,202		1,041		1.00	%
Savings		296,373		332		0.45	%		268,854		468		0.71	%
Time deposits:
Less than $100,000		507,797		1,896		1.50	%		542,760		2,243		1.68	%
$100,000 and more		259,364		1,109		1.72	%		264,169		1,248		1.92	%
Total interest-bearing deposits		2,061,290		4,277		0.83	%		2,055,378		5,533		1.09	%

Federal funds purchased and securities sold under agreements to repurchase		835		6		2.95	%		1,044		8		3.07	%
Federal Home Loan Bank advances and other borrowings		57,363		438		3.02	%		80,000		640		3.20	%
Subordinated debt		32,991		341		4.09	%		32,991		262		3.18	%

		91,189		785		3.41	%		114,035		910		3.19	%

Total interest-bearing liabilities		2,152,479		5,062		0.94	%		2,169,413		6,443		1.20	%

Total noninterest-bearing liabilities		328,147							313,097

Total liabilities		2,480,626							2,482,510
Stockholders' equity		416,998							427,732

Total liabilities and stockholders' equity	$	2,897,624						$	2,910,242


Net interest income (tax equivalent)			$	24,622						$	24,576
Average interest rate spread						3.70	%						3.65	%
Interest expense as percentage of average earning assets						0.79	%						1.01	%
Net interest margin						3.85	%						3.85	%

(1)	Income and yields are reported on a taxable equivalent basis using a 35% tax rate.

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Noninterest Income

On an operating basis, which excludes gains and losses from sales and impairments of securities and other assets, total non-interest income amounted to $8.1 million for the first quarter of 2012, up $197 thousand or 2.5% on a sequential basis compared to $7.9 million for the fourth quarter of 2011, and up $408 thousand or 5.3% compared to the same period in the prior year. Other income increased $592 thousand sequentially due to increases in pass through insurance and investment income. The $408 thousand increase in operating noninterest income when compared to the same period in the prior year stemmed from an increase in retail banking fees of $239 thousand and $119 thousand in mortgage banking-related fees, which were offset by a $220 thousand increase in losses/impairments on foreclosed assets.

Noninterest Expense

The efficiency ratio was 69.77% for the first quarter of 2012, compared to 71.83% for the fourth quarter of 2011 and 71.20% for the same quarter in 2011. The sequential quarter decrease in the efficiency ratio reflects a 4.1% decrease in overhead offset by a 1.3% decrease in revenues.

The $1.0 million sequential quarter decrease in noninterest expense was driven by decreases of $391 thousand in compensation and benefits expense, $335 thousand in professional fees and $340 thousand in other operating expenses. The decrease in compensation and benefits is due to the reduction of 35 FTE’s since December 31, 2011 and the absence of nonrecurring items which occurred in the fourth quarter of 2011. Benefits from the branch closings we affected in the first quarter of 2012 along with the FTE reduction made during the quarter are expected to be fully realized in the coming quarters.

The decrease relative to the same period in the prior year was largely driven by a 2.0% increase in net revenues, resulting from higher noninterest income driven by increased retail banking fees, mortgage revenues and elevated levels of pass through income reported in other operating income during the first quarter of 2012.

Management has developed and initiated a three stage program, which focuses heavily on our cost structure, to reduce our efficiency ratio. The first stage is a comprehensive internal review of operating expenses, which has identified some immediate opportunities to reduce costs. These opportunities will be implemented during the second quarter. The second stage is a comprehensive metrics driven evaluation of the organizational structure and processes. The third stage will assess all aspects of our real estate holdings. We do not anticipate cost saves from the second two stages until 2013.

Income Taxes

The provision for income taxes was $2.1 million for the first quarter of 2012 compared to $1.6 million for the fourth quarter of 2011. This produced an effective tax rate for the first quarter of 2012 of 27.8% compared to 24.7% for the prior quarter. The increase in the current quarter’s effective tax rate was primarily due to higher pre-tax earnings relative to permanent tax differences, which remained relatively flat.

