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, 2012

or

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

For the transition period from                      to                     

Commission file number: 001-34292

ORRSTOWN FINANCIAL SERVICES, INC.

(Exact Name of Registrant as Specified in its Charter)

Pennsylvania	23-2530374
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
77 East King Street, P. O. Box 250, Shippensburg, Pennsylvania	17257
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s Telephone Number, Including Area Code: (717) 532-6114

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.    Yes  x    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).    Yes  x    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 the definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨		Accelerated filer	x
Non-accelerated filer	¨	(Do not check if a smaller reporting company)	Smaller reporting company	¨

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

Number of shares outstanding of the registrant’s Common Stock as of August 1, 2012: 8,065,261

ORRSTOWN FINANCIAL SERVICES, INC.

INDEX

	Page
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Condensed consolidated balance sheets - June 30, 2012 and December 31, 2011		3
Condensed consolidated statements of operations - Three and six months ended June 30, 2012 and 2011		4
Condensed consolidated statements of comprehensive income (loss) - Three and six months ended June  30, 2012 and 2011		5
Condensed consolidated statements of changes in shareholders’ equity - Six Months Ended June  30, 2012 and 2011		6
Condensed consolidated statements of cash flows - Six months ended June 30, 2012 and 2011		7
Notes to condensed consolidated financial statements		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		33
Item 3. Quantitative and Qualitative Disclosures About Market Risk		70
Item 4. Controls and Procedures		71
PART II - OTHER INFORMATION
Item 1. Legal Proceedings		72
Item 1A. Risk Factors		72
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		73
Item 3. Defaults upon Senior Securities		73
Item 4. Mine Safety Disclosures		73
Item 5. Other Information		73
Item 6. Exhibits		73
SIGNATURES		74
EXHIBIT INDEX		75

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets

ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY

(Dollars in thousands, Except per Share Data)	(Unaudited) June 30, 2012			(Audited)* December 31, 2011
Assets
Cash and due from banks	$	15,798		$	19,630
Federal funds sold		0			0
Cash and cash equivalents		15,798			19,630
Interest bearing deposits with banks		109,725			90,039
Restricted investments in bank stock		11,495			11,758
Securities available for sale		283,078			310,365
Loans held for sale		4,825			2,553
Loans		837,980			965,440
Less: Allowance for loan losses		(36,235	)		(43,715	)
Net Loans		806,570			924,278
Premises and equipment, net		26,983			27,183
Cash surrender value of life insurance		24,579			24,147
Goodwill and intangible assets		936			1,041
Accrued interest receivable		3,593			4,548
Other assets		45,718			31,108
Total assets	$	1,328,475		$	1,444,097
Liabilities
Deposits:
Non-interest bearing	$	118,062		$	111,930
Interest bearing		1,026,322			1,104,972
Total deposits		1,144,384			1,216,902
Short-term borrowings		27,493			35,013
Long-term debt		38,142			53,798
Accrued interest and other liabilities		10,827			10,187
Total liabilities		1,220,846			1,315,900
Shareholders’ Equity
Preferred Stock, $1.25 par value per share; 500,000 shares authorized; no shares issued or outstanding		0			0
Common stock, no par value - $ 0.05205 stated value per share 50,000,000 shares authorized; 8,066,073 and 8,055,787 shares issued; 8,065,261 and 8,054,975 shares outstanding		420			419
Additional paid - in capital		122,616			122,514
Retained earnings (accumulated deficit)		(16,937	)		1,195
Accumulated other comprehensive income		1,550			4,089
Treasury stock - common, 812 and 812 shares, at cost		(20	)		(20	)
Total shareholders’ equity		107,629			128,197
Total liabilities and shareholders’ equity	$	1,328,475		$	1,444,097

* The consolidated balance sheet at December 31, 2011 has been derived from audited financial statements at that date.

The Notes to Consolidated Financial Statements are an integral part of these statements.

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Consolidated Statements of Operations

ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY

	Three Months Ended						Six Months Ended
(Dollars in thousands, Except per Share Data)	June 30, 2012			June 30, 2011			June 30, 2012			June 30, 2011
Interest and dividend income
Interest and fees on loans	$	10,044		$	12,383		$	21,150		$	24,818
Interest and dividends on investment securities
Taxable		1,029			2,364			2,337			4,459
Tax-exempt		474			769			1,088			1,540
Short-term investments		82			21			143			45
Total interest and dividend income		11,629			15,537			24,718			30,862
Interest expense
Interest on deposits		1,862			2,359			3,840			4,884
Interest on short-term borrowings		41			95			93			218
Interest on long-term debt		180			273			397			562
Total interest expense		2,083			2,727			4,330			5,664
Net interest income		9,546			12,810			20,388			25,198
Provision for loan losses		23,000			21,230			42,200			24,425
Net interest income after provision for loan losses		(13,454	)		(8,420	)		(21,812	)		773
Noninterest income
Service charges on deposit accounts		1,543			1,645			3,062			3,130
Other service charges, commissions and fees		284			327			598			697
Trust department income		1,116			1,034			2,252			2,046
Brokerage income		421			484			784			888
Mortgage banking activities		727			636			1,212			1,332
Earnings on life insurance		250			250			498			580
Merchant processing revenue		0			285			0			540
Other income (loss)		91			79			(14	)		224
Investment securities gains		2,595			469			4,826			848
Total noninterest income		7,027			5,209			13,218			10,285
Noninterest expense
Salaries and employee benefits		4,977			4,176			9,634			9,008
Occupancy expense		513			477			1,027			1,039
Furniture and equipment		727			692			1,405			1,373
Data processing		134			349			263			661
Telephone		182			165			342			341
Advertising and bank promotions		308			296			681			554
FDIC Insurance		710			762			1,231			1,312
Professional services		751			546			1,552			868
Taxes other than income		230			205			464			410
Collection expense		579			177			1,297			331
OREO expense		100			40			476			78
Intangible asset amortization		52			53			105			105
Other operating expenses		1,470			1,784			3,139			3,081
Total noninterest expenses		10,733			9,722			21,616			19,161
Income (loss) before income tax (benefit)		(17,160	)		(12,933	)		(30,210	)		(8,103	)
Income tax expense (benefit)		(7,246	)		(2,310	)		(12,078	)		(1,307	)
Net income (loss)	$	(9,914	)	$	(10,623	)	$	(18,132	)	$	(6,796	)
Per share information:
Basic earnings (loss) per share	$	(1.23	)	$	(1.33	)	$	(2.25	)	$	(0.85	)
Diluted earnings (loss) per share		(1.23	)		(1.33	)		(2.25	)		(0.85	)
Dividends per share		0.00			0.23			0.00			0.46

The Notes to Consolidated Financial Statements are an integral part of these statements.

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Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY

	Three Months Ended						Six Months Ended
(Dollars in thousands)	June 30, 2012			June 30, 2011			June 30, 2012			June 30, 2011
Net income (loss)	$	(9,914	)	$	(10,623	)	$	(18,132	)	$	(6,796	)
Other comprehensive income (loss), net of tax:
Unrealized holding gains (losses) on securities available for sale arising during the period		(118	)		4,729			919			5,654
Reclassification adjustment for (gains) realized in net income		(2,595	)		(469	)		(4,826	)		(848	)
Net unrealized gains (losses)		(2,713	)		4,260			(3,907	)		4,806
Tax effect		949			(1,491	)		1,368			(1,682	)
		(1,764	)		2,769			(2,539	)		3,124
Unrealized holding gains (losses) in fair value of derivatives used for cash flow hedges		0			140			0			(129	)
Reclassification adjustment for (gains) realized in net income		0			0			0			(118	)
Net unrealized gains (losses)		0			140			0			(247	)
Tax effect		0			(49	)		0			86
		0			91			0			(161	)
Total other comprehensive income (loss), net of tax and reclassification adjustments		(1,764	)		2,860			(2,539	)		2,963
Total comprehensive income (loss)	$	(11,678	)	$	(7,763	)	$	(20,671	)	$	(3,833	)

The Notes to Consolidated Financial Statements are an integral part of these statements.

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Consolidated Statements of Changes in Shareholders’ Equity

ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY

	Six Months Ended June 30, 2012 and 2011
(Dollars in thousands, except per share data)	Common Stock		Additional Paid-In Capital			Retained Earnings (Accumulated Deficit)			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Total Shareholders’ Equity
Balance, January 1, 2011	$	416	$	121,508		$	38,680		$	(88	)	($	32	)	$	160,484
Net income (loss)		0		0			(6,796	)		0			0			(6,796	)
Total other comprehensive income, net of taxes		0		0			0			2,963			0			2,963
Cash dividends ($0.46 per share)		0		0			(3,677	)		0			0			(3,677	)
Stock-based compensation plans:
Issuance of stock		1		473			0			0			0			474
Purchase of treasury stock (2,232 shares)		0		0			0			0			(54	)		(54	)
Issuance of treasury stock (2,719 shares)		0		(19	)		0			0			66			47
Balance, June 30, 2011	$	417	$	121,962		$	28,207		$	2,875		($	20	)	$	153,441
Balance, January 1, 2012	$	419	$	122,514		$	1,195		$	4,089		($	20	)		128,197
Net income (loss)		0		0			(18,132	)		0			0			(18,132	)
Total other comprehensive income (loss), net of taxes		0		0			0			(2,539	)		0			(2,539	)
Stock-based compensation plans:
Issuance of stock (8,879 shares)		1		68			0			0			0			69
Compensation expense		0		23			0			0			0			23
Issuance of stock under dividend reinvestment plan (1,407 shares)		0		11			0			0			0			11
Balance, June 30, 2012	$	420	$	122,616		$	(16,937	)	$	1,550		($	20	)	$	107,629

The Notes to Consolidated Financial Statements are an integral part of these statements.

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Consolidated Statements of Cash Flows

ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY

	Six Months Ended
(Dollars in Thousands, Except per Share Data)	June 30, 2012			June 30, 2011
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	(18,132	)	$	(6,796	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Amortization of premiums on securities available for sale		3,505			2,787
Depreciation and amortization		1,294			1,391
Provision for loan losses		42,200			24,425
Net change in loans held for sale		(2,272	)		(2,252	)
Net (gain) loss on disposal of other real estate owned		79			(30	)
Write-down of other real estate owned		343			181
Deferred income taxes		(2,538	)		(3,791	)
Investment securities gains		(4,826	)		(848	)
Gain on sale of rate swap		0			(118	)
Earnings on cash surrender value of life insurance		(432	)		(521	)
Decrease in accrued interest receivable		955			30
Increase (decrease) in accrued interest payable		(425	)		26
Other, net		(9,644	)		(1,307	)
Net cash provided by operating activities		10,107			13,177
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in interest bearing deposits with banks and short term investments		(19,686	)		(2,660	)
Sales of available for sale securities		93,846			36,679
Maturities, repayments and calls of available for sale securities		38,444			29,359
Purchases of available for sale securities		(107,587	)		(52,539	)
Net proceeds (purchases) of restricted investments in bank stocks		263			(533	)
Net (increase) decrease in loans		75,617			(48,546	)
Investment in limited partnerships		0			(55	)
Purchases of bank premises and equipment		(781	)		(600	)
Proceeds from disposal of other real estate owned		1,536			388
Proceeds from sale of rate swap		0			118
Purchases of bank owned life insurance		0			(500	)
Net cash provided (used) by investing activities		81,652			(38,889	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits		(72,518	)		71,819
Net decrease in short term purchased funds		(7,520	)		(24,972	)
Payments on long-term debt		(15,656	)		(20,425	)
Dividends paid		0			(3,677	)
Proceeds from issuance of common stock		103			474
Purchase of treasury stock		0			(54	)
Net proceeds from issuance of treasury stock		0			47
Net cash provided (used) by financing activities		(95,591	)		23,212
Net decrease in cash and cash equivalents		(3,832	)		(2,500	)
Cash and cash equivalents at beginning of period		19,630			19,200
Cash and cash equivalents at end of period	$	15,798		$	16,700
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	4,755		$	5,638
Income taxes		1,267			3,591
Supplemental schedule of noncash investing activities:
Other real estate acquired in settlement of loans	$	2,130		$	556

The Notes to Consolidated Financial Statements are an integral part of these statements

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Notes to Consolidated Financial Statements

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations - Orrstown Financial Services, Inc. (the “Company”) is a financial holding company whose primary activity consists of supervising its wholly-owned subsidiary, Orrstown Bank (the “Bank”). The Company operates through its office in Shippensburg, Pennsylvania. Orrstown Bank provides services through its network of offices in Franklin, Cumberland and Perry Counties of Pennsylvania and in Washington County, Maryland. The Bank engages in lending services for commercial loans, residential loans, commercial mortgages and various forms of consumer lending. Deposit services include checking, savings, time and money market deposits. The Bank also provides investment and brokerage services through its Orrstown Financial Advisors division. The Bank has twenty-one branches located in Shippensburg (2), Carlisle (5), Spring Run, Orrstown, Chambersburg (3), Mechanicsburg (2), Camp Hill, Greencastle, Newport (2), Duncannon, and New Bloomfield, Pennsylvania and Hagerstown, Maryland. The Company and its subsidiary are subject to the regulation of certain federal and state agencies and undergo periodic examinations by such regulatory authorities.

Basis of Presentation - The unaudited financial statements of the Company and its subsidiary are presented for the three and six months ended June 30, 2012 and 2011 and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. However, unaudited information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, considered necessary for a fair presentation of the financial position, results of operations and cash flows for the interim period. Information presented at December 31, 2011 is condensed from audited year-end financial statements. For further information, refer to the audited consolidated financial statements and footnotes thereto, included in the Annual Report on Form 10-K for the year ended December 31, 2011.

All significant intercompany transactions and accounts have been eliminated. Operating results for the three and six months ended June 30, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties.

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for losses on loans and foreclosed real estate. Such agencies may require the Company to recognize additions to the allowance based on their judgments concerning information available to them at the time of their examination. Because of these factors, management’s estimate of credit losses inherent in the loan portfolio and the related allowance may change in the near term.

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Subsequent Events - GAAP establishes standards for accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. The subsequent events principle sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition in the financial statements, identifies the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and specifies the disclosures that should be made about events or transactions that occur after the balance sheet date. In preparing these financial statements, the Company evaluated the events and transactions that occurred after June 30, 2012, through the date these financial statements were filed with the Securities and Exchange Commission (the “Commission”).

Concentration of Credit Risk - The Company grants agribusiness, commercial, residential and consumer loans to customers in its market area. Although the Company maintains a diversified loan portfolio, a significant portion of its customers’ ability to honor their contracts is dependent upon economic sectors for construction contractors, residential and non-residential building operators, sales finance, sub-dividers and developers. Management evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if collateral is deemed necessary by the Company upon the extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but generally includes real estate and equipment.

The types of securities the Company invests in are included in Note 2, “Securities Available for Sale” and the type of lending the Company engages in are included in Note 3, “Loans Receivable and Allowance for Loan Losses.”

Cash and Cash Equivalents - For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash, balances due from banks and federal funds sold, all of which have original maturities of 90 days or less.

Restricted Investments in Bank Stocks - Restricted investment in bank stocks, which represents required investments in the common stock of correspondent banks, is carried at cost as of June 30, 2012 and December 31, 2011, and consists of common stock of the Federal Reserve Bank of Philadelphia, Atlantic Central Bankers Bank and the Federal Home Loan Bank (“FHLB”) of Pittsburgh stocks.

Management evaluates the restricted investment in bank stocks for impairment in accordance with Accounting Standard Codification (“ASC”) Topic 942, Accounting by Certain Entities (Including Entities with Trade Receivables) That Lend to or Finance the Activities of Others. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the correspondent bank as compared to the capital stock amount for the correspondent bank and the length of time this situation has persisted, (2) commitments by the correspondent bank to make payments required by law or regulation and the level of such payments in relation to the operating performance of the correspondent bank, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the correspondent bank.

Management believes no impairment charge is necessary related to the restricted investment in bank stocks as of June 30, 2012. However, security impairment analysis is completed quarterly and the determination that no impairment had occurred as of June 30, 2012 is no assurance that impairment may not occur in the future.

Interest-Bearing Deposits in Banks - Interest bearing deposits in banks are due on demand or mature within one year and are carried at cost.

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Securities - Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. “Trading” securities are recorded at fair value with changes in fair value included in earnings. As of June 30, 2012 and December 31, 2011 the Company had no held to maturity or trading securities. Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

The Company follows the accounting guidance related to recognition and presentation of other-than-temporary impairment (FASB ASC 320-10). This guidance specifies that (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.

The Company had no debt securities it deemed to be other than temporarily impaired at June 30, 2012 and December 31, 2011.

The Company’s securities are exposed to various risks, such as interest rate, market risk, currency and credit risks. Due to the level of risk associated with certain investments and the level of uncertainty related to changes in the value of investments, it is at least reasonably possible that changes in risks in the near term would materially affect investment assets reported in the consolidated financial statements.

For equity securities, when the Company has decided to sell an impaired available-for-sale security and the entity does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed other-than-temporarily impaired in the period in which the decision to sell is made. The Company recognizes an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made.

Loans Held for Sale - Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value (LOCM). Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in non-interest income.

Loans - The Company grants commercial, mortgage, and consumer loans to its customers located principally in south-central Pennsylvania and northern Maryland. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and amortized as a yield adjustment over the respective term of the loan.

For all classes of loans, the accrual of interest income on loans, including impaired loans, ceases when principal or interest is past due 90 days or more or immediately if, in the opinion of management, full collection is unlikely. Interest will continue to accrue on loans past due 90 days or more if the collateral is adequate to cover principal and interest, and the loan is in the process of collection. Interest accrued, but not collected, as of the date of placement on nonaccrual status, is reversed and charged against current interest income, unless fully collateralized. Subsequent payments received are either applied to the

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outstanding principal balance or recorded as interest income, depending upon management’s assessment of the ultimate collectability of principal. Loans are returned to accrual status, for all loan classes, when all the principal and interest amounts contractually due are brought current, the loan has performed in accordance with the contractual terms of the note for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is reasonably assured. Past due status is based on contractual terms of the loan.

