10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2011

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER: 0-22955

BAY BANKS OF VIRGINIA, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

VIRGINIA	54-1838100
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)	(I.R.S. EMPLOYER IDENTIFICATION NO.)

100 SOUTH MAIN STREET, KILMARNOCK, VA	22482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)	(ZIP CODE)

(804) 435-1171

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  yes    ¨  no

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  yes    ¨  no

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  yes    x  no

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

2,605,856 shares of common stock on August 9, 2011

FORM 10-Q

For the interim period ending June 30, 2011.

INDEX

PART I - FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS JUNE 30, 2011 (UNAUDITED) AND DECEMBER 31, 2010		3
CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE  30, 2011 AND 2010 (UNAUDITED)		4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)		5
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (UNAUDITED)		6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS		7
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	19
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	27
ITEM 4.	CONTROLS AND PROCEDURES	27
PART II - OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	28
ITEM 1A.	RISK FACTORS	28
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	28
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	28
ITEM 4.	REMOVED AND RESERVED	28
ITEM 5.	OTHER INFORMATION	28
ITEM 6.	EXHIBITS	28

2

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

	June 30, 2011		December 31, 2010
	(Unaudited)
ASSETS
Cash and due from banks	$	4,169,893	$	3,275,584
Interest-bearing deposits		29,354,853		14,735,892
Federal funds sold		5,314,545		4,727,084
Securities available for sale, at fair value		31,174,512		34,073,728
Restricted securities		2,281,800		2,358,500
Loans, net of allowance for loan losses of $3,317,105 and $3,230,677		234,199,711		244,142,325
Premises and equipment, net		12,392,041		12,697,447
Accrued interest receivable		1,164,530		1,159,924
Other real estate owned, net of valuation allowance		3,165,995		4,085,939
Goodwill		2,807,842		2,807,842
Other assets		2,692,201		3,021,300
Total assets	$	328,717,923	$	327,085,565
LIABILITIES
Noninterest-bearing deposits	$	43,089,933	$	44,960,718
Savings and interest-bearing demand deposits		109,081,025		103,908,863
Time deposits		114,886,421		111,984,418
Total deposits	$	267,057,379	$	260,853,999
Federal funds purchased and securities sold under repurchase agreements		7,491,774		7,598,021
Federal Home Loan Bank advances		25,000,000		30,000,000
Other liabilities		1,348,634		1,291,235
Commitments and contingencies		—		—
Total liabilities	$	300,897,787	$	299,743,255
SHAREHOLDERS’ EQUITY
Common stock ($5 par value; authorized - 5,000,000 shares; outstanding - 2,605,856 and 2,605,856 shares, respectively)	$	13,029,280	$	13,029,280
Additional paid-in capital		4,973,408		4,965,460
Retained earnings		9,408,864		9,193,492
Accumulated other comprehensive income, net		408,584		154,078
Total shareholders’ equity	$	27,820,136	$	27,342,310
Total liabilities and shareholders’ equity	$	328,717,923	$	327,085,565

See Notes to unaudited Consolidated Financial Statements.

3

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

	Quarter ended June 30, 2011			Quarter ended June 30, 2010			For the six months ended June 30, 2011			For the six months ended June 30, 2010
INTEREST INCOME
Loans, including fees	$	3,422,673		$	3,630,664		$	6,860,836		$	7,238,354
Securities:
Taxable		188,895			233,064			394,029			477,832
Tax-exempt		60,161			79,899			124,611			184,220
Federal funds sold		2,142			1,406			5,114			2,469
Interest -bearing deposit accounts		14,810			11,126			23,870			21,481
Total interest income		3,688,681			3,956,159			7,408,460			7,924,356
INTEREST EXPENSE
Deposits		833,092			1,050,214			1,653,773			2,121,908
Federal funds purchased		—			131			—			131
Securities sold under repurchase agreements		4,011			3,203			7,409			6,009
FHLB advances		253,598			346,613			595,786			688,801
Total interest expense		1,090,701			1,400,161			2,256,968			2,816,849
Net interest income		2,597,980			2,555,998			5,151,492			5,107,507
Provision for loan losses		165,000			196,422			220,000			392,844
Net interest income after provision for loan losses		2,432,980			2,359,576			4,931,492			4,714,663
NON-INTEREST INCOME
Income from fiduciary activities		149,054			140,961			303,487			286,169
Service charges and fees on deposit accounts		158,029			162,909			324,285			317,116
VISA-related fees		193,420			207,893			356,378			359,054
Other service charges and fees		205,435			182,815			371,030			347,571
Secondary market lending fees		18,817			29,720			56,705			79,313
Gains on sale of securities available for sale		125,259			137,416			123,583			138,842
Other real estate gains (losses)		(170,277	)		—			(288,053	)		32,261
Other income		16,061			2,927			23,261			5,092
Total non-interest income		695,798			864,641			1,270,676			1,565,418
NON-INTEREST EXPENSES
Salaries and employee benefits		1,548,310			1,488,970			3,080,486			2,986,507
Occupancy expense		479,328			478,788			944,442			1,001,171
Bank franchise tax		36,780			41,115			73,560			82,230
VISA expense		167,698			174,667			294,835			293,499
Telephone expense		45,283			42,024			88,336			90,215
FDIC assessments		104,856			162,027			251,954			268,260
Other expense		654,160			678,150			1,241,238			1,263,905
Total non-interest expenses		3,036,415			3,065,741			5,974,851			5,985,787
Net income before income taxes		92,363			158,476			227,317			294,294
Income tax		5,727			16,312			11,945			16,854
Net income	$	86,636		$	142,164		$	215,372		$	277,440
Basic Earnings Per Share
Average basic shares outstanding		2,605,856			2,605,856	*		2,605,856			2,605,856	*
Earnings per share, basic	$	0.03		$	0.05		$	0.08		$	0.11
Diluted Earnings Per Share
Average diluted shares outstanding		2,605,856			2,605,856	*		2,605,856			2,605,856	*
Earnings per share, diluted	$	0.03		$	0.05		$	0.08		$	0.11

* Adjusted for a 1-for-25 stock dividend on August 27, 2010.

See Notes to Consolidated Financial Statements.

4

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(unaudited)

	Common Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income			Total Shareholders’ Equity
Balance at January 1, 2010	$	12,047,357	$	4,842,756	$	9,912,781		$	95,697		$	26,898,591
Comprehensive income:
Net income		—		—		277,440			—			277,440
Changes in unrealized holding gains on securities arising during the period, net of taxes of $147,988		—		—		—			287,272
Reclassification adjustment for securities gains included in net income, net of taxes of ($47,206)		—		—		—			(91,636	)
Total other comprehensive income									195,636			195,636
Total comprehensive income												473,076
Stock-based compensation		—		9,527		—			—			9,527
Stock dividend		481,402		168,491		(650,558	)		—			(665	)
Balance at June 30, 2010	$	12,528,759	$	5,020,774	$	9,539,663		$	291,333		$	27,380,529
Balance at January 1, 2011	$	13,029,280	$	4,965,460	$	9,193,492		$	154,078		$	27,342,310
Comprehensive income:
Net income		—		—		215,372			—			215,372
Changes in unrealized holding gains on securities arising during the period, net of taxes of $173,128		—		—		—			336,071
Reclassification adjustment for securities gains included in net income, net of taxes of ($42,018)		—		—		—			(81,565	)
Total other comprehensive income									254,506			254,506
Total comprehensive income												469,878
Stock-based compensation		—		7,948		—			—			7,948
Balance at June 30, 2011	$	13,029,280	$	4,973,408	$	9,408,864		$	408,584		$	27,820,136

See Notes to Consolidated Financial Statements.

5

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

Six months ended	June 30, 2011			June 30, 2010
Cash Flows From Operating Activities
Net income	$	215,372		$	277,440
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		407,458			448,494
Net amortization and accretion of securities		38,178			24,369
Provision for loan losses		220,000			392,844
Stock-based compensation		7,948			9,527
Deferred income tax (benefit)		—			(20,805	)
(Gain) on securities available-for-sale		(123,583	)		(138,842	)
Increase in OREO valuation allowance		249,835			—
Loss (Gain) on sale of other real estate		38,218			(32,261	)
(Gain) on disposal of fixed assets		(4,082	)		—
Decrease in accrued income and other assets		297,060			549,804
(Decrease) increase in other liabilities		(73,710	)		79,950
Net cash provided by operating activities	$	1,272,694		$	1,590,520
Cash Flows From Investing Activities
Proceeds from maturities and principal paydowns of available-for-sale securities		4,769,373			1,304,634
Proceeds from sales and calls of available-for-sale securities		4,081,190			9,722,377
Purchases of available-for-sale securities		(5,480,327	)		(9,727,304	)
Sales (purchases) of restricted securities		76,700			(120,000	)
(Increase) in interest bearing deposits in other banks		(14,618,961	)		(3,102,027	)
(Increase) in federal funds sold		(587,461	)		(2,421,182	)
Loan principal collections, net		8,502,482			119,745
Proceeds from sale of other real estate		1,879,456			290,761
Purchases of premises and equipment		(97,970	)		(106,051	)
Net cash (used in) investing activities	$	(1,475,518	)	$	(4,039,047	)
Cash Flows From Financing Activities
Increase in demand, savings, and other interest-bearing deposits		3,301,377			2,824,571
Net increase in time deposits		2,902,003			465,557
Net (decrease) increase in securities sold under repurchase agreements and federal funds purchased		(106,247	)		253,416
Decrease in FHLB advances		(5,000,000	)		—
Dividends paid and cash in lieu of fractional shares		—			(665	)
Net cash provided by financing activities	$	1,097,133		$	3,542,879
Net increase in cash and due from banks		894,309			1,094,351
Cash and due from banks at beginning of period		3,275,584			3,461,483
Cash and due from banks at end of period	$	4,169,893		$	4,555,834
Supplemental Schedule of Cash Flow Information
Interest paid	$	2,354,537		$	2,816,982
Income taxes paid		103,827			—
Unrealized gain on investment securities		385,616			296,418
Loans transferred to other real estate owned		1,220,132			2,512,044

See Notes to Consolidated Financial Statements.

6

Notes to Consolidated Financial Statements

Note 1: General

Bay Banks of Virginia, Inc. (the “Company”) owns 100% of the Bank of Lancaster (the “Bank”), 100% of Bay Trust Company, Inc. (the “Trust Company”) and 100% of Steptoes Holdings, LLC (“Steptoes Holdings”). The consolidated financial statements include the accounts of the Bank, the Trust Company, Steptoes Holdings and Bay Banks of Virginia, Inc.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and to the general practices within the banking industry. In management’s opinion, all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the consolidated financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

Certain amounts in the consolidated financial statements have been reclassified to conform to current year presentations.

These consolidated financial statements should be read in conjunction with the financial statements and notes to financial statements included in the Company’s 2010 Annual Report to Shareholders.

Note 2: Securities

The aggregate amortized costs and fair values of the available-for-sale securities portfolio are as follows:

Available-for-sale securities June 30, 2011 (unaudited)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. Government agencies	$	6,723,872	$	68,976	$	(3,134	)	$	6,789,714
State and municipal obligations		23,613,852		794,722		(23,776	)		24,384,798
	$	30,337,724	$	863,698	$	(26,910	)	$	31,174,512
Available-for-sale securities December 31, 2010	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. Government agencies	$	8,738,339	$	43,318	$	(27,800	)	$	8,753,857
State and municipal obligations		24,884,217		502,878		(67,224	)		25,319,871
	$	33,622,556	$	546,196	$	(95,024	)	$	34,073,728

Securities with a market value of $9.0 million were pledged as collateral for repurchase agreements and for other purposes as required by law as of June 30, 2011. The market value of pledged securities at December 31, 2010 was $9.9 million.

Securities in an unrealized loss position at June 30, 2011 and December 31, 2010, by duration of the unrealized loss, are shown below. The unrealized loss positions were directly related to interest rate movements as there is minimal credit risk exposure in these investments. All securities are investment grade or better and all losses are considered temporary. Management does not intend to sell the securities and does not expect to be required to sell the securities. Furthermore, we do expect to recover the entire amortized cost basis. Bonds with unrealized loss positions at June 30, 2011 included 1 mortgage backed security, 1 federal agency and 5 municipal bonds. Bonds with unrealized loss positions at December 31, 2010 included 16 municipals and 4 federal agencies. The tables are shown below.

7

	Less than 12 months				12 months or more				Total
June 30, 2011 (unaudited)	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government agencies	$	860,694	$	3,134	$	—	$	—	$	860,694	$	3,134
States and municipal obligations		2,018,056		23,776		—		—		2,018,056		23,776
Total temporarily impaired securities	$	2,878,750	$	26,910	$	—	$	—	$	2,878,750	$	26,910
	Less than 12 months				12 months or more				Total
December 31, 2010	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government agencies	$	1,964,436	$	27,800	$	—	$	—	$	1,964,436	$	27,800
States and municipal obligations		6,679,896		67,224		—		—		6,679,896		67,224
Total temporarily impaired securities	$	8,644,332	$	95,024	$	—	$	—	$	8,644,332	$	95,024

The Company’s investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock totaled $1.8 million at June 30, 2011 and December 31, 2010. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs or its member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Despite the FHLB’s temporary suspension of repurchases of excess capital stock in 2010, the Company does not consider this investment to be other-than-temporarily impaired at June 30, 2011 and no impairment has been recognized. FHLB stock is shown in the restricted securities line item on the consolidated balance sheets and is not a part of the available-for-sale securities portfolio.