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Asset Quality

Non-performing assets totaled $44.5 million at March 31, 2012, down $3.2 million or 6.7% sequentially from $47.7 million at December 31, 2011 and down $7.7 million or 14.7% compared to $52.2 million at March 31, 2011. The ratio of non-performing assets as a percentage of total assets decreased to 1.52% as of March 31, 2012, compared to 1.64% as of December 31, 2011 and 1.80% at March 31, 2011.

Net charge-offs for the first quarter of 2012 totaled $1.8 million or down $2.6 million or 58.8% compared to the $4.4 million during the fourth quarter of 2011 and down $2.8 million or 60.6% when compared to $4.6 million during the first quarter of 2011. Annualized net charge-offs as a percentage of average loans receivable amounted to 0.35% for the first quarter of 2012, down from 0.86% for the fourth quarter of 2011 and down from 0.88% for the first quarter of 2011.

Foreclosed assets totaled $6.8 million at March 31, 2012, down $1.7 million or 20.3% compared to $8.6 million at December 31, 2011 and down $2.2 million or 24.3% compared to $9.0 million at March 31, 2011. Past due and matured loans between 30 and 89 days totaled $32.7 million at March 31, 2012, down $1.8 million or 5.2% compared to $34.5 million at December 31, 2011.

Included in the loan portfolio at March 31, 2012, are loans classified as troubled debt restructurings (“TDRs”) totaling $34.8 million or 1.7% of total loans. TDRs were reduced sequentially by 10.2% or $3.9 million as compared to $38.7 million at December 31, 2011. At March 31, 2012, $28.7 million or 82.5% of total TDRs represent residential consumer real estate loans under a mortgage modification program designed to help homeowners remain in their homes.

We recorded a provision for loan losses of $850 thousand for the first quarter of 2012, a decrease of $900 thousand compared to the $1.8 million recognized for the fourth quarter of 2011 and a decrease of $3.7 million compared to the first quarter of 2011. This decrease is reflective of the improvement in underlying credit quality metrics used in measuring the risk inherent in the loan portfolio. The allowance as a percentage of non-performing loans increased to 83.9% at March 31, 2012, from 83.2% at December 31, 2011. The first quarter 2012 provision compares to net charge-offs of $1.8 million, resulting in an allowance for loan losses of $31.6 million at March 31, 2012, a decrease of $973 thousand when compared to $32.6 million at December 31, 2011. The allowance as a percentage of total loans was 1.55% at March 31, 2012, compared to 1.60% at December 31, 2011.

Our nonaccrual loans are composed of the following (In thousands):

	March 31, 2012
	Loans Outstanding		Nonaccrual Loans		Nonaccrual Loans to Loans Outstanding
Construction and land development	$	207,231	$	8,414		4.06	%
Commercial real estate		852,114		14,378		1.69	%
Consumer real estate		754,094		14,272		1.89	%
Commercial and industrial loans (except those secured by real estate)		199,453		598		0.30	%
Consumer and other		21,548		30		0.14	%
Total loans	$	2,034,440	$	37,692		1.85	%

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table provides information on asset quality statistics for the periods presented (In thousands):

	March 31, 2012			December 31, 2011			March 31, 2011
Non-accrual loans	$	31,558		$	30,985		$	39,096
Troubled debt restructurings - non-accrual status		6,134			8,189			4,078
Foreclosed assets		6,836			8,575			9,036
Total non-performing assets	$	44,528		$	47,749		$	52,210
Nonperforming assets to total assets		1.52	%		1.64	%		1.80	%
Nonperforming assets to loans and foreclosed property		2.18	%		2.34	%		2.52	%
Allowance for loan losses as a percentage of loans receivable		1.55	%		1.60	%		1.82	%
Allowance for loan losses as a percentage of nonperforming loans		83.88	%		83.19	%		86.90	%
Annualized net charge-offs as a percentage of average loans receivable		0.35	%		0.86	%		0.88	%

Liquidity and Capital Resources

Capital Resources

The management of capital in a regulated financial services industry must properly balance return on equity to stockholders while maintaining sufficient capital levels and related risk-based capital ratios to satisfy regulatory requirements. Additionally, capital management must also consider acquisition opportunities that may exist, and the resulting accounting treatment. Our capital management strategies have been developed to provide attractive rates of returns to stockholders, while maintaining its “well-capitalized” position at the banking subsidiary.

