NOTE 4 CAPITAL:

Capital Requirements and Ratios

The Company and the Bank are subject to various capital requirements administered by 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 the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes that, as of September 30, 2012, the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of September 30, 2012 the Bank was well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the Company’s and Bank’s category.

The Company’s and the Bank’s actual capital amounts and ratios are presented in the table as of September 30, 2012 and December 31, 2011, respectively.


		Actual		Minimum Capital Requirement			Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions
(Dollars are in thousands)	Amount		Ratio	Amount	Ratio		Amount	Ratio
September 30, 2012:
Total Capital to Risk Weighted Assets
The Company	$	46,159	10.36%	35,650	8%	$	N/A	N/A
The Bank		48,007	10.75%	35,713	8%		44,641	10%
Tier 1 Capital Risk Weighted Assets:
The Company		33,688	7.56%	17,825	4%		N/A	N/A
The Bank		42,279	9.47%	17,857	4%		26,785	6%
Tier 1 Capital to Average Assets:
The Company		33,688	4.74%	28,454	4%		N/A	N/A
The Bank		42,279	5.94%	28,485	4%		35,607	5%

December 31, 2011:
Total Capital to Risk Weighted Assets
The Company	$	45,856	9.15%	40,104	8%	$	N/A	N/A
The Bank		53,070	10.56%	40,189	8%		50,236	10%
Tier 1 Capital Risk Weighted Assets:
The Company		32,941	6.57%	20,052	4%		N/A	N/A
The Bank		46,641	9.28%	20,095	4%		30,142	6%
Tier 1 Capital to Average Assets:
The Company		33,461	4.23%	31,658	4%		N/A	N/A
The Bank		46,641	5.99%	31,160	4%		38,950	5%

Conversion of Notes to Common Stock and Warrants

In December, 2010, the Company borrowed $250,000 from Director Scott White for one year. The note bore interest at the variable rate of interest equal to the Wall Street Journal prime rate payable at maturity or conversion, was unsecured and was convertible into the Company’s common stock under certain conditions. In January, 2011, the Company received an additional $250,000 loan from Director Lynn Keene on identical terms. The purpose of these borrowings was to provide cash for operating expenses of the Company. On March 16, 2011 Directors Keene and White loaned the Company an additional $4.95 million which, after receiving regulatory approval, the Company used to retire its indebtedness to the FDIC as receiver for Silverton Bank. The loans had a stated maturity of December 31, 2011 with the same terms as the previous notes. In each case, the Company was obligated to convert the debt into the Company's common stock if, before the stated maturity, the Company conducted an offering of its common stock at the price per share at which it was offered. If the Company did not conduct an offering prior to the stated maturity, the Company had the option, but not the obligation, to convert the debt into shares of its common stock within 30 days of the stated maturity at a price per share to be established by the Company's Board of Directors. On December 21, 2011, with regulatory approval the Company consolidated the earlier loans into a loan in the principal amount of $2.8 million from Director White and $2.65 million from Director Keene on the same terms as the previous loans except that the maturity date of the borrowings was extended to June 30, 2012. Prior to their maturity, the maturity of the loans was extended to December 31, 2012 on the same terms. The Company believes this indebtedness was on more favorable terms to the Company than could be obtained from unrelated parties.

On September 19, 2012, in conjunction with the public offering of its common stock, the Company converted both notes to common stock and Mr. White received 1,959,889 shares and Mr. Keene received 1,854,630 shares. Each director also obtained warrants that are immediately exercisable to purchase common stock over the next five years at a price of $1.75 per share. Mr. White received 391,977 warrants and Mr. Keene received 370,926 warrants. These conversions were made on the same terms as the public offering as required by the notes. These transactions resulted in Director Keene beneficially owning 16.04% and Director White beneficially owning 19.28% of the Company’s common stock.

As a result of this noncash transaction, the Company recorded a $5.7 million increase to stockholders’ equity and reduced other borrowings by $5.45 million and accrued interest payable by $272 thousand. The $5.7 million increase to stockholders’ equity was allocated by an increase of $7.6 million to common stock, $663 thousand allocated to the commons stock warrants, and a decrease of $2.6 million to additional paid in capital. The value of the common stock warrants was calculated using the Black-Scholes Option Pricing Model.