sec10k123112_ex13.htm

2012	High		Low
First Quarter	$	19.90	$	17.07
Second Quarter		20.56		17.75
Third Quarter		19.87		18.00
Fourth Quarter		19.60		17.80

2011	High		Low
First Quarter	$	23.26	$	19.21
Second Quarter		23.10		16.50
Third Quarter		18.70		16.01
Fourth Quarter		19.09		17.00

Shown below is a table which reflects the dividends declared per share on Ohio Valley’s common shares. As of February 28, 2013, the number of holders of record of common shares was 2,159.

Dividends per share	2012		2011
First Quarter	$	.21	$	.21
Second Quarter		.25		.21
Third Quarter		.21		.21
Fourth Quarter		.42		.21

Dividends paid by the subsidiaries are the primary source of funds available to Ohio Valley for payment of dividends to shareholders and for other working capital needs. The payment of dividends by the subsidiaries to Ohio Valley is subject to restrictions by regulatory authorities. These restrictions generally limit dividends to the amount of retained earnings for the current and prior two years.

In addition, policy of the Board of Governors of the Federal Reserve System requires Ohio Valley to provide notice to the FRB in advance of the payment of a dividend to Ohio Valley's shareholders under certain circumstances, and the FRB may disapprove of such dividend payment if the FRB determines the payment would be an unsafe or unsound practice.

Dividend restrictions are also listed within the provisions of Ohio Valley's trust preferred security arrangements. Under the provisions of these agreements, the interest payable on the trust preferred securities is deferrable for up to five years and any such deferral would not be considered a default. During any period of deferral, Ohio Valley would be precluded from declaring or paying dividends to its shareholders or repurchasing any of its common stock.

PERFORMANCE GRAPH

OHIO VALLEY BANC CORP.

Year ended December 31, 2012

The following graph sets forth a comparison of five-year cumulative total returns among the Company's common shares (indicated “Ohio Valley Banc Corp.” on the Performance Graph), the S & P 500 Index (indicated “S & P 500” on the Performance Graph), and SNL Securities SNL $500 Million-$1 Billion Bank Asset-Size Index (indicated “SNL” on the Performance Graph) for the fiscal years indicated. Information reflected on the graph assumes an investment of $100 on December 31, 2007 in each of the common shares of the Company, the S & P 500 Index, and the SNL Index. Cumulative total return assumes reinvestment of dividends. The SNL Index represents stock performance of 66 of the nation's banks located throughout the United States with total assets between $500 Million and $1 Billion as selected by SNL Securities of Charlottesville, Virginia. The Company is included as one of the 66 banks in the SNL Index.

Period Ending
Index	12/31/07		12/31/08		12/31/09		12/31/10		12/31/11		12/31/12

Ohio Valley Banc Corp.		100.00		77.40		93.37		86.25		85.90		91.73
SNL $500M-$1B Bank Index		100.00		64.08		61.03		66.62		58.61		75.14
S&P 500		100.00		63.00		79.68		91.68		93.61		108.59

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The purpose of this discussion is to provide an analysis of the financial condition and results of operations of Ohio Valley Banc Corp. (“Ohio Valley” or the “Company”) that is not otherwise apparent from the audited consolidated financial statements included in this report. The accompanying consolidated financial information has been prepared by management in conformity with U.S. generally accepted accounting principles (“US GAAP”) and is consistent with that reported in the consolidated statements. Reference should be made to those statements and the selected financial data presented elsewhere in this report for an understanding of the following tables and related discussion. All dollars are reported in thousands, except share and per share data.

RESULTS OF OPERATIONS:

SUMMARY

Ohio Valley generated net income of $7,052 for 2012, an increase of 20.9% from 2011. Earnings per share were $1.75 for 2012, an increase of 19.9% from 2011. The increase in net income and earnings per share for 2012 was primarily due to lower provision for loan loss expense, which was down $3,313, or 67.7%, combined with higher noninterest income, which increased $1,261, or 17.5%, compared to 2011. The decrease in provision for loan loss expense was due to lower net charge-offs, which were down $4,916, or 70.9%, compared to 2011, due to increased charge-offs recognized during the first quarter of 2011 on select impaired loans. Furthermore, during the fourth quarter of 2012, the Company experienced a large recovery of $1,250 on a commercial loan that had been previously charged off during the first quarter of 2011.

Further contributing to the Company’s improved net income was noninterest income, which increased $1,261, or 17.5%, during 2012 as compared to the previous year. Noninterest income was largely impacted by lower net losses associated with write-downs and sales of other real estate owned (“OREO”), increased debit and credit card interchange income, and increased mortgage banking revenue. Net losses from sales and write-downs of OREO losses finished at $150 during the year ended 2012, as compared to $1,224 in losses during the year ended 2011. Higher OREO losses in 2011 were the result of impairment charges recognized on two commercial real estate OREO properties. These losses are the result of updated appraisal information received for both OREO properties, which identified $1,266 in total asset impairment in 2011 and $331 in 2012. The impairment charges were recorded as write-downs to the carrying values of both properties during 2011 and 2012.

Partially offsetting the benefits from lower provision expense and higher noninterest income was a reduction in net interest income, which decreased $1,216, or 3.6%, as compared to 2011. Contributing to the overall decrease in net interest income were lower average earning assets, which decreased during 2012 by $38,708, or 4.8%, as compared to 2011, largely from loans. Also contributing to lower net interest income was the elimination of the Bank’s refund anticipation loan (“RAL”) product. After the 2011 tax season, the Bank ceased offering RALs as recommended by the FDIC and, as a result, did not record any RAL fee income during 2012, as compared to $561 in RAL fees during 2011. Loan Central continues to provide RALs to customers. RAL volumes at Loan Central have remained at comparable levels in 2012 as compared to 2011. The sustained low-rate environment continues to have an impact in lowering funding costs, as well as causing management to emphasize growing lower-costing, core deposit relationship balances. However, the Company’s deposit accounts are perceived to be at, or near, their interest rate floors, which have limited the pace at which funding cost savings can be fully recognized. Along with lower average earning assets, reduction of RAL fees, combined with the reduction in the Company’s interest expense, the Company’s net interest income reduced to $32,655 for the year ended 2012 compared to $33,871 for the year ended 2011.

Also partially offsetting net revenue growth in 2012 were increases in salaries and employee benefits, which increased $768, or 4.6%, during 2012, as compared to 2011, in large part due to higher healthcare and retirement benefit costs, as well as annual merit increases. The Company also recognized during 2012 a combined year-to-date increase of $917 in various other noninterest expense categories related to donations, advertising, customer incentives on debit and credit card usage, and a prepayment penalty associated with the extinguishment of above market Federal Home Loan Bank (“FHLB”) advances.

During 2011, Ohio Valley generated net income of $5,835, an increase of 14.5% from 2010. Earnings per share were $1.46 for 2011, an increase of 14.1% from 2010. The increase in net income and earnings per share for 2011 was primarily due to higher noninterest income combined with improvements in higher net interest income and lower provision for loan loss expense. Noninterest income grew $1,068, or 17.4%, during 2011, largely from the Company’s tax processing fees. The Company generates fee income by facilitating tax refund payments in the form of electronic refund check/deposit (“ERC/ERD”) transactions. ERC/ERD transactions involve the issuing of a tax refund to the taxpayer after the Bank has received the refund from the federal/state government. In 2011, ERC/ERD fees increased $1,779 over the previous year due to the significant growth in transaction volume of processing tax refund payments during the first half of 2011. This activity was mostly seasonal and had little impact on Company earnings during the third and fourth quarters of 2011.

Further contributing to the Company’s successful year in net income was lower provision for loan loss expense, which decreased $975, or 16.6%, during 2011 as compared to the previous year. The decrease was in large part due to significant recoveries of commercial loans experienced in 2011 as well as larger impairment charges recorded in 2010. Net charge-offs during 2011 were up $2,255, or 48.2%, over 2010, but the majority of these charge-offs had already been specifically allocated for within the allowance for loan losses. As a result, no provision expense was required to be taken against the majority of these additional charge-offs. Conversely, recoveries of loans did have an immediate impact on lowering provision expense. Total recoveries during 2011 were $3,484, which increased $2,288, or 191.3%, from 2010, in large part due to successful collection efforts of commercial loan balances that had been previously charged off. Provision expense also benefited from impairment charges recorded during 2010 that had an opposite effect in 2011. During the fourth quarter of 2010, the Company identified asset impairment of $1,406 related to one commercial loan relationship with two loans classified as troubled debt restructurings (“TDR’s”). This impairment charge required specific reserves within the allowance for loan losses, which required a corresponding increase in provision for loan loss expense in 2010 that had the effect of lowering provision expense during 2011.

Further contributing to higher earnings in 2011 was an improved net interest income, which increased $904, or 2.7%, over 2010. The sustained low-rate environment continued to have an impact in lowering funding costs, as well as causing management to emphasize growing lower-costing, core deposit relationship balances. As a result, interest expense decreased $3,378 during 2011, as compared to 2010. This cost savings completely offset the decrease in interest income of $2,474 during 2011, as compared to 2010.

Partially offsetting the benefits from higher ERC/ERD fees, lower provision expense and higher net interest income were increases in OREO losses, as well as increases in salaries and employee benefit and foreclosed asset expenses. OREO losses finished at $1,224 at year-end 2011, up from $177 in losses at year-end 2010. Higher OREO losses were impacted most by impairment charges taken on two commercial real estate foreclosed properties classified as OREO. These losses were the result of re-evaluations of the carrying values in 2011 for both OREO properties, which identified $1,266 in total asset impairment. The impairment charges were recorded as write-downs to the carrying values of both properties and limited the growth in noninterest income during 2011. Salaries and employee benefit expense increased $1,003, or 6.4%, during 2011, as compared to 2010, in large part due to annual merit increases, higher health insurance premiums and a larger number of employees. The Company’s foreclosed asset costs also grew to $650 during 2011, an increase of $583 from the previous year. The increase was mostly related to the foreclosure expenses of two commercial real estate properties, which included taxes and other general costs to maintain both properties.

NET INTEREST INCOME

The most significant portion of the Company's revenue, net interest income, results from properly managing the spread between interest income on earning assets and interest expense incurred on interest-bearing liabilities. The Company earns interest and dividend income from loans, investment securities and short-term investments while incurring interest expense on interest-bearing deposits and short- and long-term borrowings. Net interest income is affected by changes in both the average volume and mix of assets and liabilities and the level of interest rates for financial instruments. Changes in net interest income are measured by net interest margin and net interest spread. Net interest margin is expressed as net interest income divided by average interest-earning assets. Net interest spread is the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities. Both of these are reported on a fully tax-equivalent (“FTE”) basis. Net interest margin is greater than net interest spread due to the interest earned on interest-earning assets funded from noninterest-bearing funding sources, primarily demand deposits and shareholders' equity. Following is a discussion of changes in interest-earning assets, interest-bearing liabilities and the associated impact on interest income and interest expense for the three years ended December 31, 2012. Tables I and II have been prepared to summarize the significant changes outlined in this analysis.

Net interest income on an FTE basis decreased $1,188 in 2012, or 3.5%, compared to the $34,300 earned in 2011. The decrease in net interest income was mainly due to a decline in average earning assets. For the year ended December 31, 2012, average earning assets decreased $38,708, or 4.8%, from 2011, which occurred primarily in loans. A portion of the decline in average loan balances was due to a targeted reduction in certain underperforming loans and loans with less than desirable interest rate characteristics, such as fixed-rate mortgages. Yet, as average earning assets lagged behind the prior year, the Company was able to maintain a stronger net interest margin over 2011. At December 31, 2012, the Company’s FTE net interest margin increased 6 basis points from 4.23% in 2011 to 4.29% in 2012. This result was mainly due to lower rates paid on interest-bearing deposits and a continued change in deposit mix to lower-cost core deposits from certificates of deposit (“CD”) accounts and FHLB borrowings. The Federal Reserve continues to hold the prime interest rate at 3.25%, and the target federal funds rate remains at a range from 0.0% to 0.25%. The sustained low short-term rates have continued to impact the repricings of various Bank deposit products, including public fund NOW, Gold Club and Market Watch accounts. Interest rates on CD balances continue to reprice to lower rates, which continues to lower funding costs. Management continues to emphasize lower-cost core deposit relationship balances which contributed to higher average NOW, savings and money market balances in 2012 (increasing $10,957) while experiencing a lower level of higher-cost time deposit and other borrowed money balances (decreasing $76,384). Average earning assets decreased 4.8% during 2012 compared to 2011, largely from lower average balances in loans.

Net interest income on an FTE basis increased $940 in 2011, or 2.8%, compared to the $33,360 earned in 2010, while the Company’s FTE net interest margin increased 7 basis points from 4.16% in 2010 to 4.23% in 2011. The improvements in both net interest income and net interest margin were mainly due to lower rates paid on interest-bearing deposits, a change in deposit mix to lower-cost core deposits and an increase in the Company’s average earning assets. The Federal Reserve continued to hold the prime interest rate at 3.25%, and the target federal funds rate remained at a range from 0.0% to 0.25%. The sustained low short-term rates have continued to impact the repricings of various Bank deposit products, including public fund NOW, Gold Club and Market Watch accounts. Interest rates on CD balances have also repriced to lower rates (as a lagging effect to the Federal Reserve’s action to maintain short-term interest rates at their low levels), which continues to lower funding costs. Management continued to emphasize lower-cost core deposit relationship balances which contributed to higher average NOW, savings and money market balances in 2011 (increasing $36,898) while experiencing a lower level of higher-cost time deposit and other borrowed money balances (decreasing $65,622). Average earning assets grew 1.1% during 2011 compared to 2010, largely from higher average balances being carried at the Federal Reserve and growth in average securities.

For 2012, average earning assets decreased $38,708, or 4.8%, as compared to growth of $8,756, or 1.1%, in 2011. Contributing most to this decrease in 2012 and only modest increase in 2011 were the Company’s average loans, which decreased $55,437, or 8.9%, during 2012 and $27,954, or 4.3%, during 2011. Average loans continue to be the Company’s highest portion of earning assets. Yet, the Company’s market area for lending continues to be limited due to economic pressures that have negatively impacted consumer and commercial spending and have decreased loan demand. Lower average loans were mostly affected by the commercial loan portfolio, which has experienced significant charge-offs of underperforming commercial loans, as well as large payoffs of various commercial loans during 2012 and 2011. The average installment loan portfolio has decreased primarily from auto loan balances, where competition for loan demand continues to be challenged by other financial institutions and captive finance companies. Decreases in the average residential real estate loan portfolio have been largely the result of management’s strategy to sell the majority of its long-term, fixed-rate real estate loans to the secondary market. As a result, average loans as a percentage of earning assets have decreased to 73.8% for 2012, as compared to 77.1% for 2011 and 81.4% for 2010, as most of the average earning asset growth in 2012 and 2011 has came from short-term balances with banks and investment securities.