Note 3: Loans

The following is a summary of the balances of loans:

	June 30, 2011			December 31, 2010
	(unaudited)
Mortgage loans on real estate:
Construction, Land and Land Development	$	28,681,177		$	30,620,370
Farmland		1,565,749			1,603,519
Commercial Mortgages (Non-Owner Occupied)		13,738,304			12,787,559
Commercial Mortgages (Owner Occupied)		28,692,533			29,430,716
Residential First Mortgages		110,029,330			115,530,317
Residential Junior Mortgages		29,762,265			30,943,025
Commercial and Industrial loans		16,706,807			17,591,891
Consumer Loans		8,340,651			8,865,605
Total loans	$	237,516,816		$	247,373,002
Allowance for loan losses		(3,317,105	)		(3,230,677	)
Loans, net	$	234,199,711		$	244,142,325

8

The recorded investment in past due and nonaccruing loans is shown in the following table. A loan past due by more than 90 days is generally placed on nonaccrual unless it is both well secured and in the process of collection.

Loans Past Due and Nonaccruals June 30, 2011 (unaudited)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccruals		Total Past Due and Nonaccruals		Current		Total Loans
Construction, Land and Land Development	$	—	$	—	$	—	$	405,735	$	405,735	$	28,275,442	$	28,681,177
Farmland		—		—		—		—		—		1,565,749		1,565,749
Commercial Mortgages (Non-Owner Occupied)		—		318,418		—		65,750		384,168		13,354,136		13,738,304
Commercial Mortgages (Owner Occupied)		—		—		—		424,249		424,249		28,268,284		28,692,533
Residential First Mortgages		647,960		641,097		—		1,295,266		2,584,323		107,445,007		110,029,330
Residential Junior Mortgages		96,614		391,088		—		1,572,134		2,059,836		27,702,429		29,762,265
Commercial and Industrial		18,834		—		—		657,274		676,108		16,030,699		16,706,807
Consumer Loans		33,650		15,998		3,006		125,925		178,579		8,162,072		8,340,651
Total	$	797,058	$	1,366,601	$	3,006	$	4,546,333	$	6,712,998	$	230,803,818	$	237,516,816
Loans Past Due and Nonaccruals December 31, 2010	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccruals		Total Past Due and Nonaccruals		Current		Total Loans
Construction, Land and Land Development	$	—	$	96,153	$	—	$	342,618	$	438,771	$	30,181,599	$	30,620,370
Farmland		—		—		—		—		—		1,603,519		1,603,519
Commercial Mortgages (Non-Owner Occupied)		318,043		—		—		1,356,108		1,674,151		11,113,408		12,787,559
Commercial Mortgages (Owner Occupied)		—		—		—		424,249		424,249		29,006,467		29,430,716
Residential First Mortgages		1,694,757		281,878		—		2,174,010		4,150,645		111,379,672		115,530,317
Residential Junior Mortgages		370,812		—		730		1,169,919		1,541,461		29,401,564		30,943,025
Commercial and Industrial		408,738		—		198,606		65,001		672,345		16,919,546		17,591,891
Consumer Loans		667,355		5,984		3,013		42,104		718,456		8,147,149		8,865,605
Total	$	3,459,705	$	384,015	$	202,349	$	5,574,009	$	9,620,078	$	237,752,924	$	247,373,002

Note 4: Allowance for Loan Losses

A disaggregation of and an analysis of the change in the allowance for loan losses by segment is shown below.

Allowance for Loan Losses by Portfolio Segment

For the six months ended June 30, 2011 (unaudited)

	Construction, Land and Land Development			Farmland		Commercial Mortgages (Non Owner Occupied)			Commercial Mortgages (Owner Occupied)			Residential First Mortgages			Residential Junior Mortgages			Commercial and Industrial		Consumer Loans			Unallocated			Total
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	192,518		$	3,000	$	108,000		$	1,270,451		$	206,171		$	460,648		$	69,869	$	210,662		$	709,358		$	3,230,677
(Charge-offs)							(52,117	)					(39,956	)		(18,379	)				(43,602	)				$	(154,054	)
Recoveries		175																			20,307					$	20,482
Provision		(1,373	)		2,000		24,117			(155,073	)		431,283			158,722			29,479		(68,896	)		(200,259	)	$	220,000
Ending Balance	$	191,320		$	5,000	$	80,000		$	1,115,378		$	597,498		$	600,991		$	99,348	$	118,471		$	509,099		$	3,317,105
Individually evaluated for impairment	$	76,320		$	—	$	—		$	223,378		$	109,498		$	308,991		$	14,479	$	4,471		$	—		$	737,137
Collectively evaluated for impairment	$	115,000		$	5,000	$	80,000		$	892,000		$	488,000		$	292,000		$	84,869	$	114,000		$	509,099		$	2,579,968
LOAN RECEIVABLES:
Ending Balance:
Individually evaluated for impairment	$	342,618		$	—	$	—		$	2,194,621		$	2,230,571		$	1,487,130		$	458,668	$	556,087					$	7,269,695
Collectively evaluated for impairment		28,338,559			1,565,749		13,738,304			26,497,912			107,798,759			28,275,135			16,248,139		7,784,564						230,247,121
Total Gross Loans	$	28,681,177		$	1,565,749	$	13,738,304		$	28,692,533		$	110,029,330		$	29,762,265		$	16,706,807	$	8,340,651					$	237,516,816

9

Provision is negative for Construction, Land and Land Development loans due to a reduction in the size of this segment, which reduces the necessary allowance. Provision is negative for the Commercial Mortgages (Owner Occupied) segment due mainly to the charge-off of one impaired loan, which reduced the allowance for impairments by $238 thousand, plus the addition of one impaired loan and an increase in the impairment allowance for one other loan. Provision is negative for Consumer loans because charge-offs are lower, resulting in a smaller historical charge-off factor.

Allowance for Loan Losses by Portfolio Segment

For the Year Ended December 31, 2010

	Construction, Land and Land Development		Farmland		Commercial Real Estate (Non-Owner Occupied)		Commercial Real Estate (Owner Occupied)		Residential First Mortgages		Residential Junior Mortgages		Commercial and Industrial		Consumer Loans		Unallocated		Total
Allowance for loan losses:
Beginning Balance																			$	3,769,287
Charge-offs																				(1,491,707	)
Recoveries																				232,883
Provision																				720,214
Ending Balance	$	192,518	$	3,000	$	108,000	$	1,270,451	$	206,171	$	460,648	$	69,869	$	210,662	$	709,358	$	3,230,677
Individually evaluated for impairment	$	64,518	$	—	$	—	$	397,451	$	93,171	$	67,648	$	—	$	17,662	$	—	$	640,450
Collectively evaluated for impairment	$	128,000	$	3,000	$	108,000	$	873,000	$	113,000	$	393,000	$	69,869	$	193,000	$	709,358	$	2,590,227
Loan Receivables:
Ending Balance:
Individually evaluated for impairment	$	342,618	$	—	$	711,850	$	1,966,334	$	1,803,831	$	1,474,024	$	65,000	$	569,918			$	6,933,575
Collectively evaluated for impairment		30,277,752		1,603,519		12,075,709		27,464,382		113,726,486		29,469,001		17,526,891		8,295,687				240,439,427
Total Gross Loans	$	30,620,370	$	1,603,519	$	12,787,559	$	29,430,716	$	115,530,317	$	30,943,025	$	17,591,891	$	8,865,605			$	247,373,002

	December 31, 2010			June 30, 2010
				(unaudited)
Balance, beginning of year	$	3,769,287		$	3,769,287
Provision for loan losses		720,214			392,844
Recoveries		232,883			166,484
Loans charged off		(1,491,707	)		(1,134,757	)
Balance, end of period	$	3,230,677		$	3,193,858

Internal risk rating grades are assigned to commercial loans not secured by real estate, commercial mortgages, residential mortgages greater than $1 million, loans to real estate developers and contractors, and consumer loans greater than $250,000 with chronic delinquency, as shown in the following table. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. Risk grades are evaluated as new information becomes available for each borrowing relationship or at least quarterly.

10

As of June 30, 2011 (unaudited)

	Construction, Land and Land Development		Farmland		Commercial Real Estate (Non-Owner Occupied)		Commercial Real Estate (Owner Occupied)		Commercial and Industrial		Total
INTERNAL RISK RATING GRADES
Grade:
Pass	$	21,305,808	$	1,565,749	$	11,620,977	$	19,270,422	$	12,897,487	$	66,660,443
Watch		1,426,527		—		1,369,070		4,149,873		1,606,955		8,552,425
Special mention		4,044,341		—		—		2,590,737		828,910		7,463,988
Substandard		1,904,501		—		748,257		2,681,501		1,151,102		6,485,361
Doubtful		—		—		—		—		222,353		222,353
Total	$	28,681,177	$	1,565,749	$	13,738,304	$	28,692,533	$	16,706,807	$	89,384,570

As of December 31, 2010

	Construction, Land and Land Development		Farmland		Commercial Real Estate (Non-Owner Occupied)		Commercial Real Estate (Owner Occupied)		Commercial and Industrial		Total
INTERNAL RISK RATING GRADES
Grade:
Pass	$	22,095,455	$	1,603,519	$	8,356,208	$	18,948,652	$	14,323,275	$	65,327,109
Watch		2,066,022		—		2,393,854		5,960,095		986,309		11,406,280
Special mention		4,036,860		—		318,043		2,592,417		1,334,108		8,281,428
Substandard		2,422,033		—		364,902		1,672,803		948,199		5,407,937
Doubtful		—		—		1,354,552		256,749		—		1,611,301
Total	$	30,620,370	$	1,603,519	$	12,787,559	$	29,430,716	$	17,591,891	$	92,034,055

Loans not assigned internal risk rating grades are comprised of residential mortgages and smaller consumer loans. Payment activity of these loans is reviewed monthly by management. Loans are considered to be nonperforming when they are delinquent by 90 days or more or on nonaccrual, as shown in the table below.

As of June 30, 2011 (unaudited)

	Residential First Mortgages		Residential Junior Mortgages		Consumer Loans		Total
PAYMENT ACTIVITY STATUS
Performing	$	108,734,064	$	28,190,131	$	8,211,720	$	145,135,915
Nonperforming		1,295,266		1,572,134		128,931		2,996,331
Total	$	110,029,330	$	29,762,265	$	8,340,651	$	148,132,246

As of December 31, 2010

	Residential First Mortgages		Residential Junior Mortgages		Consumer Loans		Total
PAYMENT ACTIVITY STATUS
Performing	$	113,356,307	$	29,772,376	$	8,820,488	$	151,949,171
Nonperforming		2,174,010		1,170,649		45,117		3,389,776
Total	$	115,530,317	$	30,943,025	$	8,865,605	$	155,338,947

11

The following table shows the Company’s recorded investment and the customers’ unpaid principal balances for impaired loans, with the associated allowance amount, if applicable. Also shown are the average recorded investments in impaired loans and the related amount of interest recognized and collected during the time the loans were impaired.

IMPAIRED LOANS

As of June 30, 2011 (unaudited)

With no related allowance:	Recorded Investment		Customers’ Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Interest Income Collected
Construction, land & land development	$	—	$	—	$	—	$	—	$	—	$	—
Farmland		—		—		—		—		—		—
Residential First Mortgages		1,968,323		2,058,779		—		1,724,830		67,763		69,847
Residential Junior Mortgages (1)		100,000		100,000		—		33,333		2,521		2,458
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		870,671		870,671		—		786,731		25,481		25,572
Commercial & industrial		393,668		393,668		—		131,223		6,841		5,290
Consumer (2)		—		—		—		—		—		—
	$	3,332,662	$	3,423,118	$	—	$	2,676,117	$	102,606	$	103,167
With an allowance recorded:
Construction, land & land development	$	342,618	$	342,618	$	76,320	$	342,618	$	—	$	—
Farmland		—		—		—		—		—		—
Residential First Mortgages		262,248		262,248		109,498		262,248		—		—
Residential Junior Mortgages (1)		1,387,130		1,676,273		308,991		1,392,465		—		—
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		1,323,950		1,326,848		223,378		1,142,278		28,545		29,836
Commercial & industrial		65,000		115,625		14,479		65,000		453		453
Consumer (2)		556,087		556,087		4,471		562,451		16,717		20,339
	$	3,937,033	$	4,279,699	$	737,137	$	3,767,061	$	45,715	$	50,628
Total Impaired Loans:
Construction, land & land development	$	342,618	$	342,618	$	76,320	$	342,618	$	—	$	—
Farmland		—		—		—		—		—		—
Residential First Mortgages		2,230,571		2,321,027		109,498		1,987,078		67,763		69,847
Residential Junior Mortgages (1)		1,487,130		1,776,273		308,991		1,425,799		2,521		2,458
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		2,194,621		2,197,519		223,378		1,929,009		54,026		55,408
Commercial & industrial		458,668		509,293		14,479		196,223		7,294		5,743
Consumer (2)		556,087		556,087		4,471		562,451		16,717		20,339
	$	7,269,695	$	7,702,817	$	737,137	$	6,443,177	$	148,321	$	153,795