Loans, the terms of which are modified, are classified as troubled debt restructurings if a concession was granted, for legal or economic reasons, related to a debtor’s financial difficulties. Concessions granted under a troubled debt restructuring typically involve a temporary deferral of scheduled loan payments, an extension of a loan’s stated maturity date, temporary reduction in interest rates, or granting of an interest rate below market rates given the risk of the transaction. If a modification occurs while the loan is on accruing status, it will continue to accrue interest under the modified terms. Nonaccrual troubled debt restructurings are restored to accrual status if scheduled principal and interest payments, under the modified terms, are current for six months after modification, and the borrower continues to demonstrate its ability to meet the modified terms. Troubled debt restructurings are evaluated individually for impairment if they have been restructured during the most recent calendar year, or if they are not performing according to their modified terms.

Allowance for Loan Losses - The allowance for loan losses is reestablished as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

Loans Serviced - The Bank administers secondary market mortgage programs available through the FHLB of Pittsburgh and the Federal National Mortgage Association and offers residential mortgage products and services to customers. The Bank originates single-family residential mortgage loans for immediate sale in the secondary market, and retains the servicing of those loans. At June 30, 2012 and December 31, 2011 the balance of loans serviced for others was $309,117,000 and $299,998,000.

Transfers of Financial Assets - Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Foreclosed Real Estate - Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at the lower of carrying value or fair value less estimated costs to sell the underlying collateral. Capitalized costs include accrued interest and any costs that significantly improve the value of the properties. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of its carrying amount or fair value less estimated costs to sell. Foreclosed real estate totaled $2,337,000 and $2,165,000 as of June 30, 2012 and December 31, 2011 and is included in other assets.

Stock Compensation Plans - The Company has stock option plans that cover employees and non-employee directors. Stock compensation accounting guidance (FASB ASC 718, Compensation - Stock Compensation) requires that the compensation cost relating to share-based payment transactions be

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recognized in financial statements. That cost is measured based on the grant date fair value of the stock award, including a Black-Scholes model for stock options. Compensation cost for all stock awards are calculated and recognized over the employees’ service period, generally defined as the vesting period.

Income Taxes - The Company accounts for Income Taxes in accordance with income tax accounting guidance (FASB ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. The Company recognizes interest and penalties, if any, on income taxes as a component of income tax expense.

Treasury Stock - Common stock shares repurchased are recorded as treasury stock at cost.

Earnings Per Share - Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect the additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate solely to outstanding stock options.

Treasury shares are not deemed outstanding for earnings per share calculations.

Comprehensive Income - Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains on securities available for sale, and unrealized losses related to factors other than credit on debt securities and unrealized gains and losses on cash flow hedges.

The component of accumulated other comprehensive income, net of taxes, at June 30, 2012 and December 31, 2011 consisted of unrealized gains on securities available for sale and totaled $1,550,000 and $4,089,000.

Fair Value of Financial Instruments - Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

Segment Reporting - The Company only operates in one significant segment - Community Banking. The Company’s non-banking activities are insignificant to the consolidated financial statements.

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Recent Accounting Pronouncements - In April 2011, the FASB issued ASU 2011-2, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. This guidance clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for the purpose of recording an impairment charge and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-2, that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. As allowed by the guidance, the Company adopted the provisions of ASU 2011-2 in the quarter ending June 30, 2011. See further discussion in Note 3 - Loans Receivable and Allowance for Loan Losses.

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. The ASU requires certain disclosures about transfers between Level 1 and Level 2 of the fair value hierarchy, sensitivity of fair value measurements categorized within Level 3 of the fair value hierarchy, and categorization by level of items that are reported at cost but are required to be disclosed at fair value. The disclosures are to be applied prospectively in the first interim and annual periods beginning after December 15, 2011. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which defers certain provisions of ASU 2011-05, Presentation of Comprehensive Income. One of ASU 2011-05’s provisions requires entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented (for both interim and annual financial statements). Accordingly, this requirement is indefinitely deferred by ASU 2011-12 and will be further deliberated by the FASB at a future date. ASUs 2011-05 and 2011-12 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and should be applied retrospectively for all periods presented in the financial statements. The Company adopted the provisions of this guidance which are incorporated in these consolidated financial statements.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The ASU requires new disclosures regarding the nature of an entity’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. The new disclosures are designed to make GAAP financial statements more comparable to those prepared under International Financial Reporting Standards. The new disclosures entail presenting information about both gross and net exposures. The new disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein; retrospective application is required. The Company has not yet completed its evaluation of this ASU; however, since the provisions of ASU 2011-11 are disclosure-related, the Company’s adoption of this ASU is not expected to have an impact to its financial condition or results of operations.

NOTE 2. SECURITIES AVAILABLE FOR SALE

At June 30, 2012 and December 31, 2011, the investment securities portfolio was comprised exclusively of securities classified as “available for sale”, resulting in investment securities being carried at fair value. The amortized cost and fair values of investment securities available for sale at June 30, 2012 and December 31, 2011 were:

(Dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
June 30, 2012
U.S. Treasury	$	14,994	$	0	$	11	$	14,983
U.S. Government Sponsored Enterprises (GSE)		39,855		171		34		39,992
States and political subdivisions		38,803		1,254		15		40,042

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GSE residential mortgage-backed securities		186,736		1,211		207		187,740
Total debt securities		280,388		2,636		267		282,757
Equity securities		305		27		11		321
Totals	$	280,693	$	2,663	$	278	$	283,078

(Dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
December 31, 2011
U.S. Government Sponsored Enterprises (GSE)	$	41,563	$	2,081	$	22	$	43,622
States and political subdivisions		75,232		2,852		33		78,051
GSE residential mortgage-backed securities		186,018		1,783		217		187,584
Total debt securities		302,813		6,716		272		309,257
Equity securities		1,260		41		193		1,108
Totals	$	304,073	$	6,757	$	465	$	310,365

The following table shows gross unrealized losses and fair value of the Company’s available for sale securities that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2012 and December 31, 2011:

	Less Than 12 Months				12 Months or More				Total
(Dollars in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
June 30, 2012
U.S. Treasury	$	14,983	$	11	$	0	$	0	$	14,983	$	11
U.S. Government Sponsored Enterprises (GSE)		16,682		34		0		0		16,682		34
States and political subdivisions		2,063		15		0		0		2,063		15
GSE residential mortgage-backed securities		46,095		169		4,134		38		50,229		207
Total debt securities		79,823		229		4,134		38		83,957		267
Equity securities		0		0		68		11		68		11
Total temporarily impaired securities	$	79,823	$	229	$	4,202	$	49	$	84,025	$	278
December 31, 2011
U.S. Government Sponsored Enterprises (GSE)	$	8,685	$	22	$	0	$	0	$	8,685	$	22
States and political subdivisions		0		0		1,467		33		1,467		33
GSE residential mortgage-backed securities		45,019		217		0		0		45,019		217
Total debt securities		53,704		239		1,467		33		55,171		272
Equity securities		751		193		0		0		751		193
Total temporarily impaired securities	$	54,455	$	432	$	1,467	$	33	$	55,922	$	465

The Company had 29 securities and 35 securities at June 30, 2012 and December 31, 2011 in which the amortized cost exceeds their values, as discussed below.

U.S. Treasuries and Government Sponsored Enterprises (GSE). Four U.S Treasuries and 20 GSE securities, including mortgage-backed securities, have amortized costs which exceed their fair values, all but one of which are in the less than 12 months category at June 30, 2012. At December 31, 2011, the Company had 15 GSE securities with unrealized losses, all of which were in the less than 12 months category. These unrealized losses have been caused by a rise in interest rates from the time the securities were purchased. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2012 or at December 31, 2011.

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State and Political Subdivisions. Three state and political subdivision securities had an amortized cost which exceeded their fair value for less than 12 months at June 30, 2012. At December 31, 2011, two state and political subdivision securities had unrealized losses, both of which were greater than 12 months. These unrealized losses have been caused by a rise in interest rates from the time the securities were purchased. Management considers the investment rating, the state of the issuer of the security and other credit support in determining whether the security is other-than-temporarily impaired. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2012 or at December 31, 2011.

Equity Securities. Two equity securities have cost which exceeds their fair value, both of which had unrealized losses for greater than 12 months at June 30, 2012. At December 31, 2011, 18 equity securities had unrealized losses, all of which had unrealized losses for less than 12 months. These securities are among various industries, including financial, industrial, consumer, energy, health care and a large cap fund, In considering whether the equity securities are other-than-temporarily impaired, management reviews the severity and duration of decline in fair value, research reports, analysts recommendations, credit rating changes, news stories and other relevant information. Management believes the equity securities are not other-than-temporarily impaired and will equal or exceed our cost basis within a reasonable period of time. Since these companies are considered viable and carry the possibility of price appreciation in the future, impairments are considered temporary. The Company recorded no other than temporary impairment expense on equity securities for the three or six months ended June 30, 2012 and 2011.

The amortized cost and fair values of securities available for sale at June 30, 2012 by contractual maturity are shown below. Contractual maturities will differ from expected maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale
(Dollars in thousands)	Amortized Cost		Fair Value
Due in one year or less	$	4,150	$	4,179
Due after one year through five years		43,122		43,222
Due after five years through ten years		22,309		22,728
Due after ten years		24,071		24,888
GSE residential mortgage-backed securities		186,736		187,740
Total debt securities		280,388		282,757
Equity securities		305		321
	$	280,693	$	283,078

Gross gains on the sales of securities were $2,706,000 and $500,000 for the quarters ended June 30, 2012 and 2011. Gross losses on the sales of securities available for sale were $111,000 and $31,000 for the quarters ended June 30, 2012 and 2011. Gross gains on the sales of securities were $4,966,000 and $921,000 for the six months ended June 30, 2012 and 2011. Gross losses on the sales of securities were $140,000 and $73,000 for the six months ended June 30, 2012 and 2011.

Securities with a fair value of $238,976,000 and $283,501,000 at June 30, 2012 and December 31, 2011 were pledged to secure public funds and for other purposes as required or permitted by law.

NOTE 3. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The Company’s loan portfolio is broken down into segments to an appropriate level of disaggregation to allow management to monitor the performance by the borrower and to monitor the yield on the portfolio. Management has incorporated the provisions of ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Loan Losses, resulting in a refinement in its portfolio segregation. Consistent with the standard, the segments were further broken down into classes, to allow for differing risk characteristics within a segment.

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The risks associated with lending activities differ among the various loan classes, and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans, and general economic conditions. All of these factors may adversely impact the borrower’s ability to repay its loans, and impact the associated collateral.

The Company has various types of commercial real estate loans which have differing levels of credit risk associated with them. Owner-occupied commercial real estate loans are generally dependent upon the successful operation of the borrower’s business, with the cash flows generated from the business being the primary source of repayment of the loan. If the business suffers a downturn in sales or profitability, the borrower’s ability to repay the loan could be in jeopardy.

Non-owner occupied and multi-family commercial real estate loans present a different credit risk to the Company than owner-occupied commercial real estate, as the repayment of the loan is dependent upon the borrower’s ability to generate a sufficient level of occupancy to produce rental income that exceeds debt service requirements and operating expenses. Lower occupancy or lease rates may result in a reduction in cash flows, which hinder the ability of the borrower to meet debt service requirements, and may result in lower collateral values. The Company generally recognizes greater risk is inherent in these credit relationships as compared to owner-occupied loans mentioned above in its loan pricing.

Acquisition and development loans consist of 1-4 family residential construction and commercial and land development loans. The risk of loss on these loans is largely dependent on the Company’s ability to assess the property’s value at the completion of the project, which should exceed the property’s construction costs. During the construction phase, a number of factors could potentially negatively impact the collateral value, including cost overruns, delays in completing the project, competition, and real estate market conditions which may change based on the supply of similar properties in the area. In the event the collateral value at the completion of the project is not sufficient to cover the outstanding loan balance, the Company must rely upon other repayment sources, including the guarantors of the project or other collateral securing the loan.

Commercial and industrial loans include advances to local and regional businesses for general commercial purposes and include permanent and short-term working capital, machinery and equipment financing, and may be either in the form of lines of credit or term loans. Although commercial and industrial loans may be unsecured to our highest rated borrowers, the majority of these loans are secured by the borrower’s accounts receivable, inventory and machinery and equipment. In a majority of these loans, the collateral also includes the business real estate or the business owner’s personal real estate or assets. Commercial and industrial loans present credit exposure to the Company as they are more susceptible to risk of loss during a downturn in the economy, as borrowers may have greater difficulty in meeting their debt service requirements and the value of the collateral may decline. The Company attempts to mitigate this risk through its underwriting standards, including evaluating the credit worthiness of the borrower and to the extent available, credit ratings on the business. Additionally, monitoring of the loans through annual renewals and meetings with the borrowers are common. However, these procedures cannot eliminate the risk of loss associated with commercial and industrial lending.

The Company originates loans to its retail customers, including fixed-rate and adjustable rate first lien mortgage loans with the underlying 1-4 family owner-occupied residential property securing the credit. The Company’s risk exposure is minimized in these types of loans through the evaluation of the credit worthiness of the borrower, including credit scores and debt-to-income ratios, and underwriting standards which limit the loan-to-value ratio to generally no more than 80% upon loan origination, unless the borrower obtains private mortgage insurance.

Home equity loans, including term loans and lines of credit, present a slightly higher risk to the Company than 1-4 family first liens, as these loans can be first or second liens on 1-4 family owner-occupied residential property, but can have loan-to-value ratios of no greater than 90% of the value of the real estate taken as collateral. The credit worthiness of the borrower is considered including credit scores and debt-to-income ratios, which generally cannot exceed 38%.

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Installment and other loans’ credit risk are mitigated through the Company’s underwriting standards, including the evaluation of the credit worthiness of the borrower, including credit scores and debt-to-income ratios, and if secured, the collateral value of the assets. As these loans can be unsecured or secured by assets the value of which may depreciate quickly or may fluctuate, they present a greater risk to the Company than 1-4 family residential loans.

The loan portfolio, excluding residential loans held for sale, broken out by classes, as of June 30, 2012 and December 31, 2011 was as follows:

(Dollars in thousands)	June 30, 2012		December 31, 2011
Commercial real estate:
Owner-occupied	$	170,948	$	199,646
Non-owner occupied		149,819		141,037
Multi-family		30,239		27,327
Acquisition and development:
1-4 family residential construction		4,610		7,098
Commercial and land development		49,153		77,564
Commercial and industrial		211,717		277,900
Residential mortgage:
First lien		117,642		104,327
Home equity - term		14,826		37,513
Home equity - Lines of credit		81,319		80,951
Installment and other loans		7,707		12,077
	$	837,980	$	965,440

In order to monitor ongoing risk associated with its loan portfolio and specific credits within the segments, management uses an eight point internal grading system. The first four rating categories, representing the lowest risk to the Bank, are combined and given a “Pass” rating. The “Special Mention” category includes loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Bank’s position at some future date. These assets pose elevated risk, but their weakness does not yet justify a more severe, or criticized rating. Management generally follows regulatory definitions in assigning criticized ratings to loans, including substandard, doubtful or loss. “Substandard” loans are classified as they have a well-defined weakness, or weaknesses that jeopardize liquidation of the debt. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. “Substandard” loans include loans that management has determined not to be impaired, as well as loans considered to be impaired. A “doubtful” loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset; its classification of loss is deferred. “Loss” assets are considered uncollectible, as the underlying borrowers are often in bankruptcy, have suspended debt repayments, or ceased business operations. Once a loan is classified as “Loss”, there is little prospect of collecting the loan’s principal or interest and it is generally written off.

The Bank has a loan review policy and program which is designed to reduce and control risk in the lending function. The Credit Administration Committee, comprised of members of the Board, is charged with the overall credit quality and risk exposure of the Company’s loan portfolio. This includes the monitoring of the lending activities of all Bank personnel with respect to underwriting and processing new loans and the timely follow-up and corrective action for loans showing signs of deterioration in quality. The loan review program provides the Bank with an internal (through an outsourced third party beginning in 2011), independent review of the Bank’s loan portfolio on an ongoing basis. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as extended delinquencies, bankruptcy, repossession or death of the borrower occurs, which heightens awareness as to a possible credit event.

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Loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of $1,000,000. Loan review documentation is submitted to the Credit Administration Committee quarterly with a formal review and rating as presented by independent loan review personnel. In addition, all relationships greater than $250,000 rated Substandard, Doubtful or Loss are reviewed by the Credit Administration Committee on a quarterly basis, with reaffirmation of the rating as recommended by the Bank’s Problem Loan Committee or independent loan review personnel. In addition to the policy and procedure guidelines noted above, the Company expanded its review coverage during the last three quarters of 2011 in light of softness in overall economic conditions and deterioration of underlying collateral securing lending relationships. As a result, all commercial real estate, construction and development loans, and commercial loans in excess of $500,000, representing over 75% coverage of these portfolios, have been reviewed. The Company will continue with this expanded review throughout 2012.

The following summarizes the Bank’s ratings based on its internal risk rating system as of June 30, 2012 and December 31, 2011:

(Dollars in thousands)	Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		Total
June 30, 2012:
Commercial real estate:
Owner-occupied	$	138,056	$	14,141	$	10,727	$	7,834	$	190	$	170,948
Non-owner occupied		107,427		11,596		15,330		15,466		0		149,819
Multi-family		18,014		7,812		4,227		186		0		30,239
Acquisition and development:
1-4 family residential construction		1,647		436		533		1,269		725		4,610
Commercial and land development		16,304		9,482		9,821		12,914		632		49,153
Commercial and industrial		158,368		27,874		8,541		15,196		1,738		211,717
Residential mortgage:
First lien		111,245		1,783		1,787		2,827		0		117,642
Home equity - term		14,568		50		166		42		0		14,826
Home equity - Lines of credit		78,579		1,034		1,669		37		0		81,319
Installment and other loans		7,656		42		6		3		0		7,707
	$	651,864	$	74,250	$	52,807	$	55,774	$	3,285	$	837,980
December 31, 2011:
Commercial real estate:
Owner-occupied	$	161,695	$	19,820	$	8,321	$	8,828	$	982	$	199,646
Non-owner occupied		93,379		19,689		7,785		16,661		3,523		141,037
Multi-family		14,896		7,581		1,387		1,328		2,135		27,327
Acquisition and development:
1-4 family residential construction		3,361		724		831		2,182		0		7,098
Commercial and land development		28,513		16,274		13,713		19,064		0		77,564
Commercial and industrial		190,675		19,859		14,232		50,047		3,087		277,900
Residential mortgage:
First lien		102,398		0		596		1,333		0		104,327
Home equity - term		36,290		0		638		585		0		37,513
Home equity - Lines of credit		80,881		0		70		0		0		80,951
Installment and other loans		12,075		0		2		0		0		12,077
	$	724,163	$	83,947	$	47,575	$	100,028	$	9,727	$	965,440

Classified loans may also be evaluated for impairment. For commercial real estate, acquisition and development and commercial and industrial loans, a loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Generally, loans that are more than 90 days past due are deemed impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed, to determine if the loan should be placed in nonaccrual status. Nonaccrual loans in the commercial and commercial real estate portfolios are, by definition, deemed to be impaired. Impairment is

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measured on a loan-by-loan basis for commercial, construction and restructured loans by either the present value of the expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For loans that are deemed to be impaired for extended periods of time, periodic updates on fair values are obtained, which may include updated appraisals. The updated fair values will be incorporated into the impairment analysis as of the next reporting period. In the event an updated appraisal that requires a higher impairment reserve is received after a reporting period, but prior to the issuance of the financial statements, an evaluation is made as to the significance of the difference and whether the amounts need to be reflected in the financial statements not yet issued.