While average loans were down in 2012 and 2011, the Company did experience increases in its average interest-bearing balances with banks and investment securities. At year-end 2012, average interest-bearing balances with banks totaled $81,387, up from $67,947 at year-end 2011 and $43,450 at year-end 2010. The increasing trend of larger interest-bearing balances with banks is primarily due to seasonal excess funds resulting from the clearing of tax refund checks and deposits. These ERC/ERD deposits occurred primarily during the first half of 2012 and 2011 and are the result of the Company’s relationship with a third-party tax software provider. The Company acts as the facilitator for these ERC/ERD transactions and earns a fee for each cleared item. For the short time the Company holds such refunds, constituting noninterest-bearing deposits, the Company increases its deposits with the Federal Reserve. This has caused the interest-bearing balances with banks to represent a large percentage of earning assets during the time the Company holds the refunds, although such balances decrease at year-end. For the year-end December 31, 2012, average interest-bearing balances with banks totaled 10.5% of earning assets, as compared to 8.4% for 2011 and 5.4% for 2010. As loan growth was challenged during 2012 and 2011, the Company re-invested a portion of its short-term Federal Reserve balances into longer-term investment securities. As a result, the Company’s average investment securities, both taxable and tax exempt, increased during 2012, with its percentage of earning assets averaging 15.7% for the year, compared to 14.5% for 2011 and 13.1% for 2010.

Management continues to focus on generating loan growth as this portion of earning assets provides the greatest return to the Company. Although loans make up the largest percentage of earning assets, management is comfortable with the current level of loans based on collateral values, the balance of the allowance for loan losses, strict underwriting standards and the Company's well-capitalized status. Management maintains securities at a dollar level adequate enough to provide ample liquidity and cover pledging requirements.

Average interest-bearing liabilities decreased 10.2% between 2011 and 2012, and decreased 4.3% between 2010 and 2011, largely due to decreasing time deposits and other borrowings partially offset by increasing savings and money market accounts. The fluctuations of interest-bearing deposits since 2010 are in large part due to the Company’s preference of core deposit relationship balances over higher-costing time deposits and other borrowing liabilities, which have changed the funding composition mix during this time. Interest-bearing liabilities continue to be comprised largely of time deposits, which represented 39.8% of total interest-bearing liabilities in 2012. This composition mix, however, has decreased the most since 2010, which represented 44.0% and 48.9% of total interest-bearing liabilities in 2011 and 2010, respectively. As interest rates on time deposits have continued to readjust to current market rates in 2012, competitive pricing pressures have grown, contributing to a significant maturity runoff of CD’s during 2012 and 2011. In addition, other borrowings have lowered to 3.5% of total interest-bearing liabilities in 2012, as compared to 6.8% in 2011 and 9.5% in 2010.

The Company’s core deposit segment of interest-bearing liabilities, which include NOW and savings and money market accounts, together represented 54.3% of total interest-bearing liabilities in 2012, as compared to 47.1% in 2011 and 39.5% in 2010. The primary reason for this composition increase has particularly been in the Company's statement savings and Market Watch products. As CD market rates continue to adjust downward, the spread between a short-term CD rate and a statement savings rate has become small enough for the customer to invest balances into a more liquid statement savings account, causing the average statement savings product to grow. The Market Watch product is a limited transaction investment account with tiered rates that competes with current market rate offerings and serves as an alternative to certificates of deposit for some customers. With an added emphasis on further building and maintaining core deposit relationships, the Company has marketed several attractive incentive offerings in the past several years to draw customers to this particular product. While, the terms of these special incentive offerings have ended, the Company continues to maintain higher average balances within this product than in previous years.

The overall composition shift from 2010 to 2012 with higher NOW, savings and money market balances and lower time deposits and other borrowed money has served as a cost effective contribution to the net interest margin. The average cost of the “growing” NOW, savings and money market account core segment was 0.55%, 0.90% and 1.14% during the years ended 2012, 2011 and 2010, respectively. The higher average costs of time deposits and other borrowed money segment were 1.54%, 1.96% and 2.42% during the years ended 2012, 2011 and 2010, respectively.

The net interest margin increased to 4.29% in 2012 from 4.23% in 2011 and 4.16% in 2010. The 6 basis point and 7 basis point improvement in 2012 and 2011 was largely the result of lower average costs on interest-bearing liabilities completely offsetting the lower yields on earning assets, which improved the Company’s net interest rate spread. During 2012, the net interest rate spread increased 11 basis points to 4.00%, resulting from the decrease in average cost of interest-bearing liabilities of 48 basis points from 1.59% to 1.11%, completely offsetting the decrease in average yield on interest-earning assets of 37 basis points from 5.48% to 5.11%. Partially offsetting the net interest rate spread increase in 2012 was a 5 basis point decrease in contributions from interest-free funds (i.e., demand deposits, shareholders' equity), which lowered from 0.34% in 2011 to 0.29% in 2012. During 2011, the net interest rate spread increased 7 basis points to 3.89%, resulting from the decrease in average cost of interest-bearing liabilities of 44 basis points from 2.03% to 1.59%, completely offsetting the decrease in average yield on interest-earning assets of 37 basis points from 5.85% to 5.48%.

Lower asset yields and decreases in average earning loans caused interest income on an FTE basis to decrease $5,011, or 11.3%, during 2012, and $2,438, or 5.2%, during 2011. Lower asset yields were mostly impacted by decreasing market rates and the reduction of RAL fees in 2012. Asset yields were also negatively impacted by an average balance increase in the Company’s interest-bearing Federal Reserve Bank clearing account. The increase came from higher excess funds from continued loan payoffs and paydowns, as well as an increased volume of short-term tax refund deposits. The Company continues to invest the majority of its excess funds into its interest-bearing Federal Reserve Bank clearing account, which yields just 0.25%. While these increases in Federal Reserve Bank balances contributed most to the Company’s average interest-bearing balances with banks growth during 2012 and 2011, these balances also contributed most to the decrease in earning asset yields, with the majority of this growth yielding just 0.25%. The intention for these short-term Federal Reserve Bank balances that were not related to tax refund clearing items or other seasonal deposits was to re-invest them into future loan growth or longer-term securities with higher interest rate yields to improve the net interest margin. Further contributing to lower asset yields were yields on loans decreasing 22 basis points from 2011 to 2012 and 5 basis points from 2010 to 2011. This decrease reflects the extended low interest rate environment the Federal Reserve has been maintaining since it began reducing short-term rates in 2008. The Company's commercial, participation and real estate loan portfolios have been most sensitive to these decreases in short-term interest rates since that time, particularly the prime interest rate, which remained at 3.25% at year-end 2012.

The decrease in interest and fee income came largely from the commercial loan portfolio. The Company experienced lower average balances within the commercial loan portfolio during 2012 and 2011 primarily from significant charge-offs of underperforming commercial loans, as well as large payoffs of various commercial loans. These lower loan balances have contributed to a $2,202, or 14.3%, decrease in commercial interest and fee revenue during the year ended 2012, as compared to 2011, and a $233, or 1.5%, decrease during the year ended 2011, as compared to 2010.

Further contributing to lower interest income during 2012 and 2011 were decreases in mortgage loan volume as a result of management’s strategy to sell most of its long-term, fixed-rate real estate loans to the secondary market, while retaining the servicing rights to these loans. As previously discussed, the Federal Reserve continues to maintain interest rates at their low levels, which has had an impact on long-term interest rates that affect mortgage loan pricing. The lower rates have contributed to a consumer demand for mortgage loan refinancing to help lower their monthly costs. The interest rate risks associated with satisfying this demand for long-term fixed-rate mortgages prompted management to sell the majority of these real estate loans to the secondary market, while retaining the servicing rights. This action continues to generate loan sale and servicing fee revenue within noninterest income, but has contributed to a $1,201, or 8.1%, decrease in real estate interest and fee income during the year ended 2012, as compared to 2011, and an $889, or 5.7%, decrease during the year ended 2011, as compared to 2010.

The Company’s consumer loan interest and fee income also decreased $1,517, or 13.5%, during the year ended 2012 compared to 2011, and $1,081, or 8.8%, during the year ended 2011 compared to 2010. Contributing to this were lower consumer loan average balances during 2012, primarily from auto loan balances, where competition for loan demand continues to be challenged by other financial institutions and captive finance companies. Also contributing to this decrease was the reduction of tax refund anticipation loan fees during the year ended 2012. The Company’s participation with a third-party tax software provider had given the Bank the opportunity to make RALs during the tax refund loan season, typically from January through March. During the year ended 2011, the Company recognized $561 in RAL fees. In response to the FDIC's expressions of concern about RALs, the Bank decided to discontinue offering RALs after April 19, 2011. As a result, the Bank did not originate RAL loans during the year ended 2012. Additionally, during 2011, the Bank recognized $561 in RAL fees, compared to $655 during 2010, a decrease of $94, or 14.4%. The FDIC's concern and recommendation does not affect the Bank's offering of other tax refund products, such as ERC’s and ERD’s. Furthermore, the FDIC’s recommendation does not affect the offerings of RALs by Loan Central, which has remained comparable from 2010 to 2012.

In relation to lower earning asset yields, the Company’s interest-bearing liability costs also decreased 48 basis points during 2012 and 44 basis points during 2011. The lower costs have caused interest expense to drop $3,823, or 37.6%, from 2011 to 2012 and $3,378, or 24.9%, from 2010 to 2011 as a result of lower rates paid on interest-bearing liabilities. The Federal Reserve continues to hold the prime interest rate at 3.25%, and the target federal funds rate remains at a range from 0.0% to 0.25%. The sustained low short-term rates have continued to impact the repricings of various Bank deposit products, including public fund NOW, Gold Club and Market Watch accounts. However, contributing most to the decrease in funding costs were interest rates on time deposit balances, which continued to reprice at lower rates during 2012 and 2011 (as a continued lagging effect to the Federal Reserve action to drop short-term interest rates). The year-to-date weighted average costs of the Company’s time deposits have decreased from 2.46% at year-end 2010 to 2.03% at year-end 2011 and 1.46% at year-end 2012.

Further contributing to lower interest-bearing deposit expense has been the Company’s continued emphasis on growing core deposits during 2012 and 2011. The Company continues to experience a deposit composition shift from a higher level of average time deposits to an increasing level of average core deposit balances in NOW, savings and money market balances. During 2012, the Company’s average time deposit balances, with a weighted average cost of 1.46%, decreased $52,947, as compared to the average time deposit balances during 2011. This is compared to an average balance increase of $10,957 in the Company’s lower costing, average core deposit balances, with a weighted average cost of 0.55% during 2012, as compared to 2011. As a result of decreases in the average market interest rates mentioned above and the deposit composition shift to lower costing deposit balances, the Company’s total weighted average funding costs have decreased to 1.11% at year-end 2012 as compared to 1.59% at year-end 2011 and 2.03% at year-end 2010.

The Company has experienced margin improvement during 2012 and 2011 due to a higher deposit mix of lower-costing NOW, savings and money market balances while also benefiting from a sustained low interest rate environment. However, the pace of improvement lowered in 2012, as the net interest margin increased 6 basis points as compared to a 7 basis point improvement in 2011. The lower pace of improvement was partly due to higher average balances being carried at the Federal Reserve yielding just 0.25% during 2012. This, combined with declining average loan balances, has placed increased pressure on net interest margin growth during 2012.

The Company will continue to focus on re-deploying the Federal Reserve balances earning 0.25% into higher yielding instruments as opportunities arise. Net interest margin will benefit if these deposits with the Federal Reserve Bank can be re-invested in loans and other longer-term, higher yielding investments. It is difficult to speculate on future changes in net interest margin and the frequency and size of changes in market interest rates. The past several years has seen the banking industry under continued stress due to declining real estate values and asset impairments. Earlier in 2012, the Federal Reserve announced it would maintain the current state of low interest rates through 2014 or longer to help boost the economy as its recovery has been short of expectations. However, further decreases in interest rates by the Federal Reserve are estimated to have a negative effect on the Company’s net interest income, as most of its deposit balances are perceived to be at or near their interest rate floors. The Company will also continue to face pressure on its net interest income and margin improvement unless loan balances begin to expand and become a larger component of overall earning assets. For additional discussion on the Company's rate sensitive assets and liabilities, please see “Interest Rate Sensitivity and Liquidity” and “Table VIII” within this Management's Discussion and Analysis.

PROVISION EXPENSE

Credit risk is inherent in the business of originating loans. The Company sets aside an allowance for loan losses through charges to income, which are reflected in the consolidated statement of income as the provision for loan losses. This provision charge is recorded to achieve an allowance for loan losses that is adequate to absorb losses in the Company’s loan portfolio. Management performs, on a quarterly basis, a detailed analysis of the allowance for loan losses that encompasses loan portfolio composition, loan quality, loan loss experience and other relevant economic factors.

The Company’s provision expense decreased during 2012 by $3,313, or 67.7%, as compared to 2011. The impact to provision expense during 2012 is largely related to the changes in net charge-offs, as well as changes in both specific and general allocations of the allowance for loan losses. During 2012, the Company’s net charge-offs totaled $2,022, a decrease of $4,916, or 70.9%, from the $6,938 in net charge-offs recognized during 2011. This was largely due to the partial charge-offs of various commercial and residential real estate loans classified as impaired and TDRs during the first two quarters of 2011. Management believed these charge-offs of collateral dependent loans were necessary given the status of the economy and the customers’ continued financial weakness. The largest of these charge-offs occurred during the first quarter of 2011, when the Company partially charged off $3,839 on two commercial loans classified as TDRs from one relationship due to a continued deterioration in collateral values. Of this partially charged-off amount, a specific allocation of approximately $2,906 already had been reserved in the allowance for loan losses from prior impairment analysis. Additional analysis of the loans’ collateral values revealed a $933 impairment that required a corresponding increase to provision expense that was used to absorb part of the $3,839 write-down during the first quarter of 2011. Most recently, during the fourth quarter of 2012, the Company was successful in recovering approximately $1,250 from these previously charged-off commercial loan balances. The recovery had a direct effect in decreasing net charge-offs and lowering provision expense during 2012 as compared to 2011.

As a result of the previously mentioned impaired and TDR loan charge-offs during the first and second quarters of 2011, the Company’s historical loan loss factors increased, which increased the Company’s general allocations in the Company’s allowance for loan losses. The Company’s general allocation evaluates, among other things, the average historical loan losses over the previous 36 months. These charge-offs contributed to an increase in the Company’s general allocation from $4,156 at December 31, 2010 to $6,689 at December 31, 2011. In 2012, the historical loan loss factors decreased as compared to 2011 as the net charge-offs for 2012 were less than the 2009 net charge-off activity which were replaced by the 2012 net charge-offs in the Company’s allowance for loan loss calculations. This caused the Company’s general allocation of the allowance for loan losses to decrease $1,891, or 28.3%, from December 31, 2011, which contributed to lower provision expense during the year ended December 31, 2012. Furthermore, the general allocation also evaluates other factors, such as economic risk, as well as changes in classified and criticized assets.