(1) Junior mortgages include equity lines

(2) includes credit cards

12

IMPAIRED LOANS

As of December 31, 2010

With no related allowance:	Recorded Investment		Customers’ Unpaid Principal  Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Interest Income Collected
Construction, land & land development	$	200,000	$	200,000	$	—	$	120,000	$	2,213	$	—
Residential First Mortgages		1,145,848		1,148,692		—		910,146		63,077		60,955
Residential Junior Mortgages (1)		542,376		822,003		—		726,032		24,787		24,042
Commercial Mortgages (Non-owner-occupied)		711,850		711,850		—		283,796		—		—
Commercial Mortgages (Owner-occupied)		615,327		615,327		—		1,328,235		20,677		18,552
Commercial & industrial		65,000		93,948		—		145,064		10,884		4,843
Consumer (2)		—		—		—		—		—		—
	$	3,280,401	$	3,591,820	$	—	$	3,513,274	$	121,638	$	108,392
With an allowance recorded:
Construction, land & land development	$	142,618	$	142,618	$	64,518	$	146,155	$	4,723	$	4,791
Residential First Mortgages		657,983		661,483		93,171		210,744		7,547		1,000
Residential Junior Mortgages (1)		931,648		931,648		67,648		746,447		55,726		58,184
Commercial Mortgages (Non-owner-occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner-occupied)		1,351,007		1,368,724		397,451		1,091,400		24,657		37,027
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		569,918		569,918		17,662		456,449		34,232		31,337
	$	3,653,174	$	3,674,391	$	640,450	$	2,651,195	$	126,885	$	132,339
Total Impaired Loans:
Construction, land & land development	$	342,618	$	342,618	$	64,518	$	266,155	$	6,936	$	4,791
Residential First Mortgages		1,803,831		1,810,175		93,171		1,120,890		70,624		61,955
Residential Junior Mortgages (1)		1,474,024		1,753,651		67,648		1,472,479		80,513		82,226
Commercial Mortgages (Non-owner-occupied)		711,850		711,850		—		283,796		—		—
Commercial Mortgages (Owner-occupied)		1,966,334		1,984,051		397,451		2,419,636		45,334		55,579
Commercial & industrial		65,000		93,948		—		145,064		10,884		4,843
Consumer (2)		569,918		569,918		17,662		456,449		34,232		31,337
	$	6,933,575	$	7,266,211	$	640,450	$	6,164,469	$	248,523	$	240,731

(1) Junior mortgages include equity lines

(2) includes credit cards

At June 30, 2011, the Bank had two relationships that constitute troubled debt restructurings (TDR’s). One relationship involves seven loans totaling $1.8 million at June 30, 2011, which are included above in the commercial and industrial segment; the construction, land and land development segment; and the residential junior mortgages segment. These loans have been nonaccruing since October of 2010, and were modified during the second quarter of 2011 to provide cross-collateralization between loans and reduced payments. The second relationship involves one loan included above in residential first mortgages, which is a commercial purpose loan secured by a residence, with a principal balance of $623,692 on June 30, 2011 and December 31, 2010. This loan was modified to extend the amortization period by five years. Additionally, the repayment terms were modified to reflect the seasonal nature of the borrower’s business, to more closely coincide with the borrower’s cash flows.

At June 30, 2011 and December 31, 2010, non-accrual loans excluded from the impaired loan disclosure totaled $1,338,625 and $899,350, respectively. If interest on these loans had been accrued, such income would have approximated $34,884 during the six months ended June 30, 2011 and $34,567 during the year ended December 31, 2010.

Note 5: Earnings per share

The following table shows the weighted average number of shares used in computing earnings per share and the effect on the weighted average number of shares of dilutive potential common stock.

	Three Months Ended								Six Months Ended
	June 30, 2011				June 30, 2010 (1)				June 30, 2011				June 30, 2010 (1)
(Unaudited)	Average Shares		Per share Amount		Average Shares		Per share Amount		Average Shares		Per share Amount		Average Shares		Per share Amount
Basic earnings per share		2,605,856	$	0.03		2,605,856	$	0.05		2,605,856	$	0.08		2,605,856	$	0.11
Effect of dilutive securities:
Stock options		—				—				—				—
Diluted earnings per share		2,605,856	$	0.03		2,605,856	$	0.05		2,605,856	$	0.08		2,605,856	$	0.11

(1) Adjusted for a 1-for-25 stock dividend on August 27, 2010.

As of June 30, 2011 and 2010, options on 206,388 and 212,629 shares, respectively, were not included in computing diluted earnings per share, because their effects were anti-dilutive.

13

Note 6: Stock-Based Compensation

Incremental stock-based compensation expense recognized was $7,948 during the first six months of 2011 and $9,527 for the same period in 2010. As of June 30, 2011, there was unrecognized compensation expense of $6,580 related to stock options.

Stock option compensation expense is the estimated fair value of options granted using the Black-Scholes Model amortized on a straight-line basis over the vesting period of the award. There were 40,600 options granted and no options exercised during the six month period ended June 30, 2011.

The weighted average fair value of incentive stock options granted during the first six months of 2011 and 2010 was $0.60 and $0.55, respectively. The weighted average fair value of non-employee director’s stock options granted during the first six months of 2011 and 2010 was $0.55 and $.59, respectively.

Stock option plan activity for the six months ended June 30, 2011, is summarized below:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Aggregate Intrinsic Value (1)
Options outstanding, January 1		210,819		$	11.35		5.6
Granted		40,600			4.81
Forfeited		(25,686	)		6.41
Exercised		—			—
Expired		(19,345	)		15.61
Options outstanding, June 30		206,388			10.28		6.1	$	—
Options exercisable, June 30		171,788			11.37		5.4	$	—

(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on June 30, 2011. This amount changes based on changes in the market value of the Company’s stock.

Note 7: Goodwill

The Company has goodwill recorded on the consolidated financial statements relating to the purchase of five branches during the years 1994 through 2000. The balance of the goodwill at June 30, 2011 and December 31, 2010, as reflected on the consolidated balance sheets was $2,807,842. Management determined that these purchases qualified as acquisitions of businesses and that the related unidentifiable intangibles were goodwill. Therefore, amortization was discontinued effective January 1, 2002. The goodwill balance was tested for impairment in the fourth quarter of 2010, and no impairment was determined to exist.

Note 8: Employee Benefit Plans

The Company has a non-contributory, defined benefit pension plan for all full-time employees over 21 years of age. Under this cash balance plan, the account balance for each participant will grow each year with annual pay credits based on age and years of service and monthly interest credits based on an amount established each year by the Company’s Board of Directors. The Company funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.

The Company sponsors a postretirement benefit plan covering current and future retirees who acquire age 55 and 10 years of service or age 65 and 5 years of service. The post-retirement benefit plan provides coverage toward a retiree’s eligible medical and life insurance benefits expenses.

14

Components of Net Periodic Benefit Cost

(Unaudited)

	Pension Benefits						Post Retirement Benefits
Six months ended June 30,	2011			2010			2011		2010
Service cost	$	137,474		$	124,073		$	11,141	$	10,321
Interest cost		103,988			97,601			15,886		15,678
Expected return on plan assets		(176,574	)		(161,201	)		—		—
Amortization of unrecognized prior service cost		(26,982	)		(26,981	)		—		—
Amortization of unrecognized net loss		21,210			21,466			84		—
Amortization of transition obligation		—			—			1,456		1,457
Net periodic benefit cost	$	59,116		$	54,958		$	28,567	$	27,456

The Company expects to make no contribution to its pension plan and $22,571 to its post-retirement benefit plan in 2011. The Company has contributed $6,781 toward the post-retirement plan during the first six months of 2011.

Note 9: Long Term Debt

On June 30, 2011, the Bank had FHLB debt consisting of four advances. The FHLB holds an option to terminate the $10 million advance on any quarterly payment date. The $10 million advance has an early conversion option which gives the FHLB the option to convert, in whole only, into a one-month LIBOR-based floating rate advance, effective on any quarterly payment date. If the FHLB elects to convert, the Bank may elect to terminate, in whole or in part, without a prepayment fee.

Advances on the FHLB lines are secured by a blanket lien on qualified 1 to 4 family residential real estate loans with a lendable collateral value of $55.6 million. Immediate available credit, as of June 30, 2011, was $30.6 million. With additional collateral, the total line of credit is worth $65.5 million, with $40.5 million available.

The four advances are shown in the following table.

Description	Balance		Acquired		Current Interest Rate			Maturity Date
Convertible	$	10,000,000		9/12/2006		4.23	%		9/12/2016
Fixed Rate Hybrid		5,000,000		5/18/2011		0.30	%		5/18/2012
Fixed Rate Hybrid		5,000,000		5/18/2011		0.72	%		5/20/2013
Fixed Rate Hybrid		5,000,000		5/20/2011		2.69	%		5/20/2014
	$	25,000,000

Note 10: Fair Value Measurements

The Company uses fair value to record certain assets and liabilities and to determine fair value disclosures. Authoritative accounting guidance clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Authoritative accounting guidance specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:

Level 1	–	Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2	–	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3	–	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

15

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available-for-sale: Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2).

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2011 and December 31, 2010:

			Fair Value Measurements at June 30, 2011 Using
Description	Balance as of June 30, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(unaudited)
U. S. Government agencies	$	6,789,714	$	—	$	6,789,714	$	—
State and municipal obligations		24,384,798		—		24,384,798		—
			Fair Value Measurements at December 31, 2010 Using
Description	Balance as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U. S. Government agencies	$	8,753,857	$	—	$	8,753,857	$	—
State and municipal obligations		25,319,871		—		25,319,871		—

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

16

Other Real Estate Owned: Certain assets such as other real estate owned are measured at the lower of their carrying value or fair value less estimated costs to sell. At or near the time of foreclosure, the Bank obtains real estate appraisals on the properties acquired through foreclosure. The real estate is then valued at the lesser of the loan balance, including interest receivable, or the appraised value at the time of foreclosure less an estimate of costs to sell the property. Management believes that the fair value component in its valuation follows the provisions of Financial Accounting Standards Board ASC 820 and that current real estate appraisals support a Level 2 valuation.

The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis during the period.

			Fair value measurements at June 30, 2011 using
Description	Balance as of June 30, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(unaudited)
Impaired Loans, net of valuation allowance	$	3,199,896	$	—	$	3,199,896	$	—
Other real estate owned	$	3,165,995	$	—	$	3,165,995	$	—
			Fair value measurements at December 31, 2010 using
Description	Balance as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired Loans, net of valuation allowance	$	3,012,724	$	—	$	3,012,724	$	—
Other real estate owned	$	4,085,939	$	—	$	4,085,939	$	—

17

The estimated fair values of financial instruments are shown in the following table. The carrying amounts in the table are included in the balance sheet under the applicable captions.

	June 30, 2011(unaudited)				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial Assets:
Cash and due from banks	$	4,169,893	$	4,169,893	$	3,275,584	$	3,275,584
Interest-bearing deposits		29,354,853		29,354,853		14,735,892		14,735,892
Federal funds sold		5,314,545		5,314,545		4,727,084		4,727,084
Securities available-for-sale		31,174,512		31,174,512		34,073,728		34,073,728
Restricted securities		2,281,800		2,281,800		2,358,500		2,358,500
Loans, net		234,199,711		234,230,561		244,142,325		243,940,477
Accrued interest receivable		1,164,530		1,164,530		1,159,924		1,159,924
Financial Liabilities:
Non-interest-bearing deposits	$	43,089,933	$	43,089,933	$	44,960,718	$	44,960,718
Savings and other interest-bearing deposits		109,081,025		109,081,025		103,908,863		103,908,863
Time deposits		114,886,421		116,068,491		111,984,418		113,513,561
Securities sold under repurchase agreements		7,491,774		7,491,774		7,598,021		7,598,021
FHLB advances		25,000,000		25,830,504		30,000,000		31,715,392
Accrued interest payable		194,052		194,052		291,621		291,621

The fair values shown do not necessarily represent the amounts which would be received on immediate settlement of the instruments. Authoritative accounting guidance excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The carrying amounts of cash and due from banks, federal funds sold or purchased, accrued interest, non-interest-bearing deposits, savings, and securities sold under repurchase agreements, represent items which do not present significant market risks, are payable on demand, or are of such short duration that carrying value approximates market value.

Available-for-sale securities are carried at the quoted market prices for the individual securities held. Therefore carrying value equals market value. The carrying value of restricted securities approximates fair value based on the redemption provisions.

The fair value of loans is estimated by discounting future cash flows using the interest rates at which similar loans would be made to borrowers.

Time deposits are presented at estimated fair value using interest rates offered for deposits of similar remaining maturities.

The fair value of the FHLB advances is estimated by discounting the future cash flows using the interest rate offered for similar advances.

The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date.

At June 30, 2011 and December 31, 2010, the fair value of loan commitments and standby letters of credit was immaterial. Therefore, they are not included in the table above.

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair value of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

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ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist in understanding the results of operations and the financial condition of the Company. This discussion should be read in conjunction with the above consolidated financial statements and the notes thereto.

EXECUTIVE SUMMARY

The Company has not been immune to the continued challenges presented by the current economic and financial regulatory environment. However, management is pleased to report continued profitability into the second quarter of 2011. We believe our conservative philosophy is contributing to our positive results. We are proud of this conservative philosophy and service to our community. The Bank does not invest in non-traditional debt securities or risky derivatives, nor does it have programs that originate Sub-Prime, Alt-A, or other types of mortgages that have a high risk profile.

The quality of the Bank’s loan portfolio is improving, as evidenced by a reduction in non-performing loans to 1.8% of total loans as of June 30, 2011 compared to 2.3% as of December 31, 2010. Net loan charge-offs during the second quarter of 2011 provide more evidence of that improvement, with a reduction in annualized net loan charge-offs to 0.12% of total loans for the second quarter of 2011 compared to 0.50% for the fourth quarter of 2010. Also, non-performing loans and other real estate owned (“OREO”) decreased to 3.1% of total loans and OREO as of June 30, 2011 compared to 3.9% on December 31, 2010.