Loan charge-offs, which may include partial charge-offs, are taken on an impaired loan that is collateral dependent if the loan’s carrying balance exceeds its collateral’s appraised value; the loan has been identified as uncollectible; and it is deemed to be a confirmed loss. Typically, impaired loans with a charge-off or partial charge-off will continue to be considered impaired, unless the note is split into two, and management expects the performing note to continue to perform and is adequately secured. The second, or non-performing note, would be charged-off. As of the periods presented, the Company has no loans to borrowers that resulted from splitting impaired loans into multiple notes. Generally, an impaired loan with a partial charge-off will continue to have an impairment reserve on it after the partial charge-off, if factors warrant.

As of June 30, 2012 and December 31, 2011, nearly all of the Company’s impaired loans’ extent of impairment was measured based on the estimated fair value of the collateral securing the credit, except for certain troubled debt restructurings not in nonaccrual status. By definition, troubled debt restructurings are considered impaired. For real estate loans, collateral generally consists of commercial real estate, but in the case of commercial and industrial loans, it would also consist of accounts receivable, inventory, equipment or other business assets. Commercial and industrial loans may also have real estate collateral.

At the time a real estate-secured loan is deemed impaired, management determines whether an updated certified appraisal of the real estate is necessary to assist in determining the extent of an impairment reserve, if any. The decision for requiring an updated appraisal takes into consideration the age of the most recent appraisal, the loan-to-value ratio based on the original certified appraisal, the Company’s recent experience and knowledge of market conditions, recent list prices or broker opinions, the condition of the property, and environmental factors. If market conditions have changed significantly from the date of the most recent appraisal, an updated appraisal will be obtained. As of October 1, 2011, the Company amended its policy, which now requires annual updated appraisals for criticized loans in excess of $250,000. In many cases the “as is value” provided in the appraisal is used as the fair value of the collateral in determining impairment, unless circumstances, such as subsequent improvements, approvals, or other circumstances dictate that another value provided by the appraiser is more appropriate.

Generally impaired loans secured by real estate were measured at fair value using certified real estate appraisals that had been completed within the last year. Appraised values are further discounted for estimated costs to sell the property and other selling considerations to arrive at the property’s fair value. In those situations in which it is determined an updated appraisal is not required for loans individually evaluated for impairment, fair values are based on one or a combination of the following approaches. In those situations in which a combination of approaches is considered, the one that carries the most consideration will be the one management believes is warranted. The approaches are as follows:

• Original appraisal - if the original appraisal provides a strong loan-to-value (generally 70% or lower) and, after consideration of market conditions and knowledge of the property and area, it is determined by the Credit Administration staff that there has not been a significant deterioration in the collateral value, the original certified appraised value may be used. Discounts as deemed appropriate for selling costs are factored into the appraised value in arriving at fair value.

• Discounted cash flows - In limited cases, discounted cash flows may be used on projects in which the collateral is liquidated to reduce the borrowings outstanding, and is also used to validate collateral values derived from other approaches.

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Collateral on certain impaired loans is not limited to real estate, and consists of accounts receivable, inventory, equipment or other business assets. Estimated fair values are determined based on borrowers’ financial statements, inventory ledgers, accounts receivable agings or appraisals from individuals with knowledge in the business. Stated balances are generally discounted for the age of the financial information or the quality of the assets. In determining fair value, liquidation discounts are applied to this collateral based on existing loan evaluation policies.

The Company distinguishes Substandard loans on both an impaired and non-impaired basis, as it places less emphasis on a loan’s classification, and increased reliance on whether the loan was performing in accordance with the contractual terms. “Substandard” classification does not automatically meet the definition of “impaired”. A Substandard credit is one that is inadequately protected by current sound worth or paying capacity of the obligor or the collateral pledged, if any. Extensions of credit so classified have well-defined weaknesses which may jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of Substandard credits, does not have to exist in individual extensions of credit classified Substandard. As a result, the Company revised its methodology in its evaluation of certain accruing commercial real estate, acquisition and development and commercial and industrial loans rated “Substandard” to be collectively evaluated for impairment as opposed to evaluating these loans individually for impairment. Although we believe these loans have well defined weaknesses and meet the definition of “Substandard”, they are generally performing and management has concluded that it is likely it will be able to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.

Larger groups of smaller balance homogenous loans are collectively evaluated for impairment. Generally, the Bank does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

The following summarizes impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required as of June 30, 2012 and December 31, 2011. In the first quarter of 2012, the Company began to more aggressively charge off specific reserve allocations on impaired loans rather than to carry related allowances. At December 31, 2011, specific reserves related to anticipated closing costs, additional market discounts on appraisal values and specific reserves identified during periods subsequent to the balance sheet. Allowances established at June 30, 2012 generally pertain to those credits in which an updated appraisal is pending, and the partial charge-off will be recorded when received.

	Impaired Loans with a Specific Allowance						Impaired Loans with No Specific Allowance
(Dollars in thousands)	Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)		Related Allowance		Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)
June 30, 2012
Commercial real estate:
Owner-occupied	$	0	$	0	$	0	$	8,024	$	11,162
Non-owner occupied		1,274		1,274		346		14,192		25,667
Multi - family		0		0		0		186		2,969
Acquisition and development:
1-4 family residential construction		725		725		413		1,269		3,756
Commercial and land development		632		632		363		12,914		28,420
Commercial and industrial		1,830		1,830		945		15,104		25,636
Residential mortgage:
First lien		453		453		8		2,374		2,826
Home equity - term		0		0		0		42		277
Home equity - lines of credit		0		0		0		37		37
Installment and other loans		0		0		0		3		3
	$	4,914	$	4,914	$	2,075	$	54,145	$	100,753
December 31, 2011

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Commercial real estate:
Owner-occupied	$	5,016	$	5,200	$	1,762	$	4,794	$	4,838
Non-owner occupied		16,682		20,472		6,876		3,502		4,071
Multi - family		3,129		5,117		1,213		334		334
Acquisition and development:
1-4 family residential construction		2,182		3,715		926		0		0
Commercial and land development		10,657		13,899		4,369		8,407		9,712
Commercial and industrial		46,685		47,256		14,591		6,449		6,551
Residential mortgage:
First lien		1,122		1,122		9		211		211
Home equity - term		41		41		42		544		709
	$	85,514	$	96,822	$	29,788	$	24,241	$	26,426

The following summarizes the average recorded investment in impaired loans and related interest income recognized on loans deemed impaired as of June 30:

	Three Months Ended June 30,
	2012				2011
(Dollars in thousands)	Average Impaired Balance		Interest Income Recognized		Average Impaired Balance
Commercial real estate:
Owner-occupied	$	10,336	$	4	$	1,727
Non-owner occupied		16,911		293		1,589
Multi-family		1,175		0		1,533
Acquisition and development:
1-4 family residential construction		1,620		2		66
Commercial and land development		13,358		116		5,231
Commercial and industrial		26,742		72		20,182
Residential mortgage:
First lien		1,657		27		466
Home equity - term		304		2		710
Home equity - lines of credit		19		0		0
Installment and other loans		2		0		0
Total	$	72,124	$	516	$	31,504

	Six Months Ended June 30,
	2012				2011
(Dollars in thousands)	Average Impaired Balance		Interest Income Recognized		Average Impaired Balance
Commercial real estate:
Owner-occupied	$	10,161	$	44	$	1,380
Non-owner occupied		18,002		360		1,747
Multi-family		1,938		0		1,052
Acquisition and development:
1-4 family residential construction		1,807		2		44
Commercial and land development		15,260		187		3,487
Commercial and industrial		35,539		226		17,027
Residential mortgage:
First lien		1,549		27		467
Home equity - term		398		2		710
Home equity - lines of credit		12		0		0
Installment and other loans		1		0		0
Total	$	84,667	$	848	$	25,914

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The following presents impaired loans that are troubled debt restructurings, as well as the number of loans modified as of June 30, 2012 and December 31, 2011:

	Troubled Debt Restructurings At Period End				New Troubled Debt Restructurings Six Months Ended June 30,
(Dollars in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
June 30, 2012
Accruing:
Commercial real estate:
Non-owner occupied		2	$	2,008		0	$	0
Commercial and industrial		2		334		0		0
Residential mortgage:
First lien		1		453		0		0
Home equity - lines of credit		1		37		1		37
		6		2,832		1		37
Nonaccruing:
Commercial real estate:
Owner-occupied		2		709		0		0
Non-owner occupied		1		193		0		0
Acquisition and development:
Commercial and land development		4		1,671		0		0
Commercial and industrial		9		3,709		1		203
Residential mortgage:
First lien		1		299		1		299
		17		6,581		2		502
		23	$	9,413		3	$	539

	Troubled Debt Restructurings At Period End				New Troubled Debt Restructurings Year Ending December 31, 2011
(Dollars in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
December 31, 2011
Accruing:
Commercial real estate:
Owner-occupied		1	$	924		1	$	924
Non-owner occupied		2		2,039		2		2,039
Acquisition and development:
1-4 family residential construction		0		0		0		0
Commercial and land development		2		1,061		2		1,061
Commercial and industrial		10		23,434		10		23,434
Residential mortgage:

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First lien	1		459	0		0
	16		27,917	15		27,458
Nonaccruing:
Commercial real estate:
Owner-occupied	1		54	1		54
Non-owner occupied	1		221	1		221
Acquisition and development:
Commercial and land development	3		3,179	3		3,179
Commercial and industrial	10		5,648	10		5,648
Residential mortgage:
Home equity - term	1		544	0		0
	16		9,646	15		9,102
	32	$	37,563	30	$	36,560

The loans presented above were considered troubled debt restructurings as the result of the Company agreeing to below market interest rates for the risk of the transaction, allowing the loan to remain on interest only status, or for residential mortgage loans, agreeing to a temporary reduction in interest rates for periods not exceeding 12 months in order to assist the borrowers to improve cash flows during such periods.

Troubled debt restructurings included in nonaccrual status at June 30, 2012 were designated as such either due to the borrower defaulting on the modified terms within the past twelve months, or management’s determination the borrower would not be able to continue to meet debt service requirements for a sustainable period of time or where newly restructured debts had not yet reached a minimum of 6 months of performance according to modifications. As of June 30, 2012, 17 loans totaling $6,581,000 were in default of their restructured terms.

No additional commitments have been made to borrowers whose loans are considered troubled debt restructurings.

Management further monitors the performance and credit quality of the loan portfolio by analyzing the length of time a portfolio is past due, by aggregating loans based on its delinquencies. The following table presents the classes of the loan portfolio summarized by aging categories of performing loans and nonaccrual loans as of June 30, 2012 and December 31, 2011:

			Days Past Due
	Current		30-59		60-89		90+ (still accruing)		Total Past Due		Non- Accrual		Total Loans
June 30, 2012
Commercial real estate:
Owner-occupied	$	161,362	$	434	$	782	$	346	$	1,562	$	8,024	$	170,948
Non-owner-occupied		136,239		122		0		0		122		13,458		149,819
Multi-family		29,188		198		400		267		865		186		30,239
Acquisition and development:
1-4 family residential construction		2,808		391		0		142		533		1,269		4,610
Commercial and land development		34,699		721		27		159		907		13,547		49,153
Commercial and industrial		193,329		206		602		255		1,063		17,325		211,717
Residential mortgage:
First lien		112,460		1,443		604		106		2,153		3,029		117,642
Home equity - term		14,688		72		0		0		72		66		14,826
Home equity - Lines of credit		81,163		129		27		0		156		0		81,319
Installment and other loans		7,633		46		15		0		61		13		7,707
	$	773,569	$	3,762	$	2,457	$	1,275	$	7,494	$	56,917	$	837,980
December 31, 2011
Commercial real estate:
Owner-occupied	$	188,679	$	2,135	$	0	$	0	$	2,135	$	8,832	$	199,646
Non-owner-occupied		122,816		75		0		0		75		18,146		141,037
Multi-family		23,864		0		0		0		0		3,463		27,327
Acquisition and development:
1-4 family residential construction		4,916		0		0		0		0		2,182		7,098
Commercial and land development		59,121		440		0		0		440		18,003		77,564
Commercial and industrial		246,696		1,341		15		0		1,356		29,848		277,900
Residential mortgage:

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First lien		100,215		1,637		547		0		2,184		1,928		104,327
Home equity - term		35,998		283		9		0		292		1,223		37,513
Home equity - Lines of credit		80,783		98		0		0		98		70		80,951
Installment and other loans		11,932		141		2		0		143		2		12,077
	$	875,020	$	6,150	$	573	$	0	$	6,723	$	83,697	$	965,440

The Bank maintains the allowance for loan losses at a level believed adequate by management to absorb losses inherent in the portfolio. It is established and maintained through a provision for loan losses charged to earnings. Quarterly, management assesses the adequacy of the allowance for loan losses utilizing a defined methodology, which considers specific credit evaluation of impaired loans as discussed above, past loan loss historical experience, and qualitative factors. Management believes the approach properly addresses the requirements of ASC Section 310-10-35 for loans individually identified as impaired, and ASC Subtopic 450-20 for loans collectively evaluated for impairment, and other bank regulatory guidance.

For each loan class presented above, general allowances are provided for loans that are collectively evaluated for impairment, which is based on quantitative factors, principally historical loss trends for the respective loan class, adjusted for qualitative factors. Effective December 31, 2011, the historical loss factor was based on average charge-offs for the last eight quarters and applied to the entire pool of loans, excluding those loans evaluated for impairment under ASC 310-10-35. In addition, an additional adjustment to the historical loss factors is made to account for delinquency and other potential risk not elsewhere defined within the Allowance for Loan and Lease Loss methodology. The refinement to the methodology was made as management determined that the most recent eight quarters loss history as adjusted based on other portfolio analysis and applied to an entire pool of loans is a better reflection of the losses inherent on non-impaired loans within the portfolio. In making this determination, management considered current economic and real estate conditions, trends in historical charge-off percentages at the Company as well as peers, and feedback from regulators.

In addition to the changes mentioned under ASC 450-20, the Company refined its methodology under ASC 310-10-35 in the manner in which partial charge offs are calculated. Based on management’s assessment and in compliance with regulatory guidance, the Company will generally incur partial charge offs in total by the amount a loan’s carrying value exceeds its fair value, less discount for market conditions and costs to dispose, eliminating the need for specific reserves. This will be accomplished by charging the loan off to a level below the fair market value, or appraisal value, of collateral less costs to sell. This method will result in the loan being carried at the fair market value of collateral, less any discounted determined necessary based on current market conditions, less costs to dispose of the asset. As a result, the Company experienced significantly higher charge-offs than would have been incurred in prior periods. Management estimates that charge-offs for the six months ended June 30, 2012 were increased by $43,000,000 when compared to methods used over prior periods. In direct correlation with this change in methodology, the historical loss rates have been elevated when compared to prior periods which does affect the reserves held under ASC 450-20. Management believes this is a more conservative method for calculating the allowance for loan losses.

In addition to the quantitative analysis, additional reserves are allocated on loans collectively evaluated for impairment based on additional qualitative factors. The qualitative factors used by management to adjust the historical loss percentage to the anticipated loss allocation, which range from 0 – 8 basis points per factor, include:

Nature and Volume of Loans - Loan growth in the current and subsequent quarters based on the Bank’s targeted growth and strategic plan, coupled with the types of loans booked based on risk management and credit culture, and number of exceptions to loan policy; supervisory loan to value exceptions etc.

Concentrations of Credit and Changes within Credit Concentrations - Factors considered including the Bank’s overall portfolio makeup and managements evaluation relating to concentration risk management and the inherent risk associated with the concentrations identified.

- 24 -

Experience, Ability and Depth of Management/Lending staff - Factors considered include the years experience of Senior and Middle Management and the lending and loan review staff and turnover of the staff.

Other External Factors (Economic, Legal, Competition, Regulatory etc.) - Ratios and factors considered include trends in the consumer price index (CPI); unemployment rates; housing price index; housing statistics compared to the prior year; bankruptcy rates; regulatory and legal environment risks and competition.

