form10q_3q.htm

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STELLARONE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands)
	September 30, 2012		December 31, 2011
Assets
Cash and due from banks	$	45,004	$	40,931
Federal funds sold		52		21,117
Interest-bearing deposits in banks		9,801		37,922
Cash and cash equivalents		54,857		99,970
Investment securities available for sale, at fair value		557,138		477,964
Mortgage loans held for sale		26,006		42,027
Loans receivable, net of allowance for loan losses, 2012, $29,860; 2011, $32,588		2,025,048		1,998,842
Premises and equipment, net		72,195		74,602
Accrued interest receivable		9,373		8,908
Core deposit intangibles, net		3,773		5,011
Goodwill		113,652		113,652
Bank owned life insurance		43,736		42,413
Foreclosed assets		7,907		8,575
Other assets		46,161		45,964
Total assets	$	2,959,846	$	2,917,928

Liabilities
Deposits:
Noninterest-bearing	$	349,099	$	310,756
Interest-bearing		2,072,636		2,084,844
Total deposits		2,421,735		2,395,600
Federal Home Loan Bank advances		55,000		60,000
Subordinated debt		32,991		32,991
Accrued interest payable		1,792		2,122
Deferred income tax liability		4,012		2,654
Other liabilities		16,239		10,388
Total liabilities		2,531,769		2,503,755

Stockholders' Equity
Preferred stock; no par value; 5,000,000 shares authorized; no shares issued and outstanding.		-		-
Common stock; $1 par value; 35,000,000 shares authorized; 2012: 22,881,857 shares issued and outstanding; 2011: 22,819,000 shares issued and outstanding.		22,882		22,819
Additional paid-in capital		271,537		271,080
Retained earnings		122,726		110,940
Accumulated other comprehensive income		10,932		9,334
Total stockholders' equity		428,077		414,173
Total liabilities and stockholders' equity	$	2,959,846	$	2,917,928

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

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STELLARONE CORPORATION AND SUBSIDIARY
CONSOLIDATED INCOME STATEMENTS
(In thousands, except per share data)
	Three Months Ended
	September 30,
	2012			2011
Interest Income
Loans, including fees	$	25,812		$	27,018
Federal funds sold and deposits in other banks		24			78
Investment securities:
Taxable		1,725			1,829
Tax-exempt		1,282			1,469
Total interest income		28,843			30,394

Interest Expense
Deposits		3,779			5,357
Federal funds purchased and securities sold under agreements to repurchase		8			8
Federal Home Loan Bank advances		413			523
Subordinated debt		344			2 63
Total interest expense		4,544			6,151
Net interest income		24,299			24,243
Provision for loan losses		1,900			3,300
Net interest income after provision for loan losses		22,399			20,943

Noninterest Income
Retail banking fees		3,844			4,019
Commissions and fees from fiduciary activities		901			821
Brokerage fee income		389			374
Mortgage banking-related fees		2,335			1,967
(Losses) gains on mortgage indemnifications and repurchases		(28	)		31
Gains (losses) on sale of premises and equipment		17			(9	)
Gains on sale of securities available for sale		9			41
Losses on sale / impairments of foreclosed assets		(381	)		(311	)
Income from bank owned life insurance		445			327
Other operating income		1,176			516
Total noninterest income		8,707			7,776
Noninterest Expense
Compensation and employee benefits		12,772			12,527
Net occupancy		2,223			2,104
Equipment		1,885			2,018
Amortization of intangible assets		413			413
Marketing		376			153
State franchise taxes		564			596
FDIC insurance		490			590
Data processing		765			729
Professional fees		587			641
Telecommunications		420			406
Other operating expenses		3,099			3,081
Total noninterest expense		23,594			23,258

Income before income taxes		7,512			5,461
Income tax expense		1,952			1,242
Net income	$	5,560		$	4,219
Dividends and accretion on preferred stock		-			(296	)
Net income available to common shareholders	$	5,560		$	3,923

Basic net income per common share available to common shareholders	$	0.24		$	0.17
Diluted net income per common share available to common shareholders	$	0.24		$	0.17

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

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STELLARONE CORPORATION AND SUBSIDIARY
CONSOLIDATED INCOME STATEMENTS
(In thousands, except per share data)
	Nine Months Ended
	September 30,
	2012			2011
Interest Income
Loans, including fees	$	77,705		$	81,365
Federal funds sold and deposits in other banks		90			211
Investment securities:
Taxable		5,054			5,373
Tax-exempt		3,886			4,119
Total interest income		86,735			91,068

Interest Expense
Deposits		12,053			16,424
Federal funds purchased and securities sold under agreements to repurchase		20			24
Federal Home Loan Bank advances		1,260			1,681
Subordinated debt		1,028			790
Total interest expense		14,361			18,919
Net interest income		72,374			72,149
Provision for loan losses		4,150			10,950
Net interest income after provision for loan losses		68,224			61,199

Noninterest Income
Retail banking fees		11,450			11,415
Commissions and fees from fiduciary activities		2,702			2,572
Brokerage fee income		1,254			1,315
Mortgage banking-related fees		6,272			5,563
Losses on mortgage indemnifications and repurchases		(584	)		(232	)
Gains (losses) on sale of premises and equipment		10			(6	)
Gains on sale of securities available for sale		88			62
Losses on sale / impairments on foreclosed assets		(1,051	)		(981	)
Income from bank owned life insurance		1,323			969
Other operating income		3,462			2,115
Total noninterest income		24,926			22,792
Noninterest Expense
Compensation and employee benefits		38,728			37,186
Net occupancy		6,382			6,154
Equipment		6,255			6,202
Amortization of intangible assets		1,238			1,238
Marketing		1,004			737
State franchise taxes		1,691			1,788
FDIC insurance		1,673			2,108
Data processing		2,142			2,029
Professional fees		2,152			1,873
Telecommunications		1,256			1,221
Other operating expenses		8,854			9,303
Total noninterest expense		71,375			69,839

Income before income taxes		21,775			14,152
Income tax expense		5,833			3,036
Net income	$	15,942		$	11,116
Dividends and accretion on preferred stock		-			(1,482	)
Net income available to common shareholders	$	15,942		$	9,634

Basic net income per common share available to common shareholders	$	0.69		$	0.42
Diluted net income per common share available to common shareholders	$	0.69		$	0.42

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 September 30,
	2012					2011
Net income				$	5,560				$	4,219
Other comprehensive income, net of tax:
Unrealized holding gains arising during the period (net of tax 2012: $975, 2011: $2,004)	$	1,810				$	3,720
Reclassification adjustment (net of tax 2012: $3, 2011: $15)		(6	)				(26	)
Change in post retirement liability		-					-
Change in cash flow hedge (net of tax 2012: $99, 2011: $62)		(184	)				(116	)
Other comprehensive income					1,620					3,578
Total comprehensive income				$	7,180				$	7,797


	Nine months ended September 30,
		2012					2011
Net income				$	15,942				$	11,116
Other comprehensive income, net of tax:
Unrealized holding gains arising during the period (net of tax 2012: $1,150, 2011: $3,209)	$	2,137				$	5,960
Reclassification adjustment (net of tax 2012: $31, 2011: $22)		(57	)				(40	)
Change in post retirement liability (net of tax 2012: $1, 2011: $42)		2					78
Change in cash flow hedge (net of tax 2012: $261, 2011: $188)		(484	)				(349	)
Other comprehensive income					1,598					5,649
Total comprehensive income				$	17,540				$	16,765

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		-			-		-			11,116			-		11,116
Other comprehensive income		-			-		-			-			5,649		5,649
Cash dividends paid or accrued:															-
Common ($0.12 per share)		-			-		-			(2,757	)		-		(2,757	)
Preferred cumulative 5%		-			-		-			(947	)		-		(947	)
Accretion of preferred stock discount		250			-		-			(250	)		-		-
Partial repurchase of preferred stock issued to U.S. Treasury and associated accelerated accretion		(7,215	)							(285	)				(7,500	)
Stock-based compensation expense (35,954 shares)		-			36		521			-			-		557
Exercise of stock options (31,920 shares)		-			32		278			-			-		310
Balance, September 30, 2011	$	21,798		$	22,816	$	270,846		$	108,065		$	9,340	$	432,865