Deposit insurance premiums remain historically high for all financial institutions holding domestic deposits as the Federal Deposit Insurance Corporation (“FDIC”) rebuilds the Deposit Insurance Fund. However, the FDIC’s revised calculation of the assessment premiums is saving the Bank approximately $34 thousand per quarter, which began in the second quarter of 2011.

Interest margins are being managed effectively. Declines in interest income have been entirely mitigated by reductions in interest expense so far in 2011. Loan yields remain low, contributing to reduced interest income, which is also negatively impacted to a lesser degree by non-accruing loans. However, management’s strategy has been to reduce the cost of funds through shifts in the mix of deposits, with focus on core customer relationships, creating compensating reductions in interest expense, and therefore preventing further declines in net interest income as noted previously. Management also reduced FHLB borrowings during the second quarter of 2011, which resulted in reductions in the interest cost of those borrowings. Looking forward, as time deposits mature and new instruments are purchased at lower rates, reductions in interest expense are expected to continue. As a result, continued improvements in net interest income during the remainder of 2011 are anticipated.

The size of the loan portfolio has declined noticeably since December 31, 2010. Although the Bank originates millions of dollars in new loans each month, the level of originations has not been sufficient to mitigate loan pay downs, prepayments and foreclosures. A significant portion of the Bank’s local economy is driven by residential real estate and the local trend in real estate activity is weak. This has contributed to the decline in interest income. Regarding commercial loan activity, it remains slow in the current economy.

The Company’s liquidity, core capital levels and regulatory ratios remain good. According to the Bank’s regulators, the Bank remains well capitalized. Given continued economic uncertainty, management continues to give priority to protecting capital and maintaining elevated levels of liquidity.

Management continues efforts to identify and implement earnings opportunities and diligently manage controllable expenses. Unfortunately, foreclosed properties held in OREO are taking a toll as noticeable write-downs, maintenance expenses and losses on sales continue to be a challenge.

The Bank’s new branch office in Burgess, which opened in June 2008, is already making a positive contribution to earnings, and the newest branch in Colonial Beach, which opened in March 2009, is on plan. Management believes these new offices will position the Company to take advantage of a recovering economy.

For more information, visit the Company’s website at www.baybanks.com. Information contained on the Company’s website is not a part of this report.

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CRITICAL ACCOUNTING POLICIES

GENERAL. The Company’s financial statements are prepared in accordance with accounting principles GAAP. The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. For example, historical loss factors are one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors used. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of transactions would be the same, the timing of events that would impact those transactions could change.

ALLOWANCE FOR LOAN LOSSES (“ALL”). ALL is an estimate which reflects management’s judgment of probable losses inherent in the loan portfolio. The ALL is based on two basic principles of accounting: (1) that losses be accrued when they are probable of occurring and estimable and (2) that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The ALL is increased by charges to income, through the provision for loan losses expense, and decreased by charge-offs (net of recoveries).

Management calculates the ALL and evaluates it for adequacy every quarter. This process is lengthy and thorough. The calculation is based on information such as past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions. The quarterly process includes consideration of certain borrowers’ payment histories compared to the terms of each loan agreement and other adverse factors such as divorce, loss of employment income, and bankruptcy. Each loan is then given a risk grade which represents the extent (or lack) of weakness. This grading process occurs dynamically throughout each quarter as new information is learned about each borrowing relationship.

The ALL calculation has three main elements. First, large commercial and construction loan relationships with adverse risk rating grades, in bankruptcy, nonaccruing, or more than 30 days past due are evaluated for impairment. For loans determined to be impaired, a specific allowance is provided when the loan balance exceeds its discounted collateral value. Real estate collateral value is determined based on appraisals done by third parties. At such time as a loan is assigned to a ‘watch’ grade, if the most recent appraisal is more than two years old, a new appraisal will generally be ordered. Discounts applied to collateral include estimated realtor commissions on real estate (in consideration of selling costs should the Bank end up owning the property), and industry-standard reductions in values for accounts receivable, inventory and other varying forms of collateral.

Second, loans not deemed impaired under the first element plus smaller commercial loans, residential mortgages and consumer loans are collectively evaluated in groups of homogenous pools called segments, then a historical loss factor is applied to each segment of loans. The historical loss factor for each segment is calculated by averaging the losses over the prior six quarters.

Finally, a set of qualitative factors, such as changes in credit quality, changes in loan staff experience, changes in loan policies and underwriting guidelines, and changes in national and local economic conditions, is used to estimate the value of intrinsic risk in each of the segments.

The summation of these three elements results in the total estimated ALL. Management may also include an unallocated component to cover uncertainties in the level of probable losses. This estimate is inherently subjective and actual losses could be greater or less than the estimates. For a more detailed description of the ALL, see Note 1 to the Consolidated Financial Statements in Item 8 of the previously filed Form 10-K for the year ended December 31, 2010.

EARNINGS SUMMATION

For the six months ended June 30, 2011, net income was $215 thousand, a decrease of 22.4% compared to the $277 thousand for the similar period in 2010. Diluted earnings per average share for the six months ended June 30, 2011 and 2010 were $0.08 and $0.11, respectively; annualized return on average assets was 0.13% and 0.17%, respectively; and annualized return on average equity was 1.6% and 2.1%, respectively. For the quarter ended June 30, 2011, net income was $87 thousand, a decrease of $56 thousand compared to the quarter ended June 30, 2010. Diluted earnings per share were $0.03 and $0.05 for the quarter ended June 30, 2011, and June 30, 2010, respectively; annualized return on average assets was 0.11% and 0.17%, respectively; and annualized return on average equity was 1.26% and 1.91%, respectively.

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The principal source of earnings for the Company is net interest income. Net interest income is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of interest-earning assets. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, the associated yields and rates, and the volume of non-performing assets have an effect on net interest income, the net interest margin, and net income. Although interest income is down by $516 thousand in the first six months of 2011 compared to the same period in 2010, interest expense is down more, by $560 thousand, thereby increasing the level of net interest income. The $516 thousand decrease in interest income was driven by both lower average loan balances and reduced loan yields. The $560 thousand decrease in interest expense was primarily due to reductions in time deposit balances and rates. Reduced provision expense contributed further to an improvement in net interest income after the provision for loan losses of $217 thousand, or 4.6% for the first six months of 2011 compared to the same period in 2010. For the quarter ended June 30, 2011, compared to the same quarter in 2010, the results are the same – interest income is down by $267 thousand, but interest expense is down by $309 thousand, creating an increase in net interest income of $42 thousand. Net interest income after the provision for loan losses is up by $73 for the same time frame comparison.

Net Interest Income Analysis (unaudited)

	Average Balances, Income and Expense, Yields and Rates
(Fully taxable equivalent basis)	Six months ended 6/30/2011							Six months ended 6/30/2010
(Dollars in Thousands)	Average Balance		Income/ Expense		Yield/ Cost			Average Balance		Income/ Expense		Yield/ Cost
INTEREST EARNING ASSETS:
Taxable investments	$	25,244	$	394		3.12	%	$	24,562	$	478		3.89	%
Tax-exempt investments (1)		6,865		189		5.52	%		9,922		279		5.62	%
Total investments		32,109		583		3.63	%		34,484		757		4.39	%
Gross loans (2)		244,560		6,861		5.62	%		250,773		7,238		5.78	%
Interest-bearing deposits		20,289		24		0.24	%		17,641		21		0.25	%
Federal funds sold		5,557		5		0.19	%		2,989		2		0.13	%
Total Interest Earning Assets	$	302,515	$	7,473		4.94	%	$	305,887	$	8,018		5.24	%
INTEREST-BEARING LIABILITIES:
Savings deposits	$	48,589	$	200		0.83	%	$	45,088	$	195		0.87	%
NOW deposits		38,380		49		0.26	%		35,848		55		0.31	%
Time deposits => $100,000		47,920		590		2.48	%		52,835		755		2.88	%
Time deposits < $100,000		64,485		736		2.30	%		71,787		1,027		2.88	%
Money market deposit accounts		20,289		79		0.79	%		20,450		90		0.89	%
Total Deposits	$	219,663	$	1,654		1.52	%	$	226,008	$	2,122		1.89	%
Federal funds purchased	$	—	$	—		0.00	%	$	33	$	—		0.66	%
Securities sold under repurchase agreements		6,747		7		0.21	%		5,753		6		0.21	%
FHLB advances		28,790		596		4.17	%		30,000		689		4.63	%
Total Interest-Bearing Liabilities	$	255,200	$	2,257		1.78	%	$	261,794	$	2,817		2.17	%
Net interest income and net interest margin			$	5,215		3.45	%			$	5,201		3.40	%
Net interest rate spread						3.16	%						3.07	%

Notes:

(1) Yield and income assumes a federal tax rate of 34%.

(2) Includes VISA program and nonaccrual loans.

21

The annualized net interest margin was 3.45% for the six months ended June 30, 2011, up from 3.40% for the same period in 2010. The main reason for this improvement is reductions in deposit costs. Unfortunately, because interest rates remain at historic lows, new loans are generally added to the loan portfolio at lower yields than the average yield of the portfolio as a whole. Combined with paydowns and payoffs of generally higher yielding loans, and shrinkage of the loan portfolio, interest income has continued to decline. However, deposit rates have declined to reduce the cost of funding and interest expense. One FHLB advance matured during the second quarter of 2011, allowing management to reduce the level of FHLB borrowings at materially lower interest rates. Another FHLB advance was restructured to reduce the rate in May, 2011. These reductions in rates and balances of interest bearing liabilities have more than mitigated the declines in interest income, thus improving net interest income and the net interest margin. Further reductions in the cost of funds are anticipated as time deposits mature and are replaced at lower rates. This trend is expected to continue and to have positive effects on the net interest margin.

Average interest-earning assets decreased 1.1% to $302.5 million for the six months ended June 30, 2011 as compared to $305.9 million for the six months ended June 30, 2010. Average interest-earning assets as a percent of total average assets was 93.0% for the six months ended June 30, 2011 as compared to 92.2% for the comparable period of 2010. As shown in the table above, for the six months ended June 31, 2011, the loan portfolio, with $244.6 million, is the largest category of interest-earning assets.

Average interest-bearing liabilities decreased 2.5% to $255.2 million for the six months ended June 30, 2011, as compared to $261.8 million for the six months ended June 30, 2010. The largest category of interest-bearing liabilities is time deposits, with combined average balances of $112.4 million for the six months ended June 30, 2011, down from $124.6 million for the similar period in 2010. Noticeable increases in average balances occurred in negotiable order of withdrawal (“NOW”) and savings account deposits.

The net interest spread, which is the difference between the annualized yield on earning assets and the annualized cost of interest-bearing liabilities, increased to 3.16% for the six months ended June 30, 2011 compared to 3.07% for the same period in 2010.

LIQUIDITY

Liquidity represents an institution’s ability to meet present and future financial obligations (such as commitments to fund loans) through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with other banks, federal funds sold and investments and loans maturing within one year. The Company’s ability to obtain deposits and purchase funds at favorable rates are major factors for liquidity. Management believes that the Company maintains overall liquidity that is sufficient to satisfy its depositors’ requirements and to meet its customers’ credit needs.

At June 30, 2011, federal funds sold totaled $5.3 million, interest-bearing deposits at the Federal Reserve Bank of Richmond totaled $29.3 million, and securities maturing in one year or less totaled $6.2 million. The liquidity ratio as of June 30, 2011 was 19.7% as compared to 15.3% as of December 31, 2010. The Company determines this ratio by dividing the sum of cash and cash equivalents, investment securities maturing in one year or less, loans maturing in one year or less and federal funds sold, by total assets. The Bank has a formal liquidity management policy and contingency plan. Given current economic uncertainty, management is maintaining a historically high level of liquidity.

In addition, as noted earlier, the Company has a line of credit with the FHLB worth $65.5 million, plus federal funds lines of credit with correspondent banks totaling $20.3 million.

OFF BALANCE SHEET COMMITMENTS

In the normal course of business, the Company offers various financial products to its customers to meet their credit and liquidity needs. These instruments may involve elements of liquidity, credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheets. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby-letters of credit is represented by the contractual amount of these instruments. Subject to its normal credit standards and risk monitoring procedures, the Company makes contractual commitments to extend credit. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Conditional commitments are issued by the Company in the form of performance stand-by letters of credit, which guarantee the performance of a customer to a third-party. The credit risk of issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

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Off Balance Sheet Arrangements

(Dollars in Thousands)	June 30, 2011		December 31, 2010
Total Loan Commitments Outstanding	$	31,961	$	32,351
Standby-by Letters of Credit		289		446

The Company maintains liquidity and credit facilities with non-affiliated banks in excess of the total loan commitments and stand-by letters of credit. As these commitments are earning assets only upon takedown of the instrument by the customer, thereby increasing loan balances, management expects the revenue of the Company to be enhanced as these credit facilities are utilized.

There have been no material changes to the off balance sheet items disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operation” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

CONTRACTUAL OBLIGATIONS

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

CAPITAL RESOURCES

Capital resources represent funds, earned or obtained, over which a financial institution can exercise greater long-term control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of the Company’s resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses, yet allow management to effectively leverage its capital to maximize return to shareholders. The Company’s capital, also known as equity, is comprised mainly of outstanding stock and retained earnings. Capital can be increased with securities offerings or through earnings. The Company has a formal capital policy and plan and management believes that the capital level at June 30, 2011, is sufficient to support current economic uncertainty.

From December 31, 2010 to June 30, 2011, total shareholders’ equity increased from $27.3 million to $27.8 million. Several factors impact shareholder’s equity, including net income, earnings returned to shareholders through cash dividends and regulatory capital requirements.