Partially offsetting the benefits of lower net charge-offs and lower general allocations was an increase in the Company’s specific allocations. The portion of allowance for loan losses that was specifically allocated to loans that were individually evaluated for impairment totaled $2,107 at December 31, 2012, increasing from $655 at December 31, 2011. The increase in specific allocations was largely related to an asset impairment of $1,979 on one commercial real estate loan classified as a TDR. The Company continues to monitor and make loan modifications to certain TDR loans that will ease payment performance pressures off of the borrower. For TDR loans that have had existing loan terms modified, an impairment analysis would be measured by comparing the present value of expected future cash flows discounted at the loan’s effective interest rate to the cash flows based on the original contractual terms of the loan or based upon an evaluation of collateral. The difference between the two measurements results in an impairment charge. Any impairment deficiency resulting from either analysis method would require a specific allocation of the allowance for loan losses and a corresponding increase to provision for loan losses expense. The impairment charge of $1,979 on the previously mentioned commercial real estate TDR loan was based on collateral values and required a corresponding increase to provision for loan losses expense.

During 2011, the Company recognized lower provision expense, decreasing $975, or 16.6%, as compared to 2010. The impact to provision expense during 2011 is largely related to actions taken on one commercial loan during the previous year of 2010. During 2010, the Company experienced an increase in provision expense from $1,995 in partial charge-offs taken on one commercial loan classified as impaired due to a continued deterioration in collateral values. At the time of charge-off, the Company had specific allocations of $1,825 within the allowance for loan losses, for which approximately $820 had been recognized prior to 2010. As a result, the $1,995 in partial charge-offs led to $990 in additional provision expense charges during 2010. This action had an opposite effect in 2011, contributing to the Company’s lower provision expense.

While the Company’s allowance for loan losses decreased $439, or 6.0%, from year-end 2011, the allowance-to-total-loan ratio remained higher than the previous year. The allowance for loan losses finished at 1.24% of total loans at December 31, 2012, as compared to 1.23% at December 31, 2011. This was largely due to a decrease in loans of $40,020 from year-end 2011. Management believes that the allowance for loan losses was adequate at December 31, 2012 to absorb probable losses in the portfolio. Future provisions to the allowance for loan losses will continue to be based on management’s quarterly in-depth evaluation that is discussed in further detail under the caption “Critical Accounting Policies - Allowance for Loan Losses” within this Management’s Discussion and Analysis.

NONINTEREST INCOME

Total noninterest income increased $1,261, or 17.5%, in 2012 as compared to 2011. Contributing most to the 2012 growth in noninterest income were lower losses related to OREO, as well as increases in debit/credit card interchange and mortgage banking income.

The successful growth in noninterest revenue was largely due to lower net OREO losses of $150 recorded in 2012, as compared to net losses of $1,224 recorded in 2011. Lower OREO costs were primarily related to the impairment charges taken on two commercial real estate foreclosed properties classified as OREO in 2011. These losses were derived from a re-evaluation of the carrying values for both OREO properties during the third and fourth quarters of 2011. Based on weakened market conditions, management applied a discount to the appraised value of the properties and increased the estimated liquidation expenses associated with both properties. The result was a $1,266 impairment charge that was recorded in 2011, as compared to a $331 additional impairment charge identified during the fourth quarter of 2012. The impairment charges recognized during 2011 and 2012 were recorded as write-downs to the carrying values of both properties.

The Company also experienced noninterest income growth from its debit and credit interchange income, which increased $313, or 22.6%, during the year ended 2012 as compared to 2011. The volume of transactions utilizing the Company’s credit card and Jeanie® Plus debit card continue to increase from a year ago. Beginning in the second half of 2010, the Company began offering incentive based credit cards that would permit its users to redeem accumulated points for merchandise, as well as cash incentives paid, particularly to business users based on transaction criteria. In addition, similar incentives were introduced to the Company’s Jeanie® Plus debit cards during the first quarter of 2011 to promote customer spending. While incenting debit/credit card customers has increased customer use of electronic payments, which has contributed to higher interchange revenue, the strategy also fits well with the Company’s emphasis on growing and enhancing its customer relationships.

Noninterest revenue improvement was also driven by higher mortgage banking income affected by an increase in the volume of real estate loans sold to the secondary market. To help manage consumer demand for longer-termed, fixed-rate real estate mortgages during the year ended 2012, the Company sold a portion of the real estate loans it originated during that period. Historic low interest rates on long-term fixed-rate mortgage loans continue to provide consumers with opportunities to refinance their existing mortgages. The decision to sell long-term fixed-rate mortgages at lower rates also helps to minimize the interest rate risk exposure to rising rates. During 2012, the Company experienced an increase in the number of loans sold to the secondary market by 112 loans, as compared to 2011. This generated an increase in mortgage banking income of $240 during the year ended 2012, as compared to the same period in 2011.

Contributing most to the $250, or 26.2%, increase in other noninterest income during the year ended December 31, 2012 were revenues received from the Company’s interest rate swap agreements. The Company utilizes interest rate swaps to satisfy the desire of large commercial customers to have a fixed-rate loan while permitting the Company to originate a variable-rate loan, which helps mitigate interest rate risk. In association with establishing an interest rate swap agreement, the Company earns a swap fee at the time of origination. The increase in transactions involving an interest rate swap during 2012 led to an increase in swap fees of $202 during the year ended December 31, 2012, as compared to the same period in 2011.

Partially offsetting the noninterest improvements mentioned above was a reduction in income from service charges on deposit accounts, which decreased $387, or 17.4%, during the year ended December 31, 2012, as compared to the same period in 2011. This decrease was in large part due to lower overdraft fees related to a lower volume of non-sufficient fund transactions that were processed due to customer behavior.

The Company also experienced less income from lower seasonal tax refund processing fees classified as ERC/ERD fees. During the year ended December 31, 2012, the Company’s ERC/ERD fees decreased by $270, or 10.6%, as compared to the same period in 201. During the first and second quarters of 2012, the volume of ERC/ERD items increased over the same periods in 2011. However, the fee per ERC/ERD transaction was reduced from the prior year, which contributed to lower fee revenue. While ERC/ERD fee income has generated less income during 2012, management is pleased with the significant contribution this revenue source has made, accounting for 27.0% of the overall noninterest income at year-end 2012. As a result of ERC/ERD fee activity being mostly seasonal, the majority of income was recorded during the first half of 2012.

The remaining noninterest income categories were up $89, or 4.8%, during the year ended 2012, as compared to 2011. These changes were due mostly to higher earnings from BOLI and annuity investments, and gains recorded on the sale of land in Jackson, Ohio, partially offset by lower trust fee income.

In 2011, total noninterest income increased $1,068, or 17.4%, in 2011 as compared to 2010. Contributing most to the 2011 growth in noninterest income was largely due to increased ERC/ERD fees. During 2011, the Company’s ERC/ERD fees increased by $1,779, or 228.1%, as compared to the same period in 2010. The increase was due to a volume increase in the number of ERC/ERD transactions that were processed during the first and second quarters of 2011. For the 2011 tax season, the tax software provider was able to expand the number of tax preparers utilizing its software, which contributed to the volume increase. The Company also experienced noninterest income growth from its debit and credit interchange income, which increased $389, or 39.0%, during the year ended 2011 as compared to 2010. The volume of transactions utilizing the Company’s credit card and Jeanie® Plus debit card continued to increase from a year ago. Beginning in the second half of 2010, the Company began offering incentive-based credit cards that would permit its users to redeem accumulated points for merchandise, as well as cash incentives paid, particularly to business users based on transaction criteria. In addition, similar incentives were introduced to the Company’s Jeanie® Plus debit cards during the first quarter of 2011 to promote customer spending. Partially offsetting the noninterest revenue improvements in 2011 from ERC/ERD and debit/credit card interchange fees were higher net losses on the sales of OREO. During the year ended 2011, sales of OREO resulted in a net loss of $1,224, which was up from the $177 in net OREO losses experienced during the year ended 2010. The increase in net losses during 2011 was largely attributed to impairment charges taken on two commercial real estate foreclosed properties. These losses were the result re-evaluations of the carrying values for both properties. Based on weakened market conditions, management applied a discount to the appraised value of the properties and increased the estimated liquidation expenses associated with both properties. The results were a $480 impairment charge recorded in September 2011 and a $786 impairment charge recorded in December 2011. The remaining noninterest income categories were down $53, or 1.2%, during the year ended 2011, as compared to 2010. These changes were due mostly to lower trust fee income, lower earnings from tax-free BOLI investments and lower loan insurance income due to the decline in loan demand, which has limited insurance sale opportunities.

NONINTEREST EXPENSE

Management continues to work diligently to minimize the growth in noninterest expense. For 2012, total noninterest expense increased $1,442, or 5.1%. Contributing most to the growth in net overhead expense were higher salaries and employee benefits, as well as increases in various other noninterest expense categories related to donations, advertising, customer incentives on debit and credit card usage, and a prepayment penalty associated with the extinguishment of above market FHLB advances.

The Company’s largest noninterest expense item, salaries and employee benefits, increased $768, or 4.6%, during 2012 as compared to 2011. The increase was largely due to higher healthcare and retirement benefit costs. Salary expense remained relatively stable, increasing $188, or 1.5%, over 2011, in large part to annual merit increases. During 2012, the Company experienced a lower full-time equivalent employee base, decreasing from 285 employees at year-end 2011 to 277 employees at year-end 2012. During 2011, salary and employee benefits increased $1,003, or 6.4%, during 2011 as compared to 2010. The increase was largely due to annual merit increases, higher health insurance premiums and an increase in the number of employees. During 2011, the Company experienced a higher full-time equivalent employee base, increasing from 279 employees at year-end 2010 to 285 employees at year-end 2011, increasing salaries and employee benefit expenses during 2011.

In 2012, the Company’s other noninterest expenses increased $1,195, or 21.3%, as compared to 2011. The increases were led by donation, advertising, customer incentive and prepayment penalty costs. Donation costs increased $340, or 156.8%, during 2012 largely from contributions to various communities within the Company’s market areas. This action was part of the Company’s new “Community First” initiative that emphasizes giving back to the communities in which it serves. The Company also increased its marketing efforts by utilizing more paper media and billboard images, which contributed to additional advertising costs of $184, or 34.3%, during 2012. Customer incentive costs also increased $190, or 76.7%, on debit and credit card usage. These customer card incentives incurred during 2012 was part of management’s added emphasis on further building and maintaining core deposit relationships while increasing interchange revenue. Also contributing to higher other noninterest expense was a $203 prepayment penalty that was realized as part of the Company’s strategy to prepay three FHLB advances totaling $5,689. The three FHLB advances were extinguished in December 2012 and had interest rate costs ranging from 2.2% to 3.4%. The prepayment penalty allowed management to, in effect, accelerate the interest expense on these higher-costing FHLB advances into 2012 to further reduce interest expense and promote net interest margin improvement in 2013.

Further impacting noninterest expense was the Company’s data processing costs, which increased $130, or 14.6%, during the year ended 2012, as compared to 2011. The Company continues to take great strides in utilizing the growing technology offered to financial institutions to enhance its loan and deposit products to better serve its customers. Data processing costs include processing services for the Company’s debit and credit cards as well as online and mobile banking technology. During 2011, data processing expense increased $206, or 30.1%, as compared to 2010.

Various noninterest expense categories decreased during 2012, as compared to 2011, which partially offset the expense increases described above. The Company’s FDIC premium expense decreased $274, or 26.6%, during the year ended December 31, 2012, as compared to the same period in 2011. The Company has benefited from lower FDIC assessment rates and a change in assessment method. Beginning April 1, 2011, the assessment base for deposit insurance premiums changed from total domestic deposits to average total assets minus average tangible equity. The new assessment method has afforded the Company lower net premium assessments. While the Company has benefited from these changes in calculation methods, continued declines in the Deposit Insurance Fund could result in the FDIC imposing assessments in the future, which could adversely affect the Company's capital levels and earnings. The Company’s FDIC premium expense decreased $32, or 3.0%, during the year ended 2011, as compared to 2010. This was impacted most by the new assessment method which began in April 2011 and afforded the Company lower net premium assessments during the third and fourth quarters of 2011.

Also partially offsetting overhead expense increases during 2012 were decreases in the Company’s occupancy and furniture/equipment costs, which decreased $209, or 7.7%, during the year ended 2012, as compared to the same period in 2011. This decrease was largely due to lower depreciation expense on equipment due to a reduction in recent equipment purchases. Also contributing to lower facility and equipment costs was the closing of the Company’s Columbus, Ohio branch during the fourth quarter of 2011. Occupancy and furniture/equipment costs decreased $95, or 3.4%, during 2011, as compared to 2010, largely due to lower depreciation expense on purchased equipment from prior years based on a declining balance method.

During 2012, the Company also recognized overhead expense savings within its foreclosed asset costs, which decreased $204, or 31.4%, as compared to 2011. Conversely, foreclosed asset costs increased $583 to $650 during the year ended 2011 as compared to just $67 during 2010. The changes in foreclosed asset costs during 2012 and 2011 were mostly related to two commercial real estate properties. Foreclosure expenses include the costs in maintaining the properties, which consist of taxes and general maintenance.

The Company’s efficiency ratio is defined as noninterest expense as a percentage of fully tax-equivalent net interest income plus noninterest income. Management continues to place emphasis on managing its balance sheet mix and interest rate sensitivity to help expand the net interest margin as well as developing more innovative ways to generate noninterest revenue. During 2012, revenue levels have been negatively affected by lower net interest income due to decreases in RAL fees combined with lower average earning assets. Furthermore, higher overhead expense during 2012 was the result of increased salaries and employee benefits, as well as various other noninterest expense categories which placed additional pressure on efficiency improvement during 2012. As a result, overhead expense during 2012 outpaced revenue levels, causing the year-to-date efficiency ratio to increase (worsen) to 71.5% at December 31, 2012, as compared to 68.2% at December 31, 2011. During 2011, the Company’s efficiency ratio also increased to 68.2% from the 67.4% experienced during 2010. A strong net interest income due to lower funding costs combined with higher noninterest income from ERC/ERD fees had a positive effect on efficiency during 2011. However, the Company experienced non-recurring OREO impairment charges of $1,266 which limited the growth in noninterest revenue during 2011. Furthermore, the Company experienced increased foreclosure costs of $583, primarily during the fourth quarter of 2011, on two commercial real estate properties which contributed to higher overhead expense. As a result, overhead expense for 2011 outpaced revenue levels, which caused the efficiency ratio to worsen from 2010.