Activity in the allowance for loan losses for three months ended June 30, 2012 and 2011 is as follows:

(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Installment and Other			Unallocated			Total
June 30, 2012
Balance, beginning of period	$	10,836		$	6,719		$	7,242		$	1,301		$	45		$	2,013		$	28,156
Provision for loan losses		13,000			2,549			7,824			(377	)		79			(75	)		23,000
Charge-offs		(10,039	)		(2,665	)		(3,890	)		(44	)		(57	)		0			(16,695	)
Recoveries		1,407			200			158			7			2			0			1,774
Balance, end of period	$	15,204		$	6,803		$	11,334		$	887		$	69		$	1,938		$	36,235

(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Installment and Other			Unallocated		Total
June 30, 2011
Balance, beginning of period	$	4,884		$	3,245		$	8,212		$	1,712		$	93		$	252	$	18,398
Provision for loan losses		2,894			4,357			12,138			517			13			1,311		21,230
Charge-offs		(542	)		(2,576	)		(9,218	)		(79	)		(17	)		0		(12,432	)
Recoveries		8			0			0			0			8			0		16
Balance, end of period	$	7,244		$	5,026		$	11,132		$	2,150		$	97		$	1,563	$	27,212

Activity in the allowance for loan losses for six months ended June 30, 2012 and 2011 is as follows:

(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Installment and Other			Unallocated		Total
June 30, 2012
Balance, beginning of period	$	13,864		$	9,708		$	17,569		$	933		$	75		$	1,566	$	43,715
Provision for loan losses		21,772			6,399			13,387			215			55			372		42,200
Charge-offs		(21,846	)		(9,977	)		(19,814	)		(272	)		(69	)		0		(51,978	)
Recoveries		1,414			673			192			11			8			0		2,298
Balance, end of period	$	15,204		$	6,803		$	11,334		$	887		$	69		$	1,938	$	36,235
June 30, 2011
Balance, beginning of period	$	5,324		$	1,767		$	6,795		$	1,863		$	106		$	165	$	16,020
Provision for loan losses		3,165			5,835			13,600			427			0			1,398		24,425
Charge-offs		(1,253	)		(2,576	)		(9,263	)		(140	)		(24	)		0		(13,256	)
Recoveries		8			0			0			0			15			0		23
Balance, end of period	$	7,244		$	5,026		$	11,132		$	2,150		$	97		$	1,563	$	27,212

The following summarizes the ending loan balance individually evaluated for impairment based upon loan segment, as well as the related allowance for loan loss allocation for each at June 30, 2012 and December 31, 2011:

- 25 -

(Dollars in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Installment and Other		Unallocated		Total
June 30, 2012
Loans allocated by:
Individually evaluated for impairment	$	23,676	$	15,540	$	16,934	$	2,906	$	3	$	0	$	59,059
Collectively evaluated for impairment		327,330		38,223		194,783		210,881		7,704		0		778,921
	$	351,006	$	53,763	$	211,717	$	213,787	$	7,707	$	0	$	837,980
Allowance for loan losses allocated by:
Individually evaluated for impairment	$	346	$	776	$	945	$	8	$	0	$	0	$	2,075
Collectively evaluated for impairment		14,858		6,027		10,389		879		69		1,938		34,160
	$	15,204	$	6,803	$	11,334	$	887	$	69	$	1,938	$	36,235
December 31, 2011
Loans allocated by:
Individually evaluated for impairment	$	33,457	$	21,246	$	53,134	$	1,918	$	0	$	0	$	109,755
Collectively evaluated for impairment		334,553		63,416		224,766		220,873		12,077		0		855,685
	$	368,010	$	84,662	$	277,900	$	222,791	$	12,077	$	0	$	965,440
Allowance for loan losses allocated by:
Individually evaluated for impairment	$	9,851	$	5,295	$	14,591	$	51	$	0	$	0	$	29,788
Collectively evaluated for impairment		4,013		4,413		2,978		882		75		1,566		13,927
	$	13,864	$	9,708	$	17,569	$	933	$	75	$	1,566	$	43,715

NOTE 4. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY

As of December 31, 2010, the Company had two interest rate swap agreements related to fixed rate loans. The Company used these interest rate swaps to reduce interest rate risks and to manage interest income. By entering into these agreements, the Company converted floating rate assets into fixed rate assets. These interest rate swap agreements were considered cash flow hedge derivative instruments that qualified for hedge accounting. A portion of the amount was included in other comprehensive income and was reclassified from other comprehensive income to the appropriate income statement line item as net settlements occurred.

During the three months ended March 31, 2011, the Company sold one of its interest rate swaps and recognized an $118,000 gain on the sale, which was included as ineffective, once it no longer qualified as a hedge. The second interest rate swap was sold in the third quarter of 2011 and as of December 31, 2011, there were no interest rate swaps remaining.

A roll forward of the unrealized gains (losses) on the derivatives, and the effects on the Company’s income statement for the three and six months ended June 30, 2011 was as follows:

(Dollars in thousands)	Three Months Ended June 30, 2011			Six Months Ended June  30, 2011
Unrealized gains on derivatives in cash flow from hedging relationship, beginning of period	$	530		$	918
Amount of gain recognized in other comprehensive income on derivative for effective portion of cash flow hedge		252			130
Amount of gain reclassified from accumulated other comprehensive income into interest income		(100	)		(235	)
Amount of gain recognized as noninterest income for the ineffective portion of the cash flow hedge		(11	)		(142	)
Unrealized gains on derivatives in cash flow from hedging relationship, end of period	$	671		$	671

- 26 -

NOTE 5. SHAREHOLDERS’ EQUITY AND REGULATORY CAPITAL

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to financial holding companies.

Quantitative measures established by regulators to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (as set forth in the following table) of total and Tier 1 capital (as defined in regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes that, as of June 30, 2012 and December 31, 2011 the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of June 30, 2012, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since the notification that management believes have changed the Bank’s category. The Company and the Bank’s actual capital ratios as of June 30, 2012 and December 31, 2011 are also presented in the table.

	Actual					Minimum Capital Requirement					Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
June 30, 2012
Total capital to risk weighted assets
Orrstown Financial Services, Inc.	$	106,227		11.7	%	$	72,732		8.0	%		n/a		n/a
Orrstown Bank		103,515		11.4	%		72,685		8.0	%	$	90,856		10.0	%
Tier 1 capital to risk weighted assets
Orrstown Financial Services, Inc.		94,545		10.4	%		36,366		4.0	%		n/a		n/a
Orrstown Bank		91,840		10.1	%		36,342		4.0	%		54,514		6.0	%
Tier 1 capital to average assets
Orrstown Financial Services, Inc.		94,545		6.7	%		56,323		4.0	%		n/a		n/a
Orrstown Bank		91,840		6.5	%		56,365		4.0	%		70,457		5.0	%
December 31, 2011
Total capital to risk weighted assets
Orrstown Financial Services, Inc.	$	134,621		13.0	%	$	83,090		8.0	%		n/a		n/a
Orrstown Bank		127,529		12.3	%		82,899		8.0	%	$	103,624		10.0	%
Tier 1 capital to risk weighted assets
Orrstown Financial Services, Inc.		121,249		11.7	%		41,545		4.0	%		n/a		n/a
Orrstown Bank		114,187		11.0	%		41,450		4.0	%		62,175		6.0	%
Tier 1 capital to average assets
Orrstown Financial Services, Inc.		121,249		8.2	%		58,851		4.0	%		n/a		n/a
Orrstown Bank		114,187		7.8	%		58,682		4.0	%		73,352		5.0	%

NOTE 6. EARNINGS PER SHARE

Earnings per share for the three and six months ended June 30, 2012 and June 30, 2011 were as follows:

(In thousands, except per share data)	Three Months Ended						Six Months Ended
	June 30, 2012			June 30, 2011			June 30, 2012			June 30, 2011
Net income (loss)	$	(9,914	)	$	(10,623	)	$	(18,132	)	$	(6,796	)
Weighted average shares outstanding		8,065			8,000			8,060			7,994

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Impact of common stock equivalents		0			0			0			19
Weighted average shares outstanding (diluted)		8,065			8,000			8,060			8,013
Per share information:
Basic earnings (loss) per share	$	(1.23	)	$	(1.33	)	$	(2.25	)	$	(0.85	)
Diluted earnings (loss) per share		(1.23	)		(1.33	)		(2.25	)		(0.85	)

Stock options for 314,000 and 371,000 shares of common stock were not considered in computing diluted earnings per share for the three months ended June 30, 2012 and 2011, and stock options for 330,000 and 289,000 shares of common stock were not considered for the six months ended June 30, 2012 and 2011 as they were anti-dilutive.

NOTE 7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

	Contract or Notional Amount
(Dollars in thousands)	June 30, 2012		December 31, 2011
Commitments to fund:
Revolving, open ended home equity loans	$	78,027	$	80,197
1-4 family residential construction loans		1,586		2,021
Commercial real estate, construction and land development loans		2,931		31,788
Commercial, industrial and other loans		69,106		91,530
Standby letters of credit		17,832		25,751

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, equipment, residential real estate, and income-producing commercial properties.

Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company holds collateral supporting those commitments when deemed necessary by management. The current amount of liability, as of June 30, 2012 and December 31, 2011, for guarantees under standby letters of credit issued was not material.

The Company currently maintains a reserve in other liabilities totaling $851,000 and $782,000 at June 30, 2012 and December 31, 2011 for off-balance sheet credit exposures that currently are not funded, based on historical loss experience of the related loan class. For the three months ended June 30, 2012 and 2011, ($34,000) and $250,000 was charged to other noninterest expense for this exposure, and for the six months ended June 30, 2012 and 2011, the amount expensed was $69,000 and $250,000.

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The Company has sold loans to the Federal Home Loan Bank of Chicago as part of its Mortgage Partnership Finance Program (“MPF Program”). Under the terms of the MPF Program, there is limited recourse back to the Company for loans that do not perform in accordance with the terms of the loan agreement. Each loan that is sold under the program is “credit enhanced” such that the individual loan’s rating is raised to “AA,” as determined by the Federal Home Loan Bank of Chicago. The sum of each individual total of loans sold under the MPF Program was $132,735,000, with limited recourse back to the Company on these loans of $8,420,000. Many of the loans sold under the MPF Program have primary mortgage insurance, which reduces the Company’s overall exposure.

NOTE 8. FAIR VALUE DISCLOSURES

Fair value measurements under generally accepted accounting principles defines fair value, describes a framework for measuring fair value and requires disclosures about fair value measurements by establishing a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets in which the assets and liabilities are traded and the reliability and transparency of the assumptions used to determine fair value.

The three levels are defined as follows: Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar instruments in markets that are not active or by model-based techniques in which all significant inputs are observable in the market for the asset or liability, for substantially the full term of the financial instrument. Level 3 – the valuation methodology is derived from model-based techniques in which at least one significant input is unobservable to the fair value measurement and based on the Company’s own assumptions about market participants’ assumptions.

Following is a description of the valuation methodologies used for instruments measured on a recurring basis at estimated fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Securities

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, securities are classified within Level 2 and fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. All of the Company’s securities are classified as available for sale.

The Company had no fair value liabilities at June 30, 2012 and December 31, 2011. A summary of assets at June 30, 2012 and December 31, 2011, measured at estimated fair value on a recurring basis was as follows:

(Dollars in Thousands)	Level 1		Level 2		Level 3		Total Fair Value Measurements
June 30, 2012
Securities available for sale:
U.S. Treasury	$	0	$	14,983	$	0	$	14,983
U.S. Government Sponsored Enterprises (GSE)		0		39,992		0		39,992
States and political subdivisions		0		40,042		0		40,042

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GSE residential mortgage-backed securities		0		187,740		0		187,740
Total debt securities		0		282,757		0		282,757
Equity securities:
Financial services		124		69		0		193
Other		128		0		0		128
Total equity securities		252		69		0		321
Total securities	$	252	$	282,826	$	0	$	283,078
December 31, 2011
Securities available for sale:
U.S. Government Sponsored Enterprises (GSE)	$	0	$	43,622	$	0	$	43,622
States and political subdivisions		0		78,051		0		78,051
GSE residential mortgage-backed securities		0		187,584		0		187,584
Total debt securities		0		309,257		0		309,257
Equity securities:
Diversified		37		0		0		37
Energy		141		0		0		141
Financial services		166		70		0		236
Industrials		150		0		0		150
Technology		221		0		0		221
Other		323		0		0		323
Total equity securities		1,038		70		0		1,108
Total securities	$	1,038	$	309,327	$	0	$	310,365

Certain financial 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 financial 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 loan, less estimated costs to sell. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The value of the 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 management adjusts the appraisal value, 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’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans with an allocation to the allowance for loan losses are measured at fair value on a nonrecurring basis; however not all impaired loans have an allocation to the allowance for loan losses. Any fair value adjustments are recorded in the period incurred as a provision for loan losses on the consolidated statement of income. Specific allocations to the allowance for loan losses were $2,075,000 and $29,788,000 at June 30, 2012 and December 31, 2011.

Foreclosed Real Estate

Other real estate property acquired through foreclosure is initially recorded at the fair value of the property at the transfer date less estimated selling cost. Subsequently, other real estate owned is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined

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based upon an independent third-party appraisal of the property or occasionally upon a recent sales offer. Specific charges to value the real estate owned at the lower of cost or fair value on properties held at June 30, 2012 and December 31, 2011 were $449,000 and $365,000.

Mortgage Servicing Rights

The fair value of mortgage servicing rights is estimated to be equal to its carrying value, unless the quarterly valuation model calculates the present value of the estimated net servicing income as less than its carrying value, in which case a lower of cost or fair value charge is taken. As of June 30, 2012 and December 31, 2011, a $533,000 and $284,000 lower of cost or fair value reserve existed on the mortgage servicing rights portfolio.

A summary of assets at June 30, 2012 and December 31, 2011 measured at fair value on a nonrecurring basis is as follows:

(Dollars in Thousands)	Level 1		Level 2		Level 3		Total Fair Value Measurements
June 30, 2012
Impaired loans, net	$	0	$	0	$	45,983	$	45,983
Foreclosed real estate		0		0		1,141		1,141
Mortgage servicing rights		0		0		2,112		2,112
December 31, 2011
Impaired loans, net	$	0	$	0	$	55,726	$	55,726
Foreclosed real estate		0		0		1,378		1,378
Mortgage servicing rights		0		0		2,253		2,253

The following table presents additional qualitative information about assets measured on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:

	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range
June 30, 2012
Impaired loans	$	45,983	Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	0% - 30% discount
				Management adjustments for liquidation expenses	5% - 10% discount
Foreclosed real estate		1,141	Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	0% - 30% discount
				Management adjustments for liquidation expenses	5% - 10% discount
Mortgage servicing rights		2,112	Discounted cash flows	Remaining term Discount rate	4.0 years 10.70%

Fair values of financial instruments

The Company meets the requirements for disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

In addition to those disclosed above, the following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein:

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Cash and Due from Banks, Federal Funds Sold, Short-Term Investments and Interest Bearing Deposits with Banks

The carrying amounts of cash and due from banks, short-term investments and interest bearing deposits with banks and federal funds sold approximate their fair value.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value. These loans typically consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale.

Loans Receivable

For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered in the market for loans with similar terms to borrowers of similar credit quality.

Restricted Investment in Bank Stock

These investments are carried at cost. The Company is required to maintain minimum investment balances in these stocks, which are not actively traded and therefore have no readily determinable market value.

Deposit Liabilities

The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposits and IRAs are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market to a schedule of aggregated expected maturities on time deposits.

Short-Term Borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Long-Term Debt

The fair value of the Company’s fixed rate long-term borrowings is estimated using a discounted cash flow analysis based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements. The carrying amounts of variable-rate long-term borrowings approximate their fair values at the reporting date.

Accrued Interest

The carrying amounts of accrued interest approximate their fair values.

Off-Balance-Sheet Instruments

The Company generally does not charge commitment fees. Fees for standby letters of credit and other off-balance-sheet instruments are not significant.

The estimated fair values of the Company’s financial statements were as follows at June 30, 2012 and December 31, 2011:

(Dollars in thousands)	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
June 30, 2012:
Financial Assets
Cash and due from banks	$	15,798	$	15,798	$	15,798	$	0	$	0
Interest bearing deposits with banks		109,725		109,725		109,725		0		0
Restricted investments in bank stock		11,495		11,495		0		0		11,495

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Securities available for sale		283,078		283,078	252	282,826	0
Loans held for sale		4,825		4,825	0	4,825	0
Loans, net of allowance for loan losses		801,745		813,627	0	0	813,627
Accrued interest receivable		3,593		3,593	0	1,059	2,534
Mortgage servicing rights		2,112		2,112	0	0	2,112
Financial Liabilities
Deposits		1,144,384		1,148,716	0	1,148,716	0
Short-term borrowings		27,493		27,493	0	27,493	0
Long-term debt		38,142		39,384	0	39,384	0
Accrued interest payable		482		482	0	482	0
Off-balance sheet instruments		0		0	0	0	0
December 31, 2011:
Financial Assets
Cash and due from banks	$	19,630	$	19,630
Interest bearing deposits with banks		90,039		90,039
Restricted investments in bank stock		11,758		11,758
Securities available for sale		310,365		310,365
Loans held for sale		2,553
Loans, net of allowance for loan losses		921,725		925,923
Accrued interest receivable		4,548		4,548
Mortgage servicing rights		2,253		2,253
Financial Liabilities
Deposits	$	1,216,902	$	1,222,058
Short-term borrowings		35,013		35,013
Long-term debt		53,798		54,998
Accrued interest payable		907		907
Off-balance sheet instruments		0		0

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

Orrstown Financial Services, Inc. (the “Company”) is a financial holding company with a wholly-owned bank subsidiary, Orrstown Bank (the “Bank”). The following is a discussion of our consolidated financial condition at June 30, 2012 and results of operations for the three and six months ended June 30, 2012. Throughout this discussion, the yield on earning assets is stated on a fully taxable-equivalent basis and balances represent average daily balances unless otherwise stated. The discussion and analysis should be read in conjunction with our Condensed Consolidated Financial Statements (Unaudited) and Notes thereto presented elsewhere in this report. Certain prior period amounts, presented in this discussion and analysis, have been reclassified to conform to current period classifications.

Certain statements appearing herein which are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements refer to a future period or periods, reflecting management’s current views as to likely future developments, and use words like “may,” “will,” “expect,” “estimate,” “anticipate” or similar terms. Because forward-looking statements involve certain risks, uncertainties and other factors over which the Company has no direct control, actual results could differ materially from those contemplated in such statements. These factors include (but are not limited to) the following: general economic conditions, changes in interest rates, changes in the Company’s cost of funds, changes in government monetary policy, changes in government regulation and taxation of financial institutions, including changes resulting from the Dodd-Frank Wall Street Reform and Consumer Protection Act and related regulations, changes in the rate of inflation, changes in technology, our ability to attract skilled personnel and retain key members of our senior management team, the intensification of competition within the Company’s market area, the outcome of litigation against the Company and other similar factors. For a discussion of these forward-looking statements and important factors that could cause results to differ materially from the forward-looking statements contained in this Report, see “Important Factors Relating to Forward Looking Statements” contained in our Annual Report on Form 10-K for the year ended December 31, 2011.

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Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and follow general practices within the financial services industry in which it operates. Management, in order to prepare the Company’s consolidated financial statements, is required to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the balance sheet date through the date the financial statements are filed with the SEC. As this information changes, the consolidated financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources.

The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, the Company has identified the adequacy of the allowance for loan losses and accounting for income taxes as critical accounting policies.

The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet.