The Company’s capital resources are also impacted by net unrealized gains or losses on securities. The available-for-sale securities portfolio is marked to market monthly and unrealized gains or losses, net of taxes, are recognized as accumulated other comprehensive income on the balance sheets and statement of changes in shareholders’ equity. Another factor effecting accumulated other comprehensive income is changes in the fair value of the Company’s pension and post-retirement benefit plans. Shareholders’ equity before accumulated other comprehensive income was $27.4 million on June 30, 2011 compared to $27.2 million on December 31, 2010. Accumulated other comprehensive income increased $254.5 thousand between December 31, 2010 and June 30, 2011, a result of unrealized gains in the investment portfolio.

Book value per share, basic, increased by 1.81% to $10.68 on June 30, 2011 from $10.49 on December 31, 2010. Book value per share, basic, before accumulated other comprehensive income on June 30, 2011, compared to December 31, 2010, increased to $10.52 from $10.43. No cash dividends were paid for the six-month period ended June 30, 2011, nor for the comparable period ended June 30, 2010. Of the 5,000,000 common shares authorized, 2,605,856 were outstanding on June 30, 2011 and December 31, 2010.

The Company began a share repurchase program in August of 1999 and has continued the program into 2011. No repurchases were made during the first six months of 2011 or during the comparable period in 2010.

The Bank is subject to minimum regulatory capital ratios as defined by Federal Financial Institutions Examination Council guidelines. These ratios continue to be well in excess of regulatory minimums. As of June 30, 2011, the Bank maintained Tier 1 capital of $24.3 million, net risk weighted assets of $220.6 million, and Tier 2 capital of $2.8 million. On June 30, 2011, the Tier 1 capital to risk weighted assets ratio was 11.03%, the total capital ratio was 12.28%, and the Tier 1 leverage ratio was 7.44%.

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FINANCIAL CONDITION

Total assets increased by 0.5% to $328.7 million during the six months ended June 30, 2011. Cash and cash equivalents, which produce no income, increased to $4.2 million on June 30, 2011 from $3.3 million at year-end 2010.

During the six months ended June 30, 2011, gross loans declined by $9.8 million or 4.0%, to $237.5 million from $247.4 million at year-end 2010. The largest component of this decrease was in residential first mortgages with a 4.8% decrease of $5.5 million to $110.0 million. The bright spot was growth in Non-owner-occupied Commercial Mortgages with an increase of $951 thousand to $13.7 million.

Consumer loans, including residential real estate loans, are generally underwritten based on the borrower’s debt-to-income ratio, credit score or payment history and the ratio of the requested loan amount to the value of any collateral. There are established underwriting criteria for these parameters to determine if a loan will be considered an acceptable credit risk. For commercial borrowers, factors we assess include the legal entity of the borrower, the capacity of the borrower to cover its debt service obligations, the strength and creditworthiness of any guarantor support, the value of any collateral relative to the loan amount, stability and predictability of the borrower’s cash flow, and the borrower’s standing with the State Corporation Commission.

As of June 30, 2011, loans valued at $7.3 million were considered impaired, whereas $6.9 million were considered impaired as of December 31, 2010. Between December 31, 2010 and June 30, 2011, new impaired loans totaled $3.0 million, whereas $2.6 million were dispensed, mainly through foreclosures. Management has reviewed these impaired credits and the underlying collateral and expects no additional losses above those which are specifically reserved in the ALL.

Risk rating grades are assigned conservatively, causing some homogenous loans, like residential mortgages, to fall into the pool of adversely risk rated loans and thereby evaluated for impairment, even though they may be performing as agreed and therefore not impaired. An expanded set of risk rating grades was completed and implemented during December, 2010, which expanded the number of pass grades to improve monitoring of performing loans.

Non-performing Assets

	June 30, 2011					December 31, 2010
(percentages are as a percent of total loans)	$		%			$		%
Loans past due 90 days or more and still accruing	$	3,006		0.0	%	$	202,349		0.1	%
Non-accruing loans		4,546,333		1.9	%		5,574,009		2.3	%
Total non-performing loans	$	4,549,339		1.8	%	$	5,776,358		2.3	%
(percentages are as a percent of total loans plus OREO)
Other real estate owned		3,165,995		1.3	%		4,085,939		1.6	%
Total non-performing assets	$	7,715,334		3.1	%	$	9,862,297		3.9	%

Non-performing loans, which include loans past due 90 days or more and still accruing plus non-accruing loans, as a percentage of total loans, declined to 1.8% as of June 30, 2011 from 2.3% as of December 31, 2010. Non-accruing loans totaled $4.5 million as of June 30, 2011, down from $5.6 million at year-end 2010. Loans still accruing interest but delinquent for 90 days or more totaled $3 thousand on June 30, 2011, down from $202 thousand on December 31, 2010. Non-performing assets, which include OREO in addition to non-performing loans, decreased to 3.1% at June 30, 2011 from 3.9% at December 31, 2010. This compares very favorably to the Bank’s national peer group ratio of 4.6% as of June 30, 2011. Troubled debt restructures (“TDR’s”) are comprised by two borrowers, one more at June 30, 2011 than at December 31, 2010. The new TDR involves seven loans totaling $1.8 million, all of which had already been placed on nonaccrual during the fourth quarter of 2010, bringing the total level of TDR’s to $2.4 million.

Loans charged off during the first six months of 2011, net of recoveries, totaled $134 thousand compared to $968 thousand for the comparable period in 2010. This is a material reduction in the annualized net charge-off ratio from 0.77% for the first six months of 2010 to 0.11% for the same period of 2011, and also compares very favorably to the Bank’s national peer group ratio of 0.72% as of June 30, 2011. The majority of these charge-offs were anticipated and specific reserves had been provided for them in the ALL. Although trends in the quality of the Bank’s loan portfolio clearly show improvement, management is maintaining a conservative level of the ALL at 1.40% of total loans up from 1.31% on December 31, 2010.

The Company now maintains $3.2 million of OREO as of June 30, 2011 compared to $4.1 million at year-end 2010. OREO consists of five residences, nine lots, one former restaurant, a former lodging property with a restaurant, two former convenience stores, a former seafood house and one piece of farmland. In 2011, four OREO properties with a book value of $1.9 million was sold for a loss of $38 thousand, and four properties with a total value of $ $1.2 million from two borrowers were added through a deed in lieu of foreclosure. All properties maintained as OREO are valued at the lesser of carrying value or fair value less estimated costs to sell and are actively marketed.

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As of June 30, 2011, securities available-for-sale at fair value totaled $31.2 million as compared to $34.1 million on December 31, 2010. This represents a net decrease of $2.9 million or 8.5% for the six months. As of June 30, 2011, these securities represented 9.5% of total assets and 10.3% of earning assets. The Company’s entire investment portfolio is classified as available-for-sale and marked to market on a monthly basis. These gains or losses are booked as an adjustment to shareholders’ equity based upon market conditions, and are not realized as an adjustment to earnings until the securities are actually sold or an other than temporary impairment occurs. Management does not consider any of the securities to be other than temporarily impaired.

As of June 30, 2011, total deposits were $267.1 million compared to $260.9 million at year-end 2010. This represents an increase in balances of $6.2 million or 2.4% during the six months. This increase was due materially to savings and interest bearing demand deposits with a 5.0% increase of $5.2 million.

RESULTS OF OPERATIONS

NON-INTEREST INCOME

Non-interest income for the six months ended June 30, 2011, was down by $295 thousand, or 19%, compared to the six months ended June 30, 2010. The main driver of this decrease is write-downs and losses of $320 thousand on OREO. Income from Investment Advantage was down to $120 thousand from $135 thousand for the same period of 2010, a decline of $15 thousand. Investment Advantage contributes the majority of income to other service charges and fees, and since income from Investment Advantage is commission-based, declines in investment activity will cause declines in the Company’s income. VISA^® related fees decreased by $3 thousand to $356 thousand in the first six months of 2011 compared to the similar period in 2010. For the quarter ended June 30, 2011 compared to the same quarter of 2010, non-interest income was down by $169 thousand, again due primarily to an increase in OREO losses of $170 thousand.

Income from fiduciary activities was up by $17 thousand to $303 thousand for the first six months of 2011 compared to the similar period in 2010. The Company’s fiduciary income is derived from the operations of its subsidiary, Bay Trust Company, which offers a broad range of trust and related fiduciary services. Among these are estate settlement and testamentary trusts, revocable and irrevocable personal trusts, managed agency, custodial accounts, and rollover IRAs, both self-directed and managed. Fiduciary income is largely affected by changes in the performance of the stock and bond market, which directly impacts the market value of the accounts upon which fees are earned and therefore the levels of this fee income.

NON-INTEREST EXPENSE

For the six months ended June 30, 2011, non-interest expenses totaled $6.0 million, a decrease of $11 thousand, or 0.2%, compared to the same period in 2010, due mainly to a $56 thousand decrease in occupancy expense. FDIC assessments and other expenses were also down, by $16 thousand and $23 thousand, respectively. Salaries and employee benefits expense, the largest component of non-interest expense, is up by $94 thousand for the comparable six-month periods due to the filling of one vacancy and one new credit-related position. The main driver of the reduced occupancy expense is declines in depreciation expense for equipment acquired in 2008 which is now fully depreciated.

Other non-interest expenses include bank franchise taxes, which decreased to $74 thousand for the first six months of 2011 compared to $82 thousand for the same period in 2010; expenses related to the VISA^® program, which increased to $295 thousand for the first six months of 2011 compared to $293 thousand for the same period in 2010; other expense, which decreased by $23 thousand to $1.2 million for the first six months of 2011 as compared to $1.3 million for the same period in 2010; and telephone expenses, which decreased to $88 thousand for the current period compared to $90 thousand for the same period in 2010. Telephone expenses include the cost of the Company’s Customer Care Center and data network communications.

For the quarter ended June 30, 2011 compared to the same quarter in 2010, non-interest expense was down by $29 thousand, due primarily to a $57 thousand reduction in FDIC assessments and a $24 thousand reduction in other expense. For the same reason as above, salaries and benefits expense is up by $59 thousand for the same period comparison.

25

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20, “Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures will be required for periods beginning on or after December 15, 2010. The Company has included the required disclosures in its consolidated financial statements.

In December 2010, the FASB issued ASU 2010-28, “Intangible – Goodwill and Other (Topic 350) – When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805) – Disclosure of Supplementary Pro Forma Information for Business Combinations.” The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

The Securities Exchange Commission (“SEC”) issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting.” The rule requires companies to submit financial statements in extensible business reporting language (“XBRL”) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011.

In March 2011, the SEC issued Staff Accounting Bulletin (“SAB”) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty. The amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company is currently assessing the impact that ASU 2011-02 its consolidated financial statements.

26

In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2011-03 will have on its consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU is the result of joint efforts by the FASB and IASB to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and IFRSs. The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. The Company is currently assessing the impact that ASU 2011-04 will have on its consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share. The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. The Company is currently assessing the impact that ASU 2011-05 will have on its consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required.

ITEM 4. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As of the end of the period to which this report relates, the Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934. In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that objectives of the disclosure controls and procedures are met. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential conditions. Based upon their evaluation, the Company’s Chief Executive Officer and Principal Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings as of June 30, 2011.

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

There was no change to the Company’s internal control over financial reporting during the quarter ended June 30, 2011 that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

27

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the ordinary course of its operations, the Company is a party to various legal proceedings. Based upon information currently available, management believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the business, financial condition, or results of operations of the Company.

ITEM 1A. RISK FACTORS

Not required.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The Company began a share repurchase program in August of 1999 and has continued the program into 2011. There are a total of 280,000 shares authorized for repurchase under the program. No shares were repurchased during the quarter ended June 30, 2011.

ITEM 3. DEFAULT UPON SENIOR SECURITIES

None to report.

ITEM 4. REMOVED AND RESERVED

ITEM 5. OTHER INFORMATION

None to report.

ITEM 6. EXHIBITS

31.1	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010, (ii) Consolidated Statements of Income for the three months and six months ended June 30, 2011 and 2010, (iii) Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2011 and 2010, (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010, and (v) Notes to Consolidated Financial Statements.*
	* Pursuant to Rule 406T of Regulation S-T, the Interactive Data File attached as Exhibit 101 hereto is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under such sections.

28

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		Bay Banks of Virginia, Inc.
		(Registrant)
August 12, 2011	By:	/s/     Robert F. Hurliman
		Robert F. Hurliman
		Chairman of the Board (Interim Principal Executive Officer)
	By:	/s/     Deborah M. Evans
		Deborah M. Evans
		Treasurer (Principal Financial Officer)

29

EX-31.1

Exhibit 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

Section 302 Certification

I, Robert F. Hurliman, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Bay Banks of Virginia, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting practices.

(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/    Robert F. Hurliman	Dated: August 12, 2011
Robert F. Hurliman Chairman of the Board

EX-31.2

Exhibit 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

Section 302 Certification

I, Deborah M. Evans, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Bay Banks of Virginia, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting practices.

(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and;

5. The registrant’s other certifying office and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/    Deborah M. Evans	Dated: August 12, 2011
Deborah M. Evans Treasurer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE

SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Bay Banks of Virginia, Inc. (the “Company”) on Form 10-Q for the period ending June 30, 2011, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned Principal Executive Officer and Principal Financial Officer of the Company hereby certifies, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002 that based on their knowledge and belief: 1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and 2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the periods covered in the Report.