FINANCIAL CONDITION:

CASH AND CASH EQUIVALENTS

The Company’s cash and cash equivalents consist of cash, as well as interest- and non-interest bearing balances due from banks. The amounts of cash and cash equivalents fluctuate on a daily basis due to customer activity and liquidity needs. At December 31, 2012, cash and cash equivalents had decreased $5,979, or 11.6%, to $45,651 as compared to $51,630 at December 31, 2011. The decrease in cash and cash equivalents was largely affected by the Company’s decrease in interest-bearing Federal Reserve Bank clearing account balances. The Company continues to utilize its interest-bearing Federal Reserve Bank clearing account to manage its excess funds during periods of significant liquidity. In 2012, loan demand continued to be challenged, causing proceeds from loan payments to exceed disbursements from new loan originations, which contributed to excess funds. During 2012, the Company utilized its Federal Reserve Bank clearing account to manage both investment security purchases and maturities, as well as to fund continued maturities of retail and wholesale CD’s. At December 31, 2012, the Company experienced a net increase of $9,958 in investment security balances, while its retail and wholesale CD’s decreased $34,246 from maturity runoff. In addition, during the first quarter of 2012, the Company experienced higher levels of excess funds due to increased tax refund deposits from its ERC/ERD tax clearing business. The Company will generally experience higher levels of excess funds during the first quarter than any other part of the year as a result of this. However, these liquidity levels normalized during the second and third quarters of 2012 as most of these short-term tax refund deposits were fully disbursed from the Federal Reserve Bank clearing account.

The interest rate paid on both the required and excess reserve balances of the Company’s Federal Reserve Bank clearing account is based on the targeted federal funds rate established by the Federal Open Market Committee. As of the filing date of this report, the interest rate calculated by the Federal Reserve continues to be 0.25%. This interest rate is similar to what the Company would have received from its investments in federal funds sold, currently in a range of less than 0.25%. Furthermore, Federal Reserve Bank balances are 100% secured.

As liquidity levels vary continuously based on consumer activities, amounts of cash and cash equivalents can vary widely at any given point in time. The Company’s focus will be to continue to re-invest these liquid funds back into longer-term, higher yielding assets, such as loans and investment securities during 2013 when the opportunities arise. Further information regarding the Company’s liquidity can be found under the caption “Liquidity” in this Management’s Discussion and Analysis.

SECURITIES

Management's goal in structuring the portfolio is to maintain a prudent level of liquidity while providing an acceptable rate of return without sacrificing asset quality. Maturing securities have historically provided sufficient liquidity such that management has not sold a debt security in several years, other than renewals or replacements of maturing securities.

During 2012, the balance of total securities increased $9,958, or 9.2%, as compared to 2011, with the ratio of securities to total assets also increasing to 15.4% at December 31, 2012, compared to 13.5% at December 31, 2011. The Company’s investment securities portfolio has consisted of U.S. Treasury securities, U.S. Government sponsored entity (“GSE”) securities, Agency mortgage-backed securities and obligations of states and political subdivisions. During 2012, the Company experienced an increase in its liquidity position impacted by retained excess funds from seasonal tax clearing activities and increased loan payments and payoffs. As a result, the Company invested a portion of its excess funds into new long-term Agency mortgage-backed securities, which increased $16,349, or 21.1%, from year-end 2011. Typically, the primary advantage of Agency mortgage-backed securities has been the increased cash flows due to the more rapid monthly repayment of principal as compared to other types of investment securities, which deliver proceeds upon maturity or call date. However, with the current low interest rate environment and loan balances at a declining pace, the cash flow that is being collected is being reinvested at lower rates. Principal repayments from Agency mortgage-backed securities totaled $25,297 during 2012.

While security growth has been evident within the Agency mortgage-backed securities portfolio, the Company saw its U.S. Treasury and GSE securities balances decrease $7,060, or 87.5%, collectively, from year-end 2011. In addition to helping achieve diversification within the Company’s investment securities portfolio, U.S. Treasury and GSE securities had been used to satisfy pledging requirements for repurchase agreements. However, during the third quarter of 2011, newly enacted legislation permitted business checking accounts to earn interest on their deposits. This legislation prompted all of the Company’s repurchase agreement accounts to reinvest into either interest-bearing demand accounts subject to normal FDIC insurance coverage or noninterest-bearing demand accounts with unlimited FDIC insurance coverage until the end of 2012. As a result, the Company no longer has any repurchase agreement balances on hand, eliminating the need to secure these balances with U.S. Treasury and GSE investment securities.

With the general decrease in interest rates evident since 2008, the reinvestment rates on debt securities continue to show lower returns during 2012. The weighted average FTE yield on debt securities at year-end 2012 was 2.17%, as compared to 2.36% at year-end 2011 and 2.94% at year-end 2010. As a result, the Company’s focus will be to generate interest revenue primarily through loan growth, as loans generate the highest yields of total earning assets. Table III provides a summary of the portfolio by category and remaining contractual maturity. Issues classified as equity securities have no stated maturity date and are not included in Table III.

LOANS

In 2012, the Company's primary category of earning assets and most significant source of interest income, total loans, decreased $40,020, or 6.7%, to finish at $558,288. Lower loan balances were mostly influenced by the commercial loan portfolio, which includes both commercial real estate and commercial and industrial loans. While commercial loans were down, management continues to place emphasis on its commercial lending, which generally yields a higher return on investment as compared to other types of loans.

Commercial real estate, the Company’s largest segment of commercial loans, decreased $32,445, or 15.6%, from year-end 2011. Commercial real estate consists of owner-occupied, nonowner-occupied and construction loans. Commercial real estate also includes loan participations with other banks outside the Company’s primary market area. Although the Company is not actively seeking to participate in loans originated outside its primary market area, it has taken advantage of the relationships it has with certain lenders in those areas where the Company believes it can profitably participate with an acceptable level of risk. Commercial real estate loans were down largely from its owner-occupied portfolio during 2012, which decreased $24,522, or 19.0%, from year-end 2011. This decrease was mostly due to large loan payoffs during the first quarter of 2012 totaling $18,381 on various owner-occupied commercial real estate loans with three borrowers. Owner-occupied loans consist of nonfarm, nonresidential properties. A commercial owner-occupied loan is a loan secured by a borrower purchased building or space for which the repayment of principal is dependent upon cash flows from the ongoing operations conducted by the party, or an affiliate of the party, who owns the property. Owner-occupied loans of the Company include loans secured by hospitals, churches, and hardware and convenience stores. Nonowner-occupied loans decreased $3,828, or 6.8%, from year-end 2011 in large part due to loan payoffs and paydowns during the first and fourth quarters of 2012 with three borrowers. Nonowner-occupied loans are property loans for which the repayment of principal is dependent upon rental income associated with the property or the subsequent sale of the property, such as apartment buildings, condominiums, hotels and motels. These loans are primarily impacted by local economic conditions, which dictate occupancy rates and the amount of rent charged. Commercial construction loans, which decreased $4,095, or 19.1%, from year-end 2011, are extended to individuals as well as corporations for the construction of an individual property or multiple properties and are secured by raw land and the subsequent improvements. The decrease was in large part due to one commercial loan relationship that transitioned from the construction/land development phase of its borrowing arrangement during the third quarter of 2012.

At December 31, 2012, the Company’s commercial and industrial loan portfolio was up from year-end 2011 by $12,039, or 26.6%. The increase was largely due to $8,770 in new loans and advances during 2012 with two commercial loan borrowers. Commercial and industrial loans consist of loans to corporate borrowers primarily in small to mid-sized industrial and commercial companies that include service, retail and wholesale merchants. Collateral securing these loans includes equipment, inventory, and stock.

Over sixty-two percent of the Company’s total commercial loan portfolio, including participation loans, consists of rental property loans (28.3% of portfolio), hotel and motel loans (7.1% of portfolio), government and education loans (6.7% of portfolio), church loans (5.2% of portfolio), construction and remodeling loans (5.1% of portfolio), and manufacturing loans (5.0% of portfolio). At December 31, 2012, the primary market areas for the Company’s commercial loan originations, excluding loan participations, were in the areas of Gallia, Jackson and Pike counties of Ohio, which accounted for 42.6% of total originations. The growing West Virginia markets also accounted for 29.2% of total originations for the same time period. While management believes lending opportunities exist in the Company’s markets, future commercial lending activities will depend upon economic and related conditions, such as general demand for loans in the Company’s primary markets, interest rates offered by the Company, the effects of competitive pressure and normal underwriting considerations.

Generating residential real estate loans remains a significant focus of the Company’s lending efforts. Residential real estate loan balances comprise the largest portion of the Company’s loan portfolio and consist primarily of one- to four-family residential mortgages and carry many of the same customer and industry risks as the commercial loan portfolio. During 2012, total residential real estate loan balances decreased $12,468, or 5.2%, from year-end 2011. The decrease was mostly from the Company’s 15-, 20- and 30-year fixed-rate loans, which declined $27,980, or 17.0%, from year-end 2011. Long-term interest rates continue to remain at historic low levels and have prompted periods of increased refinancing demand for long-term, fixed-rate real estate loans in recent years. Management has determined that originating 100% of the demand for long-term fixed-rate real estate loans to the loan portfolio at such low rates would present an unacceptable level of interest rate risk. Therefore, to help manage interest rate risk while also satisfying the demand for long-term, fixed-rate real estate loans, the Company has strategically chosen to originate and sell most of its fixed-rate mortgage loans to the secondary market, which allowed its customers to take advantage of low rates and reduce their monthly costs. The Company maintains its relationship with the customer by servicing the loan. The customer must qualify to take advantage of a secondary market loan based on various criteria which could limit volume growth. The Company has experienced an increase in refinancing volume, which has led to higher secondary market sales in 2012 versus 2011. During 2012, a total of 230 loans totaling $29,573 were sold, compared to 118 loans sold totaling $13,637 during 2011. The remaining real estate loan portfolio balances increased $15,512, or 20.9%. This increase came primarily from the Company’s other variable-rate loan products being offered to its customers as alternative financing options. A customer that may not qualify for a long-term, secondary market loan may choose from one of the Company’s other adjustable-rate mortgage products. This has contributed to higher balances of five-year, adjustable-rate mortgages, which were up $17,227 or 103.9%, from year-end 2011. The Company believes it has limited its interest rate risk exposure due to its practice of promoting and selling residential mortgage loans to the secondary market. The Company will continue to follow this secondary market strategy until long-term interest rates increase back to a range that falls within an acceptable level of interest rate risk.

Lower loan balances during 2012 were also influenced by the Company’s total consumer loans, which decreased $7,146, or 6.7%, from year-end 2011. The Company’s consumer loans are primarily secured by automobiles, mobile homes, recreational vehicles and other personal property. Personal loans and unsecured credit card receivables are also included as consumer loans. The decrease in consumer loans came mostly from the Company’s automobile lending portfolio, which decreased $4,534, or 9.9%, from year-end 2011. The automobile lending component comprises the largest portion of the Company’s consumer loan portfolio, representing 41.2% of total consumer loans at December 31, 2012. In recent years, growing economic factors have weakened the economy and have limited consumer spending. During this time of economic challenge, the Company continues to maintain a strict loan underwriting process on its consumer auto loan offerings to limit future loss exposure. The Company’s interest rates offered on indirect automobile opportunities have struggled to compete with the more aggressive lending practices of local banks and alternative methods of financing, such as captive finance companies offering loans at below-market interest rates related to this segment. The decreasing trend of auto loan balances should continue during 2013, as the larger institutions and captive finance companies will continue to aggressively compete for a larger share of the market.

The remaining consumer loan products not discussed above declined $2,612, or 4.2%, which include general decreases in loan balances from recreational vehicles, mobile homes, home equity lines of credit and unsecured loans. Management will continue to place more emphasis on other loan portfolios (i.e. commercial and, to a smaller extent, residential real estate) that will promote increased profitable loan growth and higher returns. Indirect automobile loans bear additional costs from dealers that partially offset interest revenue and lower the rate of return.

The Company continues to monitor the pace of its loan volume. The well-documented housing market crisis and other disruptions within the economy have negatively impacted consumer spending, which has continued to limit the lending opportunities within the Company's market locations. Declines in the housing market since 2007, with falling home prices and increasing foreclosures and unemployment, have continued to result in significant write-downs of asset values by financial institutions. To combat this ongoing potential for loan loss, the Company will remain consistent in its approach to sound underwriting practices and a focus on asset quality. The Company anticipates its overall loan growth in 2013 to remain challenged.

ALLOWANCE FOR LOAN LOSSES

Tables IV and V have been provided to enhance the understanding of the loan portfolio and the allowance for loan losses. Management evaluates the adequacy of the allowance for loan losses quarterly based on several factors, including, but not limited to, general economic conditions, loan portfolio composition, prior loan loss experience, and management's estimate of probable incurred losses. Management continually monitors the loan portfolio to identify potential portfolio risks and to detect potential credit deterioration in the early stages, and then establishes reserves based upon its evaluation of these inherent risks. Actual losses on loans are reflected as reductions in the reserve and are referred to as charge-offs. The amount of the provision for loan losses charged to operating expenses is the amount necessary, in management's opinion, to maintain the allowance for loan losses at an adequate level that is reflective of probable and inherent loss. The allowance required is primarily a function of the relative quality of the loans in the loan portfolio, the mix of loans in the portfolio and the rate of growth of outstanding loans. Impaired loans, which include loans classified as TDR’s, are considered in the determination of the overall adequacy of the allowance for loan losses.

The struggles of our U.S. economy in recent years have had a direct impact on the Company’s borrowers, as they continue to experience financial difficulties and liquidity strains. The Company is faced with the ongoing decision of whether to foreclose on these troubled loans and take possession of the collateral or to work with the borrower to modify the original terms of the loan. A successful loan modification not only avoids costly foreclosure proceedings but, more importantly, could result in the full repayment of the loan principal amount. The Company continues to monitor and make loan modifications to certain troubled loans that would ease payment pressures on the borrower. Most generally, the modification “period” of the original terms of the loan is only temporary (i.e. 12 months), after which the loan would resume under the original contractual terms of the loan. GAAP and regulatory guidance identifies certain loan modifications as TDR’s, which, in general, is when a bank, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the bank would not otherwise consider. One such qualification would be if the bank modified the original terms of the loan for the remaining original life of the debt. Modifications of the original terms would include temporarily adjusting the contractual interest rate of the loan or converting the payment method from principal and interest amortization payments to interest-only for a temporary period of time.

During 2012, the Company’s allowance for loan losses decreased $439, or 6.0%, to finish at $6,905 as compared to $7,344 at year-end 2011. This decrease in the allowance was largely from a decrease of $1,891 in general allocations related to improving economic risk trends, lower average historical loan losses, and lower loan balances. As previously mentioned, the U.S. economy has been under financial stress in recent years, causing the Company’s borrowers to experience financial difficulties and liquidity strains. Management has focused on improving asset quality and lowering credit risk while working to maintain its relationships with its borrowers. The Company has continued to work with its borrowers during their periods of financial hardship to grant temporary concessions on their loan terms in the form of TDRs. As part of the Company’s quarterly analysis of the allowance for loan losses, an improving trend has been identified within its economic risk allocation, which, among other things, accounts for unemployment rates and classified/criticized asset levels. Since year-end 2011, unemployment rates within the Company’s lending markets have decreased, while classified and criticized asset balances have also decreased. These improving trends have placed less pressure on the economic risk allocation of the allowance for loans losses.