Balance, January 1, 2012	$	-		$	22,819	$	271,080		$	110,940		$	9,334	$	414,173
Net income		-			-		-			15,942			-		15,942
Other comprehensive income		-			-		-			-			1,598		1,598
Common dividends paid ($0.18 per share)		-			-		-			(4,156	)		-		(4,156	)
Stock-based compensation expense (59,665 shares)		-			60		668			-			-		728
Exercise of stock options (3,192 shares)		-			3		(211	)		-			-		(208	)
Balance, September 30, 2012	$	-		$	22,882	$	271,537		$	122,726		$	10,932	$	428,077

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)
	Nine Months Ended September 30,
	2012			2011
Cash Flows from Operating Activities
Net income	$	15,942		$	11,116
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		4,774			4,926
Amortization of intangible assets		1,238			1,238
Provision for loan losses		4,150			10,950
Deferred tax expense		508			472
Stock-based compensation expense		728			557
Losses on sale / impairments of foreclosed assets		1,051			981
Losses on mortgage indemnifications and repurchases		584			232
(Gains) losses on sale of premises and equipment		(10	)		6
Gains on sale of securities available for sale		(88	)		(62	)
Mortgage banking-related fees		(6,272	)		(5,563	)
Proceeds from sale of mortgage loans		226,848			299,509
Origination of mortgage loans for sale		(204,555	)		(276,256	)
Amortization of securities premiums and accretion of discounts, net		1,388			1,044
Income on bank owned life insurance		(1,323	)		(969	)
Changes in assets and liabilities:
(Increase) decrease in accrued interest receivable		(465	)		182
Decrease in other assets		1,353			5,869
Decrease in accrued interest payable		(330	)		(191	)
Increase in other liabilities		4,228			1,856
Net cash provided by operating activities	$	49,749		$	55,897

Cash Flows from Investing Activities
Proceeds from maturities, calls and principal payments of securities available for sale	$	107,498		$	104,026
Proceeds from sales of securities available for sale		-			2,584
Purchase of securities available for sale		(184,772	)		(198,041	)
Net (increase) decrease in loans		(34,211	)		53,011
Proceeds from sale of premises and equipment		1,141			12
Purchase of premises and equipment		(5,082	)		(2,347	)
Proceeds from sale of foreclosed assets		3,793			6,567
Net cash used by investing activities	$	(111,633	)	$	(34,188	)

Cash Flows from Financing Activities
Net increase in demand, money market and savings deposits	$	82,769		$	39,613
Net decrease in certificates of deposit		(56,634	)		(7,727	)
Principal payments on Federal Home Loan Bank advances		(5,000	)		(25,000	)
Exercise of stock options		(208	)		310
Partial repurchase of preferred stock issued to the U.S. Treasury		-			(7,500	)
Cash dividends paid		(4,156	)		(3,704	)
Net cash provided (used) by financing activities	$	16,771		$	(4,008	)

(Decrease) increase in cash and cash equivalents	$	(45,113	)	$	17,701

Cash and Cash Equivalents
Beginning		99,970			139,886
Ending	$	54,857		$	157,587

Supplemental Disclosures of Cash Flow Information
Cash paid for interest	$	18,275		$	23,284
Cash paid for income taxes	$	3,796		$	2,000

Supplemental Schedule of Noncash Activities
Foreclosed assets acquired in settlement of loans	$	4,245		$	5,604

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 September 30, 2012 and December 31, 2011, the results of operations for the three and nine months ended September 30, 2012 and 2011 and cash flows for the nine months ended September 30, 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 nine month period ended September 30, 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 with gross unrealized gains and losses is presented below (In thousands).

	September 30, 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	$	250,180	$	1,996	$	-	$	252,176	$	151,155	$	1,370	$	(58	)	$	152,467
State and municipals		140,547		12,617		-		153,164		148,933		10,582		-			159,515
Corporate bonds		4,822		51		-		4,873		4,478		140		-			4,618
Collateralized mortgage obligations		5,688		226		-		5,914		7,251		221		-			7,472
Mortgage backed securities		124,885		6,127		-		131,012		139,330		5,563		-			144,893
Other investments		9,999		-		-		9,999		8,999		-		-			8,999
Total	$	536,121	$	21,017	$	-	$	557,138	$	460,146	$	17,876	$	(58	)	$	477,964

Other investments consist of Certificates of Deposit and investments in Small Business Administration loan funds.

The carrying value of securities pledged to secure deposits and for other purposes amounted to $154.4 million and $157.4 million at September 30, 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				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011

Proceeds from sales/calls	$	5,205	$	12,662	$	20,650	$	37,612
Gross realized gains		9		41		88		62

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 September 30, 2012, there were no available for sale securities with unrealized losses.

The amortized cost and fair value of securities available for sale at September 30, 2012 are presented below by contractual maturity (In thousands):

	Amortized Cost		Fair Value
Due in one year or less	$	45,447	$	45,824
Due after one year through five years		252,604		255,681
Due after five years through ten years		88,731		94,461
Due after ten years		148,339		160,172
Equity securities		1,000		1,000
Total	$	536,121	$	557,138

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

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 September 30, 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 September 30, 2012, the cash flow hedge had a fair value of $1.5 million 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 $65.7 million as of September 30, 2012.

4.	Loans and Allowance 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):

	September 30,			December 31,
	2012			2011
Construction and land development:
Residential	$	52,257		$	49,995
Commercial		136,611			164,672
Total construction and land development		188,868			214,667
Commercial real estate:
Commercial real estate - owner occupied		291,442			317,976
Commercial real estate - non-owner occupied		510,319			417,658
Farmland		11,314			15,756
Multifamily, nonresidential and junior liens		100,249			93,470
Total commercial real estate		913,324			844,860
Consumer real estate:
Home equity lines		253,446			263,035
Secured by 1-4 family residential, secured by first deeds of trust		448,759			450,667
Secured by 1-4 family residential, secured by second deeds of trust		36,259			42,534
Total consumer real estate		738,464			756,236
Commercial and industrial loans (except those secured by real estate)		185,041			189,887
Consumer and other:
Consumer installment loans		25,595			20,216
Deposit overdrafts		2,194			3,526
All other loans		1,613			1,739
Total consumer and other		29,402			25,481
Total loans		2,055,099			2,031,131
Deferred loan costs		(191	)		299
Allowance for loan losses		(29,860	)		(32,588	)
Net loans	$	2,025,048		$	1,998,842

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

As of September 30, 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 $627.7 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
	September 30,		December 31,		September 30,		December 31,
	2012		2011		2012		2011
Construction and land development	$	9,408	$	8,324	$	-	$	-
Commercial real estate		11,404		15,055		-		1,416
Consumer real estate		13,712		14,629		-		-
Commercial and industrial loans (except those secured by real estate)		625		1,141		-		96
Consumer and other		23		25		2		4
Total	$	35,172	$	39,174	$	2	$	1,516

If interest under the accrual method had been recognized on nonaccrual loans, such income would have approximated $422 thousand and $654 thousand for the three months ended September 30, 2012 and 2011, respectively and $1.3 million and $1.4 million for the nine months ended September 30, 2012 and 2011, respectively.

The following table presents the aging of the recorded investment in past due loans 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
September 30, 2012
Construction and land development	$	2,471	$	2,581	$	-	$	9,408	$	14,460	$	174,408	$	188,868
Commercial real estate		8,265		5,202		-		11,404		24,871		888,453		913,324
Consumer real estate		10,040		5,503		-		13,712		29,255		709,209		738,464
Commercial and industrial loans (except those secured by real estate)		1,171		589		-		625		2,385		182,656		185,041
Consumer and other		202		40		2		23		267		29,135		29,402
Total loans	$	22,149	$	13,915	$	2	$	35,172	$	71,238	$	1,983,861	$	2,055,099

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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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 (“ALLL”) and in the determination of the necessary provision for loan losses. 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.