/s/    Robert F. Hurliman

Robert F. Hurliman, Chairman of the Board

/s/    Deborah M. Evans

Deborah M. Evans, Treasurer

August 12, 2011

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 will be retained by Bay Banks of Virginia, Inc., and furnished to the Securities and Exchange Commission and its staff upon request.

XML



Consolidated Balance Sheets (Parenthetical) (USD $)	Jun. 30, 2011	Dec. 31, 2010
Consolidated Balance Sheets
Loans, allowance for loan losses	$ 3,317,105	$ 3,230,677
Common stock, par value	$ 5	$ 5
Common stock, authorized shares	5,000,000	5,000,000
Common stock, outstanding shares	2,605,856	2,605,856

XML



Consolidated Statements Of Income (USD $)	3 Months Ended			6 Months Ended
	Jun. 30, 2011	Jun. 30, 2010		Jun. 30, 2011	Jun. 30, 2010
INTEREST INCOME
Loans, including fees	$ 3,422,673	$ 3,630,664		$ 6,860,836	$ 7,238,354
Securities:
Taxable	188,895	233,064		394,029	477,832
Tax-exempt	60,161	79,899		124,611	184,220
Federal funds sold	2,142	1,406		5,114	2,469
Interest -bearing deposit accounts	14,810	11,126		23,870	21,481
Total interest income	3,688,681	3,956,159		7,408,460	7,924,356
INTEREST EXPENSE
Deposits	833,092	1,050,214		1,653,773	2,121,908
Federal funds purchased		131			131
Securities sold under repurchase agreements	4,011	3,203		7,409	6,009
FHLB advances	253,598	346,613		595,786	688,801
Total interest expense	1,090,701	1,400,161		2,256,968	2,816,849
Net interest income	2,597,980	2,555,998		5,151,492	5,107,507
Provision for loan losses	165,000	196,422		220,000	392,844
Net interest income after provision for loan losses	2,432,980	2,359,576		4,931,492	4,714,663
NON-INTEREST INCOME
Income from fiduciary activities	149,054	140,961		303,487	286,169
Service charges and fees on deposit accounts	158,029	162,909		324,285	317,116
VISA-related fees	193,420	207,893		356,378	359,054
Other service charges and fees	205,435	182,815		371,030	347,571
Secondary market lending fees	18,817	29,720		56,705	79,313
Gains on sale of securities available for sale	125,259	137,416		123,583	138,842
Other real estate gains (losses)	(170,277)			(288,053)	32,261
Other income	16,061	2,927		23,261	5,092
Total non-interest income	695,798	864,641		1,270,676	1,565,418
NON-INTEREST EXPENSES
Salaries and employee benefits	1,548,310	1,488,970		3,080,486	2,986,507
Occupancy expense	479,328	478,788		944,442	1,001,171
Bank franchise tax	36,780	41,115		73,560	82,230
VISA expense	167,698	174,667		294,835	293,499
Telephone expense	45,283	42,024		88,336	90,215
FDIC assessments	104,856	162,027		251,954	268,260
Other expense	654,160	678,150		1,241,238	1,263,905
Total non-interest expenses	3,036,415	3,065,741		5,974,851	5,985,787
Net income before income taxes	92,363	158,476		227,317	294,294
Income tax	5,727	16,312		11,945	16,854
Net income	$ 86,636	$ 142,164		$ 215,372	$ 277,440
Basic Earnings Per Share
Average basic shares outstanding	2,605,856	2,605,856	[1]	2,605,856	2,605,856	[1]
Earnings per share, basic	$ 0.03	$ 0.05		$ 0.08	$ 0.11
Diluted Earnings Per Share
Average diluted shares outstanding	2,605,856	2,605,856	[1]	2,605,856	2,605,856	[1]
Earnings per share, diluted	$ 0.03	$ 0.05		$ 0.08	$ 0.11

[1] Adjusted for a 1-for-25 stock dividend on August 27, 2010.

XML



Document And Entity Information	6 Months Ended
	Jun. 30, 2011	Aug. 09, 2011
Document And Entity Information
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Jun. 30, 2011
Document Fiscal Year Focus	2011
Document Fiscal Period Focus	Q2
Entity Registrant Name	BAY BANKS OF VIRGINIA INC
Entity Central Index Key	0001034594
Current Fiscal Year End Date	--12-31
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding		2,605,856

XML



Earnings Per Share

6 Months Ended

Jun. 30, 2011

Earnings Per Share

Earnings Per Share

Note 5: Earnings per share

The following table shows the weighted average number of shares used in computing earnings per share and the effect on the weighted average number of shares of dilutive potential common stock.

	Three Months Ended								Six Months Ended
	June 30, 2011				June 30, 2010 (1)				June 30, 2011				June 30, 2010 (1)
(Unaudited)	Average Shares		Per share Amount		Average Shares		Per share Amount		Average Shares		Per share Amount		Average Shares		Per share Amount
Basic earnings per share		2,605,856	$	0.03		2,605,856	$	0.05		2,605,856	$	0.08		2,605,856	$	0.11
Effect of dilutive securities:
Stock options		—				—				—				—
Diluted earnings per share		2,605,856	$	0.03		2,605,856	$	0.05		2,605,856	$	0.08		2,605,856	$	0.11

(1) Adjusted for a 1-for-25 stock dividend on August 27, 2010.

As of June 30, 2011 and 2010, options on 206,388 and 212,629 shares, respectively, were not included in computing diluted earnings per share, because their effects were anti-dilutive.

XML



Fair Value Measurements

6 Months Ended

Jun. 30, 2011

Fair Value Measurements

Fair Value Measurements

Note 10: Fair Value Measurements

The Company uses fair value to record certain assets and liabilities and to determine fair value disclosures. Authoritative accounting guidance clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Authoritative accounting guidance specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:

Level 1	–	Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2	–	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3	–	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available-for-sale: Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2).

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2011 and December 31, 2010:

			Fair Value Measurements at June 30, 2011 Using
Description	Balance as of June 30, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(unaudited)
U. S. Government agencies	$	6,789,714	$	—	$	6,789,714	$	—
State and municipal obligations		24,384,798		—		24,384,798		—
			Fair Value Measurements at December 31, 2010 Using
Description	Balance as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U. S. Government agencies	$	8,753,857	$	—	$	8,753,857	$	—
State and municipal obligations		25,319,871		—		25,319,871		—

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business's financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned: Certain assets such as other real estate owned are measured at the lower of their carrying value or fair value less estimated costs to sell. At or near the time of foreclosure, the Bank obtains real estate appraisals on the properties acquired through foreclosure. The real estate is then valued at the lesser of the loan balance, including interest receivable, or the appraised value at the time of foreclosure less an estimate of costs to sell the property. Management believes that the fair value component in its valuation follows the provisions of Financial Accounting Standards Board ASC 820 and that current real estate appraisals support a Level 2 valuation.

The following table summarizes the Company's assets that were measured at fair value on a nonrecurring basis during the period.

			Fair value measurements at June 30, 2011 using
Description	Balance as of June 30, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(unaudited)
Impaired Loans, net of valuation allowance	$	3,199,896	$	—	$	3,199,896	$	—
Other real estate owned	$	3,165,995	$	—	$	3,165,995	$	—
			Fair value measurements at December 31, 2010 using
Description	Balance as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired Loans, net of valuation allowance	$	3,012,724	$	—	$	3,012,724	$	—
Other real estate owned	$	4,085,939	$	—	$	4,085,939	$	—

The estimated fair values of financial instruments are shown in the following table. The carrying amounts in the table are included in the balance sheet under the applicable captions.

	June 30, 2011(unaudited)				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial Assets:
Cash and due from banks	$	4,169,893	$	4,169,893	$	3,275,584	$	3,275,584
Interest-bearing deposits		29,354,853		29,354,853		14,735,892		14,735,892
Federal funds sold		5,314,545		5,314,545		4,727,084		4,727,084
Securities available-for-sale		31,174,512		31,174,512		34,073,728		34,073,728
Restricted securities		2,281,800		2,281,800		2,358,500		2,358,500
Loans, net		234,199,711		234,230,561		244,142,325		243,940,477
Accrued interest receivable		1,164,530		1,164,530		1,159,924		1,159,924
Financial Liabilities:
Non-interest-bearing deposits	$	43,089,933	$	43,089,933	$	44,960,718	$	44,960,718
Savings and other interest-bearing deposits		109,081,025		109,081,025		103,908,863		103,908,863
Time deposits		114,886,421		116,068,491		111,984,418		113,513,561
Securities sold under repurchase agreements		7,491,774		7,491,774		7,598,021		7,598,021
FHLB advances		25,000,000		25,830,504		30,000,000		31,715,392
Accrued interest payable		194,052		194,052		291,621		291,621

The fair values shown do not necessarily represent the amounts which would be received on immediate settlement of the instruments. Authoritative accounting guidance excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The carrying amounts of cash and due from banks, federal funds sold or purchased, accrued interest, non-interest-bearing deposits, savings, and securities sold under repurchase agreements, represent items which do not present significant market risks, are payable on demand, or are of such short duration that carrying value approximates market value.

Available-for-sale securities are carried at the quoted market prices for the individual securities held. Therefore carrying value equals market value. The carrying value of restricted securities approximates fair value based on the redemption provisions.

The fair value of loans is estimated by discounting future cash flows using the interest rates at which similar loans would be made to borrowers.

Time deposits are presented at estimated fair value using interest rates offered for deposits of similar remaining maturities.

The fair value of the FHLB advances is estimated by discounting the future cash flows using the interest rate offered for similar advances.

The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date.

At June 30, 2011 and December 31, 2010, the fair value of loan commitments and standby letters of credit was immaterial. Therefore, they are not included in the table above.

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair value of the Company's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company's overall interest rate risk.

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General

6 Months Ended

Jun. 30, 2011

General

General

Note 1: General

Bay Banks of Virginia, Inc. (the "Company") owns 100% of the Bank of Lancaster (the "Bank"), 100% of Bay Trust Company, Inc. (the "Trust Company") and 100% of Steptoes Holdings, LLC ("Steptoes Holdings"). The consolidated financial statements include the accounts of the Bank, the Trust Company, Steptoes Holdings and Bay Banks of Virginia, Inc.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America ("GAAP") and to the general practices within the banking industry. In management's opinion, all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the consolidated financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

Certain amounts in the consolidated financial statements have been reclassified to conform to current year presentations.

These consolidated financial statements should be read in conjunction with the financial statements and notes to financial statements included in the Company's 2010 Annual Report to Shareholders.

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Goodwill

6 Months Ended

Jun. 30, 2011

Goodwill

Goodwill

Note 7: Goodwill

The Company has goodwill recorded on the consolidated financial statements relating to the purchase of five branches during the years 1994 through 2000. The balance of the goodwill at June 30, 2011 and December 31, 2010, as reflected on the consolidated balance sheets was $2,807,842. Management determined that these purchases qualified as acquisitions of businesses and that the related unidentifiable intangibles were goodwill. Therefore, amortization was discontinued effective January 1, 2002. The goodwill balance was tested for impairment in the fourth quarter of 2010, and no impairment was determined to exist.

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Employee Benefit Plans

6 Months Ended

Jun. 30, 2011

Employee Benefit Plans

Employee Benefit Plans

Note 8: Employee Benefit Plans

The Company has a non-contributory, defined benefit pension plan for all full-time employees over 21 years of age. Under this cash balance plan, the account balance for each participant will grow each year with annual pay credits based on age and years of service and monthly interest credits based on an amount established each year by the Company's Board of Directors. The Company funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.

The Company sponsors a postretirement benefit plan covering current and future retirees who acquire age 55 and 10 years of service or age 65 and 5 years of service. The post-retirement benefit plan provides coverage toward a retiree's eligible medical and life insurance benefits expenses.

Components of Net Periodic Benefit Cost

(Unaudited)

	Pension Benefits						Post Retirement Benefits
Six months ended June 30,	2011			2010			2011		2010
Service cost	$	137,474		$	124,073		$	11,141	$	10,321
Interest cost		103,988			97,601			15,886		15,678
Expected return on plan assets		(176,574	)		(161,201	)		—		—
Amortization of unrecognized prior service cost		(26,982	)		(26,981	)		—		—
Amortization of unrecognized net loss		21,210			21,466			84		—
Amortization of transition obligation		—			—			1,456		1,457
Net periodic benefit cost	$	59,116		$	54,958		$	28,567	$	27,456

The Company expects to make no contribution to its pension plan and $22,571 to its post-retirement benefit plan in 2011. The Company has contributed $6,781 toward the post-retirement plan during the first six months of 2011.

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Stock-Based Compensation

6 Months Ended

Jun. 30, 2011

Stock-Based Compensation

Stock-Based Compensation

Note 6: Stock-Based Compensation

Incremental stock-based compensation expense recognized was $7,948 during the first six months of 2011 and $9,527 for the same period in 2010. As of June 30, 2011, there was unrecognized compensation expense of $6,580 related to stock options.

Stock option compensation expense is the estimated fair value of options granted using the Black-Scholes Model amortized on a straight-line basis over the vesting period of the award. There were 40,600 options granted and no options exercised during the six month period ended June 30, 2011.

The weighted average fair value of incentive stock options granted during the first six months of 2011 and 2010 was $0.60 and $0.55, respectively. The weighted average fair value of non-employee director's stock options granted during the first six months of 2011 and 2010 was $0.55 and $.59, respectively.

Stock option plan activity for the six months ended June 30, 2011, is summarized below:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Aggregate Intrinsic Value (1)
Options outstanding, January 1		210,819		$	11.35		5.6
Granted		40,600			4.81
Forfeited		(25,686	)		6.41
Exercised		—			—
Expired		(19,345	)		15.61
Options outstanding, June 30		206,388			10.28		6.1	$	—
Options exercisable, June 30		171,788			11.37		5.4	$	—

(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on June 30, 2011. This amount changes based on changes in the market value of the Company's stock.

