(4)

Loans

The composition of the Company's loan portfolio, by loan class, at December 31, is as follows:

	2011			2010

Commercial	$	91,914		$	82,815
Commercial Real Estate		175,793			186,405
Agriculture		52,064			53,040
Residential Mortgage		51,586			52,347
Residential Construction		7,492			10,246
Consumer		64,150			68,374

		442,999			453,227
Allowance for loan losses		(10,408	)		(11,039	)
Net deferred origination fees and costs		198			(173	)

Loans, net	$	432,789		$	442,015

The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk rating standards and criteria similar to those employed by state and federal banking regulatory agencies.

Residential mortgage loans, which are secured by real estate, are primarily susceptible to three risks; non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfalls in collateral value. In general, non-payment is due to loss of employment and follows general economic trends in the marketplace, particularly the upward movement in the unemployment rate, loss of collateral value, and demand shifts.

Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner occupied real estate are primarily susceptible to changes in the market conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles. These same risks apply to commercial loans whether secured by equipment, receivables or other personal property or unsecured. Losses on loans secured by owner occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often, these shifts are a result of changes in general economic or market conditions or overbuilding and resultant over-supply of space. Losses are dependent on the value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs. Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, sales invoices, or other appropriate means. Appropriate valuations are obtained at origination of the credit and periodically thereafter, (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Construction loans, whether owner occupied or non-owner occupied residential development loans, are not only susceptible to the related risks described above but the added risks of construction itself including cost over-runs, mismanagement of the project, or lack of demand and market changes experienced at time of completion. Again, losses are primarily related to underlying collateral value and changes therein as described above. Problem construction loans are generally identified by periodic review of financial information that may include financial statements, tax returns and payment history of the borrower. Based on this information the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors, the Company may pursue repossession or foreclosure of the underlying collateral. Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter, (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Agricultural loans, whether secured or unsecured, generally are made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or service. Agricultural loans are generally secured by inventory, receivables, equipment, and other real property. Agricultural loans primarily are susceptible to changes in market demand for specific commodities. This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles, as well as changing weather conditions. Problem agricultural loans are generally identified by periodic review of financial information that may include financial statements, tax returns, crop budgets, payment history, and crop inspections. Based on this information, the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter, (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Commercial loans, whether secured or unsecured, generally are made to support the short-term operations and other needs of small businesses. These loans are generally secured by the receivables, equipment, and other real property of the business and are susceptible to the related risks described above. Problem commercial loans are generally identified by periodic review of financial information that may include financial statements, tax returns, and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically there after, (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Consumer loans, whether unsecured or secured are primarily susceptible to three risks; non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfall in collateral value. In general, non-payment is due to loss of employment and will follow general economic trends in the marketplace, particularly the upward movements in the unemployment rate, loss of collateral value, and demand shifts.

As of December 31, 2011, approximately 40% of the Company's loans are for commercial real estate, which consists of construction and land development loans and real estate loans. Approximately 12% of the Company's loans are residential mortgage loans. Approximately 2% of the Company's loans are residential construction loans. Approximately 33% of the Company's loans are for general commercial uses including professional, retail, agriculture and small businesses. Approximately 13% of the Company's loans are consumer loans.

Once a loan becomes delinquent and repayment becomes questionable, a Company collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral or a principal payment. If this is not forthcoming and payment in full is unlikely, the Company will estimate its probable loss, using a recent valuation as appropriate to the underlying collateral less estimated costs of sale, and charge-off the loan down to the estimated net realizable amount. Depending on the length of time until final collection, the Bank may periodically revalue the underlying collateral and take additional charge-offs as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when collateral is liquidated and actual loss is known. Unpaid balances on loans after or during collection and liquidation may also be pursued through lawsuit and attachment of wages or judgment liens on borrower's other assets.

All loans at December 31, 2011 and December 31, 2010 were pledged under a blanket collateral lien to secure actual and potential borrowings from the Federal Home Loan Bank.