The primary source of additional capital to us is earnings retention, which represents net income less dividends declared. We paid or accrued $1.4 million in common dividends during the three month period ended March 31, 2012. These dividends combined with net income of $5.5 million resulted in an increase to retained earnings of $3.7 million during the period. Future dividends will be dependent upon our ability to generate earnings in future periods.

We, along with our banking subsidiary, are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on us and the subsidiary bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action under the Federal Deposit Insurance Act of 1991 (“FDICIA”), we and our banking subsidiary must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and reclassifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require us and our banking subsidiary to maintain minimum amounts and ratios of total and Tier 1 capital to average assets. The most recent notification from the Federal Reserve Bank of Richmond categorized us and our subsidiary bank as “well capitalized” under FIDICIA. There are no conditions or events that we believe have changed ours or our subsidiary bank’s well capitalized position.

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table includes information with respect to our risk-based capital and equity levels as of March 31, 2012 (In thousands):

	Corporation			Bank
Tier 1 capital	$	326,457		$	311,821
Tier 2 capital		26,437			26,368
Total risk-based capital		352,894			338,189
Total risk-weighted assets		2,109,582			2,103,987
Average adjusted total assets		2,782,020			2,775,399
Capital ratios:
Tier 1 risk-based capital ratio		15.47	%		14.82	%
Total risk-based capital ratio		16.73	%		16.07	%
Leverage ratio (Tier 1 capital to average adjusted total assets)		11.73	%		11.24	%
Equity to assets ratio		14.28	%		15.02	%
Tangible common equity to assets ratio		10.64	%		11.40	%

Liquidity

Liquidity is identified as the ability to generate or acquire sufficient amounts of cash when needed and at a reasonable cost to accommodate withdrawals, payments of debt, and increased loan demand. These events may occur daily or at other short-term intervals in the normal operation of the business. Experience helps management predict time cycles in the amount of cash required. In assessing liquidity, management gives consideration to relevant factors including stability of deposits, quality of assets, economic conditions in the market served, concentrations of business and industry, competition, and our overall financial condition. Our bank subsidiary has available a $243.5 million line of credit with the Federal Home Loan Bank of Atlanta, uncollateralized, unused lines of credit totaling $70 million with nonaffiliated banks and access to the Federal Reserve discount window to support liquidity as conditions dictate.

The liquidity of our parent company also represents an important aspect of liquidity management. The parent company’s cash outflows consist of overhead associated with corporate expenses, executive management, and shareholder related expenses. It also includes outflows associated with dividends to shareholders and interest on subordinated debt. The main sources of funding for the parent company are the management fees and dividends we receive from our banking subsidiary and availability on the equity market as deemed necessary. As of March 31, 2012, there were no additional unrestricted funds that could be transferred from the bank subsidiary to us without prior regulatory approval, due to a deficit at the bank level arising from the TARP repayment in December 2011. Management believes that the parent company’s liquidity position is sufficient to cover all expenses until the bank subsidiary earns back the remaining $2.3 million deficit and is again able to transfer funds to the parent.

In the judgment of management, we maintain the ability to generate sufficient amounts of cash to cover normal requirements and any additional funds as needs may arise.

Off Balance Sheet Items

There have been no material changes to the off balance sheet items disclosed in “Management’s Discussion and Analysis” in our annual report on Form 10-K for the fiscal year ended December 31, 2011.

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Contractual Obligations

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in our annual report on Form 10-K for the fiscal year ended December 31, 2011.

Effects of Inflation

The effect of changing prices on financial institutions is typically different from other industries as our assets and liabilities are monetary in nature. Interest rates and thus our asset-liability management are impacted by changes in inflation, but there is not a direct correlation between the two measures. Management monitors the impact of inflation on the financial markets.

Forward Looking Statements

In addition to historical information, this report on Form 10-Q contains forward-looking statements. The forward-looking statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from historical results, or those anticipated. When we use words such as “believe,” “expect,” “anticipates or similar expressions, we are making forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date thereof. We wish to caution the reader that factors, such as those listed below, in some cases have affected and could affect our actual results, causing actual results to differ materially from those in any forward-looking statement. These factors include: (i) expected cost savings from our acquisitions and dispositions, (ii) competitive pressure in the banking industry or in our markets may increase significantly, (iii) changes in the interest rate environment may reduce margins, (iv) general economic conditions, either nationally or regionally, may be less favorable than expected, resulting in, among other things, credit quality deterioration, (v) changes may occur in banking legislation and regulation, (vi) changes may occur in general business conditions, and (vii) changes may occur in the securities markets. Please refer to our filings with the Securities and Exchange Commission for additional information, which may be accessed at www.StellarOne.com.