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Consolidated Statements Of Changes In Shareholders' Equity (Parenthetical) (USD $)	6 Months Ended
	Jun. 30, 2011	Jun. 30, 2010
Consolidated Statements Of Changes In Shareholders' Equity
Changes in unrealized holding gains on securities arising during the period, taxes	$ 173,128	$ 147,988
Reclassification adjustment for securities gains included in net income, taxes	$ (42,018)	$ (47,206)

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Securities

6 Months Ended

Jun. 30, 2011

Securities

Securities

Note 2: Securities

The aggregate amortized costs and fair values of the available-for-sale securities portfolio are as follows:

Available-for-sale securities June 30, 2011 (unaudited)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. Government agencies	$	6,723,872	$	68,976	$	(3,134	)	$	6,789,714
State and municipal obligations		23,613,852		794,722		(23,776	)		24,384,798
	$	30,337,724	$	863,698	$	(26,910	)	$	31,174,512
Available-for-sale securities December 31, 2010	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. Government agencies	$	8,738,339	$	43,318	$	(27,800	)	$	8,753,857
State and municipal obligations		24,884,217		502,878		(67,224	)		25,319,871
	$	33,622,556	$	546,196	$	(95,024	)	$	34,073,728

Securities with a market value of $9.0 million were pledged as collateral for repurchase agreements and for other purposes as required by law as of June 30, 2011. The market value of pledged securities at December 31, 2010 was $9.9 million.

Securities in an unrealized loss position at June 30, 2011 and December 31, 2010, by duration of the unrealized loss, are shown below. The unrealized loss positions were directly related to interest rate movements as there is minimal credit risk exposure in these investments. All securities are investment grade or better and all losses are considered temporary. Management does not intend to sell the securities and does not expect to be required to sell the securities. Furthermore, we do expect to recover the entire amortized cost basis. Bonds with unrealized loss positions at June 30, 2011 included 1 mortgage backed security, 1 federal agency and 5 municipal bonds. Bonds with unrealized loss positions at December 31, 2010 included 16 municipals and 4 federal agencies. The tables are shown below.

	Less than 12 months				12 months or more				Total
June 30, 2011 (unaudited)	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government agencies	$	860,694	$	3,134	$	—	$	—	$	860,694	$	3,134
States and municipal obligations		2,018,056		23,776		—		—		2,018,056		23,776
Total temporarily impaired securities	$	2,878,750	$	26,910	$	—	$	—	$	2,878,750	$	26,910
	Less than 12 months				12 months or more				Total
December 31, 2010	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government agencies	$	1,964,436	$	27,800	$	—	$	—	$	1,964,436	$	27,800
States and municipal obligations		6,679,896		67,224		—		—		6,679,896		67,224
Total temporarily impaired securities	$	8,644,332	$	95,024	$	—	$	—	$	8,644,332	$	95,024

The Company's investment in Federal Home Loan Bank of Atlanta ("FHLB") stock totaled $1.8 million at June 30, 2011 and December 31, 2010. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs or its member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Despite the FHLB's temporary suspension of repurchases of excess capital stock in 2010, the Company does not consider this investment to be other-than-temporarily impaired at June 30, 2011 and no impairment has been recognized. FHLB stock is shown in the restricted securities line item on the consolidated balance sheets and is not a part of the available-for-sale securities portfolio.

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Loans

6 Months Ended

Jun. 30, 2011

Loans

Loans

Note 3: Loans

The following is a summary of the balances of loans:

	June 30, 2011			December 31, 2010
	(unaudited)
Mortgage loans on real estate:
Construction, Land and Land Development	$	28,681,177		$	30,620,370
Farmland		1,565,749			1,603,519
Commercial Mortgages (Non-Owner Occupied)		13,738,304			12,787,559
Commercial Mortgages (Owner Occupied)		28,692,533			29,430,716
Residential First Mortgages		110,029,330			115,530,317
Residential Junior Mortgages		29,762,265			30,943,025
Commercial and Industrial loans		16,706,807			17,591,891
Consumer Loans		8,340,651			8,865,605
Total loans	$	237,516,816		$	247,373,002
Allowance for loan losses		(3,317,105	)		(3,230,677	)
Loans, net	$	234,199,711		$	244,142,325

The recorded investment in past due and nonaccruing loans is shown in the following table. A loan past due by more than 90 days is generally placed on nonaccrual unless it is both well secured and in the process of collection.

Loans Past Due and Nonaccruals June 30, 2011 (unaudited)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccruals		Total Past Due and Nonaccruals		Current		Total Loans
Construction, Land and Land Development	$	—	$	—	$	—	$	405,735	$	405,735	$	28,275,442	$	28,681,177
Farmland		—		—		—		—		—		1,565,749		1,565,749
Commercial Mortgages (Non-Owner Occupied)		—		318,418		—		65,750		384,168		13,354,136		13,738,304
Commercial Mortgages (Owner Occupied)		—		—		—		424,249		424,249		28,268,284		28,692,533
Residential First Mortgages		647,960		641,097		—		1,295,266		2,584,323		107,445,007		110,029,330
Residential Junior Mortgages		96,614		391,088		—		1,572,134		2,059,836		27,702,429		29,762,265
Commercial and Industrial		18,834		—		—		657,274		676,108		16,030,699		16,706,807
Consumer Loans		33,650		15,998		3,006		125,925		178,579		8,162,072		8,340,651
Total	$	797,058	$	1,366,601	$	3,006	$	4,546,333	$	6,712,998	$	230,803,818	$	237,516,816
Loans Past Due and Nonaccruals December 31, 2010	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccruals		Total Past Due and Nonaccruals		Current		Total Loans
Construction, Land and Land Development	$	—	$	96,153	$	—	$	342,618	$	438,771	$	30,181,599	$	30,620,370
Farmland		—		—		—		—		—		1,603,519		1,603,519
Commercial Mortgages (Non-Owner Occupied)		318,043		—		—		1,356,108		1,674,151		11,113,408		12,787,559
Commercial Mortgages (Owner Occupied)		—		—		—		424,249		424,249		29,006,467		29,430,716
Residential First Mortgages		1,694,757		281,878		—		2,174,010		4,150,645		111,379,672		115,530,317
Residential Junior Mortgages		370,812		—		730		1,169,919		1,541,461		29,401,564		30,943,025
Commercial and Industrial		408,738		—		198,606		65,001		672,345		16,919,546		17,591,891
Consumer Loans		667,355		5,984		3,013		42,104		718,456		8,147,149		8,865,605
Total	$	3,459,705	$	384,015	$	202,349	$	5,574,009	$	9,620,078	$	237,752,924	$	247,373,002

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Allowance For Loan Losses

6 Months Ended

Jun. 30, 2011

Allowance For Loan Losses

Allowance For Loan Losses

Note 4: Allowance for Loan Losses

A disaggregation of and an analysis of the change in the allowance for loan losses by segment is shown below.

Allowance for Loan Losses by Portfolio Segment

For the six months ended June 30, 2011 (unaudited)

	Construction, Land and Land Development			Farmland		Commercial Mortgages (Non Owner Occupied)			Commercial Mortgages (Owner Occupied)			Residential First Mortgages			Residential Junior Mortgages			Commercial and Industrial		Consumer Loans			Unallocated			Total
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	192,518		$	3,000	$	108,000		$	1,270,451		$	206,171		$	460,648		$	69,869	$	210,662		$	709,358		$	3,230,677
(Charge-offs)							(52,117	)					(39,956	)		(18,379	)				(43,602	)				$	(154,054	)
Recoveries		175																			20,307					$	20,482
Provision		(1,373	)		2,000		24,117			(155,073	)		431,283			158,722			29,479		(68,896	)		(200,259	)	$	220,000
Ending Balance	$	191,320		$	5,000	$	80,000		$	1,115,378		$	597,498		$	600,991		$	99,348	$	118,471		$	509,099		$	3,317,105
Individually evaluated for impairment	$	76,320		$	—	$	—		$	223,378		$	109,498		$	308,991		$	14,479	$	4,471		$	—		$	737,137
Collectively evaluated for impairment	$	115,000		$	5,000	$	80,000		$	892,000		$	488,000		$	292,000		$	84,869	$	114,000		$	509,099		$	2,579,968
LOAN RECEIVABLES:
Ending Balance:
Individually evaluated for impairment	$	342,618		$	—	$	—		$	2,194,621		$	2,230,571		$	1,487,130		$	458,668	$	556,087					$	7,269,695
Collectively evaluated for impairment		28,338,559			1,565,749		13,738,304			26,497,912			107,798,759			28,275,135			16,248,139		7,784,564						230,247,121
Total Gross Loans	$	28,681,177		$	1,565,749	$	13,738,304		$	28,692,533		$	110,029,330		$	29,762,265		$	16,706,807	$	8,340,651					$	237,516,816

Provision is negative for Construction, Land and Land Development loans due to a reduction in the size of this segment, which reduces the necessary allowance. Provision is negative for the Commercial Mortgages (Owner Occupied) segment due mainly to the charge-off of one impaired loan, which reduced the allowance for impairments by $238 thousand, plus the addition of one impaired loan and an increase in the impairment allowance for one other loan. Provision is negative for Consumer loans because charge-offs are lower, resulting in a smaller historical charge-off factor.

Allowance for Loan Losses by Portfolio Segment

For the Year Ended December 31, 2010

	Construction, Land and Land Development		Farmland		Commercial Real Estate (Non-Owner Occupied)		Commercial Real Estate (Owner Occupied)		Residential First Mortgages		Residential Junior Mortgages		Commercial and Industrial		Consumer Loans		Unallocated		Total
Allowance for loan losses:
Beginning Balance																			$	3,769,287
Charge-offs																				(1,491,707	)
Recoveries																				232,883
Provision																				720,214
Ending Balance	$	192,518	$	3,000	$	108,000	$	1,270,451	$	206,171	$	460,648	$	69,869	$	210,662	$	709,358	$	3,230,677
Individually evaluated for impairment	$	64,518	$	—	$	—	$	397,451	$	93,171	$	67,648	$	—	$	17,662	$	—	$	640,450
Collectively evaluated for impairment	$	128,000	$	3,000	$	108,000	$	873,000	$	113,000	$	393,000	$	69,869	$	193,000	$	709,358	$	2,590,227
Loan Receivables:
Ending Balance:
Individually evaluated for impairment	$	342,618	$	—	$	711,850	$	1,966,334	$	1,803,831	$	1,474,024	$	65,000	$	569,918			$	6,933,575
Collectively evaluated for impairment		30,277,752		1,603,519		12,075,709		27,464,382		113,726,486		29,469,001		17,526,891		8,295,687				240,439,427
Total Gross Loans	$	30,620,370	$	1,603,519	$	12,787,559	$	29,430,716	$	115,530,317	$	30,943,025	$	17,591,891	$	8,865,605			$	247,373,002

	December 31, 2010			June 30, 2010
				(unaudited)
Balance, beginning of year	$	3,769,287		$	3,769,287
Provision for loan losses		720,214			392,844
Recoveries		232,883			166,484
Loans charged off		(1,491,707	)		(1,134,757	)
Balance, end of period	$	3,230,677		$	3,193,858

Internal risk rating grades are assigned to commercial loans not secured by real estate, commercial mortgages, residential mortgages greater than $1 million, loans to real estate developers and contractors, and consumer loans greater than $250,000 with chronic delinquency, as shown in the following table. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. Risk grades are evaluated as new information becomes available for each borrowing relationship or at least quarterly.

As of June 30, 2011 (unaudited)

	Construction, Land and Land Development		Farmland		Commercial Real Estate (Non-Owner Occupied)		Commercial Real Estate (Owner Occupied)		Commercial and Industrial		Total
INTERNAL RISK RATING GRADES
Grade:
Pass	$	21,305,808	$	1,565,749	$	11,620,977	$	19,270,422	$	12,897,487	$	66,660,443
Watch		1,426,527		—		1,369,070		4,149,873		1,606,955		8,552,425
Special mention		4,044,341		—		—		2,590,737		828,910		7,463,988
Substandard		1,904,501		—		748,257		2,681,501		1,151,102		6,485,361
Doubtful		—		—		—		—		222,353		222,353
Total	$	28,681,177	$	1,565,749	$	13,738,304	$	28,692,533	$	16,706,807	$	89,384,570

As of December 31, 2010

	Construction, Land and Land Development		Farmland		Commercial Real Estate (Non-Owner Occupied)		Commercial Real Estate (Owner Occupied)		Commercial and Industrial		Total
INTERNAL RISK RATING GRADES
Grade:
Pass	$	22,095,455	$	1,603,519	$	8,356,208	$	18,948,652	$	14,323,275	$	65,327,109
Watch		2,066,022		—		2,393,854		5,960,095		986,309		11,406,280
Special mention		4,036,860		—		318,043		2,592,417		1,334,108		8,281,428
Substandard		2,422,033		—		364,902		1,672,803		948,199		5,407,937
Doubtful		—		—		1,354,552		256,749		—		1,611,301
Total	$	30,620,370	$	1,603,519	$	12,787,559	$	29,430,716	$	17,591,891	$	92,034,055

Loans not assigned internal risk rating grades are comprised of residential mortgages and smaller consumer loans. Payment activity of these loans is reviewed monthly by management. Loans are considered to be nonperforming when they are delinquent by 90 days or more or on nonaccrual, as shown in the table below.