Non-accrual and Past Due Loans

The Company's non-accrual loans by loan class, at December 31, are as follows:

	2011		2010

Commercial	$	2,905	$	1,817
Commercial Real Estate		3,071		5,864
Agriculture		992		1,752
Residential Mortgage		1,334		2,301
Residential Construction		48		272
Consumer		360		268

	$	8,710	$	12,274

Non-accrual loans amounted to $8,710 at December 31, 2011 and were comprised of four residential mortgage loans totaling $1,334, one residential construction loan totaling $48, six commercial real estate loans totaling $3,071, one agricultural loan totaling $992, twelve commercial loans totaling $2,905 and five consumer loans totaling $360. At December 31, 2010, non-accrual loans amounted to $12,274 and were comprised of seven residential mortgage loans totaling $2,301, four residential construction loans totaling $272, nine commercial real estate loans totaling $5,864, one agricultural loan totaling $1,752, ten commercial loans totaling $1,817 and five consumer loans totaling $268. It is generally the Company's policy to charge-off the portion of any non-accrual loan for which the Company does not expect to collect by writing the loan down to estimated net realizable value of the underlying collateral.

An age analysis of past due loans, segregated by loan class, as of December 31, 2011 and December 31, 2010 is as follows:

	30-59 Days Past Due		60-89 Days Past Due		90 Days or more Past Due		Total Past Due		Current		Total Loans
December 31, 2011
Commercial	$	1,051	$	166	$	113	$	1,330	$	90,584	$	91,914
Commercial Real Estate		-		2,746		446		3,192		172,601		175,793
Agriculture		-		-		991		991		51,073		52,064
Residential Mortgage		792		420		426		1,638		49,948		51,586
Residential Construction		273		-		48		321		7,171		7,492
Consumer		20		212		225		457		63,693		64,150
Total	$	2,136	$	3,544	$	2,249	$	7,929	$	435,070	$	442,999

December 31, 2010
Commercial	$	1,606	$	193	$	228	$	2,027	$	80,788	$	82,815
Commercial Real Estate		1,270		1,974		3,767		7,011		179,394		186,405
Agriculture		-		-		1,751		1,751		51,289		53,040
Residential Mortgage		749		-		1,326		2,075		50,272		52,347
Residential Construction		462		-		63		525		9,721		10,246
Consumer		421		88		242		751		67,623		68,374
Total	$	4,508	$	2,255	$	7,377	$	14,140	$	439,087	$	453,227

The Company had no loans 90 days past due and still accruing at December 31, 2011 and 2010.

Impaired Loans

Impaired loans, segregated by loan class, as of December 31, 2011 and December 31, 2010 were as follows:

	Unpaid Contractual Principal Balance		Recorded Investment with no Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance
December 31, 2011
Commercial	$	4,694	$	2,919	$	569	$	3,488	$	101
Commercial Real Estate		4,856		3,071		1,198		4,269		22
Agriculture		3,847		3,598		-		3,598		-
Residential Mortgage		5,336		1,875		3,194		5,069		731
Residential Construction		1,147		48		1,099		1,147		668
Consumer		985		309		346		655		126
Total	$	20,865	$	11,820	$	6,406	$	18,226	$	1,648

December 31, 2010
Commercial	$	3,725	$	1,660	$	1,334	$	2,994	$	89
Commercial Real Estate		7,414		5,864		1,224		7,088		22
Agriculture		2,785		1,752		383		2,135		41
Residential Mortgage		6,544		2,123		3,910		6,033		543
Residential Construction		2,058		272		1,349		1,621		575
Consumer		312		258		36		294		12
Total	$	22,838	$	11,929	$	8,236	$	20,165	$	1,282

Interest income on impaired loans recognized using a cash-basis method of accounting during the years ended December 31, 2011 and 2010 was as follows:

($ in thousands)	December 31, 2011				December 31, 2010
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Commercial	$	3,366	$	107	$	2,507	$	158
Commercial Real Estate		7,750		505		8,518		212
Agriculture		1,963		27		2,834		19
Residential Mortgage		5,593		186		5,752		213
Residential Construction		1,492		67		2,599		47
Consumer		492		9		308		2
Total	$	20,656	$	901	$	22,518	$	651

The average recorded investment on impaired loans totaled $21,280 at December 31, 2009. Interest income recognized on impaired loans totaled $246 for the year ended December 31, 2009.