Access to Filings

We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other filings with the SEC. The public may read and copy any documents we file at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our SEC filings can also be obtained on the SEC’s website on the internet at http://www.sec.gov. Annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are posted on our website at http://www.stellarone.com under the “Investor Relations” tab as soon as reasonably practical after filing electronically with the SEC.

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Critical Accounting Policies

General

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“USGAAP”). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining inherent losses in our loan portfolio. Actual losses could differ significantly from the historical factors that we use.

Investment Securities

Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. The initial classification of securities is determined at the date of purchase.

Based on management’s interpretations of related authoritative accounting guidance, management has determined that other-than-temporary impairment on equity securities exists and should be recorded if the fair value of an equity security represents (1) less than 70% of the book value of a security regardless of loss period, or (2) if the loss period has been more than 18 months regardless of the fair value’s relationship to carrying value. If either of these conditions does not exist, but management becomes aware of possible impairment outside of this scope, management will conduct additional research to determine if market price recoveries can reasonably be expected to occur within an acceptable forecast period. For purposes of this analysis, a near term recovery period has been defined as 3-6 months.

Purchase premiums and discounts are recognized in interest income using the effective interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the intent and ability of us to retain our investment in the issuer for a period of time sufficient to allow for any anticipated increase in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Please see Note 2 of Notes to Unaudited Consolidated Financial Statements for additional information related to investment securities.

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have been incurred, but not realized through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

Our banking subsidiary conducts an analysis of the loan portfolio on a regular basis. This analysis is used in assessing the sufficiency of the allowance for loan losses and in the determination of the necessary provision for loan losses. The review process generally begins with lenders identifying problem loans to be reviewed on an individual basis for impairment. When a loan has been identified as impaired (i.e. it is probable that we will be unable to collect amounts due according to the original contractual terms), a specific reserve may be established based on management’s calculation of the loss embedded in the individual loan. Loans meeting the criteria for impairment are segregated for analysis from performing loans within the portfolio. In addition to impairment testing, the banking subsidiary has a grading system which is applied to each non-homogeneous loan in the portfolio. Loans are then grouped by loan type and, in the case of commercial and construction loans, by risk rating. Each loan type is assigned an allowance factor based on historical loss experience, economic conditions, overall portfolio quality including delinquency rates and commercial real estate loan concentrations. The total of specific reserves required for impaired classified loans and the calculated reserves by loan category are then used to compute an estimated range of losses which is then compared to the recorded allowance for loan losses. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management for impaired loans include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment.

In situations where, for economic or legal reasons related to a borrower’s financial difficulties, we grant a concession for other than an insignificant period of time to the borrower than we would otherwise consider, the related loan is classified as a troubled debt restructuring (“TDR”). We strive to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral.

Accrued Losses Associated With Mortgage Indemnifications and Repurchases

In certain loan sales, we provide recourse to the buyer whereby we are required to repurchase loans at par value plus accrued interest on the occurrence of certain credit-related events within a certain time period. The maximum exposure to loss represents the outstanding principal balance of the loans sold that are subject to recourse provisions, but the likelihood of the repurchase of the entire balance is remote and amounts paid can be recovered in whole or in part from the sale of collateral.

We enter into other types of indemnification agreements in the ordinary course of business under which we agree to indemnify third parties against any damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with us. These relationships or transactions include those arising from service as a director or officer of the company, acquisition agreements and various other business transactions or arrangements. Because the extent of our obligations under these agreements depends entirely upon the occurrence of future events, our potential future liability under these agreements is not determinable.