Average historical loan losses have also decreased since 2011, due to lower net charge-offs in 2012. During 2012, net charge-offs decreased $4,916, or 70.9%, from 2011, largely due to the partial charge-offs of various commercial and residential real estate loans classified as impaired and TDR’s during the first half of 2011. Beginning in 2011, the Company began to take partial charge-offs more quickly on collateral dependent loans. As management further evaluated the trends in the real estate market, as well as the status of long-term, collateral dependent impaired loans, the decision to charge off these specific allocations was made. Given that a majority of these loan losses had been previously identified and specifically allocated for in periods prior to 2011, increases in provision expense were not required. However, these TDR and impaired loan charge-offs had an immediate impact on increasing the Company’s general allocations related to the historical loan loss factor. This general allocation evaluates the average historical loan losses over the past 36 months and requires general allocations of the allowance for loan losses to be recorded as average loan losses increase. Due to the surge in net charge-offs during the first half of 2011, the Company’s annualized ratio of net charge-offs to average loans grew to 1.11%, as compared to 0.72% during 2010. During 2012, the net charge-off ratio has lowered to 0.35% contributing to a lower historical loss factor allocation of the allowance for loan losses at December 31, 2012. This lower charge-off ratio in 2012 was also impacted by a large loan recovery of $1,250 from previously charged-off commercial loan balances which had a direct effect in decreasing net charge-offs.

In addition, the Company’s total loan portfolio balance decreased $40,020 from year-end 2011, having a direct impact on lowering the general allocations of the allowance.

Partially offsetting the decreases in the allowance mentioned above were higher specific allocations related to various loan impairments which contributed to a $1,452 increase in specific allocations from year-end 2011. These additional specific allocations include the impairments in collateral values and ongoing cash flows of two commercial real estate loan relationships. Both impairments required specific allocations within the allowance for loan losses and corresponding increases to provision for loan losses expense.

The Company’s impaired loans increased $5,829, or 50.4%, from year-end 2011 in large part due to the addition of one commercial real estate loan totaling $4,244. Modifications of the contractual terms of this loan were performed during the first quarter of 2012, which provided the borrower a temporary concession. An impairment analysis was performed on the collateral values of the loan which revealed no need for a specific allocation of the allowance for loan losses. The portions of impaired loans for which there are specific allocations reflect losses that the Company expects to incur, as they will not likely be able to collect all amounts due according to the contractual terms of the loan. Although impaired loans have been identified as potential problem loans, they may never become delinquent or classified as nonperforming.

The Company experienced an $848 increase in its nonperforming loans from year-end 2011. Nonperforming loans consist of nonaccruing loans and accruing loans past due 90 days or more. Nonperforming loans finished at $3,985 at December 31, 2012, compared to $3,137 at year-end 2011. The increase was mostly related to two impaired commercial real estate loans totaling $975 that were classified as nonaccrual during the first and third quarters of 2012. As a result, the Company’s ratio of nonperforming loans to total loans increased from 0.52% at December 31, 2011 to 0.71% at December 31, 2012. Furthermore, the Company experienced an increase in its nonperforming assets to total assets ratio, increasing from 0.92% at December 31, 2011 to 0.99% at December 31, 2012. Approximately 34.2% of nonperforming assets is related to two loans with one commercial borrower totaling $2,617 that was transferred into other real estate owned during the second quarter of 2008. Both nonperforming loans and nonperforming assets at December 31, 2012 continue to be in various stages of resolution for which management believes such loans are adequately collateralized or otherwise appropriately considered in its determination of the adequacy of the allowance for loan losses.

While the allowance for loan losses decreased $439 from year-end 2011 due to lower general allocations, the ratio of the allowance for loan losses to total loans still increased to 1.24% at December 31, 2012, compared to 1.23% at December 31, 2011. The effects of lower general allocations were completely offset by the effects of lower loan balances since year-end 2011. Management believes that the allowance for loan losses at December 31, 2012 was adequate and reflected probable incurred losses in the loan portfolio. There can be no assurance, however, that adjustments to the allowance for loan losses will not be required in the future. Changes in the circumstances of particular borrowers, as well as adverse developments in the economy are factors that could change and make adjustments to the allowance for loan losses necessary. Asset quality will continue to remain a key focus, as management continues to stress not just loan growth, but quality in loan underwriting as well.

DEPOSITS

Deposits are used as part of the Company’s liquidity management strategy to meet obligations for depositor withdrawals, to fund the borrowing needs of loan customers, and to fund ongoing operations. Deposits, both interest- and noninterest-bearing, continue to be the most significant source of funds used by the Company to support earning assets. The Company seeks to maintain a proper balance of core deposit relationships on hand while also utilizing various wholesale deposit sources, such as brokered and internet CD balances, as an alternative funding source to manage efficiently the net interest margin. Deposits are influenced by changes in interest rates, economic conditions and competition from other banks. The accompanying table VII shows the composition of total deposits as of December 31, 2012, 2011 and 2010. Total deposits decreased $32,822, or 4.8%, to finish at $655,064 at December 31, 2012, mostly from lower time deposits. This change in time deposits from year-end 2011 fits within management’s strategy of focusing on more “core” deposit balances that include interest-bearing demand, savings, money market and noninterest-bearing deposit balances. Core relationship deposits are considered by management as a primary source of the Bank’s liquidity. The Bank focuses on these kinds of deposit relationships with consumers from local markets who can maintain multiple accounts and services at the Bank. The Company views core deposits as the foundation of its long-term funding sources because it believes such core deposits are more stable and less sensitive to changing interest rates and other economic factors. As a result, the Bank’s core customer relationship strategy has resulted in a higher portion of its deposits being held in NOW, savings and money market accounts at December 31, 2012 than at December 31, 2011. This is combined with a lesser portion of deposits being held in brokered and retail time deposits at December 31, 2012 than at December 31, 2011. Furthermore, the Company’s core noninterest-bearing demand account balances increased from year-end 2011.

Due to the increased emphasis on core relationship deposits, time deposits represented 32.3% of total deposits at December 31, 2012 compared to 36.0% of total deposits December 31, 2011, a decrease of $35,869, or 14.5%. With loan balances down 6.7% from year-end 2011, the Company has not needed to employ aggressive measures, such as offering higher rates, to attract customer investments in CD’s. Furthermore, as market rates remain at low levels, the Company has seen the cost of its retail CD balances continue to reprice downward to reflect current deposit rates. As a result, the Bank’s CD customers have been more likely to consider re-investing their matured CD balances into other short-term deposit products or with other institutions offering the most attractive rates. This has led to an increased maturity runoff within its “customer relation” retail CD portfolio. Furthermore, with the significant downturn in economic conditions, the Bank’s CD customers in general have experienced reduced funds available to deposit with structured terms, choosing to remain more liquid. As a result, the Company has experienced a decrease within its retail CD balances, which were down $19,915 from year-end 2011. The Company’s preference of core deposit funding sources has created a lesser reliance on wholesale funding deposits (i.e., brokered and internet CD issuances), which were also down $15,954 from year-end 2011. The Company will continue to evaluate its use of brokered CD’s to manage interest rate risk associated with longer-term, fixed-rate loan demand.

Further decreases in the Company’s deposit balances came from money market accounts, which were down $8,449, or 5.5%, from year-end 2011. The decrease came largely from the Company’s Market Watch product. The Market Watch product is a limited transaction investment account with tiered rates that competes with current market rate offerings and serves as an alternative to certificates of deposit for some customers. With an added emphasis on further building and maintaining core deposit relationships, the Company has marketed several attractive incentive offerings in the past several years to draw customers to this particular product. As the terms of these special incentive offerings have ended, the interest rates have adjusted down to current market rates, which has resulted in the decrease in Market Watch balances.

Partially offsetting the decreases in time deposits and money market account balances was growth in the Company’s interest-bearing NOW account balances, which increased $4,674, or 4.6%, during 2012. This increase was largely driven by general increases in public fund account balances. While the Company feels confident in the relationships it has with its public fund customers, these balances will continue to experience larger fluctuations than other deposit account relationships due to the nature of the account activity. Larger public fund balance fluctuations are, at times, seasonal and can be predicted while most other large fluctuations are outside of management’s control. The Company values these public fund relationships it has secured and will continue to market and service these accounts to maintain its long-term relationships.

Also partially offsetting overall deposit decreases was growth in the Company’s savings account balances, which increased $5,439, or 11.6%, from year-end 2011, coming primarily from the statement savings product. As CD market rates continue to adjust downward, the spread between a short-term CD rate and a statement savings rate has become small enough for the customer to invest balances into a more liquid statement savings account, perhaps hoping for rising rates in the near future.

The Company’s interest-free funding source, noninterest-bearing demand deposits, also was up during 2012, increasing $1,383, or 1.0%, from year-end 2011. Decreases within the Company’s business checking accounts from year-end 2011 were completely offset by growth in the Company’s other noninterest-bearing products, particularly those offering incentive rewards to customers.

The Company will continue to experience increased competition for deposits in its market areas that could challenge growth within its core deposit products. The Company will continue to emphasize growth in its core deposit relationships during 2013, reflecting the Company’s efforts to reduce its reliance on higher cost funding and improving net interest income.

OTHER BORROWED FUNDS

The Company also accesses other funding sources, including short-term and long-term borrowings, to fund potential asset growth and satisfy short-term liquidity needs. Other borrowed funds consist primarily of Federal Home Loan Bank (“FHLB”) advances and promissory notes. During 2012, other borrowed funds were down $6,011, or 29.6%, from year-end 2011. This was primarily due to the Company’s strategy to prepay three higher-costing FHLB advances totaling $5,689. The three FHLB advances were paid off in December 2012 with interest rate costs ranging from 2.2% to 3.4%. A prepayment penalty of $203 was recorded into other noninterest expense as part of this early extinguishment. Management’s intent was to accelerate the interest expense on these higher-costing FHLB advances into 2012 to further reduce interest expense and promote net interest margin improvement in 2013. With net loan demand continuing on a declining pace during 2012, management will consider the use of its core deposit growth and retained deposit proceeds from the first quarter’s seasonal tax activity to repay FHLB borrowings, as necessary. While deposits continue to be the primary source of funding for growth in earning assets, management will continue to utilize various wholesale borrowings to help manage interest rate sensitivity and liquidity.

OFF-BALANCE SHEET ARRANGEMENTS

As discussed in Notes G and J, the Company engages in certain off-balance sheet credit-related activities, including commitments to extend credit and standby letters of credit, which could require the Company to make cash payments in the event that specified future events occur. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Standby letters of credit are conditional commitments to guarantee the performance of a customer to a third party. While these commitments are necessary to meet the financing needs of the Company’s customers, many of these commitments are expected to expire without being drawn upon. Therefore, the total amount of commitments does not necessarily represent future cash requirements.

CAPITAL RESOURCES

The Company maintains a capital level that exceeds regulatory requirements as a margin of safety for its depositors. As detailed in Note N to the financial statements at December 31, 2012, the Bank’s capital exceeded the requirements to be deemed “well capitalized” under applicable prompt corrective action regulations. Total shareholders' equity at December 31, 2012 of $75,820 was up $3,977, or 5.5%, as compared to the balance of $71,843 at December 31, 2011. Contributing most to this increase was year-to-date net income of $7,052, partially offset by cash dividends paid of $4,393, or $1.09 per share.

INTEREST RATE SENSITIVITY AND LIQUIDITY

The Company’s goal for interest rate sensitivity management is to maintain a balance between steady net interest income growth and the risks associated with interest rate fluctuations. Interest rate risk (“IRR”) is the exposure of the Company’s financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability, but excessive levels of IRR can threaten the Company’s earnings and capital.

The Company evaluates IRR through the use of an earnings simulation model to analyze net interest income sensitivity to changing interest rates. The modeling process starts with a base case simulation, which assumes a static balance sheet and flat interest rates. The base case scenario is compared to rising and falling interest rate scenarios assuming a parallel shift in all interest rates. Comparisons of net interest income and net income fluctuations from the flat rate scenario illustrate the risks associated with the current balance sheet structure.

The Company’s Asset/Liability Committee monitors and manages IRR within Board approved policy limits. The current IRR policy limits anticipated changes in net interest income to an instantaneous increase or decrease in market interest rates over a 12 month horizon to +/- 5% for a 100 basis point rate shock, +/- 7.5% for a 200 basis point rate shock and +/- 10% for a 300 basis point rate shock. Based on the level of interest rates, management did not test interest rates down 200 or 300 basis points.

The estimated percentage change in net interest income due to a change in interest rates was within the policy guidelines established by the Board. With the historical low interest rate environment, management generally has been focused on limiting the duration of assets, while trying to extend the duration of our funding sources to the extent customer preferences will permit us to do so. At December 31, 2012, the interest rate risk profile reflects a liability sensitive position, which produces lower net interest income due to an increase in interest rates. In a declining rate environment, net interest income decreases due to the interest rate on many deposit accounts not being able to adjust downward. With interest rates so low, deposit accounts are perceived to be at or near an interest rate floor. Overall, management is comfortable with the current interest rate risk profile which reflects minimal exposure to interest rate changes.

Liquidity relates to the Company's ability to meet the cash demands and credit needs of its customers and is provided by the ability to readily convert assets to cash and raise funds in the market place. Total cash and cash equivalents, held to maturity securities maturing within one year and available for sale securities, totaling $140,616, represented 18.3% of total assets at December 31, 2012. In addition, the FHLB offers advances to the Bank, which further enhances the Bank's ability to meet liquidity demands. At December 31, 2012, the Bank could borrow an additional $161,328 from the FHLB, of which $95,000 could be used for short-term, cash management advances. Furthermore, the Bank has established a borrowing line with the Federal Reserve. At December 31, 2012, this line had total availability of $41,317. Lastly, the Bank also has the ability to purchase federal funds from a correspondent bank. For further cash flow information, see the condensed consolidated statement of cash flows. Management does not rely on any single source of liquidity and monitors the level of liquidity based on many factors affecting the Company’s financial condition.

INFLATION

Consolidated financial data included herein has been prepared in accordance with US GAAP. Presently, US GAAP requires the Company to measure financial position and operating results in terms of historical dollars with the exception of securities available for sale, which are carried at fair value. Changes in the relative value of money due to inflation or deflation are generally not considered.