Troubled Debt Restructurings

The Company's loan portfolio includes certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), which are loans on which concessions in terms have been granted because of the borrowers' financial difficulties. These concessions typically result from the Company's loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are placed on non-accrual status at the time of restructure and may only be returned to accruing status after considering the borrower's sustained repayment performance for a reasonable period, generally six months.

When a loan is modified, it is measured based upon the present value of future cash flows discounted at the contractual interest rate of the original loan agreement, or the fair value of collateral less selling costs if the loan is collateral dependent. If the value of the modified loan is less than the recorded investment in the loan, impairment is recognized through a specific allowance or a charge-off of the loan.

In April 2011, FASB issued ASU 2011-02. This update provides additional guidance in determining whether a restructuring constitutes a troubled debt restructuring. In evaluating whether a restructuring is a troubled debt restructuring, a creditor must separately conclude that the restructuring constitutes a concession and the debtor is experiencing financial difficulties. The amendment clarifies the guidance on a creditor's evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. The amendments in this update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption.

As a result of adopting the amendments in ASU 2011-02, management reassessed all restructuring that occurred on or after January 1, 2011 for identification as TDRs. Management identified as TDRs for which the allowance for loan losses associated had previously been measured under a general allowance for loan losses methodology. Upon identifying those receivables as TDRs, they are newly considered as impaired under the guidance in the Accounting Standards Codification (ASC) Section 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment guidance in ASC Section 310-10-35 for those receivables newly identified as impaired. At the end of the first annual period of adoption (December 31, 2011), the recorded investment in receivables for which the allowance for loan losses was previously measured under a general allowance for loan losses methodology and now considered impaired was $688, and their related specific allowance, based on a current evaluation of loss, was $123.

The Company had $9,410 and $10,259 TDR loans as of December 31, 2011 and December 31, 2010, respectively. Specific reserves for TDR loans totaled $1,596 and $1,187 as of December 31, 2011 and December 31, 2010, respectively. TDR loans performing in compliance with modified terms totaled $7,471 and $7,891 as of December 31, 2011 and December 31, 2010, respectively.

Loans modified as troubled debt restructurings during the year ended December 31, 2011 were as follows:

($ in thousands)	Year Ended December 31, 2011
	Number of Contracts		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment
Commercial		3	$	445	$	445
Residential Mortgage		1		404		404
Residential Construction		2		221		162
Consumer		1		295		295
Total		7	$	1,365	$	1,306

The loan modifications generally involved reductions in the interest rate, payment extensions, forgiveness of principal, and forbearance. There were no troubled debt restructurings modified within the previous 12 months and for which there was a payment default during the year ended December 31, 2011. There were no commitments to lend funds to borrowers whose terms have been modified in a troubled debt restructuring.

Credit Quality Indicators

All new loans are rated using the credit risk ratings and criteria adopted by the Company. Risk ratings are adjusted as future circumstances warrant. All credits risk rated 1, 2, 3 or 4 equate to a Pass as indicated by Federal and State regulatory agencies; a 5 shall equate to a Special Mention; a 6 equates to Substandard; a 7 equates to Doubtful; and 8 equates to a Loss. General definitions for each risk rating are as follows:

Risk Rating “1” – Pass (High Quality): This category is reserved for loans fully secured by Company CD's or savings and properly margined (as defined in the Company's Credit Policy) and actively traded securities (including stocks, as well as corporate, municipal and U.S. Government bonds).

Risk Rating “2” – Pass (Above Average Quality): This category is reserved for borrowers with strong balance sheets that are well structured with manageable levels of debt and good liquidity. Cash flow is sufficient to service all debt, including the Company's, as agreed. Historical earnings, cash flow, and payment performance have all been strong and trends are positive and consistent. Collateral protection is better than the Company's Credit Policy guidelines.