The analysis of the loan portfolio generally begins with the identification of potential problem loans to be reviewed on an individual basis for impairment. When a commercial or commercial real estate loan of $500,000 or more has been identified as impaired, our policy requires a new appraisal (to include a liquidation value) unless our in-house Chief Appraiser reviews the existing appraisal (generally less than twelve months old) and determines that it may be used with appropriate market and/or liquidation adjustments as determined by him on a case by case basis. If a new appraisal is not required, the existing appraisal is used in order to estimate the fair value of the collateral, as validated by our in-house appraisal group. Our in-house Chief Appraiser’s review of such appraisals is documented and retained as part of the quarterly ALLL process. New appraisals are generally available within a one-quarter lag and are also reviewed by the Chief Appraiser to ensure appropriateness and reasonableness of the methods and assumptions used by the external third-party appraiser. Typically, charge-offs are recognized when the loss is probable and estimable, which is typically in the same quarter as the foreclosure or disposition of the underlying collateral. Prior to being charged-off, a specific reserve may be established based on our calculation of the loss embedded in the individual loan. Due to the processes described above, we do not experience significant timing differences between the identification of losses on impaired loans and recordation.

In addition to specific reserves on impaired loans, we have a nine point grading system, which we apply to 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. The remaining 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 look-back period for calculating historical losses is four years. Management believes this period appropriately reflects the current credit cycle and accurately reflects the risk in the loan portfolio. The four year look-back period includes the higher credit losses beginning in 2008 attributable to the economic downturn. 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.

The loan portfolio analysis also consists of appraisal updates on non-impaired loans. Existing appraisals may be validated or new appraisals ordered as loans are renewed or refinanced, depending on the individual circumstances surrounding each loan. Our in-house Chief Appraiser reviews new appraisals on non-impaired loans and documents the review.

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.

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.

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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

	Three Months Ended September 30, 2012
	Construction and Land Development			Commercial Real Estate			Consumer Real Estate			Commercial and Industrial (Except those Secured by Real Estate)			Consumer and Other			Total Allowance
Balance, July 1, 2012	$	7,954		$	9,056		$	10,522		$	2,526		$	84		$	30,142
Provision for loan losses		21			2,655			(485	)		(305	)		14			1,900
Loans charged off		(300	)		(1,528	)		(643	)		(181	)		(81	)		(2,733	)
Recoveries		66			83			273			61			68			551
Net charge-offs		(234	)		(1,445	)		(370	)		(120	)		(13	)		(2,182	)
Balance, September 30, 2012	$	7,741		$	10,266		$	9,667		$	2,101		$	85		$	29,860


	Three Months Ended September 30, 2011
	Construction and Land Development			Commercial Real Estate			Consumer Real Estate			Commercial and Industrial (Except those Secured by Real Estate)			Consumer and Other			Total Allowance
Balance, July 1, 2011	$	9,876		$	8,433		$	10,957		$	6,244		$	226		$	35,736
Provisions for loan losses		52			1,457			1,412			545			(166	)		3,300
Loans charged off		(1,075	)		(768	)		(1,495	)		(673	)		(74	)		(4,085	)
Recoveries		33			11			72			87			114			317
Net (charge-offs) recoveries		(1,042	)		(757	)		(1,423	)		(586	)		40			(3,768	)
Balance, September 30, 2011	$	8,886		$	9,133		$	10,946		$	6,203		$	100		$	35,268


	Nine Months Ended September 30, 2012
	Construction and Land Development			Commercial Real Estate			Consumer Real Estate			Commercial and Industrial (Except those Secured by Real Estate)			Consumer and Other			Total Allowance
Balance, January 1, 2012	$	9,856		$	8,565		$	10,019		$	4,059		$	89		$	32,588
Provision for loan losses		(599	)		4,674			1,932			(1,771	)		(86	)		4,150
Loans charged off		(1,598	)		(3,285	)		(2,811	)		(666	)		(168	)		(8,528	)
Recoveries		82			312			527			479			250			1,650
Net (charge-offs) recoveries		(1,516	)		(2,973	)		(2,284	)		(187	)		82			(6,878	)
Balance, September 30, 2012	$	7,741		$	10,266		$	9,667		$	2,101		$	85		$	29,860


	Nine Months Ended September 30, 2011
	Construction and Land Development			Commercial Real Estate			Consumer Real Estate			Commercial and Industrial (Except those Secured by Real Estate)			Consumer and Other			Total Allowance
Balance, January 1, 2011	$	11,037		$	8,211		$	10,864		$	7,388		$	149		$	37,649
Provisions for loan losses		2,254			3,249			3,637			1,950			(140	)		10,950
Loans charged off		(4,933	)		(2,408	)		(3,730	)		(3,503	)		(309	)		(14,883	)
Recoveries		528			81			175			368			400			1,552
Net (charge-offs) recoveries		(4,405	)		(2,327	)		(3,555	)		(3,135	)		91			(13,331	)
Balance, September 30, 2011	$	8,886		$	9,133		$	10,946		$	6,203		$	100		$	35,268

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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 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
September 30, 2012
Allowance for loan losses:
Individually evaluated for impairment	$	3,857	$	2,561	$	424	$	-	$	-	$	6,842
Collectively evaluated for impairment		3,883		7,705		9,244		2,100		86		23,018
Total ending allowance	$	7,740	$	10,266	$	9,668	$	2,100	$	86	$	29,860

Loans:
Individually evaluated for impairment	$	13,577	$	24,092	$	6,049	$	-	$	-	$	43,718
Collectively evaluated for impairment		175,291		889,232		732,415		185,041		29,402		2,011,381
Total loans	$	188,868	$	913,324	$	738,464	$	185,041	$	29,402	$	2,055,099

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

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 $53.2 million and $52.8 million at September 30, 2012 and December 31, 2011, respectively. December 31, 2011 impaired loans were previously reported in the 2011 10-K as $66.3 million, due to improperly including performing TDRs that had been removed from impaired status. The following table reflects previously reported and corrected balances for the respective periods (In thousands):

	December 31,
	2011
As reported in 2011 Form 10-K	$	66,324
Performing TDRs removed from impaired status		13,516
Corrected total impaired loans	$	52,808

Included in these balances were $27.0 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 accruing, 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 TDRs for the periods presented (In thousands):

	September 30,		December 31,
	2012		2011
Performing restructurings:
Construction and land development	$	7,523	$	9,946
Commercial real estate		6,416		5,029
Consumer real estate		10,451		15,556
Total performing restructurings	$	24,390	$	30,531

Nonperforming restructurings:
Construction and land development	$	142	$	-
Commercial real estate		122		2,832
Consumer real estate		2,364		5,357
Total nonperforming restructurings	$	2,628	$	8,189

Total restructurings	$	27,018	$	38,720

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 September 30, 2012 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.

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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,
	September 30, 2012

	Number of contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial real estate		1	$	534	$	534
Total Troubled Debt Restructurings		1	$	534	$	534

Troubled Debt Restructurings that Subsequently Defaulted
	Number of contracts		Recorded Investment
Troubled Debt Restructurings
Construction and land development		1	$	142
Commercial real estate		2		62
Consumer real estate		12		2,026
Total Troubled Debt Restructurings		15	$	2,230

	Modifications for the three months ended,
	September 30, 2011

	Number of contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Construction and land development		6	$	6,020	$	6,020
Consumer real estate		10		2,628		2,643
Total Troubled Debt Restructurings		16	$	8,648	$	8,663

Troubled Debt Restructurings that Subsequently Defaulted
	Number of contracts		Recorded Investment
Troubled Debt Restructurings
Consumer real estate		5	$	821
Total Troubled Debt Restructurings		5	$	821

	Modifications for the nine months ended,
	September 30, 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
Commercial real estate		2		1,400		1,400
Consumer real estate		2		986		1,275
Total Troubled Debt Restructurings		5	$	4,587	$	4,876

Troubled Debt Restructurings that Subsequently Defaulted
	Number of contracts		Recorded Investment
Troubled Debt Restructurings
Construction and land development		1	$	142
Commercial real estate-		2		62
Consumer real estate		12		2,026
Total Troubled Debt Restructurings		15	$	2,230