As of June 30, 2011 (unaudited)

	Residential First Mortgages		Residential Junior Mortgages		Consumer Loans		Total
PAYMENT ACTIVITY STATUS
Performing	$	108,734,064	$	28,190,131	$	8,211,720	$	145,135,915
Nonperforming		1,295,266		1,572,134		128,931		2,996,331
Total	$	110,029,330	$	29,762,265	$	8,340,651	$	148,132,246

As of December 31, 2010

	Residential First Mortgages		Residential Junior Mortgages		Consumer Loans		Total
PAYMENT ACTIVITY STATUS
Performing	$	113,356,307	$	29,772,376	$	8,820,488	$	151,949,171
Nonperforming		2,174,010		1,170,649		45,117		3,389,776
Total	$	115,530,317	$	30,943,025	$	8,865,605	$	155,338,947

The following table shows the Company's recorded investment and the customers' unpaid principal balances for impaired loans, with the associated allowance amount, if applicable. Also shown are the average recorded investments in impaired loans and the related amount of interest recognized and collected during the time the loans were impaired.

IMPAIRED LOANS

As of June 30, 2011 (unaudited)

With no related allowance:	Recorded Investment		Customers' Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Interest Income Collected
Construction, land & land development	$	—	$	—	$	—	$	—	$	—	$	—
Farmland		—		—		—		—		—		—
Residential First Mortgages		1,968,323		2,058,779		—		1,724,830		67,763		69,847
Residential Junior Mortgages (1)		100,000		100,000		—		33,333		2,521		2,458
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		870,671		870,671		—		786,731		25,481		25,572
Commercial & industrial		393,668		393,668		—		131,223		6,841		5,290
Consumer (2)		—		—		—		—		—		—
	$	3,332,662	$	3,423,118	$	—	$	2,676,117	$	102,606	$	103,167
With an allowance recorded:
Construction, land & land development	$	342,618	$	342,618	$	76,320	$	342,618	$	—	$	—
Farmland		—		—		—		—		—		—
Residential First Mortgages		262,248		262,248		109,498		262,248		—		—
Residential Junior Mortgages (1)		1,387,130		1,676,273		308,991		1,392,465		—		—
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		1,323,950		1,326,848		223,378		1,142,278		28,545		29,836
Commercial & industrial		65,000		115,625		14,479		65,000		453		453
Consumer (2)		556,087		556,087		4,471		562,451		16,717		20,339
	$	3,937,033	$	4,279,699	$	737,137	$	3,767,061	$	45,715	$	50,628
Total Impaired Loans:
Construction, land & land development	$	342,618	$	342,618	$	76,320	$	342,618	$	—	$	—
Farmland		—		—		—		—		—		—
Residential First Mortgages		2,230,571		2,321,027		109,498		1,987,078		67,763		69,847
Residential Junior Mortgages (1)		1,487,130		1,776,273		308,991		1,425,799		2,521		2,458
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		2,194,621		2,197,519		223,378		1,929,009		54,026		55,408
Commercial & industrial		458,668		509,293		14,479		196,223		7,294		5,743
Consumer (2)		556,087		556,087		4,471		562,451		16,717		20,339
	$	7,269,695	$	7,702,817	$	737,137	$	6,443,177	$	148,321	$	153,795

(1) Junior mortgages include equity lines

(2) includes credit cards

IMPAIRED LOANS

As of December 31, 2010

With no related allowance:	Recorded Investment		Customers' Unpaid Principal  Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Interest Income Collected
Construction, land & land development	$	200,000	$	200,000	$	—	$	120,000	$	2,213	$	—
Residential First Mortgages		1,145,848		1,148,692		—		910,146		63,077		60,955
Residential Junior Mortgages (1)		542,376		822,003		—		726,032		24,787		24,042
Commercial Mortgages (Non-owner-occupied)		711,850		711,850		—		283,796		—		—
Commercial Mortgages (Owner-occupied)		615,327		615,327		—		1,328,235		20,677		18,552
Commercial & industrial		65,000		93,948		—		145,064		10,884		4,843
Consumer (2)		—		—		—		—		—		—
	$	3,280,401	$	3,591,820	$	—	$	3,513,274	$	121,638	$	108,392
With an allowance recorded:
Construction, land & land development	$	142,618	$	142,618	$	64,518	$	146,155	$	4,723	$	4,791
Residential First Mortgages		657,983		661,483		93,171		210,744		7,547		1,000
Residential Junior Mortgages (1)		931,648		931,648		67,648		746,447		55,726		58,184
Commercial Mortgages (Non-owner-occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner-occupied)		1,351,007		1,368,724		397,451		1,091,400		24,657		37,027
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		569,918		569,918		17,662		456,449		34,232		31,337
	$	3,653,174	$	3,674,391	$	640,450	$	2,651,195	$	126,885	$	132,339
Total Impaired Loans:
Construction, land & land development	$	342,618	$	342,618	$	64,518	$	266,155	$	6,936	$	4,791
Residential First Mortgages		1,803,831		1,810,175		93,171		1,120,890		70,624		61,955
Residential Junior Mortgages (1)		1,474,024		1,753,651		67,648		1,472,479		80,513		82,226
Commercial Mortgages (Non-owner-occupied)		711,850		711,850		—		283,796		—		—
Commercial Mortgages (Owner-occupied)		1,966,334		1,984,051		397,451		2,419,636		45,334		55,579
Commercial & industrial		65,000		93,948		—		145,064		10,884		4,843
Consumer (2)		569,918		569,918		17,662		456,449		34,232		31,337
	$	6,933,575	$	7,266,211	$	640,450	$	6,164,469	$	248,523	$	240,731

(1) Junior mortgages include equity lines

(2) includes credit cards

At June 30, 2011, the Bank had two relationships that constitute troubled debt restructurings (TDR's). One relationship involves seven loans totaling $1.8 million at June 30, 2011, which are included above in the commercial and industrial segment; the construction, land and land development segment; and the residential junior mortgages segment. These loans have been nonaccruing since October of 2010, and were modified during the second quarter of 2011 to provide cross-collateralization between loans and reduced payments. The second relationship involves one loan included above in residential first mortgages, which is a commercial purpose loan secured by a residence, with a principal balance of $623,692 on June 30, 2011 and December 31, 2010. This loan was modified to extend the amortization period by five years. Additionally, the repayment terms were modified to reflect the seasonal nature of the borrower's business, to more closely coincide with the borrower's cash flows.

At June 30, 2011 and December 31, 2010, non-accrual loans excluded from the impaired loan disclosure totaled $1,338,625 and $899,350, respectively. If interest on these loans had been accrued, such income would have approximated $34,884 during the six months ended June 30, 2011 and $34,567 during the year ended December 31, 2010.

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Consolidated Statements Of Changes In Shareholders' Equity (USD $)	Common Stock [Member]	Additional Paid-In Capital [Member]	Retained Earnings [Member]	Accumulated Other Comprehensive Income [Member]	Total
Balance, at Dec. 31, 2009	$ 12,047,357	$ 4,842,756	$ 9,912,781	$ 95,697	$ 26,898,591
Comprehensive income:
Net income			277,440		277,440
Changes in unrealized holding gains on securities arising during the period, net of taxes				287,272
Reclassification adjustment for securities gains included in net income, net of taxes				(91,636)
Total other comprehensive income				195,636	195,636
Total comprehensive income					473,076
Stock-based compensation		9,527			9,527
Stock dividend	481,402	168,491	(650,558)		(665)
Balance, at Jun. 30, 2010	12,528,759	5,020,774	9,539,663	291,333	27,380,529
Balance, at Dec. 31, 2010	13,029,280	4,965,460	9,193,492	154,078	27,342,310
Comprehensive income:
Net income			215,372		215,372
Changes in unrealized holding gains on securities arising during the period, net of taxes				336,071
Reclassification adjustment for securities gains included in net income, net of taxes				(81,565)
Total other comprehensive income				254,506	254,506
Total comprehensive income					469,878
Stock-based compensation		7,948			7,948
Balance, at Jun. 30, 2011	$ 13,029,280	$ 4,973,408	$ 9,408,864	$ 408,584	$ 27,820,136

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Consolidated Statements Of Cash Flows (USD $)	6 Months Ended
	Jun. 30, 2011	Jun. 30, 2010
Cash Flows From Operating Activities
Net income	$ 215,372	$ 277,440
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	407,458	448,494
Net amortization and accretion of securities	38,178	24,369
Provision for loan losses	220,000	392,844
Stock-based compensation	7,948	9,527
Deferred income tax (benefit)		(20,805)
(Gain) on securities available-for-sale	(123,583)	(138,842)
Increase in OREO valuation allowance	249,835
Loss (Gain) on sale of other real estate	38,218	(32,261)
(Gain) on disposal of fixed assets	(4,082)
Decrease in accrued income and other assets	297,060	549,804
(Decrease) increase in other liabilities	(73,710)	79,950
Net cash provided by operating activities	1,272,694	1,590,520
Cash Flows From Investing Activities
Proceeds from maturities and principal paydowns of available-for-sale securities	4,769,373	1,304,634
Proceeds from sales and calls of available-for-sale securities	4,081,190	9,722,377
Purchases of available-for-sale securities	(5,480,327)	(9,727,304)
Sales (purchases) of restricted securities	76,700	(120,000)
(Increase) in interest bearing deposits in other banks	(14,618,961)	(3,102,027)
(Increase) in federal funds sold	(587,461)	(2,421,182)
Loan principal collections, net	8,502,482	119,745
Proceeds from sale of other real estate	1,879,456	290,761
Purchases of premises and equipment	(97,970)	(106,051)
Net cash (used in) investing activities	(1,475,518)	(4,039,047)
Cash Flows From Financing Activities
Increase in demand, savings, and other interest-bearing deposits	3,301,377	2,824,571
Net increase in time deposits	2,902,003	465,557
Net (decrease) increase in securities sold under repurchase agreements and federal funds purchased	(106,247)	253,416
Decrease in FHLB advances	(5,000,000)
Dividends paid and cash in lieu of fractional shares		(665)
Net cash provided by financing activities	1,097,133	3,542,879
Net increase in cash and due from banks	894,309	1,094,351
Cash and due from banks at beginning of period	3,275,584	3,461,483
Cash and due from banks at end of period	4,169,893	4,555,834
Supplemental Schedule of Cash Flow Information
Interest paid	2,354,537	2,816,982
Income taxes paid	103,827
Unrealized gain on investment securities	385,616	296,418
Loans transferred to other real estate owned	$ 1,220,132	$ 2,512,044

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Long Term Debt

6 Months Ended

Jun. 30, 2011

Long Term Debt

Long Term Debt

Note 9: Long Term Debt

On June 30, 2011, the Bank had FHLB debt consisting of four advances. The FHLB holds an option to terminate the $10 million advance on any quarterly payment date. The $10 million advance has an early conversion option which gives the FHLB the option to convert, in whole only, into a one-month LIBOR-based floating rate advance, effective on any quarterly payment date. If the FHLB elects to convert, the Bank may elect to terminate, in whole or in part, without a prepayment fee.

Advances on the FHLB lines are secured by a blanket lien on qualified 1 to 4 family residential real estate loans with a lendable collateral value of $55.6 million. Immediate available credit, as of June 30, 2011, was $30.6 million. With additional collateral, the total line of credit is worth $65.5 million, with $40.5 million available.

The four advances are shown in the following table.

Description	Balance		Acquired		Current Interest Rate			Maturity Date
Convertible	$	10,000,000		9/12/2006		4.23	%		9/12/2016
Fixed Rate Hybrid		5,000,000		5/18/2011		0.30	%		5/18/2012
Fixed Rate Hybrid		5,000,000		5/18/2011		0.72	%		5/20/2013
Fixed Rate Hybrid		5,000,000		5/20/2011		2.69	%		5/20/2014
	$	25,000,000

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Consolidated Balance Sheets (USD $)	Jun. 30, 2011	Dec. 31, 2010
ASSETS
Cash and due from banks	$ 4,169,893	$ 3,275,584
Interest-bearing deposits	29,354,853	14,735,892
Federal funds sold	5,314,545	4,727,084
Securities available for sale, at fair value	31,174,512	34,073,728
Restricted securities	2,281,800	2,358,500
Loans, net of allowance for loan losses of $3,317,105 and $3,230,677	234,199,711	244,142,325
Premises and equipment, net	12,392,041	12,697,447
Accrued interest receivable	1,164,530	1,159,924
Other real estate owned, net of valuation allowance	3,165,995	4,085,939
Goodwill	2,807,842	2,807,842
Other assets	2,692,201	3,021,300
Total assets	328,717,923	327,085,565
LIABILITIES
Noninterest-bearing deposits	43,089,933	44,960,718
Savings and interest-bearing demand deposits	109,081,025	103,908,863
Time deposits	114,886,421	111,984,418
Total deposits	267,057,379	260,853,999
Federal funds purchased and securities sold under repurchase agreements	7,491,774	7,598,021
Federal Home Loan Bank advances	25,000,000	30,000,000
Other liabilities	1,348,634	1,291,235
Commitments and contingencies
Total liabilities	300,897,787	299,743,255
SHAREHOLDERS' EQUITY
Common stock ($5 par value; authorized - 5,000,000 shares; outstanding - 2,605,856 and 2,605,856 shares, respectively)	13,029,280	13,029,280
Additional paid-in capital	4,973,408	4,965,460
Retained earnings	9,408,864	9,193,492
Accumulated other comprehensive income, net	408,584	154,078
Total shareholders' equity	27,820,136	27,342,310
Total liabilities and shareholders' equity	$ 328,717,923	$ 327,085,565