Risk Rating “3” – Pass (Average Quality): Credits within this category are considered to be of average, but acceptable, quality. Loan characteristics, including term and collateral advance rates, meet the Company's Credit Policy guidelines; unsecured lines to borrowers with above average liquidity and cash flow may be considered for this category; the borrower's financial strength is well documented, with adequate, but consistent, cash flow to meet all obligations. Liquidity should be sufficient and leverage should be moderate. Monitoring of collateral may be required, including a borrowing base or construction budget. Alternative financing is typically available.

Risk Rating “4” – Pass (Below Average Quality): Credits within this category are considered sound, but merit additional attention due to industry concentrations within the borrower's customer base, problems within their industry, deteriorating financial or earnings trends, declining collateral values, increased frequency of past due payments and/or overdrafts, discovery of documentation deficiencies which may impair our borrower's ability to repay, or the Company's ability to liquidate collateral. Financial performance is average but inconsistent. There also may be changes of ownership, management or professional advisors, which could be detrimental to the borrower's future performance.

Risk Rating “5” – Special Mention (Criticized): Loans in this category are currently protected by their collateral value and have no loss potential identified, but have potential weaknesses which may, if not monitored or corrected, weaken our ability to collect payments from the borrower or satisfactorily liquidate our collateral position. Loans where terms have been modified due to their failure to perform as agreed may be included in this category. Adverse trends in the borrower's operation, such as reporting losses or inadequate cash flow, increasing and unsatisfactory leverage, or an adverse change in economic or market conditions may have weakened the borrower's business and impaired their ability to repay based on original terms. The condition or value of the collateral has deteriorated to the point where adequate protection for our loan may be jeopardized in the future. Loans in this category are in transition and, generally, do not remain in this category beyond 12 months. During this time, efforts are focused on strategies aimed at upgrading the credit or locating alternative financing.

Risk Rating “6” – Substandard (Classified): Loans in this category are inadequately protected by the borrower's net worth, capacity to repay or collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. There exists a strong possibility of loss if the deficiencies are not corrected. Loans that are dependent on the liquidation of collateral to repay are included in this category, as well as borrowers in bankruptcy or where legal action is required to effect collection of our debt.

Risk Rating “7” – Doubtful (Classified): Loans in this category indicate all of the weaknesses of a Substandard classification, however, collection of loan principal, in full, is highly questionable and improbable; possibility of loss is very high, but there is still a possibility that certain collection strategies may, yet, be successful, rendering a definitive loss difficult to estimate, at this time. Loans in this category are in transition and, generally, do not remain in this category more than 6 months.

Risk Rating “8” – Loss (Classified):

Active Charge-Off. Loans in this category are considered uncollectible and of such little value that their removal from the Company's books is required. The charge-off is pending or already processed. Collateral positions have been or are in the process of being liquidated and the borrower/guarantor may or may not be cooperative in repayment of the debt. Recovery prospects are unknown at this time, but we are still actively engaged in the collection of the loan.

Inactive Charge-Off. Loans in this category are considered uncollectible and of such little value that their removal from the Company's books is required. The charge-off is pending or already processed. Collateral positions have been liquidated and the borrower/guarantor has nothing of any value remaining to apply to the repayment of our loan. Any further collection activities would be of little value.

The following table presents the risk ratings by loan class as of December 31, 2011 and December 31, 2010.

	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2011
Commercial	$	71,229	$	8,444	$	11,804	$	437	$	-	$	91,914
Commercial Real Estate		148,317		16,492		10,984		-		-		175,793
Agriculture		48,330		-		3,734		-		-		52,064
Residential Mortgage		42,845		1,830		6,911		-		-		51,586
Residential Construction		5,140		927		1,425		-		-		7,492
Consumer		58,239		2,824		3,087		-		-		64,150
Total	$	374,100	$	30,517	$	37,945	$	437	$	-	$	442,999

December 31, 2010
Commercial	$	57,966	$	7,764	$	15,862	$	1,146	$	77	$	82,815
Commercial Real Estate		147,350		26,040		13,015		-		-		186,405
Agriculture		43,384		4,991		4,665		-		-		53,040
Residential Mortgage		41,437		3,235		7,675		-		-		52,347
Residential Construction		5,890		2,315		2,041		-		-		10,246
Consumer		59,824		4,617		3,933		-		-		68,374
Total	$	355,851	$	48,962	$	47,191	$	1,146	$	77	$	453,227

Allowance for Loan Losses

The following table details activity in the allowance for loan losses by loan category for the years ended December 31, 2011 and December 31, 2010.