	Modifications for the nine months ended,
	September 30, 2011

	Number of contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Construction and land development		10	$	6,728	$	6,736
Commercial real estate		3		1,770		1,770
Consumer real estate		44		7,259		7,353
Commercial and industrial loans (except those secured by real estate)		1		-		-
Total Troubled Debt Restructurings		58	$	15,757	$	15,859

Troubled Debt Restructurings that Subsequently Defaulted
	Number of contracts		Recorded Investment
Troubled Debt Restructurings
Consumer real estate		5	$	821
Total Troubled Debt Restructurings		5	$	821

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 TDRs (In thousands):

	Three Months Ended September 30
	Interest income recognized		Cash-basis interest income
2012
Construction and land development	$	95	$	83
Commercial real estate		251		251
Consumer real estate		51		49
Total	$	397	$	383

2011
Construction and land development	$	41	$	36
Commercial real estate		71		49
Consumer real estate		25		21
Commercial and industrial loans (except those secured by real estate)		10		9
Total	$	147	$	115

	Nine Months Ended September 30
	Interest income recognized		Cash-basis interest income recognized
2012
Construction and land development	$	310	$	324
Commercial real estate		382		396
Consumer real estate		178		167
Total	$	870	$	887

2011
Construction and land development	$	135	$	140
Commercial real estate		231		221
Consumer real estate		78		73
Commercial and industrial loans (except those secured by real estate)		47		54
Total	$	491	$	488

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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.

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. Of the $53.2 million of impaired loans at September 30, 2012, $9.5 million, consisting solely of TDRs, was collectively evaluated for impairment and $43.7 million was individually evaluated for impairment. The detail of loans individually evaluated for impairment, which includes $17.6 million of commercial TDRs, is presented below (In thousands):

	Recorded investment		Unpaid contractual principal balance		Allocated allowance		Average recorded investment
September 30, 2012
Loans without a specific valuation allowance:
Construction and land development	$	3,129	$	3,191	$	-	$	3,402
Commercial real estate		7,383		7,453		-		7,782
Consumer real estate		3,387		4,942		-		3,290
Loans with a specific valuation allowance:
Construction and land development		10,448		12,490		3,857		10,365
Commercial real estate		16,709		17,257		2,561		11,874
Consumer real estate		2,662		2,662		424		2,945
Total	$	43,718	$	47,995	$	6,842	$	39,658

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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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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.

Loans 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 - 3		4		5		6		7		8
September 30, 2012
Construction and land development	$	44,518	$	1,467	$	55,955	$	51,624	$	3,245	$	29,644	$	2,415
Commercial real estate		-		87,818		506,559		203,569		37,203		77,482		693
Consumer real estate		-		7,061		93,268		69,454		10,990		28,004		505
Commercial and industrial loans (except those secured by real estate)		-		56,403		69,220		47,367		5,606		6,399		46
Consumer and other		-		-		-		-		-		-		-
Total	$	44,518	$	152,749	$	725,002	$	372,014	$	57,044	$	141,529	$	3,659

December 31, 2011
Construction and land development	$	46,724	$	1,402	$	72,138	$	47,681	$	3,285	$	40,044	$	3,393
Commercial real estate		-		89,881		411,433		228,360		37,091		77,424		671
Consumer real estate		-		9,727		100,501		72,386		13,157		29,540		950
Commercial and industrial loans (except those secured by real estate)		-		51,421		92,000		33,088		4,859		8,482		37
Consumer and other		-		-		-		-		-		-		-
Total	$	46,724	$	152,431	$	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
	September 30, 2012		December 31, 2011		September 30, 2012		December 31, 2011
Performing	$	516,029	$	521,175	$	29,379	$	25,456
Nonperforming		13,153		8,800		23		25
Total	$	529,182	$	529,975	$	29,402	$	25,481

Repurchased Loans

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. 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. At September 30, 2012, $296 thousand of losses associated with mortgage repurchases and indemnifications was accrued. Additionally, losses of $584 thousand and $232 thousand were recognized during the nine months ended September 30, 2012 and 2011, respectively.

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 September 30, 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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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 September 30, 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).

	September 30,
	2012		2011
Earnings per common share
Net income	$	5,560	$	4,219
Preferred stock dividends and accretion		-		(296	)
Net income available to common shareholders		5,560		3,923
Weighted average common shares issued and outstanding		23,104,631		22,869,271
Earnings per common share	$	0.24	$	0.17

Diluted earnings per common share
Weighted average common shares issued and outstanding		23,104,631		22,869,271
Stock options		918		227
Total diluted weighted average common shares issued and outstanding		23,105,549		22,869,498
Diluted earnings per common share	$	0.24	$	0.17

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 nine month periods ended September 30, 2012 and 2011. Potential dilutive stock had no effect on income available to common shareholders for the nine month periods (In thousands, except share and per share amounts).

	September 30,
	2012		2011
Earnings per common share
Net income	$	15,942	$	11,116
Preferred stock dividends and accretion		-		(1,482	)
Net income available to common shareholders		15,942		9,634
Weighted average common shares issued and outstanding		23,086,118		22,853,560
Earnings per common share	$	0.69	$	0.42

Diluted earnings per common share
Weighted average common shares issued and outstanding		23,086,118		22,853,560
Stock options		347		2,846
Total diluted weighted average common shares issued and outstanding		23,086,465		22,856,406
Diluted earnings per common share	$	0.69	$	0.42

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 213,871 and 407,757 shares, respectively, were not included in the three month calculation of earnings per share, as their effect would have been anti-dilutive. For the nine month calculation of earnings per share 245,019 and 423,933 shares in 2012 and 2011, respectively, were excluded.

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

6.	Stock-Based Compensation

Stock-based compensation expense included within compensation and employee benefits expense totaled $250 thousand and $728 thousand during the three and nine months ended September 30, 2012, respectively, and $206 thousand and $557 thousand during the three and the nine months ended September 30, 2011, respectively.

A summary of the stock option plan at September 30, 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		(7,259	)		18.68		(10,805	)		18.64
Expired		(68,443	)		26.88		(162,853	)		19.21
Exercised		(3,192	)		10.95		(31,920	)		9.71
Outstanding at September 30,		212,302		$	20.14		292,596		$	21.59

Exercisable at September 30,		193,041					248,478

The aggregate intrinsic value of options outstanding as of September 30, 2012 was $5 thousand and the intrinsic value of options exercisable was $3 thousand. 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 September 30, 2012 and the exercise price, multiplied by the number of options outstanding). The weighted average remaining contractual life is 1.9 years for exercisable options at September 30, 2012.

The following table summarizes nonvested restricted shares outstanding as of September 30, 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		96,255			12.17
Vested and exercised		(59,665	)		11.43	$	745
Forfeited		(20,693	)		12.85
Nonvested at September 30, 2012		217,696		$	12.47	$	2,865

The estimated unamortized compensation expense, net of estimated forfeitures, related to nonvested stock and stock options issued and outstanding as of September 30, 2012 that will be recognized through 2017 is $2.0 million.

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

7.	Fair Value Measurements

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 or 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. The underlying securities are all Level 1 as described above.

Assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011 are summarized below (In thousands).

			Fair Value Measurements at
			September 30, 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	$	252,176	$	-	$	252,176	$	-
State and municipals		153,164		-		153,164		-
Corporate bonds		4,873		-		4,873		-
Collateralized mortgage obligations		5,914		-		5,914		-
Mortgage backed securities		131,012		-		131,012		-
Other investments		9,999		-		9,999		-
Other assets 1		2,888		2,888		-		-
Total assets at fair value	$	560,026	$	2,888	$	557,138	$	-

Cash flow hedge	$	1,549	$	-	$	1,549	$	-
Other liabilities 1		2,936		2,936		-		-
Total liabilities at fair value	$	4,485	$	2,936	$	1,549	$	-

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		-
Mortgage backed securities		144,893		-		144,893		-
Other investments		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 nine months ended September 30, 2012 was not significant and there were no transfers between Levels 1, 2 or 3 during the nine months ended September 30, 2012.