In management's opinion, changes in interest rates affect the financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not change at the same rate or in the same magnitude as the inflation rate. Rather, interest rate volatility is based on changes in the expected rate of inflation, as well as monetary and fiscal policies. A financial institution's ability to be relatively unaffected by changes in interest rates is a good indicator of its capability to perform in today's volatile economic environment. The Company seeks to insulate itself from interest rate volatility by ensuring that rate sensitive assets and rate sensitive liabilities respond to changes in interest rates in a similar time frame and to a similar degree.

CRITICAL ACCOUNTING POLICIES

The most significant accounting policies followed by the Company are presented in Note A to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those that are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management currently views the adequacy of the allowance for loan losses to be a critical accounting policy.

The allowance for loan losses is a valuation allowance for probable incurred credit losses. 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. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans generally consist of loans with balances of $200 or more on nonaccrual status or nonperforming in nature. Loans for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.

Factors considered by management in determining impairment 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 and reasons for the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed.

Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Smaller balance homogeneous loans, such as consumer and most residential real estate, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosure. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component covers non-impaired loans and impaired loans that are not individually reviewed for impairment and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent 3 years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified: Commercial Real Estate, Commercial and Industrial, Residential Real Estate, and Consumer.

Commercial and industrial loans consist of borrowings for commercial purposes to individuals, corporations, partnerships, sole proprietorships, and other business enterprises. Commercial and industrial loans are generally secured by business assets such as equipment, accounts receivable, inventory, or any other asset excluding real estate and generally made to finance capital expenditures or operations. The Company’s risk exposure is related to deterioration in the value of collateral securing the loan should foreclosure become necessary. Generally, business assets used or produced in operations do not maintain their value upon foreclosure, which may require the Company to write-down the value significantly to sell.

Commercial real estate consists of nonfarm, nonresidential loans secured by owner-occupied and nonowner-occupied commercial real estate as well as commercial construction loans. An owner-occupied loan relates to a borrower purchased building or space for which the repayment of principal is dependent upon cash flows from the ongoing business operations conducted by the party, or an affiliate of the party, who owns the property. Owner-occupied loans that are dependent on cash flows from operations can be adversely affected by current market conditions for their product or service. A nonowner-occupied loan is a property loan for which the repayment of principal is dependent upon rental income associated with the property or the subsequent sale of the property. Nonowner-occupied loans that are dependent upon rental income are primarily impacted by local economic conditions which dictate occupancy rates and the amount of rent charged. Commercial construction loans consist of borrowings to purchase and develop raw land into one- to four-family residential properties. Construction loans are extended to individuals as well as corporations for the construction of an individual or multiple properties and are secured by raw land and the subsequent improvements. Repayment of the loans to real estate developers is dependent upon the sale of properties to third parties in a timely fashion upon completion. Should there be delays in construction or a downturn in the market for those properties, there may be significant erosion in value which may be absorbed by the Company.

Residential real estate loans consist of loans to individuals for the purchase of one- to four-family primary residences with repayment primarily through wage or other income sources of the individual borrower. The Company’s loss exposure to these loans is dependent on local market conditions for residential properties as loan amounts are determined, in part, by the fair value of the property at origination.

Consumer loans are comprised of loans to individuals secured by automobiles, open-end home equity loans and other loans to individuals for household, family, and other personal expenditures, both secured and unsecured. These loans typically have maturities of 5 years or less with repayment dependent on individual wages and income. The risk of loss on consumer loans is elevated as the collateral securing these loans, if any, rapidly depreciate in value or may be worthless and/or difficult to locate if repossession is necessary. During the last several years, one of the most significant portions of the Company’s net loan charge-offs have been from consumer loans. Nevertheless, the Company has allocated the highest percentage of its allowance for loan losses as a percentage of loans to the other identified loan portfolio segments due to the larger dollar balances associated with such portfolios.

CONCENTRATIONS OF CREDIT RISK

The Company maintains a diversified credit portfolio, with residential real estate loans currently comprising the most significant portion. Credit risk is primarily subject to loans made to businesses and individuals in southeastern Ohio and western West Virginia. Management believes this risk to be general in nature, as there are no material concentrations of loans to any industry or consumer group. To the extent possible, the Company diversifies its loan portfolio to limit credit risk by avoiding industry concentrations.

FORWARD LOOKING STATEMENTS

Except for the historical statements and discussions contained herein, statements contained in this report constitute "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934 and as defined in the Private Securities Litigation Reform Act of 1995. Such statements are often, but not always, identified by the use of such words as "believes," "anticipates," "expects," and similar expressions. Such statements involve various important assumptions, risks, uncertainties, and other factors, many of which are beyond our control that could cause actual results to differ materially from those expressed in such forward looking statements. These factors include, but are not limited to: changes in political, economic or other factors such as inflation rates, recessionary or expansive trends, taxes, the effects of implementation of the Budget Control Act of 2011 and the American Taxpayer Relief Act of 2012 and the continuing economic uncertainty in various parts of the world; competitive pressures; fluctuations in interest rates; the level of defaults and prepayment on loans made by the Company; unanticipated litigation, claims, or assessments; fluctuations in the cost of obtaining funds to make loans; and regulatory changes. Additional detailed information concerning a number of important factors which could cause actual results to differ materially from the forward-looking statements contained in management’s discussion and analysis is available in the Company’s filings with the Securities and Exchange Commission, under the Securities Exchange Act of 1934, including the disclosure under the heading “Item 1A. Risk Factors” of Part 1 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012. Readers are cautioned not to place undue reliance on such forward looking statements, which speak only as of the date hereof. The Company undertakes no obligation and disclaims any intention to republish revised or updated forward looking statements, whether as a result of new information, unanticipated future events or otherwise.

CONSOLIDATED AVERAGE BALANCE SHEET & ANALYSIS OF NET INTEREST INCOME
Table I

(dollars in thousands)	December 31
	2012								2011								2010
	Average Balance			Income/ Expense		Yield/ Average			Average Balance			Income/ Expense		Yield/ Average			Average Balance			Income/ Expense		Yield/ Average
Assets
Interest-earning assets:
Interest-bearing balances with banks	$	81,387		$	195		0.24	%	$	67,947		$	163		0.24	%	$	43,450		$	93		0.21	%
Securities:
Taxable		104,178			1,887		1.81			102,740			2,043		1.99			93,846			2,462		2.62
Tax exempt		16,848			882		5.24			14,997			849		5.66			11,678			735		6.30
Loans		570,166			36,494		6.40			625,603			41,414		6.62			653,557			43,617		6.67
Total interest-earning assets		772,579			39,458		5.11	%		811,287			44,469		5.48	%		802,531			46,907		5.85	%

Noninterest-earning assets:
Cash and due from banks		10,777								9,855								8,836
Other nonearning assets		47,249								44,957								46,057
Allowance for loan losses		(8,032	)							(8,082	)							(8,722	)
Total noninterest-earning assets		49,994								46,730								46,171
Total assets	$	822,573							$	858,017							$	848,702

Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
NOW accounts	$	109,206		$	1,114		1.02	%	$	104,937		$	1,393		1.33	%	$	100,054		$	1,428		1.43	%
Savings and Money Market		203,000			597		0.29			196,312			1,317		0.67			164,297			1,582		0.96
Time deposits		228,917			3,353		1.46			281,864			5,726		2.03			327,330			8,043		2.46
Other borrowed money		20,038			493		2.46			43,475			644		1.48			63,631			1,405		2.21
Subordinated debentures		13,500			789		5.85			13,500			1,089		8.07			13,500			1,089		8.07
Total int.-bearing liabilities		574,661			6,346		1.11	%		640,088			10,169		1.59	%		668,812			13,547		2.03	%

Noninterest-bearing liabilities:
Demand deposit accounts		163,988								137,823								102,164
Other liabilities		9,893								10,240								10,120
Total noninterest-bearing liabilities		173,881								148,063								112,284

Shareholders’ equity		74,031								69,866								67,606
Total liabilities and shareholders’ equity	$	822,573							$	858,017							$	848,702

Net interest earnings				$	33,112							$	34,300							$	33,360
Net interest earnings as a percent of interest-earning assets							4.29	%							4.23	%							4.16	%
Net interest rate spread							4.00	%							3.89	%							3.82	%
Average interest-bearing liabilities to average earning assets							74.38	%							78.90	%							83.34	%

Fully taxable equivalent yields are calculated assuming a 34% tax rate, net of nondeductible interest expense. Average balances are computed on an average daily basis. The average balance for available for sale securities includes the market value adjustment. However, the calculated yield is based on the securities’ amortized cost. Average loan balances include nonaccruing loans. Loan income includes cash received on nonaccruing loans.

RATE VOLUME ANALYSIS OF CHANGES IN INTEREST INCOME & EXPENSE

Table II

(dollars in thousands)	2012									2011
	Increase (Decrease) From Previous Year Due to									Increase (Decrease) From Previous Year Due to
	Volume			Yield/Rate			Total			Volume			Yield/Rate			Total
Interest income
Interest-bearing balances with banks	$	32		$	-		$	32		$	57		$	13		$	70
Securities:
Taxable		29			(185	)		(156	)		217			(636	)		(419	)
Tax exempt		100			(67	)		33			194			(80	)		114
Loans		(3,581	)		(1,339	)		(4,920	)		(1,853	)		(350	)		(2,203	)
Total interest income		(3,420	)		(1,591	)		(5,011	)		(1,385	)		(1,053	)		(2,438	)

Interest expense
NOW accounts		55			(334	)		(279	)		68			(103	)		(35	)
Savings and Money Market		43			(763	)		(720	)		272			(537	)		(265	)
Time deposits		(955	)		(1,418	)		(2,373	)		(1,031	)		(1,286	)		(2,317	)
Other borrowed money		(450	)		299			(151	)		(396	)		(365	)		(761	)
Subordinated debentures		-			(300	)		(300	)		-			-			-
Total interest expense		(1,307	)		(2,516	)		(3,823	)		(1,087	)		(2,291	)		(3,378	)
Net interest earnings	$	(2,113	)	$	925		$	(1,188	)	$	(298	)	$	1,238		$	940

The change in interest due to volume and rate is determined as follows: Volume Variance - change in volume multiplied by the previous year's rate; Yield/Rate Variance - change in rate multiplied by the previous year's volume; Total Variance - change in volume multiplied by the change in rate. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. Fully taxable equivalent yield assumes a 34% tax rate, net of related nondeductible interest expense.

SECURITIES

Table III

	MATURING
as of December 31, 2012	Within One Year					After One but Within Five Years					After Five but Within Ten Years					After Ten Years
(dollars in thousands)	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield

U.S. Government sponsored entity securities	$	-		-		$	1,012		0.70	%	$	-		-		$	-		-
Obligations of states and political subdivisions		-		-			4,610		4.65	%		11,357		3.33	%		8,640		4.82	%
Agency mortgage-backed securities, residential		365		5.06	%		75,184		3.46	%		18,421		2.88	%		-		-
Total securities	$	365		5.06	%	$	80,806		3.49	%	$	29,778		3.05	%	$	8,640		4.82	%

Tax-equivalent adjustments have been made in calculating yields on obligations of states and political subdivisions using a 34% rate. Weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security. Mortgage-backed securities, which have prepayment provisions, are assigned to a maturity category based on estimated average lives. Securities are shown at their fair values, which include the market value adjustments for available for sale securities.

ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

Table IV

(dollars in thousands)	Years Ended December 31

	2012			2011			2010			2009			2008
Commercial loans(1)	$	4,729		$	4,129		$	6,936		$	5,777		$	5,898
Percentage of loans to total loans		41.60	%		42.22	%		43.96	%		42.68	%		39.78	%

Residential real estate loans		1,329			1,860			993			822			806
Percentage of loans to total loans		40.49	%		39.86	%		36.94	%		37.30	%		40.09	%

Consumer loans(2)		847			1,355			1,457			1,599			1,095
Percentage of loans to total loans		17.91	%		17.92	%		19.10	%		20.02	%		20.13	%

Allowance for Loan Losses	$	6,905		$	7,344		$	9,386		$	8,198		$	7,799
		100.00	%		100.00	%		100.00	%		100.00	%		100.00	%
Ratio of net charge-offs to average loans		.35	%		1.11	%		.72	%		.44	%		.42	%

The above allocation is based on estimates and subjective judgments and is not necessarily indicative of the specific amounts or loan categories in which losses may ultimately occur.

(1) Includes commercial and industrial and commercial real estate loans.

(2) Includes automobile, home equity and other consumer loans.

SUMMARY OF NONPERFORMING AND PAST DUE LOANS

Table V

(dollars in thousands)	At December 31

	2012			2011			2010			2009			2008
Impaired loans	$	17,401		$	11,572		$	23,106		$	27,644		$	21,153
Past due 90 days or more and still accruing		359			459			1,714			1,639			1,878
Nonaccrual		3,626			2,678			3,295			3,619			3,396
Accruing loans past due 90 days or more to total loans		.06	%		.08	%		.27	%		.25	%		.30	%
Nonaccrual loans as a % of total loans		.65	%		.45	%		.51	%		.56	%		.54	%
Impaired loans as a % of total loans		3.12	%		1.93	%		3.60	%		4.24	%		3.36	%
Allowance for loan losses as a % of total loans		1.24	%		1.23	%		1.46	%		1.26	%		1.24	%

Management believes that the impaired loan disclosures are comparable to the nonperforming loan disclosures except that the impaired loan disclosures do not include single family residential or consumer loans which are analyzed in the aggregate for loan impairment purposes.

Management formally considers placing a loan on nonaccrual status when collection of principal or interest has become doubtful. Furthermore, a loan should not be returned to the accrual status unless either all delinquent principal or interest has been brought current or the loan becomes well secured and is in the process of collection.

In 2009, the Company changed its methodology for identifying impaired loans. Amounts as of December 31, 2008 have been reclassified to be consistent with the 2009 methodology. The change resulted in reclassifying current or performing loans as impaired loans for which full payment under the original terms is not probable. As of December 31, 2008, $13,054 of loans were reclassified as impaired loans and the related general allowance for loan losses allocation of $2,450 was reclassified as a specific allowance for loan losses. Prior to the change in methodology, the general allowance for loan losses allocation related to these loans was based on historical credit losses, and these allocations were materially consistent with amounts that would have been determined had the loans been classified as impaired. The reclassification had no impact on the allowance for loan losses, the provision for loan losses, net income or retained earnings. Amounts as of December 31, 2008 have been reclassified to be consistent with the 2009 methodology; however, amounts prior to December 31, 2008 have not been reclassified.

MATURITY AND REPRICING DATA OF LOANS

Table VI

(dollars in thousands)	MATURING / REPRICING
	Within One Year		After One but Within Five Years		After Five Years		Total
Residential real estate loans	$	35,696	$	54,999	$	135,327	$	226,022
Commercial loans(1)		120,716		91,494		20,039		232,249
Consumer loans(2)		34,565		48,974		16,478		100,017
Total loans	$	190,977	$	195,467	$	171,844	$	558,288

Loans maturing or repricing after one year with:
Variable interest rates	$	124,727
Fixed interest rates		242,584
Total	$	367,311

(1) Includes commercial and industrial and commercial real estate loans.