	Commercial			Commercial Real Estate			Agriculture			Residential Mortgage			Residential Construction			Consumer			Unallocated			Total
Balance as of December 31, 2010	$	3,761		$	1,957		$	2,141		$	830		$	1,719		$	556		$	75		$	11,039
Provision for loan losses		2,033			1,502			511			566			(395	)		996			(75	)		5,138

Charge-offs		(2,381	)		(2,000	)		(860	)		(272	)		(197	)		(932	)		-			(6,642	)
Recoveries		185			288			142			11			71			176			-			873
Net charge-offs		(2,196	)		(1,712	)		(718	)		(261	)		(126	)		(756	)		-			(5,769	)
Ending Balance		3,598			1,747			1,934			1,135			1,198			796			-			10,408
Period-end amount allocated to:
Loans individually evaluated for impairment		101			22			-			731			668			126			-			1,648
Loans collectively evaluated for impairment		3,497			1,725			1,934			404			530			670			-			8,760
Balance as of December 31, 2011	$	3,598		$	1,747		$	1,934		$	1,135		$	1,198		$	796		$	-		$	10,408


	Commercial			Commercial Real Estate			Agriculture			Residential Mortgage			Residential Construction			Consumer			Unallocated			Total
Balance as of December 31, 2009	$	4,036		$	2,706		$	1,681		$	735		$	1,611		$	506		$	641		$	11,916
Provision for loan losses		1,115			741			1,118			788			932			786			(566	)		4,914

Charge-offs		(1,930	)		(1,491	)		(736	)		(715	)		(830	)		(914	)		-			(6,616	)
Recoveries		540			1			78			22			6			178			-			825
Net charge-offs		(1,390	)		(1,490	)		(658	)		(693	)		(824	)		(736	)		-			(5,791	)
Ending Balance		3,761			1,957			2,141			830			1,719			556			75			11,039
Period-end amount allocated to:
Loans individually evaluated for impairment		89			22			41			543			575			12			-			1,282
Loans collectively evaluated for impairment		3,672			1,935			2,100			287			1,144			544			75			9,757
Balance as of December 31, 2010	$	3,761		$	1,957		$	2,141		$	830		$	1,719		$	556		$	75		$	11,039

Changes in the allowance for loan losses for the year ended December 31, 2009 is summarized as follows:

	2009

Balance, beginning of year	$	14,435
Provision for loan losses		10,489
Loans charged-off		(14,293	)
Recoveries of loans previously charged-off		1,285

Balance, end of year	$	11,916

The Company's investment in loans as of December 31, 2011 and December 31, 2010 related to each balance in the allowance for loan losses by loan category and disaggregated on the basis of the Company's impairment methodology was as follows:

($ in thousands)	Commercial		Commercial Real Estate		Agriculture		Residential Mortgage		Residential Construction		Consumer		Total
December 31, 2011
Loans individually evaluated for impairment	$	3,488	$	4,269	$	3,598	$	5,069	$	1,147	$	655	$	18,226
Loans collectively evaluated for impairment		88,426		171,524		48,466		46,517		6,345		63,495		424,773
Ending Balance	$	91,914	$	175,793	$	52,064	$	51,586	$	7,492	$	64,150	$	442,999

December 31, 2010
Loans individually evaluated for impairment	$	2,994	$	7,088	$	2,135	$	6,033	$	1,621	$	294	$	20,165
Loans collectively evaluated for impairment		79,821		179,317		50,905		46,314		8,625		68,080		433,062
Ending Balance	$	82,815	$	186,405	$	53,040	$	52,347	$	10,246	$	68,374	$	453,227