The Company recognizes deferred tax assets and liabilities for the future effects of temporary differences and tax credits. Enacted tax rates are applied to cumulative temporary differences based on expected taxable income in the periods in which the deferred tax asset or liability is anticipated to be realized. Future tax rate changes could occur that would require the recognition of income or expense in the statement of operations in the period in which they are enacted. Deferred tax assets must be reduced by a valuation allowance if in management’s judgment it is “more likely than not” that some portion of the asset will not be realized. Management may need to modify their judgments in this regard from one period to another should a material change occur in the business environment, tax legislation, or in any other business factor that could impair the Company’s ability to benefit from the asset in the future. As of June 30, 2012 and December 31, 2011, management had concluded that no valuation allowance was needed on its net deferred tax asset.

Readers of the consolidated financial statements should be aware that the estimates and assumptions used in the Company’s current financial statements may need to be updated in future financial presentations for changes in circumstances, business or economic conditions in order to fairly represent the condition of the Company at that time.

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SUMMARY OF FINANCIAL RESULTS

The Company recorded a net loss of $9,914,000 for the second quarter of 2012 compared to a net loss of $10,623,000 for the same period in 2011. Basic and diluted earnings (loss) per share (EPS) for the second quarter of 2012 were ($1.23), compared to ($1.33) for the second quarter of 2011. On a year-to-date basis, the net loss recorded for the period was $18,132,000 for 2012, compared to a net loss of $6,796,000 for the same period in 2011. Basic and diluted earnings (loss) per share totaled ($2.25) for the six months ended June 30, 2012 compared to ($0.85) in 2011.

Included below are ratios for the return on average tangible assets (ROTA) and return on average tangible equity (ROTE) which exclude intangibles from the balance sheet and related amortization and tax expense from net income due to the associated goodwill and intangibles from the acquisition of companies and purchased deposits.

	Three Months Ended						Six Months Ended
	June, 30, 2012			June, 30, 2011			June, 30, 2012			June, 30, 2011
Return on average assets		(2.81	)%		(2.77	)%		(2.55	)%		(0.90	)%
Return on average tangible assets		(2.80	)%		(2.80	)%		(2.54	)%		(0.90	)%
Return on average equity		(33.81	)%		(26.03	)%		(29.63	)%		(8.44	)%
Return on average tangible equity		(33.97	)%		(29.69	)%		(29.76	)%		(9.57	)%
Average equity / average assets		8.31	%		10.65	%		8.61	%		10.65	%

Supplemental Reporting of Non-GAAP-based Financial Measures

Return on average tangible assets and return on average tangible equity are non-GAAP-based financial measures calculated using non-GAAP-based amounts. The most directly comparable measure is return on average assets and return on average equity, which are calculated using GAAP-based amounts. The Company calculates the return on average tangible assets and equity by excluding the balance of intangible assets and their related amortization expense, net of tax, from the calculation of return on average assets and equity. Management uses the return on average tangible assets and equity to assess the Company’s core operating results and believes that this is a better measure of our operating performance as it is based on the Company’s tangible assets and capital. We believe that excluding the impact of purchase accounting adjustments allows for a meaningful comparison with the Company’s peers; particularly those that may not have acquired other companies. Lastly, the exclusion of goodwill and other intangible assets is consistent with the treatment by bank regulatory agencies on the calculation of risk-based capital ratios, which excludes these amounts. However, these non-GAAP financial measures are supplemental and are not a substitute for an analysis based on GAAP measures. A reconciliation of return on average assets and equity to the return on average tangible assets and equity, is set forth below.

	June 30, 2012			June 30, 2011
For Quarter Ended:
Return on Average Assets (GAAP basis)		(2.81	)%		(2.77	)%
Effect of excluding average intangible assets and related amortization, net of tax		0.01	%		(0.03	)%

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Return on Average Tangible Assets	(2.80	)%	(2.80	)%
Return on Average Equity (GAAP basis)	(33.81	)%	(26.03	)%
Effect of excluding average intangible assets and related amortization, net of tax	(0.16	)%	(3.66	)%
Return on Average Tangible Equity	(33.97	)%	(29.69	)%

	June 30, 2012			June 30, 2011
For Six Months Ended:
Return on Average Assets (GAAP basis)		(2.55	)%		(0.90	)%
Effect of excluding average intangible assets and related amortization, net of tax		0.01	%		0.00	%
Return on Average Tangible Assets		(2.54	)%		(0.90	)%
Return on Average Equity (GAAP basis)		(29.63	)%		(8.44	)%
Effect of excluding average intangible assets and related amortization, net of tax		(0.13	)%		(1.13	)%
Return on Average Tangible Equity		(29.76	)%		(9.57	)%

(Dollars in thousands, except per share data)	June 30, 2012		December 31, 2011
Common shareholders’ equity	$	107,629	$	128,197
Less: Intangible assets		936		1,041
Tangible common equity	$	106,693	$	127,156
Total assets	$	1,328,475	$	1,444,097
Less: Intangible assets		936		1,041
Tangible assets	$	1,327,539	$	1,443,056

Tangible book value per share is computed by dividing shares outstanding into tangible common equity. Management uses tangible book value per share because it believes such ratio is useful in understanding the Company’s capital position and ratios. A reconciliation of book value per share to tangible book value per share is as follows:

	June 30, 2012		December 31, 2011
Book value per share	$	13.34	$	15.92
Less: Intangible assets per share		0.11		0.13
Tangible book value per share	$	13.23	$	15.79

Tax equivalent net interest income is derived from GAAP interest income and net interest income using an assumed tax rate of 35%. We believe the presentation of net interest income on a tax-equivalent basis ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. The following reconciles net interest income on a fully taxable equivalent basis:

(Dollars in thousands)	June 30, 2012		June 30, 2011
For Quarter Ended:
Net interest income	$	9,546	$	12,810
Effect of tax exempt income		583		718
Net interest income, tax equivalent basis	$	10,129	$	13,528
For Six Months Ended:
Net interest income	$	20,388	$	25,198
Effect of tax exempt income		1,235		1,404
Net interest income, tax equivalent basis	$	21,623	$	26,602

RESULTS OF OPERATIONS

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QUARTER ENDED JUNE 30, 2012 COMPARED TO QUARTER ENDED JUNE 30, 2011

Net Interest Income

The primary component of the Company’s revenue is net interest income, which is the difference between interest income and fees on interest-earning assets and interest expense on interest-bearing liabilities. Earning assets include loans, securities and federal funds sold. Interest bearing liabilities include deposits and borrowed funds. To compare the tax-exempt yields to taxable yields, amounts are adjusted to pretax equivalents based on a 35% federal corporate tax rate.

Net interest income is affected by changes in interest rates, volumes of interest-earning assets and interest-bearing liabilities and the composition of those assets and liabilities. The “net interest spread” and “net interest margin” (NIM) are two common statistics related to changes in net interest income. The net interest spread represents the difference between the yields earned on interest-earning assets and the rates paid for interest-bearing liabilities. The net interest margin is defined as the ratio of net interest income to average earning assets. Through the use of demand deposits and stockholders’ equity, the net interest margin exceeds the net interest spread, as these funding sources are non-interest bearing.

The “Average Balances and Interest Rates” table presents net interest income on a fully taxable equivalent basis, net interest spread and net interest margin for the quarters ended June 30, 2012 and 2011.

For the three months ended June 30, 2012, net interest income measured on a fully tax equivalent basis decreased $3,399,000 to $10,129,000 from $13,528,000 in the corresponding period in 2011. The primary reason for the decrease in net interest income was a decrease in average earning assets from $1,448,715,000 for the second quarter of 2011 to $1,344,493,000 for the same period in 2012. In addition, net interest margin decreased by 75 basis points, from 3.71% for the three months ended June 30, 2011 to 2.96% for the same period in 2012. The net interest spread for the three months ended June 30, 2012 was 2.88%, compared to 3.60% for the same period in 2011.

Interest income earned on loans decreased from $12,687,000 for the quarter ended June 30, 2011 to $10,372,000 for the same period in 2012, a $2,315,000 decline. Several factors have contributed to the decline. First, the average balance of impaired loans, which generally are in nonaccrual status, increased from $31,504,000 for the second quarter of 2011 to $72,124,000 for the same period in 2012. Additionally, the Company settled two floating for fixed rate interest rate swaps last year, and therefore there was no interest income from the swaps to enhance 2012’s yield. As a result of these two factors, combined with generally lower interest rates, the yield on loans declined from 4.96% for the second quarter of 2011 to 4.62% for the second quarter of 2012. In addition to lower yields, the average volume of loans declined from $1,013,111,000 for the three months ended June 30, 2011 to $880,371,000 for the same period in 2012. The Company has temporarily curbed its loan growth in order to address and enhance credit administration and underwriting processes and procedures.

Securities interest income also declined in 2012 and totaled $1,758,000 for the quarter ended June 30, 2012, a decrease of $1,789,000, compared to $3,547,000 for the same period in 2011. The average balance on securities has declined from $406,048,000 in the second quarter of 2011 to $337,180,000 for the same period in 2012, and is a reason for the decrease in securities interest income. As a result of the recent regulatory climate related to nontraditional funding sources, management anticipates it will not utilize brokered deposits to the extent it has in the past, and as such, as the brokered deposits matured, security proceeds were used to fund the payoff. In addition, the low interest rate environment has resulted in increased refinancing activity. This refinancing has resulted in accelerated prepayments on mortgage backed securities, many of which have premiums associated with them. As the prepayments have accelerated, the amortization of the premium has been faster than in the past, which has placed pressure on the yields earned on the securities. Further, the proceeds from the sales or maturities of securities have been reinvested at lower interest rates, also negatively impacting the yield earned on securities. The yields earned on securities were 2.09% for the second quarter of 2012, a 141 basis point decline as compared to the second quarter of 2011.

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Interest expense on deposits and borrowings for the three months ended June 30, 2012 was $2,083,000, a decrease of $644,000, or 23.6%, from the $2,727,000 expensed in the same period in 2011. The Company’s cost of funds on interest bearing liabilities has declined from 0.87% for the quarter ended June 30, 2011 to 0.70% for the same period in 2012. The interest rate environment has allowed the Company to lower the rates offered on its demand deposits, including interest bearing demand, money market and savings in 2012 compared to 2011, and as time deposits and long-term debt mature, it has also been able to replace the funds at slightly lower rates.

The Company’s net interest spread of 2.88 % declined 72 basis points in the quarter ended June 30, 2012 as compared to the same period in 2011. Net interest margin for the quarter ended June 30, 2012 was 2.96%, a 75 basis decline from 3.71% for the quarter ended June 30, 2011. Management anticipates continued pressure on the net interest margin in future quarters as the level of nonaccrual loans will continue to impact rates earned on loans and securities will continue to pay off or mature, and be reinvested at lower interest rates.

The table that follows shows average balances and interest yields on a fully taxable equivalent basis (FTE):

Average Balances and Interest Rates

	Three Months Ended
	June 30, 2012							June 30, 2011
(Dollars in thousands)	Average Balance		Tax Equivalent Interest		Tax Equivalent Rate			Average Balance		Tax Equivalent Interest		Tax Equivalent Rate
Assets
Federal funds sold & interest bearing bank balances	$	126,942	$	82		0.25	%	$	29,556	$	21		0.28	%
Securities		337,180		1,758		2.09			406,048		3,547		3.50
Loans		880,371		10,372		4.62			1,013,111		12,687		4.96

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Total interest-earning assets		1,344,493		12,212		3.58			1,448,715		16,255		4.47
Other assets		75,104							88,585
Total	$	1,419,597						$	1,537,300
Liabilities and Shareholders’ Equity
Interest bearing demand deposits	$	514,762	$	356		0.26		$	466,086	$	416		0.36
Savings deposits		74,938		31		0.17			71,806		36		0.20
Time deposits		495,844		1,475		1.20			596,138		1,907		1.28
Short term borrowings		42,738		41		0.42			72,943		95		0.52
Long term debt		47,675		180		1.52			44,936		273		2.43
Total interest bearing liabilities		1,175,957		2,083		0.70			1,251,909		2,727		0.87
Non-interest bearing demand deposits		116,838							111,957
Other		8,856							9,753
Total Liabilities		1,301,651							1,373,619
Shareholders’ Equity		117,946							163,681
Total	$	1,419,597				0.63	%	$	1,537,300				0.76	%
Net interest income (FTE)/net interest spread				10,129		2.88	%			$	13,528		3.60	%
Net interest margin						2.96	%						3.71	%
Tax-equivalent adjustment				(583	)						(718	)
Net interest income			$	9,546						$	12,810

NOTES: Yields and interest income on tax-exempt assets have been computed on a fully taxable equivalent basis assuming a 35% tax rate.

For yield calculation purposes, nonaccruing loans are included in the average loan balance.

Provision for Loan Losses

The provision for loan losses for the three months ended June 30, 2012 totaled $23,000,000, an increase over the second quarter of 2011’s provision of $21,230,000. As further discussed in the “Allowance for Loan Losses” section, the 2012 provision levels were impacted by several factors. First, in the second quarter of 2012, the Company sold classified loans with a book value of $28,598,000 for $19,702,000, resulting in an additional charge of $8,896,000. These loans were sold in order to reduce our classified assets and the effort and resources required to work out these problem loans. In addition, as a result of the sale of the loans, our quarterly charge-off percentage increased, thereby increasing the quantitative reserve allocation required in the determination of general pool allowances for non-impaired loans. Lastly, $21,583,000 of loans were placed in nonaccrual status during the quarter, and were generally collateral dependent, which resulted in $4,101,000 of impairment charge-offs or reserves established when placed in nonaccrual status.

See further discussion in the “Allowance for Loan Losses” section.

Noninterest Income

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Noninterest income, excluding securities gains, totaled $4,432,000 for the three months ended June 30, 2012, compared to $4,740,000 for the same period in 2011. The net decline in revenues can be attributed to several factors, including the following:

• The Company sold its merchant service business in 2011, which had accounted for $285,000 of revenue in the second quarter of 2011 with no corresponding revenue in the same 2012 period.

• Consistent with a trend noted in 2011, the Company has experienced a decline in overdraft charges, as consumers are spending less, and less likely to overdraw their account. This change in consumer behavior is the primary reason that service charges on deposit accounts declined from $1,645,000 for the three months ended June 30, 2011 to $1,543,000 for the same period in 2012.

• Trust department and brokerage income, in total, increased $19,000, or 1.3%, to $1,537,000 for the three months ended June 30, 2012 compared to the same period in 2011 despite a volatile market. The Company has been able to attract new accounts and customers which contributed to the increase.

• Mortgage banking activities revenue for the quarter ended June 30, 2012 was $727,000, a $91,000 increase from the 2011 quarter’s total of $636,000. The low interest rate environment has positively impacted loan origination volume, as refinancing activity has increased. However, the increase in revenues has been negatively impacted through acceleration of mortgage servicing rights amortization on loans sold with servicing retained.

Securities gains totaled $2,595,000 for the three months ended June 30, 2012 compared to $469,000 for the same period in 2011. Asset/liability management strategies, interest rate conditions, as well as maintaining capital levels factored into the decision to sell securities that resulted in elevated levels of security gains in the second quarter of 2012.

Noninterest Expenses

Noninterest expenses amounted to $10,733,000 for the three months ended June 30, 2012 compared to $9,722,000 for the corresponding prior year period. Asset quality and regulatory matters have contributed significantly to the increase in noninterest expenses, including the following:

• Salaries and employee benefits totaled $4,977,000 for the three months ended June 30, 2012, compared to $4,176,000 for the three months ended June 30, 2011, an increase of $801,000, or 19%. The increase in salaries and employee benefits is largely the result of the establishment of

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the Company’s Special Assets Group to assist in working through troubled assets, as well as an increase in personnel in the Credit Administration Department. During the upcoming quarters, we expect that our salaries and employee benefit charges will exceed the prior years, as we expect to recruit and add additional talent to the Company’s executive and management ranks.

• Collection and problem loan expenses totaled $579,000 for the three months ended June 30, 2012, compared to $177,000 for the three months ended June 30, 2011, an increase of $402,000. In order to properly monitor its impaired loans, the Company updates appraisals on its collateral and incurs legal expenses as it develops work out plans. Increased appraisal activity and legal expenses have led to the increased charges.

• Real estate owned expenses, which includes regular maintenance and upkeep expenses as well as write-downs of properties to fair value less costs to dispose, increased $60,000 in the second quarter of 2012 compared to 2011. This increase is consistent with the higher number of properties that the Company owns and is managing, as well as continued softness in the real estate market, which has led to lower appraised values and further write-downs of properties.

• Professional service fees, including loan review assistance, legal fees and accounting expenses, have increased $205,000 from $546,000 in the second quarter of 2011 to $751,000 in the same period in 2012. The increased complexity of the organization, as well as the increased costs of complying with regulatory orders received in the first quarter of 2012, have led to additional assistance required from professional service providers. The increases in these expense categories demonstrate the Company’s efforts to address the issues it currently faces in a diligent and expeditious manner. Over time we expect these fees to decrease as the Company hires additional expertise to address some of these matters in-house.

As noted in the “Noninterest Income” section, the Company sold its merchant services business in 2011. Data processing expenses of $231,000 were incurred in the three months ended June 30, 2011 pertaining to these revenues with no corresponding charges in 2012.

FDIC insurance premium expense totaled $710,000 for the second quarter of 2012, a 6.8% decline from the prior year. The reason for the decline is attributable to a lower asset base that is used in the assessment calculation.

Other noninterest expenses declined $314,000 from $1,784,000 for the three months ended June 30, 2011 to $1,470,000 for the three months ended June 30, 2012. The primary reason for the decline was due to a $250,000 reserve for off-balance sheet commitments established at June 30, 2011, whereas in the second quarter of 2012, a reversal of $34,000 was credited to the reserve.

In order to better understand how noninterest expenses increased in relation to related increases in revenue, operating expense levels are often measured in the financial services industry by the efficiency ratio, which expresses noninterest expense, as a percentage of tax-equivalent net interest income and

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noninterest income. The Company’s efficiency ratio was 72.7% for the three months ended June 30, 2012, compared to 52.6% for the same period in 2011. The increase in the ratio is the result of increases in noninterest expenses combined with declining net interest income. As the Company continues to address its asset quality issues and regulatory concerns, it anticipates the efficiency ratio will remain elevated in comparison to historical results.