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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. For real estate secured loans, generally external appraisals by a board approved appraiser are used to determine the fair value of the underlying collateral for collateral dependent impaired loans. These appraisals are sometimes adjusted based on management’s and Chief Appraiser’s knowledge of other factors not embedded within the appraisal, including selling costs, maintenance costs, and other estimable costs that would be incurred if collateral is required to be liquidated. Our in-house Chief Appraiser’s review of such appraisals is documented as part of the quarterly ALLL process. Other estimates of value, such as auctioneer’s estimates of value, purchase offers and/or contracts, and settlement offers and/or agreements, may be used when they are thought to represent a more accurate estimate of fair value. For loans that are not secured by real estate, fair value of the collateral may be determined by discounted book value based on available data such as current financial statements or an external appraisal or an auctioneer’s or liquidator’s estimate of value. 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 September 30, 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. As such, 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 appraised values of the collateral adjusted for estimated disposition costs 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 September 30, 2012 and December 31, 2011 are included in the table below (In thousands).

			Fair Value Measurements at
			September 30, 2012
			Using
			Level 1		Level 2		Level 3
	Total		(Quoted Prices)		(Significant Other Observable Inputs)		(Significant Unobservable Inputs)
Impaired loans	$	53,168	$	-	$	-	$	53,168
Loans held for sale - mortgage		26,006		-		26,006		-
Foreclosed assets		7,907		-		-		7,907
Total assets at fair value	$	87,081	$	-	$	26,006	$	61,075


			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	$	-	$	-	$	52,756
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	$	-	$	42,027	$	61,544

Impaired loans at December 31, 2011 were previously disclosed as both Level 2 and Level 3. Because of the adjustments management may make to appraisals, all Level 2 amounts have been reclassed to Level 3 to reflect the unobservable inputs within the appraisal review process.

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:

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 and therefore, we consider these advances Level 3.

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 September 30, 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):

	September 30, 2012
	Carrying		Fair		Fair Value Measurements Using
	Amount		Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	54,857	$	54,857	$	54,857	$	-	$	-
Investment securities		557,138		557,138		8,999		548,139		-
Mortgage loans held for sale		26,006		26,006		-		26,006		-
Loans, net		2,025,048		1,868,706		-		-		1,868,706
Accrued interest receivable		9,373		9,373		9,373		-		-

Liabilities
Deposits	$	2,421,735		2,436,562	$	-	$	-	$	2,436,562
Federal Home Loan Bank advances		55,000		60,194		-		-		60,194
Subordinated debt		32,991		32,935		-		-		32,935
Accrued interest payable		1,792		1,792		1,792		-		-

	December 31, 2011
	Carrying		Fair		Fair Value Measurements Using
	Amount		Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	99,970	$	99,970	$	99,970	$	-	$	-
Investment securities		477,964		477,964		8,999		468,965		-
Mortgage loans held for sale		42,027		42,027		-		42,027		-
Loans, net		1,998,842		1,839,635		-		-		1,839,635
Accrued interest receivable		8,908		8,908		8,908		-		-

Liabilities
Deposits	$	2,395,600	$	2,409,959	$	-	$	-	$	2,409,959
Federal Home Loan Bank advances		60,000		64,395		-		-		64,395
Subordinated debt		32,991		32,930		-		-		32,930
Accrued interest payable		2,122		2,122		2,122		-		-

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STELLARONE CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

8.	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 of residential mortgages for sale into the secondary market on a best-efforts basis. Up until the disposition of our wholesale operations in December 2011, mortgage banking was also engaged in the acquisition of residential mortgages. 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 and nine months ended September 30, 2012 and 2011 is as follows:

At and for the Three Months Ended September 30, 2012

	Commercial		Mortgage		Wealth					Intersegment
	Banking		Banking		Management		Other			Elimination			Consolidated
Net interest income	$	24,482	$	161	$	-	$	(344	)	$	-		$	24,299
Provision for loan losses		1,900		-		-		-			-			1,900
Noninterest income		6,242		2,426		1,290		27			(1,278	)		8,707
Noninterest expense		21,772		1,747		1,059		294			(1,278	)		23,594
Provision for income taxes		1,848		252		69		(217	)		-			1,952
Net income (loss)	$	5,204	$	588	$	162	$	(394	)	$	-		$	5,560

Total Assets	$	2,925,559	$	26,309	$	636	$	466,591		$	(459,249	)	$	2,959,846
Average Assets	$	2,945,031	$	20,368	$	617	$	462,947		$	(455,452	)	$	2,973,511


At and for the Three Months Ended September 30, 2011

	Commercial		Mortgage		Wealth					Intersegment
	Banking		Banking		Management		Other			Elimination			Consolidated
Net interest income	$	24,323	$	183	$	-	$	(263	)	$	-		$	24,243
Provision for loan losses		3,300		-		-		-			-			3,300
Noninterest income		5,711		2,035		1,195		28			(1,193	)		7,776
Noninterest expense		21,162		1,909		1,040		340			(1,193	)		23,258
Provision for income taxes		1,309		93		47		(207	)		-			1,242
Net income (loss)	$	4,263	$	216	$	108	$	(368	)	$	-		$	4,219

Total Assets	$	2,915,016	$	35,167	$	451	$	469,579		$	(462,372	)	$	2,957,841
Average Assets	$	2,922,570	$	22,524	$	494	$	466,416		$	(458,691	)	$	2,953,313


At and for the Nine Months Ended September 30, 2012

	Commercial		Mortgage		Wealth					Intersegment
	Banking		Banking		Management		Other			Elimination			Consolidated
Net interest income	$	72,863	$	538	$	-	$	(1,027	)	$	-		$	72,374
Provision for loan losses		4,150		-		-		-			-			4,150
Noninterest income		18,687		5,924		4,006		80			(3,771	)		24,926
Noninterest expense		65,980		5,015		3,364		787			(3,771	)		71,375
Provision for income taxes		5,828		434		192		(621	)		-			5,833
Net income (loss)	$	15,592	$	1,013	$	450	$	(1,113	)	$	-		$	15,942

Average Assets	$	2,908,031	$	20,585	$	525	$	458,776		$	(451,606	)	$	2,936,311


At and for the Nine Months Ended September 30, 2011

	Commercial		Mortgage		Wealth					Intersegment
	Banking		Banking		Management		Other			Elimination			Consolidated
Net interest income	$	72,356	$	583	$	-	$	(790	)	$	-		$	72,149
Provision for loan losses		10,950		-		-		-			-			10,950
Noninterest income		16,928		5,474		3,887		79			(3,576	)		22,792
Noninterest expense		63,930		5,451		3,295		739			(3,576	)		69,839
Provision for income taxes		3,202		182		178		(526	)		-			3,036
Net income (loss)	$	11,202	$	424	$	414	$	(924	)	$	-		$	11,116

Average Assets	$	2,897,661	$	20,653	$	540	$	464,177		$	(455,573	)	$	2,927,458

9.	New Authoritative Accounting Guidance

In July 2012, the FASB issued ASU 2012-02, Intangibles-Goodwill and Other (Topic 350) – Testing Indefinite-Lived Intangible Assets for Impairment. The amendments in this Update are intended to reduce cost and complexity by providing an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. This guidance becomes effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. We do not anticipate any effect on our consolidated financial position or consolidated results of operations as a result of adoption for the fiscal year ending December 31, 2013.

In October 2012, the FASB issued ASU 2012-04 – Technical Corrections and Improvements. The amendments in this Update cover a wide range of topics within the codification, as they incorporate multiple improvements provided through the codification’s feedback process. Amendments have been made to source literature, guidance clarification, reference corrections and relocations of guidance. Amendments that do not have transition guidance were effective upon issuance. Amendments subject to transition guidance will be effective for fiscal periods beginning after December 15, 2012. We do not anticipate any effect on our consolidated financial position or consolidated results of operations as a result of adoption.