(2) Includes automobile, home equity and other consumer loans.

DEPOSITS

Table VII

	as of December 31
(dollars in thousands)	2012		2011		2010
Interest-bearing deposits:
NOW accounts	$	106,581	$	101,907	$	101,833
Money Market		144,831		153,280		149,165
Savings accounts		52,231		46,792		42,751
IRA accounts		47,401		49,024		49,429
Certificates of Deposit		164,494		198,740		259,654
		515,538		549,743		602,832
Noninterest-bearing deposits:
Demand deposits		139,526		138,143		91,949
Total deposits	$	655,064	$	687,886	$	694,781

INTEREST RATE SENSITIVITY TABLE VIII

Change in Interest Rates Basis Points	December 31, 2012 % Change in Net Interest Income	December 31, 2011 % Change in Net Interest Income

+300	(3.20%)	(2.89%)
+200	(1.87%)	(1.75%)
+100	(.80%)	(.76%)
-100	(2.32%)	(2.36%)

CONTRACTUAL OBLIGATIONS

Table IX

	Payments Due In

(dollars in thousands)	Note Reference	One Year or Less		One to Three Years		Three to Five Years		Over Five Years		Total
Deposits without a stated maturity	E	$	443,169	$	-	$	-	$	-	$	443,169
Consumer and brokered time deposits	E		119,568		82,044		9,485		798		211,895
Other borrowed funds	G		3,238		3,831		1,875		5,341		14,285
Subordinated debentures	H		-		-		-		13,500		13,500
Lease obligations	D		452		506		282		-		1,240

KEY RATIOS

Table X

	2012			2011			2010			2009			2008

Return on average assets		.86	%		.68	%		.60	%		.81	%		.91	%
Return on average equity		9.53	%		8.35	%		7.54	%		10.23	%		11.62	%
Dividend payout ratio		62.29	%		57.59	%		65.67	%		47.95	%		42.94	%
Average equity to average assets		9.00	%		8.14	%		7.97	%		7.93	%		7.84	%


/s/Jeffrey E. Smith			/s/Thomas E. Wiseman
Jeffrey E. Smith			Thomas E. Wiseman
Chairman of the Board			President and CEO
Ohio Valley Banc Corp.			Ohio Valley Banc Corp.

American Cancer Society	Gallia Co. Community Foundation	Jackson Co. Fair Auction
Amer. Free Enterprise Leadership	Gallia Co. CVB	Jackson Co. Friends of 4-H
American Diabetes Assn.	Gallia Co. Emancipation Day	Jackson Co. Humane Society
American Legion	Gallia Co. Farm Bureau	Jackson Co. Red Cross
American Red Cross	Gallia Co. Gospel Sing	Jackson Elks
Amish School Auction	Gallia Co. Health Dept.	Jackson Firefighters Assn.
Angels Among Us 5-K Run	Gallia Co. Junior Fair	Jackson Freedom Fest
Aultman Hospice Program	Gallia Co. Local Schools	Jackson Ironmen Football Mothers
Beaver OktoberFest	Gallia Co. Relay for Life	Jackson Jaycees
Bend Area C.A.R.E.	Gallia Co. River Recreation Festival	Jackson Pee-Wee Football
Beverly Hills (WV) Youth B-Ball	Gallia Co. Sheriff’s Dept.	Jackson Stay-at-Home
Buckeye Hills Career Center	Gallia Co. Snack Pack	Jackson Support Our Soccer
Cabell Co. 4-H	Gallia Senior Citizens Ctr.	Jackson SWCD
Cabell Co. Canine Drug Program	Gallipolis Bass Busters	Jackson/Vinton Farm Bureau
Cabell Co. Fair	Gallipolis City Schools	Junior Achievement
Cabell Co. FFA	Gallipolis Elks	Juvenile Diabetes Research
Cabell Co. Fraternal Order of Police	Gallipolis In Bloom	JVAC Industries
Cabell Foundation	Gallipolis Jr. Women's Club	Kickin’ Summer Bash
Cabell Midland High School	Gallipolis Kiwanis	Lawrence Co. 4-H Horse
Chester Shade Historical Society	Gallipolis Lions Club	Lawrence Co. Beef Sweepstakes
Childrens Center of Ohio	Gallipolis Shrine Club	Lawrence Co. Fair Auction
Christian Life Academy	Garnet Wilson Public Library	Lawrence Co. Humane Society
City of Milton Fireworks	Golden Girls Group Home	Lillian Jones Museum
Delta Theta Sorority Cancer Walk	Greenfield Fire Dept. Ladies Aux.	Little Victories Animal Shelter
Digital River Project	Holzer Foundation, Camp Beaver	Main Street Point Pleasant
Earl Neff Pediatric Toy Fund	Holzer Medical Center	Marshall University
Elm Grove Youth League	Holzer Senior Care	Mason Co. 4-H
Field of Hope	Holzer Senior Outreach	Mason Co. Board of Education
Financial Ed. & Advocacy Initiative	Hospice of Huntington	Mason Co. Camp Sunshine
French Art Colony	Jackson ALS Walk	Mason Co. Chamber of Commerce
French City Chili Fest	Jackson Area YMCA	Mason Co. Fair & Queen Pageant
Friends Club of Oak Hill	Jackson Chamber of Commerce	Mason Co. Little League
Friends of Lake Alma	Jackson City Library	Mason Co. Schools
Gallia Co. 4-H	Jackson City Schools	Mason Co. Special Olympics
Gallia Co. Agricultural Society	Jackson Co. 4-H	Meigs Co. 4-H
Gallia Co. Animal Shelter	Jackson Co. Apple Festival	Meigs Co. Council on Aging
Gallia Co. Cattlemen Assn.	Jackson Co. Baseball	Meigs Co. Fair Bleacher Project
Gallia Co. Chamber of Commerce	Jackson Co. Dog Shelter	Meigs Co. Fair Livestock Auction
Gallia Co. Chautauqua	Jackson Co. Economic Development	Meigs Co. Schools

	Years Ended December 31
	2012			2011			2010			2009			2008
(dollars in thousands, except share and per share data)

SUMMARY OF OPERATIONS:

Total interest income	$	39,001		$	44,040		$	46,514		$	47,623		$	51,533
Total interest expense		6,346			10,169			13,547			16,932			20,828
Net interest income		32,655			33,871			32,967			30,691			30,705
Provision for loan losses		1,583			4,896			5,871			3,212			3,716
Total other income		8,483			7,222			6,154			7,598			6,046
Total other expenses		29,741			28,299			26,643			26,160			23,178
Income before income taxes		9,814			7,898			6,607			8,917			9,857
Income taxes		2,762			2,063			1,511			2,272			2,729
Net income		7,052			5,835			5,096			6,645			7,128

PER SHARE DATA:

Earnings per share	$	1.75		$	1.46		$	1.28		$	1.67		$	1.77
Cash dividends declared per share	$	1.09		$	0.84		$	0.84		$	.80		$	0.76
Book value per share	$	18.66		$	17.84		$	17.03		$	16.70		$	15.83
Weighted average number of common shares outstanding		4,030,322			4,001,435			3,984,229			3,983,034			4,018,367

AVERAGE BALANCE SUMMARY:

Total loans	$	570,166		$	625,603		$	653,557		$	641,878		$	629,225
Securities(1)		202,413			185,684			148,974			134,117			101,100
Deposits		705,111			720,936			693,845			652,453			606,126
Other borrowed funds(2)		33,538			56,975			77,131			89,945			102,218
Shareholders’ equity		74,031			69,866			67,606			64,941			61,346
Total assets		822,573			858,017			848,702			818,952			782,312

PERIOD END BALANCES:

Total loans	$	558,288		$	598,308		$	641,322		$	651,356		$	630,391
Securities(1)		159,791			157,515			165,070			113,307			99,218
Deposits		655,064			687,886			694,781			647,644			592,361
Shareholders’ equity		75,820			71,843			68,128			66,521			63,056
Total assets		769,223			804,177			851,514			811,988			781,108

KEY RATIOS:

Return on average assets		0.86	%		0.68	%		0.60	%		0.81	%		0.91	%
Return on average equity		9.53	%		8.35	%		7.54	%		10.23	%		11.62	%
Dividend payout ratio		62.29	%		57.59	%		65.67	%		47.95	%		42.94	%
Average equity to average assets		9.00	%		8.14	%		7.97	%		7.93	%		7.84	%

	As of December 31
	2012			2011
(dollars in thousands, except share and per share data)

Assets

Cash and noninterest-bearing deposits with banks	$	10,617		$	8,914
Interest-bearing deposits with banks		35,034			42,716
Total cash and cash equivalents		45,651			51,630

Securities available for sale		94,965			85,670
Securities held to maturity (estimated fair value: 2012 - $24,624; 2011 - $22,847)		23,511			22,848
Federal Home Loan Bank stock		6,281			6,281

Total loans		558,288			598,308
Less: Allowance for loan losses		(6,905	)		(7,344	)
Net loans		551,383			590,964

Premises and equipment, net		8,680			9,216
Other real estate owned		3,667			4,256
Accrued interest receivable		2,057			2,872
Goodwill		1,267			1,267
Bank owned life insurance and annuity assets		25,056			23,097
Other assets		6,705			6,076
Total assets	$	769,223		$	804,177

Liabilities

Noninterest-bearing deposits	$	139,526		$	138,143
Interest-bearing deposits		515,538			549,743
Total deposits		655,064			687,886

Other borrowed funds		14,285			20,296
Subordinated debentures		13,500			13,500
Accrued liabilities		10,554			10,652
Total liabilities		693,403			732,334

Commitments and Contingent Liabilities (See Note J)		-			-

Shareholders’ Equity

Common stock ($1.00 stated value per share, 10,000,000 shares authorized; 2012 - 4,721,943 shares issued; 2011 - 4,686,295 shares issued)		4,722			4,686
Additional paid-in capital		34,109			33,473
Retained earnings		51,094			48,435
Accumulated other comprehensive income		1,607			961
Treasury stock, at cost (659,739 shares)		(15,712	)		(15,712	)
Total shareholders’ equity		75,820			71,843
Total liabilities and shareholders’ equity	$	769,223		$	804,177

For the years ended December 31	2012			2011			2010
(dollars in thousands, except per share data)

Interest and dividend income:
Loans, including fees	$	36,329		$	41,263		$	43,462
Securities:
Taxable		1,608			1,776			2,187
Tax exempt		590			571			497
Dividends		279			267			275
Other interest		195			163			93
		39,001			44,040			46,514
Interest expense:
Deposits		5,064			8,436			11,053
Other borrowed funds		493			644			1,405
Subordinated debentures		789			1,089			1,089
		6,346			10,169			13,547
Net interest income		32,655			33,871			32,967
Provision for loan losses		1,583			4,896			5,871
Net interest income after provision for loan losses		31,072			28,975			27,096

Noninterest income:
Service charges on deposit accounts		1,831			2,218			2,202
Trust fees		199			215			233
Income from bank owned life insurance and annuity assets		782			725			741
Mortgage banking income		626			386			362
Electronic refund check / deposit fees		2,289			2,559			780
Debit/credit card interchange income		1,700			1,387			998
Net loss on other real estate owned		(150	)		(1,224	)		(177	)
Other		1,206			956			1,015
		8,483			7,222			6,154
Noninterest expense:
Salaries and employee benefits		17,418			16,650			15,647
Occupancy		1,565			1,585			1,609
Furniture and equipment		954			1,143			1,214
Corporation franchise tax		780			744			745
FDIC insurance		755			1,029			1,061
Data processing		1,021			891			685
Foreclosed assets		446			650			67
Other		6,802			5,607			5,615
		29,741			28,299			26,643
Income before income taxes		9,814			7,898			6,607
Provision for income taxes		2,762			2,063			1,511
NET INCOME	$	7,052		$	5,835		$	5,096
Other Comprehensive income:
Change in unrealized gains/losses on securities		979			1,127			(693	)
Income tax effect		(333	)		(383	)		236
Net of tax		646			744			(457	)
Comprehensive income	$	7,698		$	6,579		$	4,639
Earnings per share	$	1.75		$	1.46		$	1.28

For the years ended December 31, 2012, 2011, and 2010
(dollars in thousands, except share and per share data)
	Common Stock		Additional Paid-In Capital		Retained Earnings			Accumulated Other Comprehensive Income			Treasury Stock			Total Shareholders' Equity
Balances at January 1, 2010	$	4,644	$	32,704	$	44,211		$	674		$	(15,712	)	$	66,521

Net income		-		-		5,096			-			-			5,096
Other comprehensive income (loss), net		-		-		-			(457	)		-			(457	)
Common stock issued to ESOP, 16,047 shares		16		299		-			-			-			315
Cash dividends, $.84 per share		-		-		(3,347	)		-			-			(3,347	)
Balances at December 31, 2010		4,660		33,003		45,960			217			(15,712	)		68,128

Net income		-		-		5,835			-			-			5,835
Other comprehensive income (loss), net		-		-		-			744			-			744
Common stock issued to ESOP, 26,500 shares		26		470		-			-			-			496
Cash dividends, $.84 per share		-		-		(3,360	)		-			-			(3,360	)
Balances at December 31, 2011		4,686		33,473		48,435			961			(15,712	)		71,843

Net income		-		-		7,052			-			-			7,052
Other comprehensive income (loss), net		-		-		-			646			-			646
Common stock issued to ESOP, 32,765 shares		33		584		-			-			-			617
Common stock issued through dividend reinvestment, 2,883 shares		3		52		-			-			-			55
Cash dividends, $1.09 per share		-		-		(4,393	)		-			-			(4,393	)
Balances at December 31, 2012	$	4,722	$	34,109	$	51,094		$	1,607		$	(15,712	)	$	75,820

	% of Total Loans
	2012			2011
Residential real estate loans		40.49	%		39.86	%
Commercial real estate loans		31.35	%		34.67	%
Consumer loans		17.91	%		17.92	%
Commercial and industrial loans		10.25	%		7.55	%
		100.00	%		100.00	%

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Securities Available for Sale
December 31, 2012
U.S. Government sponsored entity securities	$	1,009	$	3	$	-		$	1,012
Agency mortgage-backed securities, residential		91,521		2,432		-			93,953
Total securities	$	92,530	$	2,435	$	-		$	94,965

December 31, 2011
U.S. Treasury securities	$	5,510	$	3	$	-		$	5,513
U.S. Government sponsored entity securities		2,501		58		-			2,559
Agency mortgage-backed securities, residential		76,203		1,407		(12	)		77,598
Total securities	$	84,214	$	1,468	$	(12	)	$	85,670

	Amortized Cost		Gross Unrecognized Gains		Gross Unrecognized Losses			Estimated Fair Value
Securities Held to Maturity
December 31, 2012
Obligations of states and political subdivisions	$	23,494	$	1,178	$	(65	)	$	24,607
Agency mortgage-backed securities, residential		17		-		-			17
Total securities	$	23,511	$	1,178	$	(65	)	$	24,624