Income Tax Expense

The Company recorded an income tax benefit of $7,246,000 for the quarter ended June 30, 2012, compared to $2,310,000 for the same period in 2011. A meaningful comparison of income tax expense to levels of pre-tax income is its effective tax rate, which exceeds the 35% federal statutory rate primarily due to tax-exempt loan and security income, life insurance earnings and tax credits associated with low-income housing and historic projects, offset by certain non-deductible expenses and state income taxes.

The Company’s effective tax rate was 42.2% for the quarter ended June 30, 2012, compared to 17.9% for the corresponding prior year period. The higher tax rate in 2012 compared to 2011 is due to assumptions used in calculating the 2011 tax provision, in which a lower effective tax rate was estimated for the year, in accordance with interim financial reporting guidance outlined in ASC 740-270-25.

SIX MONTHS ENDED JUNE 30, 2012 COMPARED TO SIX MONTHS ENDED JUNE 30, 2011

Net Interest Income

For the six months ended June 30, 2012, net interest income measured on a fully tax equivalent basis decreased $4,979,000 to $21,623,000 from $26,602,000 in the corresponding period in 2011. A reason for the decrease in net interest income was a decrease in average earning assets from $1,434,265,000 for the first six months of 2011 to $1,362,904,000 for the same period in 2012. In addition, net interest margin decreased by 54 basis points, from 3.70% for the six months ended June 30, 2011 to 3.16% for the same period in 2012. The net interest spread for the six months ended June 30, 2012 was 3.08%, compared to 3.58% for the same period in 2011.

The table that follows shows average balances and interest yields on a fully taxable equivalent basis (FTE):

Average Balances and Interest Rates

	Six Months Ended
	June 30, 2012							June 30, 2011
(Dollars in thousands)	Average Balance		Tax Equivalent Interest		Tax Equivalent Rate			Average Balance		Tax Equivalent Interest		Tax Equivalent Rate
Assets
Federal funds sold & interest bearing bank balances	$	109,772	$	143		0.25	%	$	23,749	$	45		0.38	%
Securities		335,913		4,011		2.39			415,787		6,828		3.29
Loans		917,219		21,799		4.75			994,729		25,393		5.10
Total interest-earning assets		1,362,904		25,953		3.81			1,434,265		32,266		4.50
Other assets		67,252							90,422

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Total	$	1,430,156						$	1,524,687
Liabilities and Shareholders’ Equity
Interest bearing demand deposits	$	528,217	$	760		0.27		$	443,289	$	865		0.39
Savings deposits		74,479		62		0.17			69,735		74		0.21
Time deposits		486,867		3,018		1.24			597,975		3,945		1.33
Short term borrowings		45,354		93		0.41			84,489		218		0.52
Long term debt		49,376		397		1.62			47,467		562		2.38
Total interest bearing liabilities		1,184,293		4,330		0.73			1,242,955		5,664		0.92
Non-interest bearing demand deposits		113,233							109,551
Other		9,558							9,801
Total Liabilities		1,307,084							1,362,307
Shareholders’ Equity		123,072							162,380
Total	$	1,430,156				0.65	%	$	1,524,687				0.80	%
Net interest income (FTE)/net interest spread				21,623		3.08	%			$	26,602		3.58	%
Net interest margin						3.16	%						3.70	%
Tax-equivalent adjustment				(1,235	)						(1,404	)
Net interest income			$	20,388						$	25,198

NOTES: Yields and interest income on tax-exempt assets have been computed on a fully taxable equivalent basis assuming a 35% tax rate. For yield calculation purposes, nonaccruing loans are included in the average loan balance.

Interest income earned on loans decreased from $25,393,000 for the six months ended June 30, 2011 to $21,799,000 in 2012, a 14.2% decline. Several factors have contributed to the decline. First, the average balance of impaired loans, which generally are in nonaccrual status, increased from $25,914,000 for the first six months of 2011 to $84,667,000 for the corresponding period in 2012. Additionally, the Company settled two floating for fixed rate interest rate swaps last year, and therefore there was no interest income from the swaps to enhance 2012’s yield compared to $235,000 included in interest income in 2011. As a result of these factors, combined with generally lower interest rates, the yield on loans declined from 5.10% for the first six months of 2011 to 4.75% for the first six months of 2012. In addition to lower yields, the average volume of loans declined from $994,729,000 for the six months ended June 30, 2011 to $917,219,000 for the same period in 2012. The Company has temporarily curbed its loan growth in order to address and enhance credit administration and underwriting processes and procedures.

Securities interest income also declined in 2012 and totaled $4,011,000 for the six months ended June 30, 2012, a decrease of $2,817,000 compared to $6,828,000 for the same period in 2011. The average balance on securities has declined significantly, from $415,787,000 in the first six months of 2011 to $335,913,000 for the same period in 2012, and is a reason for the decrease in securities interest income. As a result of the recent regulatory climate related to nontraditional funding sources, management anticipates it will not utilize brokered deposits to the extent it has in the past, and as such, as the brokered deposits matured, securities proceeds were used to fund the payoff. In addition, the low interest rate environment has resulted in increased refinancing activity. This refinancing has resulted in accelerated prepayments on mortgage backed securities, many of which have premiums associated with them. As the prepayments have accelerated, the amortization of the premium has been faster than in the past, which has placed pressure on the yields earned on the securities. Further, the proceeds from the sales or maturities of securities have been reinvested at lower interest rates, also negatively impacting the yield earned on securities. The yields earned on securities were 2.39% for the first six months of 2012, a 90 basis point decline from the same period in 2011.

Interest expense on deposits and borrowings for the six months ended June 30, 2012 was $4,330,000, a decrease of $1,334,000, or 23.4% from the $5,664,000 expensed in the same period in 2011. The Company’s cost of funds on interest bearing liabilities has declined from 0.92% for the six months ended June 30, 2011 to 0.73% for the same period in 2012. The interest rate

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environment has allowed the Company to lower the rates offered on its demand deposits, including interest bearing demand, money market and savings accounts in 2012 compared to 2011, and as time deposits and long-term debt mature, it has been able to replace the funds with slightly lower rates as well.

The Company’s net interest spread of 3.08% and net interest margin of 3.16% have declined by 50 and 54 basis points for the six months ended June 30, 2012 compared to the same period in 2011. Management anticipates continued pressure on the net interest margin in future quarters as the level of nonaccrual loans will continue to impact rates earned on loans and securities that will continue to pay off or mature, and be reinvested at lower interest rates.

Provision for Loan Losses

The provision for loan losses for the six months ended June 30, 2012 totaled $42,200,000, compared to the first six months of 2011’s provision of $24,425,000. As further discussed in the “Allowance for Loan Losses” section, the Company downgraded some credits, including $65,032,000 which moved to nonaccrual status during the first six months of 2012, and were generally evaluated for impairment based on a collateral dependent approach. As real estate conditions remain soft, additional provisioning was required for these newly impaired loans. In addition, the Company sold classified loans with a book value of $28,598,000 for $19,702,000, resulting in an additional charge of $8,896,000. These loans were sold in order to reduce our classified

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assets, and the effort and resources required to work out these problem loans. As a result of the combination of these factors, the Company’s net charge offs during the six months ended June 30, 2012 were $49,680,000, as generally all specific reserves provided on impaired loans were charged against the allowance for loan losses during the first six months. This elevated level of charge offs significantly increased our two-year average historical loss factors, leading to additional general reserves required on non-criticized loans.

See further discussion in the “Allowance for Loan Losses” section.

Noninterest Income

Noninterest income, excluding securities gains, totaled $8,392,000 for the six months ended June 30, 2012, compared to $9,437,000 for the same period in 2011. The net decline in revenues can be attributed to a number of factors, including the following:

• The Company sold its merchant service business in 2011, which had accounted for $540,000 of revenue in the first six months of 2011 with no corresponding revenue in the same 2012 period.

• Trust department and brokerage income increased $102,000, or 3.5%, to $3,036,000 for the six months ended June 30, 2012 compared to 2011 as a result of the number of accounts under management by the Company increasing.

• Mortgage banking activities revenue for the six months ended June 30, 2012 was $1,212,000, a $120,000 decline from $1,332,000 for the first six months of 2011. Although the low interest rate environment has positively impacted loan origination volume and related income, this rate environment negatively impacted the mortgage servicing rights on loans sold with servicing retained. For the six months ended June 30, 2012, the Company recorded a lower of cost or fair value reserve of $249,000 compared to the recovery of $200,000 of the reserve in 2011, a fluctuation of $449,000.

• The Company recorded a $118,000 gain on the settlement of an interest rate swap in the first six months of 2011 which was included in other income (loss), with no corresponding revenues in the same period for 2012. In connection with the Company’s asset liability management, it was determined these swaps would be settled as the gain represented much of the interest that would be earned over the remaining life of the swap, and the settlement would protect earnings in the event of rising interest rates.

• During the first six months of 2012, the Company recorded losses on sales of real estate owned of $79,000 compared to gains of $30,000 in the same period of 2011. Increased real estate activity, combined with greater discounts realized upon the sale of the properties resulted in the unfavorable variance. Gains (losses) on the sale of real estate owned are included in other interest income (loss).

Securities gains totaled $4,826,000 for the six months ended June 30, 2012 compared to $848,000 for the same period in 2011. Asset/liability management strategies, interest rate conditions, as well as maintaining capital levels factored into the decision to take elevated levels of security gains in the first six months of 2012.

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Noninterest Expenses

Noninterest expenses amounted to $21,616,000 for the six months ended June 30, 2012 compared to $19,161,000 for the corresponding prior year period. Asset quality and regulatory matters have contributed significantly to the increase in noninterest expenses, including the following:

• Salaries and employee benefits totaled $9,634,000 for the six months ended June 30, 2012, compared to $9,008,000 for the six months ended June 30, 2011, an increase of $626,000, or 6.9%. The increase in salaries and employee benefits is the result of the establishment of the Company’s Special Assets Group to assist in working through troubled assets, as well as an increase in personnel in the Credit Administration Department. During the upcoming quarters, we expect that our salaries and employee benefit charges will exceed the prior years, as we expect to recruit and add additional skilled personnel to the Company’s executive and management ranks.

• Collection and problem loan expenses totaled $1,297,000 for the six months ended June 30, 2012, compared to $331,000 for the six months ended June 30, 2011, an increase of $966,000. In order to properly monitor its impaired loans, the Company updates appraisals on its collateral and incurs legal expenses as it develops work out plans.

• Real estate owned expenses, which includes regular maintenance and upkeep expenses as well as write-downs of properties to fair value less costs to dispose, increased $398,000 in the first six months of 2012 compared to the same period in 2011, from $78,000 in 2011 to $476,000 in 2012. This increase is consistent with the higher number of properties that the Company owns and is managing, as well as continued softness in the real estate market, which led to further write-downs of properties.

• Professional service fees, including loan review assistance, legal fees and accounting expenses, have increased $684,000 from $868,000 in the first six months of 2011 to $1,552,000 in the same period in 2012. The increased complexity of the organization, as well as complying with regulatory orders received in the first quarter of 2012 have led to additional assistance required from professional service providers. The increases in these expense categories demonstrate the Company’s efforts to address the issues it currently faces in a diligent and expedient manner.

Advertising and bank promotions totaled $681,000 for the six months ended June 30, 2012, an increase of $127,000 over the corresponding period in 2011. In light of recent events, the Company has developed a successful advertising campaign focused on our commitment to customer service and the community, which has led to higher expenses than those incurred in the prior year.

As noted in the “Noninterest Income” section, the Company sold its merchant services business in 2011. Data processing expenses of $439,000 were incurred in the six months ended June 30, 2011 pertaining to these revenues with no corresponding charges in 2012.

FDIC insurance premium expense totaled $1,231,000 for the first six months of 2012, a 6.2% decline from the corresponding period in the prior year. The reason for the decline is partially attributable to lower assets, as well as a favorable adjustment to the accrual in 2012. The Company anticipated that regulatory actions would be communicated to the FDIC by its primary regulator retroactive to the fourth quarter of 2011, and accordingly accrued additional expense in 2011. However, the actions were communicated at the end of the first quarter of 2012, and as such, the slightly higher accrual was no longer necessary. Management anticipates higher assessment rates in the remaining three quarters of 2012 which will result in higher FDIC insurance expense in comparison to the prior year and the first quarter of 2012.

The increase in other operating expenses which totaled $3,139,000 for the six months ended June 30, 2012 compared to $3,081,000 for the same period in 2011, was principally due to an increase in fraud losses associated with customer accounts, consistent with industry trends.

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The remainder of the increase in other expenses is primarily the result of the growth experienced by the Company, and the development of new products and increased investments in technology.

In order to better understand how noninterest expenses increased in relation to related increases in revenue, operating expense levels are often measured in the financial services industry by the efficiency ratio, which expresses non-interest expense, as a percentage of tax-equivalent net interest income and noninterest income. The Company’s efficiency ratio was 70.1% for the six months ended June 30, 2012, compared to 52.6% for the same period in 2011. The increase in the ratio is the result of increases in noninterest expenses combined with declining net interest income. As the Company continues to address its asset quality issues and regulatory concerns, it anticipates the efficiency ratio will remain elevated in comparison to prior year’s results.

Income Tax Expense

The Company recorded an income tax benefit of $12,078,000 for the six months ended June 30, 2012, compared to $1,307,000 for the same period in 2011. A meaningful comparison of income tax expense to levels of pre-tax income is its effective tax rate, exceeds the 35% federal statutory rate, primarily due to tax-exempt loan and security income, life insurance earnings and tax credits associated with low-income housing and historic projects, offset by certain non-deductible expenses and state income taxes.

The Company’s effective tax rate was 40.0% for the six months ended June 30, 2012, compared to 16.1% for the corresponding prior year period. The higher tax rate in 2012 compared to 2011 is due to assumptions used in calculating the 2011 tax provision, in which we estimated a lower effective tax rate for the year, in accordance with interim financial reporting guidance outlined in ASC 740-270-25.

FINANCIAL CONDITION

Assets decreased $115,622,000 to $1,328,475,000 at June 30, 2012 from December 31, 2011. The Company has implemented a strategy designed to slow loan growth and reduce its risk weighted asset levels in order to maintain capital ratios at levels that exceed well capitalized limits.

Securities Available for Sale

The Company utilizes securities available for sale as a tool for managing interest rate risk, enhancing income through interest and dividend income, to provide liquidity and to provide collateral for certain deposits and borrowings. As of June 30, 2012, securities available for sale were $283,078,000, a decrease of $27,287,000, or 8.8% from December 31, 2011’s balance of $310,365,000. The state and municipal security portfolio has declined from 25.1% of the total portfolio at December 31, 2011 to 14.1% at June 30, 2012, as many of the revenue bonds were sold during the six months ended June 30, 2012, and reinvested in U.S. Treasury securities. Both the decline in the securities portfolio and the shift of investment types, are consistent with Company’s strategy to reduce its risk weighted assets.

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In addition, Government Sponsored Enterprises (GSE) agency securities and the remaining proceeds from revenue bonds have been reinvested in GSE mortgage-backed securities. GSE mortgage-backed securities as a percent of the total security portfolio have increased from 60% at December 31, 2011 to 66% at June 30, 2012. Given the current interest rate environment, GSE mortgage-backed securities provide an enhanced balance of interest yields and pledging availability.

Loan Portfolio

The Company offers various products to meet the credit needs of our borrowers, principally consisting of commercial real estate loans, commercial and industrial loans, and retail loans consisting of loans secured by residential properties, and to a lesser extent, installment loans.

The Company’s loan portfolio is broken down into segments to an appropriate level of disaggregation to allow management to monitor the performance by the borrower and to monitor the yield on the portfolio. Management has incorporated the provisions of ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Loan Losses, resulting in portfolio segregation. Consistent with this standard, the segments were further broken down into classes, to allow for differing risk characteristics within a segment.

The risks associated with lending activities differ among the various loan classes, and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans, and general economic conditions. All of these factors may adversely impact the borrower’s ability to repay its loans, and impact the associated collateral.

The Company has various types of commercial real estate loans which have differing levels of credit risk associated with them. Owner-occupied commercial real estate loans are generally dependent upon the successful operation of the borrower’s business, with the cash flows generated from the business being the primary source of repayment of the loan. If the business suffers a downturn in sales or profitability, the borrower’s ability to repay the loan could be in jeopardy.

Non-owner occupied and multi-family commercial real estate loans present a different credit risk to the Company than owner-occupied commercial real estate, as the repayment of the loan is dependent upon the borrower’s ability to generate a sufficient level of occupancy to produce rental income that exceeds the debt service requirement and operating expenses. Lower occupancy or lease rates may result in a reduction in cash flows, which hinder the ability of the borrower to meet debt service requirements, and may result in lower collateral values. The Company generally recognizes greater risk is inherent in these credit relationships as compared to owner occupied loans mentioned above in its loan pricing.

Acquisition and development loans consist of 1-4 family residential construction and commercial and land development loans. The risk of loss on these loans is largely dependent on the Company’s ability to assess the property’s value at the completion of the project, which should exceed the property’s construction costs. During the construction phase, a number of factors could potentially negatively impact the collateral value, including cost overruns, delays in completing the project, competition, and real estate market conditions which may change based on the supply of similar properties in the area. In the event the collateral value at the completion of the project is not sufficient to cover the outstanding loan balance, the Company must rely upon other repayment sources, including the guarantors of the project or other collateral securing the loan.

Commercial and industrial loans include advances to local and regional businesses for general commercial purposes and include permanent and short-term working capital, machinery and equipment

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financing, and may be either in the form of lines of credit or term loans. Although commercial and industrial loans may be unsecured to our highest rated borrowers, the majority of these loans are secured by the borrower’s accounts receivable, inventory and machinery and equipment. In a majority of these loans, the collateral also includes the business real estate or the business owner’s personal real estate or assets. Commercial and industrial loans present credit exposure to the Company, as they are more susceptible to risk of loss during a downturn in the economy, as borrowers may have greater difficulty in meeting their debt service requirements and the value of the collateral may decline. The Company attempts to mitigate this risk through its underwriting standards, including evaluating the credit worthiness of the borrower and to the extent available, credit ratings on the business. Additionally, monitoring of the loans through annual renewals and meetings with the borrowers are common. However, these procedures cannot eliminate the risk of loss associated with commercial and industrial lending.

The Company originates loans to its retail customers, including fixed-rate and adjustable first lien mortgage loans with the underlying 1-4 family owner-occupied residential property securing the credit. The Company’s risk exposure is minimized in these types of loans through the evaluation of the credit worthiness of the borrower, including credit scores and debt-to-income ratios, and underwriting standards which limit the loan-to-value ratio to generally no more than 80% upon loan origination, unless the borrower obtains private mortgage insurance.