In October 2012, the FASB issued ASU 2012-06, Business Combinations (Topic 805) – Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution. The Update specifies that when a reporting entity recognizes an indemnification asset as a result of a government-assisted acquisition of a financial institution and subsequently a change in the cash flows expected to be collected on the indemnification asset occurs, the reporting entity should subsequently account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value should be limited to the contractual term of the indemnification agreement. This Update becomes effective for fiscal years and interim periods within those years beginning on or after December 15, 2012. We will adopt the guidance effective the first quarter of 2013 and we do not anticipate any effect on our consolidated financial position or consolidated results of operations as a result of adoption.

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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 third quarter 2012 earnings were $5.6 million or $0.24 net income per diluted common share. This represents a 41.7% increase over net income available to common shareholders of $3.9 million or $0.17 net income per diluted common share during the same quarter in the prior year. Continuing improvements in asset quality, solid noninterest income growth primarily from our mortgage segment and improved commercial lending activity in our new markets contributed to the growth in recurring earnings.

Our net income for the nine month period ended September 30, 2012 was $15.9 million, or $0.69 net income per diluted common share. Those results compare to net income available to common shareholders of $9.6 million, or $0.42 net income per diluted common share during the same period in the prior year. Solid noninterest income growth from continued strong production volume from our mortgage segment contributed to the growth in recurring earnings.

Operating Segment Results

Revenue from the mortgage banking segment totaled $2.3 million for the third quarter of 2012, or up $583 thousand or 33.3% compared to $1.8 million for the second quarter of 2012 and up $368 thousand or 18.7% when compared to the same quarter in 2011. The increase is primarily volume driven and not margin related as loans sold in the third quarter of 2012 totaled $70.8 million or up $15.8 million or 28.7% from the $55.0 million sold during the second quarter of 2012. The volume increase during the third quarter is attributable to our ability to capitalize on the market demand for mortgage refinancing driven by the low rate environment. In addition to this revenue increase, a sequential decrease in mortgage indemnification expense of $174 thousand contributed to a significant improvement in earnings contribution from the mortgage segment, with after-tax earnings of $588 thousand, representing $0.03 per common diluted share.

Revenue from the mortgage banking segment totaled $6.3 million for the first nine months of 2012, or up $709 thousand or 12.7% compared to $5.6 million for the first nine months of 2011. The increase is attributable to higher fee realization on loans sold.

Retail banking fee income from the commercial banking segment remained stable at $3.8 million for the third quarter of 2012 and amounted to $11.5 million for the first nine months of 2012, an increase of $35 thousand or essentially flat compared to $11.4 million for the first nine months of 2011. The revenue mix from this line of business had a slight uptick in overdraft revenue with an offsetting decrease in interchange income.

Wealth management revenues from trust and brokerage fees for the third quarter of 2012 were $1.3 million or essentially flat on a sequential quarter basis and up $95 thousand or 7.9% when compared to the $1.2 million realized during the third quarter of 2011. The year over year increase is primarily due to higher fee realizations attributable to new asset growth and to a lesser extent increases in the market value of underlying assets. Fiduciary assets increased sequentially by $8.5 million or 1.9% amounting to $466.9 million at September 30, 2012, compared to $458.4 million at June 30, 2012. These increases were driven by both market value improvement and growth from new assets. Wealth management revenues from trust and brokerage fees for the first nine months of 2012 were $4.0 million, an increase of $69 thousand or 1.8% compared to the first nine months of 2011.

Table of Contents

STELLARONE CORPORATION

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

Net Interest Income

The net interest margin was 3.77% for the third quarter of 2012, compared to 3.84% for the second quarter of 2012 and 3.77% for the third quarter of 2011. The current low interest rate environment, market loan pricing pressures and U.S. monetary policy has accelerated asset yield compression, resulting in some margin compression. The average yield on earning assets for the current quarter decreased 12 basis points to 4.45% on a sequential basis. Investment yields and loan yields contracted 24 basis points and 10 basis points, respectively, on a sequential basis. Investment yields contracted due to lower yields realized on the recent investment activity in the current low rate environment. Loan yields contracted due to re-pricing within the current portfolio and reduced yields on new production. Due to lower rates paid on deposits, a 6 basis point improvement in the cost of interest bearing liabilities was noted sequentially, moving from 0.89% during the second quarter of 2012 to 0.83% during the third quarter of 2012. Higher earning assets offset the margin compression experienced during the quarter as net interest income on a tax-equivalent basis remained stable at $25.0 million for the third quarter of 2012, compared to $25.1 million for the third quarter last year and $24.9 million in the second quarter of 2012.

Net interest income on a tax-equivalent basis amounted to $74.6 million for the first nine months of 2012, which compares to $74.5 million for the same period in 2011. The net interest margin was 3.82% for the first nine months of 2012 and 3.81% for the first nine months of 2011. The average yield on earning assets for the first nine months of 2012 decreased 23 basis points to 4.55% as compared to 4.78% for the first nine months of 2011, which was more than offset by improvement in the cost of interest bearing liabilities, which contracted 27 basis points from 1.16% during the first nine months of 2011 to 0.89% during the first nine months of 2012. The re-pricing of interest bearing liabilities outpaced interest earning assets during the first nine months as we experienced decreases in the cost of all deposit categories and a 36 basis point decrease in the cost of FHLB advances. Loan yields contracted 17 basis points due to re-pricing within the current portfolio and lower yields realized on new production due to the protracted low rate environment.

STELLARONE CORPORATION (NASDAQ: STEL)
CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES (UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011
(Dollars in thousands)
	For the Three Months Ended September 30,
	2012							2011
	Average		Interest		Average			Average		Interest		Average
	Balance		Inc/Exp		Rates			Balance		Inc/Exp		Rates

Assets
Loans receivable, net (1)	$	2,066,911	$	25,865		4.98	%	$	2,064,789	$	27,044		5.20	%
Investment securities
Taxable		414,806		1,725		1.63	%		292,359		1,829		2.45	%
Tax exempt (1)		133,539		1,972		5.78	%		153,964		2,260		5.74	%
Total investments		548,345		3,697		2.64	%		446,323		4,089		3.58	%

Federal funds sold and deposits in banks		28,712		24		0.33	%		127,651		77		0.24	%
		577,057		3,721		2.53	%		573,974		4,166		2.84	%

Total earning assets		2,643,968	$	29,586		4.45	%		2,638,763	$	31,210		4.69	%

Total nonearning assets		329,543							314,550

Total assets	$	2,973,511						$	2,953,313

Liabilities and Stockholders' Equity
Interest-bearing deposits
Interest checking	$	604,102	$	309		0.20	%	$	573,871	$	538		0.37	%
Money market		437,761		506		0.46	%		445,187		970		0.86	%
Savings		316,922		219		0.27	%		280,640		423		0.60	%
Time deposits:
Less than $100,000		484,365		1,699		1.40	%		537,180		2,185		1.61	%
$100,000 and more		251,863		1,046		1.65	%		267,116		1,241		1.84	%
Total interest-bearing deposits		2,095,013		3,779		0.72	%		2,103,994		5,357		1.01	%

Federal funds purchased and securities sold under agreements to repurchase		1,920		8		1.63	%		1,075		8		2.91	%
Federal Home Loan Bank advances and other borrowings		55,000		413		2.94	%		60,000		523		3.41	%
Subordinated debt		32,991		344		4.08	%		32,991		263		3.12	%

		89,911		765		3.33	%		94,066		794		3.30	%

Total interest-bearing liabilities		2,184,924		4,544		0.83	%		2,198,060		6,151		1.11	%

Total noninterest-bearing liabilities		363,901							325,577

Total liabilities		2,548,825							2,523,637
Stockholders' equity		424,686							429,676

Total liabilities and stockholders' equity	$	2,973,511						$	2,953,313


Net interest income (tax equivalent)			$	25,042						$	25,059
Average interest rate spread						3.62	%						3.58	%
Interest expense as percentage of average earning assets						0.68	%						0.92	%
Net interest margin						3.77	%						3.77	%