December 31, 2011
Obligations of states and political subdivisions	$	22,825	$	558	$	(559	)	$	22,824
Agency mortgage-backed securities, residential		23		-		-			23
Total securities	$	22,848	$	558	$	(559	)	$	22,847

	Available for Sale				Held to Maturity
Debt Securities:	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Due in one year or less		-		-		-		-
Due in one to five years	$	1,009	$	1,012	$	4,529	$	4,684
Due in five to ten years		-		-		10,959		11,579
Due after ten years		-		-		8,006		8,344
Agency mortgage-backed securities, residential		91,521		93,953		17		17
Total debt securities	$	92,530	$	94,965	$	23,511	$	24,624

December 31, 2012	Less than 12 Months					12 Months or More					Total
Securities Held to Maturity	Fair Value		Unrecognized Loss			Fair Value		Unrecognized Loss			Fair Value		Unrecognized Loss

Obligations of states and political subdivisions	$	2,018	$	(63	)	$	260	$	(2	)	$	2,278	$	(65	)
Total held to maturity	$	2,018	$	(63	)	$	260	$	(2	)	$	2,278	$	(65	)

	2012		2011
Residential real estate	$	226,022	$	238,490
Commercial real estate:
Owner-occupied		104,842		129,364
Nonowner-occupied		52,792		56,620
Construction		17,376		21,471
Commercial and industrial		57,239		45,200
Consumer:
Automobile		41,168		45,702
Home equity		18,332		20,507
Other		40,517		40,954
		558,288		598,308
Less: Allowance for loan losses		6,905		7,344

Loans, net	$	551,383	$	590,964

December 31, 2012	Residential Real Estate			Commercial Real Estate			Commercial & Industrial			Consumer			Total
Allowance for loan losses:
Beginning balance	$	1,860		$	3,493		$	636		$	1,355		$	7,344
Provision for loan losses		395			2,367			(1,381	)		202			1,583
Loans charged off		(1,066	)		(1,949	)		(499	)		(1,622	)		(5,136	)
Recoveries		140			35			2,027			912			3,114
Total ending allowance balance	$	1,329		$	3,946		$	783		$	847		$	6,905

December 31, 2012	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Average Impaired Loans		Interest Income Recognized		Cash Basis Interest Recognized

With no related allowance recorded:
Residential real estate	$	619	$	407	$	-	$	493	$	-	$	-
Commercial real estate:
Owner-occupied		5,528		5,528		-		4,729		338		338
Nonowner-occupied		10,085		8,847		-		4,767		456		456
Commercial and industrial		426		-		-		-		-		-
Consumer:
Home equity		220		220		-		176		9		9

With an allowance recorded:
Residential real estate		420		420		128		420		23		23
Commercial real estate:
Nonowner-occupied		1,979		1,979		1,979		1,132		38		38

Total	$	19,277	$	17,401	$	2,107	$	11,717	$	864	$	864

	2010

Average of individually impaired loans during year	$	24,589
Interest income recognized during impairment	$	1,158
Cash basis interest income recognized	$	1,083

December 31, 2011	Pass		Criticized		Classified		Total
Commercial real estate:
Owner-occupied	$	103,743	$	15,030	$	10,591	$	129,364
Nonowner-occupied		30,375		12,815		13,430		56,620
Construction		19,519		-		1,952		21,471
Commercial and industrial		36,633		3,250		5,317		45,200
Total	$	190,270	$	31,095	$	31,290	$	252,655

	2012		2011
Land	$	1,802	$	1,890
Buildings		10,235		10,334
Leasehold improvements		2,872		2,855
Furniture and equipment		14,281		13,961
		29,190		29,040
Less accumulated depreciation		20,510		19,824
Total premises and equipment	$	8,680	$	9,216

2013	$	452
2014		319
2015		187
2016		160
2017		122
Thereafter		-
	$	1,240

	Loans Past Due 90 Days And Still Accruing		Nonaccrual
December 31, 2012
Residential real estate	$	341	$	2,533
Commercial real estate:
Owner-occupied		-		675
Nonowner-occupied		-		352
Consumer:
Automobile		11		4
Home equity		-		62
Other		7		-

Total	$	359	$	3,626

December 31, 2012	30-59 Days Past Due		60-89 Days Past Due		90 Days Or More Past Due		Total Past Due		Loans Not Past Due		Total
Residential real estate	$	5,525	$	1,033	$	2,797	$	9,355	$	216,667	$	226,022
Commercial real estate:
Owner-occupied		753		111		675		1,539		103,303		104,842
Nonowner-occupied		–		–		352		352		52,440		52,792
Construction		–		–		–		–		17,376		17,376
Commercial and industrial		202		–		–		202		57,037		57,239
Consumer:
Automobile		905		138		13		1,056		40,112		41,168
Home equity		112		37		62		211		18,121		18,332
Other		1,066		162		7		1,235		39,282		40,517

Total	$	8,563	$	1,481	$	3,906	$	13,950	$	544,338	$	558,288

	TDR’s Performing to Modified Terms		TDR’s Not Performing to Modified Terms		Total TDR’s
December 31, 2012
Residential real estate
Interest only payments	$	-	$	180	$	180
Rate reduction		420		-		420
Commercial real estate:
Owner-occupied
Interest only payments		-		675		675
Rate reduction		440		-		440
Maturity extension at lower stated rate than market rate		191		-		191
Reduction of principal and interest payments		4,222		-		4,222
Nonowner-occupied
Interest only payments		9,856		300		10,156
Reduction of principal and interest payments		670		-		670

Total TDR’s	$	15,799	$	1,155	$	16,954

	TDR’s Performing to Modified Terms				TDR’s Not Performing to Modified Terms
	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Pre-Modification Recorded Investment		Post-Modification Recorded Investment
December 31, 2012
Commercial real estate:
Owner-occupied
Reduction of principal and interest payments	$	4,308	$	4,308		-		-
Nonowner-occupied
Interest only payments		5,984		5,984		-		-
Reduction of principal and interest payments		686		686		-		-

Total TDR’s	$	10,978	$	10,978		-		-

	FHLB Borrowings		Promissory Notes		Totals
2012	$	10,759	$	3,526	$	14,285
2011	$	16,548	$	3,748	$	20,296

	2012			2011
Items giving rise to deferred tax assets:
Allowance for loan losses	$	2,394		$	2,551
Deferred compensation		1,709			1,558
Deferred loan fees/costs		322			376
Other real estate owned		554			440
Other		199			179
Items giving rise to deferred tax liabilities:
Mortgage servicing rights		(156	)		(149	)
FHLB stock dividends		(1,081	)		(1,081	)
Unrealized gain on securities available for sale		(828	)		(495	)
Depreciation		(146	)		(250	)
Prepaid expenses		(73	)		(140	)
Intangibles		(363	)		(330	)
Other		-			(1	)
Net deferred tax asset	$	2,531		$	2,658

	2012		2011
Fixed rate	$	678	$	1,456
Variable rate		50,488		54,860
Standby letters of credit		5,959		5,486

Total loans at January 1, 2012	$	5,088
New loans		1,427
Repayments		(797	)
Other changes		-
Total loans at December 31, 2012	$	5,718

	Fair Value Measurements at December 31, 2012, Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Government sponsored entity securities		-	$	1,012		-
Agency mortgage-backed securities, residential		-		93,953		-

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range			(Weighted Average)
Other real estate owned:
Commercial real estate:
Construction	$	1,562	Sales approach	Adjustment to comparables		15	%		15	%
Commercial		1,055	Sales approach	Adjustment to comparables		15	%		15	%

			Fair Value Measurements at December 31, 2012 Using:
	Carrying Value		Level 1		Level 2		Level 3		Total
Financial Assets:
Cash and cash equivalents	$	45,651	$	45,651	$	-	$	-	$	45,651
Securities available for sale		94,965		-		94,965		-		94,965
Securities held to maturity		23,511		-		11,569		13,055		24,624
Federal Home Loan Bank stock		6,281		N/A		N/A		N/A		N/A
Loans, net		551,383		-		-		564,059		564,059
Accrued interest receivable		2,057		-		283		1,774		2,057

Financial Liabilities:
Deposits		655,064		139,526		517,680		-		657,206
Other borrowed funds		14,285		-		14,536		-		14,536
Subordinated debentures		13,500		-		10,146		-		10,146
Accrued interest payable		1,377		2		1,375		-		1,377

	Actual					Minimum Required For Capital Adequacy Purposes					Minimum Required To Be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
2012
Total capital (to risk weighted assets)
Consolidated	$	93,158		17.2	%	$	43,234		8.0	%	$	54,043		N/A
Bank		84,267		15.9			42,506		8.0			53,132		10.0	%
Tier 1 capital (to risk weighted assets)
Consolidated		86,401		16.0			21,617		4.0			32,426		N/A
Bank		77,690		14.6			21,253		4.0			31,879		6.0
Tier 1 capital (to average assets)
Consolidated		86,401		10.9			31,571		4.0			39,464		N/A
Bank		77,690		10.0			31,010		4.0			38,763		5.0

2011
Total capital (to risk weighted assets)
Consolidated	$	90,288		15.6	%	$	46,174		8.0	%	$	57,718		N/A
Bank		81,991		14.4			45,544		8.0			56,930		10.0	%
Tier 1 capital (to risk weighted assets)
Consolidated		83,072		14.4			23,087		4.0			34,631		N/A
Bank		74,975		13.2			22,772		4.0			34,158		6.0
Tier 1 capital (to average assets)
Consolidated		83,072		10.3			32,414		4.0			40,517		N/A
Bank		74,975		9.4			31,969		4.0			39,962		5.0

	Years ended December 31:
Assets	2012		2011
Cash and cash equivalents	$	1,700	$	1,462
Investment in subsidiaries		87,950		84,038
Notes receivable - subsidiaries		3,423		3,743
Other assets		310		406
Total assets	$	93,383	$	89,649

Liabilities
Notes payable	$	3,526	$	3,748
Subordinated debentures		13,500		13,500
Other liabilities		537		558
Total liabilities	$	17,563	$	17,806

Shareholders’ Equity
Total shareholders’ equity		75,820		71,843
Total liabilities and shareholders’ equity	$	93,383	$	89,649

	Years ended December 31:
Income:	2012		2011		2010
Interest on notes	$	114	$	134	$	158
Other operating income		84		65		68
Dividends from subsidiaries		4,500		3,500		4,500

Expenses:
Interest on notes		114		134		159
Interest on subordinated debentures		789		1,089		1,089
Operating expenses		364		287		538
Income before income taxes and equity in undistributed earnings of subsidiaries		3,431		2,189		2,940
Income tax benefit		355		439		522
Equity in undistributed earnings of subsidiaries		3,266		3,207		1,634
Net Income	$	7,052	$	5,835	$	5,096

	Years ended December 31:
Cash flows from operating activities:	2012			2011			2010
Net Income	$	7,052		$	5,835		$	5,096
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed earnings of subsidiaries		(3,266	)		(3,207	)		(1,634	)
Common stock issued to ESOP		617			496			315
Change in other assets		96			(92	)		(12	)
Change in other liabilities		(21	)		105			64
Net cash provided by operating activities		4,478			3,137			3,829

Cash flows from investing activities:
Change in notes receivable		320			85			402
Net cash provided by investing activities		320			85			402
Cash flows from financing activities:
Change in notes payable		(222	)		(87	)		(412	)
Proceeds from common stock through dividend reinvestment		55			-			-
Cash dividends paid		(4,393	)		(3,360	)		(3,347	)
Net cash used in financing activities		(4,560	)		(3,447	)		(3,759	)
Cash and cash equivalents:
Change in cash and cash equivalents		238			(225	)		472
Cash and cash equivalents at beginning of year		1,462			1,687			1,215
Cash and cash equivalents at end of year	$	1,700		$	1,462		$	1,687

	Year Ended December 31, 2012
	Banking		Consumer Finance		Total Company
Net interest income	$	29,445	$	3,210	$	32,655
Provision expense	$	1,527	$	56	$	1,583
Noninterest income	$	7,734	$	749	$	8,483
Noninterest expense	$	27,384	$	2,357	$	29,741
Tax expense	$	2,240	$	522	$	2,762
Net income	$	6,028	$	1,024	$	7,052
Assets	$	754,490	$	14,733	$	769,223

	Year Ended December 31, 2011
	Banking		Consumer Finance		Total Company
Net interest income	$	30,792	$	3,079	$	33,871
Provision expense	$	4,809	$	87	$	4,896
Noninterest income	$	6,327	$	895	$	7,222
Noninterest expense	$	26,130	$	2,169	$	28,299
Tax expense	$	1,483	$	580	$	2,063
Net income	$	4,697	$	1,138	$	5,835
Assets	$	789,744	$	14,433	$	804,177

	Year Ended December 31, 2010
	Banking		Consumer Finance		Total Company
Net interest income	$	30,074	$	2,893	$	32,967
Provision expense	$	5,717	$	154	$	5,871
Noninterest income	$	5,578	$	576	$	6,154
Noninterest expense	$	24,756	$	1,887	$	26,643
Tax expense	$	1,029	$	482	$	1,511
Net income	$	4,149	$	947	$	5,096
Assets	$	837,359	$	14,155	$	851,514

	Quarters Ended
2012	Mar. 31		Jun. 30		Sept. 30		Dec. 31

Total interest income	$	10,665	$	9,657	$	9,405	$	9,274
Total interest expense		1,753		1,604		1,538		1,451
Net interest income		8,912		8,053		7,867		7,823
Provision for loan losses(1)		1,316		524		1,183		(1,440	)
Noninterest income		3,479		1,974		1,674		1,356
Noninterest expense		7,332		7,162		6,957		8,290
Net income		2,622		1,719		1,107		1,604

Earnings per share	$	0.65	$	0.43	$	0.27	$	.40

2011
Total interest income	$	12,025	$	10,817	$	10,693	$	10,505
Total interest expense		2,822		2,663		2,509		2,175
Net interest income		9,203		8,154		8,184		8,330
Provision for loan losses(2)		2,944		759		1,152		41
Noninterest income		3,659		1,687		1,058		818
Noninterest expense		7,098		6,981		7,001		7,219
Net income		2,033		1,555		886		1,361

Earnings per share	$	0.51	$	0.39	$	0.22	$	0.34

2010
Total interest income	$	12,228	$	11,599	$	11,438	$	11,249
Total interest expense		3,619		3,421		3,328		3,179
Net interest income		8,609		8,178		8,110		8,070
Provision for loan losses(3)		921		721		2,225		2,004
Noninterest income		1,865		1,524		1,382		1,383
Noninterest expense		6,881		6,976		6,863		5,923
Net income		1,906		1,471		421		1,298

Earnings per share	$	0.48	$	0.37	$	.10	$	0.33