Home equity loans, including term loans and lines of credit, present a slightly higher risk to the Company than 1-4 family first liens, as these loans can be first or second liens on 1-4 family owner occupied residential property, but can have loan-to-value ratios of no greater than 90% of the value of the real estate taken as collateral. The credit worthiness of the borrower is considered including credit scores and debt-to-income ratios, which generally cannot exceed 38%.

Installment and other loans’ credit risks are mitigated through conservative underwriting standards, including the evaluation of the credit worthiness of the borrower, including credit scores and debt-to-income ratios, and if secured, the collateral value of the assets. As these loans can be unsecured or secured by assets, the value of which may depreciate quickly or may fluctuate, they present a greater risk to the Company than 1-4 family residential loans.

The loan portfolio, excluding residential loans held for sale, broken out by classes as of June 30, 2012 and December 31, 2011 is as follows:

(Dollars in thousands)	June 30, 2012		December 31, 2011
Commercial real estate:
Owner-occupied	$	170,948	$	199,646
Non-owner occupied		149,819		141,037
Multi-family		30,239		27,327
Acquisition and development:
1-4 family residential construction		4,610		7,098
Commercial and land development		49,153		77,564
Commercial and industrial		211,717		277,900
Residential mortgage:
First lien		117,642		104,327
Home equity - term		14,826		37,513
Home equity - Lines of credit		81,319		80,951
Installment and other loans		7,707		12,077
	$	837,980	$	965,440

The loan portfolio at June 30, 2012 of $837,980,000 decreased $127,460,000 from $965,440,000 at December 31, 2011. The bulk of the decrease was a result of elevated charge off levels experienced in the commercial loan portfolio during the first six months of 2012, primarily in the commercial and industrial and non owner-occupied portfolios. In addition, the Company has continued to curb its new loan originations in order to focus on current portfolio analysis and maintenance and to enhance credit administration and underwriting processes and procedures. Given the softness in the economy within the Company’s market area, management feels this is a prudent course of action. Also, for longer term interest rate risk considerations, the Company continues to sell its longer term residential mortgage loans, as it is not willing to take on the interest rate risk in this environment.

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During the first quarter of 2012, the Company reviewed its term home equity loan portfolio, and re-designated certain of these loans as first lien residential mortgages. First lien and home equity term loans totaled $132,468,000 at June 30, 2012, a 6.6% decrease from $141,840,000 at December 31, 2011. As a result of the low interest rate environment, the Company has experienced early pay-offs of portfolio loans.

Asset Quality

Risk Elements

The Company’s loan portfolio is subject to varying degrees of credit risk. Credit risk is mitigated through the Company’s underwriting standards, on-going credit review, and monitoring asset quality measures. Additionally, loan portfolio diversification, limiting exposure to a single industry or borrower, and requiring collateral also mitigate the Company’s risk of credit loss.

The Company’s loan portfolio consists principally of loans to borrowers in south central Pennsylvania and Washington County, Maryland. As the majority of loans are concentrated in this geographic region, a substantial portion of the debtor’s ability to honor their obligations may be affected by the level of economic activity in the market area.

Nonperforming assets include nonaccrual and restructured loans and foreclosed real estate. In addition, loans past due 90 days or more and still accruing are also deemed to be a risk asset. For all loan classes, the accrual of interest income ceases when principal or interest is past due 90 days or more and collateral is inadequate to cover principal and interest or immediately if, in the opinion of management, full collection is unlikely. Interest will continue to accrue on loans past due 90 days or more if the collateral is adequate to cover principal and interest, and the loan is in the process of collection. Interest accrued, but not collected, as of the date of placement on nonaccrual status, is generally reversed and charged against interest income, unless fully collateralized. Subsequent payments received are either applied to the outstanding principal balance or recorded as interest income, depending on management’s assessment of the ultimate collectability of principal. Loans are returned to accrual status, for all loan classes, when all the principal and interest amounts contractually due are brought current, the loans have performed in accordance with the contractual terms of the note for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is reasonably assured. Past due status is based on contract terms of the loan.

Loans, the terms of which are modified, are classified as troubled debt restructurings if a concession was granted, for legal or economic reasons, related to a debtor’s financial difficulties. Concessions granted under a troubled debt restructuring typically involve a temporary deferral of scheduled loan payments, an extension of a loan’s stated maturity date, a temporary reduction in interest rates, or a below market rate. If a modification occurs while the loan is on accruing status, it will continue to accrue interest under the modified terms. Nonaccrual troubled debt restructurings are restored to accrual status if scheduled principal and interest payments, under the modified terms, are current for six months after modification, and the borrower continues to demonstrate its ability to meet the modified terms. Troubled debt restructurings are evaluated individually for impairment if they have been restructured during the most recent calendar year, or if they are not performing according to their modified terms.

The following table presents the Company’s risk elements, including information concerning the aggregate balances of nonaccrual, restructured, loans past due 90 days or more, and foreclosed real estate as of June 30, 2012, December 31, 2011 and June 30, 2011. Relevant asset quality ratios are also presented.

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(Dollars in Thousands)	June 30, 2012			December 31, 2011			June 30, 2011
Nonaccrual loans (cash basis)	$	56,917		$	83,697		$	14,762
Other real estate (OREO)		2,337			2,165			1,240
Total nonperforming assets		59,254			85,862			16,002
Restructured loans still accruing		2,831			27,917			34,844
Loans past due 90 days or more and still accruing		1,275			0			3,617
Total risk assets	$	63,360		$	113,779		$	54,463
Loans 30-89 days past due	$	6,219		$	6,723		$	11,021
Asset quality ratios:
Total nonaccrual loans to loans		6.79	%		8.67	%		1.48	%
Total nonperforming assets to assets		4.46	%		5.95	%		1.05	%
Total nonperforming assets to total loans and OREO		7.05	%		8.87	%		1.60	%
Total risk assets to total loans and OREO		7.54	%		11.76	%		5.44	%
Total risk assets to total assets		4.77	%		7.88	%		3.56	%
Allowance for loan losses to total loans		4.32	%		4.53	%		2.72	%
Allowance for loan losses to nonaccrual loans		63.66	%		52.23	%		184.34	%
Allowance for loan losses to nonaccrual and restructured loans still accruing		60.65	%		39.17	%		54.86	%

A further breakdown of nonaccrual loans as of June 30, 2012 and December 31, 2011 is as follows:

	Nonaccrual Loans
(Dollars in Thousands)	June 30, 2012		December 31, 2011
Commercial real estate:
Owner-occupied	$	8,024	$	8,832
Non-owner occupied		13,458		18,146
Multi-family		186		3,463
Acquisition and development:
1-4 family residential construction		1,269		2,182
Commercial and land development		13,547		18,003
Commercial and industrial		17,325		29,848
Residential mortgage:
First lien		3,029		1,928
Home equity		66		1,293
Installment and other loans		13		2
	$	56,917	$	83,697

During 2011, the Company’s asset quality deteriorated as a result of the continued softness in economic conditions and collateral values. In the first six months of 2012, the Company continued to actively identify and monitor nonperforming assets and other risk assets, and aggressively work through these assets. Risk assets, defined as nonaccrual loans, restructured and loans past due 90 days or more and still accruing, and real estate owned, declined from $113,779,000 at December 31, 2011 to $63,360,000 at June 30, 2012.

The risk element that showed the greatest percentage decline was restructured loans still accruing, which totaled $2,831,000 at June 30, 2012, a $25,086,000, or 89.9% decline from December 31, 2011. During the first six months of 2012, the Company restructured one loan totaling $37,000, received payments/payoffs on restructured loans totaling $4,339,000, and charged off $1,484,000 in connection with loan workouts. The remainder of the decline of $19,300,000 was the result of restructured loans migrating to nonaccrual status either due to missed payments or the Company’s determination that the borrowers would not be able to keep their payments current for a sustainable period of time.

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Nonaccrual loans at June 30, 2012 of $56,917,000 declined $26,780,000 from December 31, 2011’s balance of $83,697,000. The Company’s focus on asset quality remediation, including loan sales, loan workouts, additional information gathered from borrowers or additional structural enhancements has driven this significant improvement over year end 2011. This net decrease in nonaccrual loans for the six months ended June 30, 2012 was the result of $50,089,000 in loans charged off, $35,380,000 in proceeds received from loan sales and pay downs, $4,722,000 of loans returned to accrual status, and $1,612,000 of loans foreclosed on and transferred to real estate owned, offset by $65,023,000 being moved to nonaccrual status during the period, including $19,300,000 previously classified as restructured loans.

The allowance for loan losses totaled $36,235,000 at June 30, 2012, a $7,480,000 decrease from December 31, 2011. As of June 30, 2012, the allowance for loan losses to total loans was 4.32%, a slight decline from 4.53% at December 31, 2011. Despite the decline in the reserve to total loan ratio, the allowance for loan losses to nonaccrual loans and restructured loans still accruing increased to 60.65% at June 30, 2012 from 39.17% at December 31, 2011. The increase in the coverage ratios reflect lower levels of risk assets, particularly the significant decrease in non-performing assets discussed above.

The Company strives to reduce its level of nonaccruing loans and other risk elements and has increased the number of personnel in its loan workout and credit review departments, including temporarily moving certain lending staff to the loan workout department to manage lending relationships with borrowers experiencing financial difficulties. Through increased resources allocated to credit related issues, the Company believes it will be able to mitigate its risk of loss, and to reduce its level of nonaccrual and classified loans.

As of June 30, 2012, the Company has approximately 60 lending relationships that are included in the nonaccrual loan balance of $56,917,000. Of these relationships, 7 have outstanding book balances in excess of $3,000,000, totaling $28,690,000, or 50% of the total nonaccrual balance. In connection with the determination of the impairment associated with these collateral dependent relationships, partial charge-offs on relationships totaling $30,139,000 were taken on certain outstanding loan balances, and another $2,075,000 of ASC 310 impairment reserves were recorded on the balances at June 30, 2012. The $2,075,000 in impairment reserves is in contrast to $15,607,000 in impairment reserves on nonaccrual loans at December 31, 2011. In 2012, the Company began taking partial charge-offs on collateral dependent loans whose carrying value exceeded their estimated fair value, as determined by the most recent appraisal adjusted for current (within the quarter) conditions, less costs to dispose. Prior to 2012, the fair value that was used was based on the most recent appraised value of the loans, and any additional discounts determined to be appropriate based on current (within the quarter) conditions, plus costs to dispose, were separately reserved for and not included in the partial charge-off. As a result of this more conservative approach, the accumulated partial charge-offs as of June 30, 2012 increased over December 31, 2011. ASC 310 impairment reserves remain in those situations in which updated appraisals are pending, and represent management’s estimate of potential loss.

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The largest relationship that the Company has in nonaccrual status at June 30, 2012 is with a real estate developer who also actively leases residential properties and operates trailer parks. This relationship consists of separate notes with total outstanding book balances of $7,426,000, and different parcels of land or residential structures securing the outstanding loan balances. Recent appraisals on the collateral securing the outstanding notes received during the fourth quarter of 2011and 2012 resulted in the relationship being placed in nonaccrual status, as the softening of real estate prices as well as rental prices, and the lengthening of absorption periods resulted in it being classified and evaluated as a collateral dependent impaired loan. To date, partial charge-offs of approximately 42% of the outstanding loan balances were taken. The Company is actively working with the customer in reducing its outstanding loan balances.

A second significant nonaccrual relationship with outstanding book balances of $4,754,000 at June 30, 2012 is to a motel operator that has experienced declining occupancy rates, which has impacted the collateral value of the motels securing the outstanding notes. All loans are current as to scheduled payments, however, the performance of the motels has resulted in management placing the notes in nonaccrual status, and taking a a partial charge-off of 33% of the outstanding legal balances. The impairment charge was determined based on appraisals received in the first quarter of 2012.

A third nonaccrual loan relationship is one with outstanding loan book balances of $3,708,000 at June 30, 2012, which is with a real estate developer and builder with multiple subdivisions in the Company’s southern market area. The softness in the real estate market has resulted in longer absorption periods of the lots for sale, delays in commencing new phases of the subdivisions, and lower sales prices. Upon receipt of updated appraised values on the collateral in the second half of 2011, the Company moved the relationship to nonaccrual status. To date, cumulative partial charge-offs on the loans outstanding total 59%. The borrower has declared bankruptcy and we are currently working through the bankruptcy proceedings in order to remedy our delinquent loans.

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The Company has exposure to another land developer and lessor of residential properties whose loans are current as to scheduled interest and principal payments. The outstanding book balance of the relationship at June 30, 2012 is $3,290,000, after partial charge-offs totaling 9.5% of the outstanding legal balance. Appraisals have been obtained within the past year on all properties and were used in determining the extent of impairment and related partial charge-off. Despite all loans being current, the relationship was placed on nonaccrual status due to global cash flow not being sufficient to cover all principal and interest payments, as the largest loan, representing 70% of the relationship’s balance, is land that is not producing revenue, and it is not anticipated that a potential buyer will be identified in the near future.

Another significant relationship that is in nonaccrual status at June 30, 2012 is to a lessor of real estate properties who also owns several service industry enterprises. As of June 30, 2012, the outstanding book balances of the loans comprising this relationship total $3,156,000, which includes partial charge-offs of approximately 8% of the outstanding legal balance. In determining the relationship’s impairment, appraisals were obtained within the past year, and only two of the notes had collateral that was not sufficient to cover the outstanding loan balances. Charge-offs were taken on the loans in order to have the remaining loan balances line up with the values determined under a collateral dependent impairment model. Several of the loans are delinquent less than 90 days, however the entire relationship is in nonaccrual status as one loan is greater than 90 days past due and the cash flows of the Company and related enterprises is not sufficient to meet debt service requirements.

Another significant relationship in nonaccrual status is to a hotel operator in the Company’s southern market, with an outstanding loan balance of approximately $3,200,000. Despite being current as to scheduled loan payments, the loan is on nonaccrual status due to the structure of the required principal and interest payments. The loan is adequately secured by the related real estate, with an appraisal obtained in the past twelve months, and as such, no impairment charge has been taken to date.

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One additional relationship has book balance of $3,156,000 at June 30, 2012 the borrower of which is a wholesaler that supplies inventory to the commercial construction industry. As a result of deterioration in real estate conditions, the borrower’s business has been negatively impacted, and has resulted in management concluding that it will be unable to continue to service its debt requirements. The relationship also includes financing for a residence in a resort area. The Company has received appraisals in the fourth quarter of 2011 which has resulted in impairment charges being taken on the relationship, and has resulted in partial charge-offs representing 36% of the outstanding June 30, 2012 loan balance. Management is attempting to work with the borrower in order to mitigate its risk of loss.

The Company has approximately 50 additional relationships with borrowers with loans that are individually evaluated for impairment, and has taken a similar approach to those mentioned above in determining the extent of full or partial charge-offs that were required, or ASC 310 reserves that may be needed. The determination of the Company’s charge-offs or impairment reserve determination properly included an evaluation of the outstanding loan balance, and the related collateral securing the credit.

The Company believes through partial charge-offs taken to date totaling $30,139,000, the combination of the collateral securing the loans and the reserves allocated for these nonaccrual and restructured loans totaling $2,075,000, that it has adequately provided for the potential losses that it may incur on these relationships as of June 30, 2012. However, over time, additional information may become known that could result in increased reserve allocations or, alternatively, it may be deemed that the reserve allocations exceed that which is needed.

As noted previously, in the second quarter of 2012, the Company was able to sell 65 notes with an aggregate carrying balance of $28,598,000, consisting of seven relationships, to a third party. Upon the sale, an additional charge-off of $8,896,000 was taken to reflect the sales proceeds received. The sale of these notes allowed the Company to reduce its nonaccrual loan balances.

The Company’s foreclosed real estate balance of $2,337,000 at June 30, 2012 is a slight increase from $2,165,000 at December 31, 2011. As of June 30, 2012, 12 properties were owned by the Company, six of which were commercial properties and totaled $1,030,000, and the remaining six consisted of residential properties and totaled $1,307,000. The largest commercial property consisted of land with a carrying value of $365,000 that was originally purchased by the

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Company for future expansion purposes. During 2011, it was determined that this property was no longer in the Company’s strategic plans, and as such, the Company re-designated the property as held for sale. The two largest residential properties have a carrying balance of $973,000 at June 30, 2012 and are being carried at a value lower than its list price. The remaining properties have carrying values less than $210,000 and are also carried at the lower of cost or fair value, less costs to dispose.

As of June 30, 2012, the Company believes the value of foreclosed assets represents their fair values, but if the real estate market continues to remain soft, additional charges may be needed. Additionally, as the Company works through some of its problem loans, management anticipates that the foreclosed real estate balances may grow.

Credit Risk Management

Allowance for Loan Losses

The Company’s charge-offs have increased significantly in the past year, reflective of sluggish economic and real estate conditions. The Company maintains the allowance for loan losses at a level believed to be adequate by management to absorb losses inherent in the portfolio. The allowance is established and maintained through a provision for loan losses charged to earnings. Quarterly, management assesses the adequacy of the allowance for loan losses utilizing a defined methodology, which considers specific credit evaluation of impaired loans as discussed above, past loan loss historical experience, and qualitative factors. Management believes the approach properly addresses the requirements of ASC Section 310-10-35 for loans individually identified as impaired, and ASC Subtopic 450-20 for loans collectively evaluated for impairment, and other bank regulatory guidance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

In order to monitor ongoing risk associated with its loan portfolio and specific credits within the segments, management uses an eight point internal grading system. The first four rating categories, representing the lowest risk to the Bank, are combined and given a “Pass” rating. The “Special Mention” category includes loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Bank’s position at some future date. These assets pose elevated risk, but their weakness does not yet justify a more severe, or criticized rating. Management generally follows regulatory definitions in assigning criticized ratings to loans, including substandard, doubtful or loss. “Substandard” loans are classified as they have a well-defined weakness, or weaknesses that jeopardize liquidation of the debt. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. “Substandard” loans include loans that management has determined not to be impaired, as well as loans considered to be impaired. A “Doubtful” loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset, its classification of loss is deferred. “Loss” assets are considered uncollectible, as the underlying borrowers are often in bankruptcy, have suspended debt repayments, or ceased business operations. Once a loan is classified as “Loss”, there is little prospect of collecting the loan’s principal or interest and it is generally written off.