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

Table of Contents

STELLARONE CORPORATION

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

STELLARONE CORPORATION (NASDAQ: STEL)
CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011
(Dollars in thousands)
	For the Nine Months Ended September 30,
	2012							2011
	Average		Interest		Average			Average		Interest		Average
	Balance		Inc/Exp		Rates			Balance		Inc/Exp		Rates

Assets
Loans receivable, net (1)	$	2,057,773	$	77,836		5.05	%	$	2,084,621	$	81,457		5.22	%
Investment securities
Taxable		370,541		5,054		1.79	%		260,266		5,373		2.72	%
Tax exempt (1)		136,568		5,980		5.75	%		142,909		6,337		5.85	%
Total investments		507,109		11,034		2.86	%		403,175		11,710		3.83	%

Federal funds sold and deposits in banks		46,117		90		0.26	%		125,409		211		0.22	%
		553,226		11,124		2.64	%		528,584		11,921		2.97	%

Total earning assets		2,610,999	$	88,960		4.55	%		2,613,205	$	93,378		4.78	%

Total nonearning assets		325,312							314,253

Total assets	$	2,936,311						$	2,927,458

Liabilities and Stockholders' Equity
Interest-bearing deposits
Interest checking	$	593,817	$	1,101		0.25	%	$	567,188	$	1,601		0.38	%
Money market		421,755		1,551		0.49	%		430,565		3,064		0.95	%
Savings		307,840		800		0.35	%		275,404		1,306		0.63	%
Time deposits:
Less than $100,000		495,902		5,381		1.45	%		539,790		6,710		1.66	%
$100,000 and more		255,595		3,220		1.68	%		265,587		3,743		1.88	%
Total interest-bearing deposits		2,074,909		12,053		0.78	%		2,078,534		16,424		1.06	%

Federal funds purchased and securities sold under agreements to repurchase		1,209		20		2.17	%		1,091		24		2.95	%
Federal Home Loan Bank advances and other borrowings		55,785		1,260		2.97	%		66,593		1,681		3.33	%
Subordinated debt		32,991		1,028		4.09	%		32,991		790		3.16	%

		89,985		2,308		3.37	%		100,675		2,495		3.27	%

Total interest-bearing liabilities		2,164,894		14,361		0.89	%		2,179,209		18,919		1.16	%

Total noninterest-bearing liabilities		350,606							320,679

Total liabilities		2,515,500							2,499,888
Stockholders' equity		420,811							427,570

Total liabilities and stockholders' equity	$	2,936,311						$	2,927,458


Net interest income (tax equivalent)			$	74,599						$	74,459
Average interest rate spread						3.66	%						3.62	%
Interest expense as percentage of average earning assets						0.73	%						0.97	%
Net interest margin						3.82	%						3.81	%

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

Table of Contents

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 noninterest income amounted to $8.7 million for the third quarter of 2012, up $499 thousand or 6.1% on a sequential basis compared to $8.2 million for the second quarter of 2012, and up $937 thousand or 12.1% compared to the same quarter last year. Both the sequential quarter and year over year increases in operating noninterest income stemmed largely from continued strong production volumes from our mortgage segment.

Total non-interest income amounted to $24.9 million for the first nine months of 2012, or up $2.1 million or 9.4% compared to the same period in the prior year. Strong performance from our mortgage banking line contributed $709 thousand of the increase, paired with increases in other operating income of $614 thousand from loan swap fee income and $635 thousand in pass-through income.

Noninterest Expense

The efficiency ratio was 67.94% for the third quarter of 2012, compared to 71.72% for the second quarter of 2012 and 69.01% for the same quarter in 2011. The sequential quarter decrease in the efficiency ratio reflects the absence of the $824 thousand one-time charge associated with severance costs incurred during the second quarter along with improved noninterest income revenues. The year over year decrease is a result of increased revenues from noninterest income.

The efficiency ratio was 69.80% for the first nine months in 2012, compared to 69.88% for the same period in 2011. The stability in the efficiency ratio reflects an increase in revenues offset by an increase in noninterest expense. Noninterest expense for the first nine months of 2012 amounted to $71.4 million, or up $1.5 million or 2.2% when compared to $69.8 million for the same period in the prior year. The increase was driven primarily by the $824 thousand one-time severance charges described above. In addition, professional fees increased $279 thousand, primarily associated with consulting services related to CEO succession planning, phase two of our efficiency initiative and strategic training opportunities and marketing increased $267 thousand as we promoted the opening of our three new branches in Charlottesville, Richmond and Tidewater in 2012.

Phase two of our efficiency initiative is well underway, which contains strategies to enhance revenues and streamline processes in order to achieve further improvement in efficiency and effectiveness. Phase three of the initiative has begun and will serve to align our real estate holdings and associated expense structure with our current and future needs. We view these as longer-term commitments which will facilitate some immediate enhancements while other strategies implemented will be realized over a twelve to eighteen month horizon.

Income Taxes

Income tax expense for the third quarter of 2012 was $2.0 million, resulting in an effective tax rate of 26.0%, compared to an income tax expense of $1.2 million for the third quarter of 2011, or an effective rate of 22.7%. For the nine month period ended September 30, 2012, income tax expense was $5.8 million, or an effective rate of 26.8% compared to $3.0 million, or an effective rate of 21.5% for the same period in 2011. The volatility in the effective tax rate when comparing the three and nine month periods to the same periods in the prior year is a result of elevated provisioning levels in the prior year that reduced pretax earnings to a level proportionately smaller in relation to permanent tax differences. As pretax results fluctuate, substantial shifts in the effective tax rate are generated due to comparing a lower level of earnings or losses to a relatively steady level of permanent differences. The effective rate of 26.8% for the first nine months of 2012 is slightly higher than 26.3%, which represents our anticipated effective rate for the remainder of 2012.

Asset Quality

Non-performing assets, as shown below, totaled $43.1 million at September 30, 2012, up $583 thousand or 1.4% sequentially from $42.5 million at June 30, 2012 and down $9.4 million or 17.9% compared to $52.5 million at September 30, 2011. The ratio of non-performing assets as a percentage of total assets remained stable sequentially at 1.46% as of September 30, 2012, compared to 1.43% as of June 30, 2012 and was down compared to 1.77% at September 30, 2011.

	September 30, 2012		June 30, 2012		September 30, 2011
Non accrual loans	$	32,544	$	30,511	$	35,025
Non accrual TDR's		2,628		4,971		8,445
Total non-performing loans		35,172		35,482		43,470
Foreclosed assets		7,907		7,014		9,009
Total non-performing assets	$	43,079	$	42,496	$	52,479

Net charge-offs for the third quarter of 2012 totaled $2.2 million, down $691 thousand or 24.1% compared to the $2.9 million for the second quarter of 2012 and down $1.6 million or 42.1% when compared to $3.8 million for the third quarter of 2011. Annualized net charge-offs as a percentage of average loans receivable amounted to 0.42% for the third quarter of 2012, down from 0.56% for the second quarter of 2012 and down from 0.73% for the third quarter of 2011.

Foreclosed assets totaled $7.9 million at September 30, 2012, up $893 thousand or 12.7% compared to $7.0 million at June 30, 2012 and down $1.1 million or 12.2% compared to $9.0 million at September 30, 2011.

Included in the loan portfolio at September 30, 2012, are loans classified as troubled debt restructurings (“TDRs”) totaling $27.0 million or 1.4% of total loans. TDRs were reduced sequentially by 9.4% or $2.8 million as compared to $29.8 million at June 30, 2012 and 33.7% or $13.7 million as compared to $40.7 million at September 30, 2011. At September 30, 2012, $24.4 million or 90.3% of total TDRs were performing under the modified terms.

We recorded a provision for loan losses of $1.9 million for the third quarter of 2012, an increase of $500 thousand compared to the $1.4 million recognized for the second quarter of 2012 and a decrease of $1.4 million compared to the third quarter of 2011. The decreased provisioning in the first three quarters of 2012 is reflective of the continued 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 was 84.9% at September 30, 2012, or essentially unchanged from 85.0% at June 30, 2012 and up from 81.1% at September 30, 2011. The third quarter 2012 provision compares to net charge-offs of $2.2 million, resulting in an allowance for loan losses of $29.9 million at September 30, 2012, a decrease of $282 thousand when compared to $30.1 million at June 30, 2012 and $5.4 million when compared to $35.3 million at September 30, 2011. The allowance as a percentage of total loans was 1.45% at September 30, 2012, compared to 1.48% at June 30, 2012 and 1.74% at September 30, 2011.