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Goodwill

Goodwill and intangible assets that have indefinite useful lives are evaluated for impairment annually and are evaluated for impairment more frequently if events and circumstances indicate that the asset might be impaired. Our annual impairment date is October 1. During the six months following completion of our most recent annual impairment test, there have been no significant negative changes in market conditions or forecasted future income; and actual earnings have improved. As such, management determined there were no additional indicators of potential impairment and no interim goodwill impairment test was performed.

Additionally, acquired intangible assets (such as core deposit intangibles) are separately recognized if the benefit of the asset can be sold, transferred, licensed, rented, or exchanged, and amortized over their useful life. The cost of purchased deposit relationships and other intangible assets, based on independent valuation, are being amortized over their estimated lives not to exceed fifteen years.

Deferred Taxes

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Deferred taxes are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. No such valuation is deemed necessary as of March 31, 2012, as management has not taken any tax positions that it deems to be considered uncertain.

Stock-Based Compensation

We have a stock-based employee compensation plan under which nonqualified stock options may be granted periodically to certain employees. Our stock options typically have an exercise price equal to at least the fair value of the stock on the date of grant, and vest based on continued service with the company for a specified period, generally five years. We recognize the associated compensation cost relating to share-based payment transactions in the consolidated financial statements. The cost is measured based on the fair value of the equity or liability instruments issued.

New awards to employees eligible for retirement prior to the award becoming fully vested are recognized as compensation cost over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award.

Foreclosed Assets

Real estate acquired through, or in lieu of, foreclosure are held for sale and are initially recorded at fair value less costs to sell, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the carrying amount or fair value less cost to sell. Revenues and expenses from operations and changes in the valuation are included in other operating expenses.

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Non-GAAP Financial Measures

This report refers to the efficiency ratio, which is computed by dividing noninterest expense less amortization of intangibles and goodwill impairments as a percent of the sum of net interest income on a tax equivalent basis and noninterest income excluding gains on securities and losses on foreclosed assets. The efficiency ratio is not a recognized reporting measure under USGAAP. Management believes this measure provides investors with important information regarding our operational efficiency. Management believes such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for USGAAP. We, in referring to our net income, are referring to income under USGAAP. Comparison of the efficiency ratio with those of other companies may not be possible, because other companies may calculate the efficiency ratio differently.

The following table presents a reconciliation to provide a more detailed analysis of this non-USGAAP performance measure (In thousands):

	For the three months ended
	March 31, 2012			December 31, 2011			March 31, 2011
Noninterest expense	$	23,557		$	24,595		$	23,536
Less:
Foreclosed asset expense		104			151			81
Amortization of intangible assets		413			413			413
Adjusted noninterest expense	$	23,040		$	24,031		$	23,042

Net interest income (tax equivalent)	$	24,622		$	25,060		$	24,576
Noninterest income		8,125			8,409			7,670
Less:
Gains on sale of securities available for sale		73			447			10
Losses / impairments on foreclosed assets		(348	)		(432	)		(128	)
Net revenues	$	33,022		$	33,454		$	32,364

Efficiency ratio		69.77	%		71.83	%		71.20	%

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The report also refers to the tangible common equity to assets ratio, which is computed by dividing total stockholders’ equity less core deposit intangibles, goodwill and preferred stock by total assets less core deposit intangibles and goodwill. The tangible common equity to assets ratio is not a recognized reporting measure under USGAAP. Management believes it provides investors with important information about the strength of the balance sheet by removing the intangible items from the equity to assets ratio. The table below presents a reconciliation of this non-USGAAP measure (In thousands):

	Consolidated			Bank
Total stockholders' equity	$	417,920		$	438,548
Less:
Core deposit intangibles, net		4,599			4,599
Goodwill		113,652			113,652
Net other intangibles		1,084			1,084
Tangible common equity	$	298,585		$	319,213

Total assets	$	2,925,914		$	2,918,869
Core deposit intangibles, net		4,599			4,599
Goodwill		113,652			113,652
Net other intangibles		1,084			1,084
Tangible assets	$	2,806,579		$	2,799,534

Tangible common equity to assets ratio		10.64	%		11.40	%

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no significant changes to the quantitative and qualitative market risk disclosures in our Form 10-K for the year ended December 31, 2011.

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STELLARONE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 4 – CONTROLS AND PROCEDURES

We are required to include in our periodic reports, information regarding controls and procedures for complying with the disclosure requirements of the federal securities laws. These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is accumulated and communicated to management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

We have established disclosure controls and procedures to ensure that material information related to us is made known to the principal executive officer and principal financial officer on a regular basis, in particular during the periods in which quarterly and annual reports are being prepared. The principal executive officer and principal financial officer evaluated the effectiveness of these disclosure controls and procedures as of the end of the period covered by this report and, based on their evaluation, concluded that the disclosure controls and procedures are operating effectively.

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

Management is also responsible for establishing and maintaining adequate internal controls over financial reporting and control of assets to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. In the normal course of business, we review and change internal controls to reflect changes in business including acquisition related improvements. There have been no changes in internal control over financial reporting that occurred during the quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

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STELLARONE CORPORATION

PART II OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS.

There are no material legal proceedings to which we or any of our subsidiaries, directors, or officers is a party or by which they, or any of them, are threatened. Any legal proceeding presently pending or threatened against StellarOne Corporation and our subsidiaries is either not material in respect to the amount in controversy or fully covered by insurance.

ITEM 1a.

RISK FACTORS.

There have been no material changes to the risk factors as previously disclosed in Part I, Item IA of our Annual Report on Form 10K for the fiscal year ended December 31, 2011.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

We have a stock repurchase program authorized that is not currently active, with 210,000 shares remaining available for repurchase.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.

OTHER INFORMATION.

Not applicable.

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STELLARONE CORPORATION

PART II OTHER INFORMATION

ITEM 6. EXHIBITS:

(a) The following exhibits either are filed as part of this Report or are incorporated herein by reference:

Exhibit No. 3.1

Articles of Incorporation StellarOne Corporation, as amended. (incorporated by reference to Exhibit 3.1 to Form 8-K filed on May 10, 2010)

Exhibit No. 3.2

Bylaws of StellarOne Corporation, as amended and restated February 28, 2008. (incorporated by reference to Exhibit 3.2 to Current Report on Form 8-K filed on May 28, 2010)

Exhibit No. 4.1

Warrant to purchase up to 302,623 shares of Common Stock (incorporated by reference to Exhibit 4.1 to Form 8K filed on December 23, 2008)

Exhibit No. 31.1

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

Exhibit No. 31.2

Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

Exhibit No. 32

Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Exhibit No. 101

Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2012 is formatted in XBRL interactive data files: (i) Consolidated Statement of Income for the three months ended March 31, 2012 and 2011; (ii) Consolidated Balance Sheet at March 31, 2012 and December 31, 2011; (iii) Consolidated Statement of Other Comprehensive Income for the three months ended March 31, 2012 and 2011; (iv) Consolidated Statement of Changes in Equity for the three months ended March 31, 2012 and 2011; (v) Consolidated Statement of Cash Flows for the three months ended March 31, 2012 and 2011; and (vi) Notes to 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.

STELLARONE CORPORATION

/s/ O. R. Barham, Jr.

O.R. Barham, Jr.

President and Chief Executive Officer

May 9, 2012

/s/ Jeffrey W. Farrar

Jeffrey W. Farrar, CPA

Executive Vice President and Chief Financial Officer

May 9, 2012

Virginia	54-1829288
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

590 Peter Jefferson Parkway Charlottesville, Virginia	22911
(Address of principal executive offices)	(Zip Code)

STELLARONE CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1	Financial Statements (Unaudited):
	Consolidated Balance Sheets	1
	Consolidated Income Statements	2
	Consolidated Statements of Other Comprehensive Income	3
	Consolidated Statements of Changes in Stockholders' Equity	4
	Consolidated Statements of Cash Flows	5
	Notes to Consolidated Financial Statements	6

ITEM 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	26

ITEM 3	Quantitative and Qualitative Disclosures About Market Risk	37

ITEM 4	Controls and Procedures	38

PART II - OTHER INFORMATION
ITEM 1	Legal Proceedings	39

ITEM 1A	Risk Factors	39

ITEM 2	Unregistered Sales of Equity Securities and Use of Proceeds	39

ITEM 3	Defaults Upon Senior Securities	39

ITEM 4	Mine Safety Disclosures	39

ITEM 5	Other Information	39

ITEM 6	Exhibits	40