Table of Contents

STELLARONE CORPORATION

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

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

	September 30, 2012
	Loans Outstanding		Nonaccrual Loans		Nonaccrual Loans to Loans Outstanding
Construction and land development	$	188,868	$	9,408		4.98	%
Commercial real estate		913,324		11,404		1.25	%
Consumer real estate		738,464		13,712		1.86	%
Commercial and industrial loans (except those secured by real estate)		185,041		625		0.34	%
Consumer and other		29,402		23		0.08	%
Total loans	$	2,055,099	$	35,172		1.71	%

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

	September 30, 2012			December 31, 2011			September 30, 2011
Non-accrual loans	$	32,544		$	30,985		$	35,025
Troubled debt restructurings - non-accrual status		2,628			8,189			8,445
Foreclosed assets		7,907			8,575			9,009
Total non-performing assets	$	43,079		$	47,749		$	52,479
Nonperforming assets to total assets		1.46	%		1.64	%		1.77	%
Nonperforming assets to loans and foreclosed property		2.09	%		2.34	%		2.58	%
Allowance for loan losses as a percentage of loans receivable		1.45	%		1.60	%		1.74	%
Allowance for loan losses as a percentage of nonperforming loans		84.90	%		83.19	%		81.13	%
Annualized net charge-offs as a percentage of average loans receivable		0.42	%		0.86	%		0.73	%

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 our “well-capitalized” position at the banking subsidiary.

Our primary source of additional capital is earnings retention, which represents net income less dividends declared. We paid $4.2 million in common dividends during the nine month period ended September 30, 2012. These dividends combined with net income of $15.9 million resulted in an increase to retained earnings of $11.7 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 our banking subsidiary and us 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 our subsidiary bank and us as “well capitalized” under FIDICIA. There are no conditions or events that we believe have changed our subsidiary bank’s or our well capitalized position.

The following table includes information with respect to our risk-based capital and equity levels as of September 30, 2012 (in thousands):

	Consolidated			Bank
Tier 1 capital	$	335,751		$	324,169
Tier 2 capital		26,865			26,795
Total risk-based capital		362,616			350,964
Total risk-weighted assets		2,145,886			2,140,143
Average adjusted total assets		2,859,448			2,851,488
Capital ratios:
Tier 1 risk-based capital ratio		15.65	%		15.15	%
Total risk-based capital ratio		16.90	%		16.40	%
Leverage ratio (Tier 1 capital to average adjusted total assets)		11.74	%		11.37	%
Equity to assets ratio		10.90	%		15.32	%
Tangible common equity to assets ratio		10.90	%		11.78	%

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 $240.1 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, finance, marketing, human resources, loan and deposit operations, information technology, audit, compliance and credit administration functions. It also includes outflows associated with dividends to common shareholders, dividends to preferred shareholders and interest on subordinated debt. The main sources of funding for the parent company are the management fees and dividends it receives from its banking subsidiary and availability on the equity market as deemed necessary. As of September 30, 2012 there was $8.9 million in unrestricted funds that could be transferred from the bank subsidiary to us without prior regulatory approval.

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.

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 the Company files 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 the Company’s website at http://www.stellarone.com under the “Investor Relations” tab as soon as reasonably practical after filing electronically with the SEC.

Table of Contents

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 carrying 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.

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 has been estimated based on our recent historic run rate.

Goodwill

Goodwill and intangible assets that have indefinite useful lives are evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. Our annual impairment measurement date is October 1. During the second quarter of 2011, we changed the date of our annual impairment testing for goodwill from September 30th to October 1st. This annual assessment will be completed during the fourth quarter. Since 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. These intangible assets will be evaluated for impairment if a triggering event occurs; no such event was identified during the quarter.

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 September 30, 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.

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:

	For the three months ended
	September 30, 2012			June 30, 2012			September 30, 2011
Noninterest expense	$	23,594		$	24,328		$	23,258
Less:
Amortization of intangible assets		413			413			413
Adjusted noninterest expense	$	23,181		$	23,915		$	22,845

Net interest income (tax equivalent)	$	25,042		$	24,935		$	25,059
Noninterest income		8,707			8,197			7,776
Less:
Gains on sale of securities available for sale		9			7			41
Losses / impairments on foreclosed assets		(381	)		(219	)		(311	)
Net revenues	$	34,121		$	33,344		$	33,105

Efficiency ratio		67.94	%		71.72	%		69.01	%

	For the nine months ended
	September 30, 2012			September 30, 2011
Noninterest expense	$	71,375		$	69,839
Less:
Amortization of intangible assets		1,238			1,238
Adjusted noninterest expense		70,137			68,601

Net interest income (tax equivalent)		74,599			74,459
Noninterest income		24,926			22,792
Less:
Gains on sale of securities available for sale		88			62
Losses / impairments on foreclosed assets		(1,051	)		(981	)
Net revenues	$	100,488		$	98,170

Efficiency ratio		69.80	%		69.88	%

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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.

	Consolidated			Bank
Total stockholders' equity	$	428,077		$	452,216
Less:
Core deposit intangibles, net		3,773			3,773
Goodwill		113,652			113,652
Net other intangibles		886			886
Tangible common equity		309,766			333,905

Total assets		2,959,846			2,952,503
Core deposit intangibles, net		3,773			3,773
Goodwill		113,652			113,652
Net other intangibles		886			886
Tangible assets	$	2,841,535		$	2,834,192

Tangible common equity to assets ratio		10.90	%		11.78	%

The report also refers to operating noninterest income, which is computed by subtracting gains on securities available for sale and gains (losses) on sale of premises and equipment from noninterest income. Operating noninterest income is not a recognized reporting measure under USGAAP. Management believes it provides investors with important information about core business earnings by removing the income from nonoperational items. The table below presents a reconciliation of this non-USGAAP measure.

	For the three months ended					For the nine months ended
	September 30, 2012		September 30, 2011			September 30, 2012		September 30, 2011
Noninterest income	$	8,707	$	7,776		$	24,926	$	22,792
Less:
Gains on securities available for sale		9		41			88		62
Gains (losses) on sale of premises and equipment		17		(9	)		10		(6	)
Operating earnings	$	8,681	$	7,744		$	24,828	$	22,736

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.

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 September 30, 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 September 30, 2012 is formatted in XBRL interactive data files: (i) Consolidated Statement of Income for the three months ended September 30, 2012 and 2011 and nine months ended September 30, 2012 and 2011; (ii) Consolidated Balance Sheet at September 30, 2012 and December 31, 2011; (iii) Consolidated Statement of Other Comprehensive Income for the three months ended September 30, 2012 and 2011 and nine months ended September 30, 2012 and 2011; (iv) Consolidated Statement of Changes in Equity for the nine months ended September 30, 2012 and 2011; (v) Consolidated Statement of Cash Flows for the nine months ended September 30, 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

November 8, 2012

/s/ Jeffrey W. Farrar

Jeffrey W. Farrar, CPA

Executive Vice President and Chief Financial Officer

November 8, 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	4
	Consolidated Statements of Changes in Stockholders' Equity	5
	Consolidated Statements of Cash Flows	6
	Notes to Consolidated Financial Statements	7

ITEM 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	22

ITEM 3	Quantitative and Qualitative Disclosures About Market Risk	28

ITEM 4	Controls and Procedures	28

PART II - OTHER INFORMATION
ITEM 1	Legal Proceedings	29

ITEM 1A	Risk Factors	29

ITEM 2	Unregistered Sales of Equity Securities and Use of Proceeds	29

ITEM 3	Defaults Upon Senior Securities	29

ITEM 4	Mine Safety Disclosures	29

ITEM 5	Other Information	29

ITEM 6	Exhibits	30