The Bank has a loan review policy and program which is designed to reduce and control risk in the lending function. The Credit Administration Committee, comprised of members of the Board, is charged with the overall credit quality and risk exposure of the Company’s loan portfolio. This includes the monitoring of the lending activities of all Bank personnel with respect to underwriting and processing new loans and the timely follow-up and corrective action for loans showing signs of deterioration in quality. The loan review program provides the Bank with an internal (through an outsourced third party beginning in 2011), independent review of the Bank’s loan portfolio on an ongoing basis. Generally, consumer and

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residential mortgage loans are included in the Pass categories unless a specific action, such as extended delinquencies, bankruptcy, repossession or death of the borrower occurs, which heightens awareness as to a possible credit event.

Loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of $1,000,000. Loan review documentation is submitted to the Credit Administration Committee quarterly with a formal review and rating as presented by independent loan review personnel. In addition, all relationships greater than $250,000 rated Substandard, Doubtful or Loss are reviewed by the Credit Administration Committee on a quarterly basis, with reaffirmation of the rating as recommended by the Bank’s Problem Loan Committee or independent loan review personnel. In addition to the policy and procedure guidelines noted above, the Company expanded its review coverage during the last three quarters of 2011 in light of softness in overall economic conditions and deterioration of underlying collateral securing lending relationships. As a result, all commercial real estate, construction and development loans, and commercial loans in excess of $500,000, representing over 75% coverage of these portfolios, have been reviewed.

The following tables summarize the Bank’s ratings based on its internal risk rating system as of June 30, 2012 and December 31, 2011:

(Dollars in thousands)	Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		Total
June 30, 2012:
Commercial real estate:
Owner-occupied	$	138,056	$	14,141	$	10,727	$	7,834	$	190	$	170,948
Non-owner occupied		107,427		11,596		15,330		15,466		0		149,819
Multi-family		18,014		7,812		4,227		186		0		30,239
Acquisition and development:
1-4 family residential construction		1,647		436		533		1,269		725		4,610
Commercial and land development		16,304		9,482		9,821		12,914		632		49,153
Commercial and industrial		158,368		27,874		8,541		15,196		1,738		211,717
Residential mortgage:
First lien		111,245		1,783		1,787		2,827		0		117,642
Home equity - term		14,568		50		166		42		0		14,826
Home equity - Lines of credit		78,579		1,034		1,669		37		0		81,319
Installment and other loans		7,656		42		6		3		0		7,707
	$	651,864	$	74,250	$	52,807	$	55,774	$	3,285	$	837,980

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(Dollars in thousands)	Pass		Special Mention		Non- Impaired Substandard		Impaired - Substandard		Doubtful		Total
December 31, 2011:
Commercial real estate:
Owner-occupied	$	161,695	$	19,820	$	8,321	$	8,828	$	982	$	199,646
Non-owner occupied		93,379		19,689		7,785		16,661		3,523		141,037
Multi-family		14,896		7,581		1,387		1,328		2,135		27,327
Acquisition and development:
1-4 family residential construction		3,361		724		831		2,182		0		7,098
Commercial and land development		28,513		16,274		13,713		19,064		0		77,564
Commercial and industrial		190,675		19,859		14,232		50,047		3,087		277,900
Residential mortgage:
First lien		102,398		0		596		1,333		0		104,327
Home equity - term		36,290		0		638		585		0		37,513
Home equity - Lines of credit		80,881		0		70		0		0		80,951
Installment and other loans		12,075		0		2		0		0		12,077
	$	724,163	$	83,947	$	47,575	$	100,028	$	9,727	$	965,440

Potential problem loans are defined as performing loans, which have characteristics that cause management to have some doubt as to the ability of the borrower to perform under present loan repayment terms and which may result in the reporting of these loans as non-performing loans in the future. Generally, management feels that “Substandard” loans that are currently performing and not considered impaired, result in some doubt as to the borrower’s ability to continue to perform under the terms of the loan, and represent potential problem loans. Additionally, the “Special Mention” classification is intended to be a temporary classification, and is reflective of loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Bank’s position at some future date. “Special Mention” loans represent an elevated risk, but their weakness does not yet justify a more severe, or classified rating. These loans require follow-up by lenders on the information that may cause the potential weakness, and once resolved, the loan classification may be downgraded to “Substandard”, or alternatively, could be upgraded to “Pass”. As a result, these loans may become potential problem loans if conditions worsen and they are subsequently downgraded.

Classified loans may also be evaluated for impairment. For commercial real estate, acquisition and development and commercial and industrial loans, a loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Generally, loans that are more than 90 days past due are assigned a “Substandard” rating. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed to determine if the loan should be placed in nonaccrual status. Nonaccrual loans in the commercial and commercial real estate portfolios are, by definition, deemed to be impaired. Impairment is measured on a loan-by-loan basis for commercial, construction and restructured loans by either the present value of the expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For loans that are deemed to be impaired for extended periods of time, periodic updates on fair values are obtained, which may include updated appraisals. The updated fair values will be incorporated into the impairment analysis as of the next reporting period. In the event an updated appraisal that requires a higher impairment reserve is received after a reporting period, but prior to the issuance of the financial statements, an evaluation is made as to the significance of the difference and whether the amounts need to be reflected in the financial statements not yet issued.

Loan charge-offs, which may include partial charge-offs, are taken on an impaired loan that is collateral dependent if the loan’s carrying balance exceeds its collateral’s appraised value; the

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loan has been identified as uncollectible; and it is deemed to be a confirmed loss. Typically, impaired loans with a charge-off or partial charge-off will continue to be considered impaired, unless the note is split into two, and management expects the performing note to continue to perform and is adequately secured. The second, or non-performing note, would be charged-off. As of the periods presented, the Company has no loans to borrowers that resulted from splitting impaired loans into multiple notes. Generally, an impaired loan with a partial charge-off will continue to have an impairment reserve on it after the partial charge-off, if factors warrant.

As of June 30, 2012, nearly all of the Company’s impaired loans’ extent of impairment was measured based on the estimated fair value of the collateral securing the credit, except for certain troubled debt restructurings. By definition, troubled debt restructurings are considered impaired. All restructured loans’ impairment was determined based on discounted cash flows for those loans classified as troubled debt restructurings but that are accruing interest. For real estate loans, collateral generally consists of commercial real estate, but in the case of commercial and industrial loans, it would also consist of accounts receivable, inventory, equipment or other business assets. Commercial and industrial loans may also have real estate collateral.

At the time a real-estate-secured loan is deemed impaired, management determines whether an updated certified appraisal of the real estate is necessary to assist in determining the extent of an impairment reserve, if any. The decision for requiring an updated appraisal takes into consideration the age of the most recent appraisal, the loan-to-value ratio based on the original certified appraisal, the Company’s recent experience and knowledge of market conditions, recent list prices or broker opinions, the condition of the property, and environmental factors. If market conditions have changed significantly from the date of the most recent appraisal, an updated appraisal will be obtained. Updated appraisals are required for criticized loans in excess of $250,000 on at least an annual basis. The “as is value” provided in the appraisal is often used as the fair value of the collateral in determining impairment, unless circumstances, such as subsequent improvements, approvals, or other circumstances dictate that another value provided by the appraiser is more appropriate.

Generally, impaired loans secured by real estate were measured at fair value using certified real estate appraisals that had been completed within the last year. Appraised values are further discounted for estimated costs to sell the property and other selling considerations to arrive at the property’s fair value.

In those situations in which it is determined an updated appraisal is not required for loans individually evaluated for impairment, fair values are based on one or a combination of the following approaches. In those situations in which a combination of approaches is considered, the one that carries the most consideration will be the one management believes is warranted. The approaches are as follows:

• Original appraisal - if the original appraisal provides a strong loan-to-value (generally 70% or lower) and, after consideration of market conditions and knowledge of the property and area, it is determined by the Credit Administration staff that there has not been a significant deterioration in the collateral value, the original certified appraised value may be used. Discounts as deemed appropriate for selling costs are factored into the appraised value in arriving at fair value.

• Discounted cash flows - in limited cases, discounted cash flows may be used on projects in which the collateral is liquidated to reduce the borrowings outstanding, and is also used to validate collateral values derived from other approaches.

Collateral on certain impaired loans is not limited to real estate, and consists of accounts receivable, inventory, equipment or other business assets. Estimated fair values are determined based on borrowers’ financial statements, inventory ledgers, accounts receivable agings or appraisals from individuals with knowledge in the business. Stated balances are generally discounted for the age of the financial information or the quality of the assets. In determining fair value, liquidation discounts are applied to this collateral based on existing loan evaluation policies.

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The Company distinguishes Substandard loans on both an impaired and non-impaired basis, as it places less emphasis on a loan’s classification, and increased reliance on whether the loan was performing in accordance with the contractual terms. “Substandard” classification does not automatically meet the definition of “impaired”. A Substandard credit is one that is inadequately protected by current sound worth, paying capacity of the obligor or the collateral pledged, if any. Extensions of credit so classified have well-defined weaknesses which may jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard credits, does not have to exist in individual extensions of credit classified Substandard. As a result, the Company revised its methodology in its evaluation of certain accruing commercial real estate, acquisition and development and commercial and industrial loans rated “Substandard” collectively for impairment as opposed to evaluating these loans individually for impairment. Although we believe these loans have well defined weaknesses and meet the definition of “Substandard”, they are generally performing and management has concluded that it is likely it will be able to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.

Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Generally, the Bank does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

The following summarizes impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required as of June 30, 2012 and December 31, 2011:

	Impaired Loans with a Specific Allowance						Impaired Loans with No Specific Allowance
(Dollars in thousands)	Recorded Investment (Book  Balance)		Unpaid Principal Balance (Legal Balance)		Related Allowance		Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)
June 30, 2012
Commercial real estate:
Owner-occupied	$	0	$	0	$	0	$	8,024	$	11,162
Non-owner occupied		1,274		1,274		346		14,192		25,667
Multi-family		0		0		0		186		2,969
Acquisition and development:
1-4 family residential construction		725		725		413		1,269		3,756
Commercial and land development		632		632		363		12,914		28,420
Commercial and industrial		1,830		1,830		945		15,104		25,636
Residential mortgage:
First lien		453		453		8		2,374		2,826
Home equity - term		0		0		0		42		277
Home equity - lines of credit		0		0		0		37		37
Consumer		0		0		0		3		3
	$	4,914	$	4,914	$	2,075	$	54,145	$	100,753
December 31, 2011
Commercial real estate:
Owner-occupied	$	5,016	$	5,200	$	1,762	$	4,794	$	4,838
Non-owner occupied		16,682		20,472		6,876		3,502		4,071
Multi-family		3,129		5,117		1,213		334		334
Acquisition and development:
1-4 family residential construction		2,182		3,715		926		0		0
Commercial and land development		10,657		13,899		4,369		8,407		9,712
Commercial and industrial		46,685		47,256		14,591		6,449		6,551
Residential mortgage:
First lien		1,122		1,122		9		211		211
Home equity - term		41		41		42		544		709
	$	85,514	$	96,822	$	29,788	$	24,241	$	26,426

The difference between the recorded investment (book balance) and the unpaid principal balance (legal balance) generally results from partial charge-offs taken on loans and payments applied entirely to principal on those loans placed on nonaccrual status. As noted above, the book balance of impaired loans at June 30, 2012 totaled $59,059,000 whereas the legal balance, or the amount the customer contractually owes the Company, totaled $105,667,000 indicating that amounts totaling $46,608,000 were either partially charged-off or had interest payments applied to principal.

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The following presents impaired loans that are troubled debt restructurings as of June 30, 2012 and December 31, 2011.

	Troubled Debt Restructurings At Period End				New Troubled Debt Restructurings Six Months Ended June 30, 2012
(Dollars in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
June 30, 2012
Accruing:
Commercial real estate:
Non-owner occupied		2	$	2,008		0	$	0
Commercial and industrial		2		334		0		0
Residential mortgage:
First lien		1		453		0		0
Home equity - lines of credit		1		37		1		37
		6		2,832		1		37
Nonaccruing:
Commercial real estate:
Owner-occupied		2		709		0		0
Non-owner occupied		1		193		0		0
Acquisition and development:
Commercial and land development		4		1,671		0		0
Commercial and industrial		9		3,709		1		203
Residential mortgage:
Home equity - term		1		299		1		299
		17		6,581		2		502
		23	$	9,413		3	$	539

	Troubled Debt Restructurings At Period End				New Troubled Debt Restructurings Year Ended December 31, 2011
(Dollars in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
December 31, 2011
Accruing:
Commercial real estate:
Owner-occupied		1	$	924		1	$	924
Non-owner occupied		2		2,039		2		2,039
Acquisition and development:
1-4 family residential construction		0		0		0		0
Commercial and land development		2		1,061		2		1,061
Commercial and industrial		10		23,434		10		23,434
Residential mortgage:
First lien		1		459		0		0
		16		27,917		15		27,458
Nonaccruing:
Commercial real estate:
Owner-occupied		1		54		1		54
Non-owner occupied		1		221		1		221
Acquisition and development:
Commercial and land development		3		3,179		3		3,179
Commercial and industrial		10		5,648		10		5,648
Residential mortgage:
Home equity - term		1		544		0		0
		16		9,646		15		9,102
		32	$	37,563		30	$	36,560

No additional commitments have been made to borrowers whose loans are considered troubled debt restructurings.

The following summarizes the average recorded investment in impaired loans and related interest income recognized, on loans deemed impaired at June 30, 2012 on a cash basis, and interest income earned but not recognized for the period ended June 30, 2012:

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	Three Months Ended June 30,
	2012				2011
(Dollars in thousands)	Average Impaired Balance		Interest Income Recognized		Average Impaired Balance
Commercial real estate:
Owner-occupied	$	10,336	$	4	$	1,727
Non-owner occupied		16,911		293		1,589
Multi-family		1,175		0		1,533
Acquisition and development:
1-4 family residential construction		1,620		2		66
Commercial and land development		13,358		116		5,231
Commercial and industrial		26,742		72		20,182
Residential mortgage:
First lien		1,657		27		466
Home equity - term		304		2		710
Home equity - lines of credit		19		0		0
Installment and other loans		2		0		0
Total	$	72,124	$	516	$	31,504

	Six Months Ended June 30,
	2012				2011
(Dollars in thousands)	Average Impaired Balance		Interest Income Recognized		Average Impaired Balance
Commercial real estate:
Owner-occupied	$	10,161	$	44	$	1,380
Non-owner occupied		18,002		360		1,747
Multi-family		1,938		0		1,052
Acquisition and development:
1-4 family residential construction		1,807		2		44
Commercial and land development		15,260		187		3,487
Commercial and industrial		35,539		226		17,027
Residential mortgage:
First lien		1,549		27		467
Home equity - term		398		2		710
Home equity - lines of credit		12		0		0
Installment and other loans		1		0		0
Total	$	84,667	$	848	$	25,914

Management further monitors the performance and credit quality of the loan portfolio by analyzing the length of time a portfolio is past due, by aggregating loans based on its delinquencies. The following table presents the classes of loans in the portfolio summarized by aging categories of performing loans and nonaccrual loans as of June 30, 2012 and December 31, 2011.

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			Days Past Due
(Dollars in thousands)	Current		30-59		60-89		90+ (still accruing)		Total Past Due (still accruing)		Non- Accrual		Total Loans
June 30, 2012:
Commercial real estate:
Owner-occupied	$	161,362	$	434	$	782	$	346	$	1,562	$	8,024	$	170,948
Non-owner occupied		136,239		122		0		0		122		13,458		149,819
Multi-family		29,188		198		400		267		865		186		30,239
Acquisition and development:
1-4 family residential construction		2,808		391		0		142		533		1,269		4,610
Commercial and land development		34,699		721		27		159		907		13,547		49,153
Commercial and industrial		193,329		206		602		255		1,063		17,325		211,717
Residential mortgage:
First lien		112,460		1,443		604		106		2,153		3,029		117,642
Home equity - term		14,688		72		0		0		72		66		14,826
Home equity - Lines of credit		81,163		129		27		0		156		0		81,319
Installment and other loans		7,633		46		15		0		61		13		7,707
	$	773,569	$	3,762	$	2,457	$	1,275	$	7,494	$	56,917	$	837,980

			Days Past Due
(Dollars in thousands)	Current		30-59		60-89		90+ (still accruing)		Total Past Due (still accruing)		Non-Accrual		Total Loans
December 31, 2011:
Commercial real estate:
Owner-occupied	$	188,679	$	2,135	$	0	$	0	$	2,135	$	8,832	$	199,646
Non-owner occupied		122,816		75		0		0		75		18,146		141,037
Multi-family		23,864		0		0		0		0		3,463		27,327
Acquisition and development:
1-4 family residential construction		4,916		0		0		0		0		2,182		7,098
Commercial and land development		59,121		440		0		0		440		18,003		77,564
Commercial and industrial		246,696		1,341		15		0		1,356		29,848		277,900
Residential mortgage:
First lien		100,215		1,637		547		0		2,184		1,928		104,327
Home equity - term		35,998		283		9		0		292		1,223		37,513
Home equity - Lines of credit		80,783		98		0		0		98		70		80,951
Installment and other loans		11,932		141		2		0		143		2		12,077
	$	875,020	$	6,150	$	573	$	0	$	6,723	$	83,697	$	965,440

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For each loan class presented above, general allowances are provided for loans that are collectively evaluated for impairment, which are based on quantitative factors, principally historical loss trends for the respective loan class, adjusted for qualitative factors. Effective December 31, 2011, the historical loss factor was based on average charge-offs for the last eight quarters and applied to the entire pool of loans, excluding those loans evaluated for impairment under ASC 310-10-35. In addition, an additional adjustment to the historical loss factors is made to account for delinquency and other potential risk not elsewhere defined within the Allowance for Loan and Lease Loss methodology. The refinement to the methodology was made as management determined that the most recent eight quarters loss history, as adjusted based on other portfolio analysis and applied to an entire pool of loans, is a better reflection of the losses inherent on non-impaired loans within the portfolio. In making this determination, management considered current economic and real estate conditions, trends in historical charge-off percentages at the Company as well as peers, and feedback from regulators.

In addition to the changes mentioned under ASC 450-20, the Company refined its methodology under ASC 310-10-35 in the manner in which partial charge offs are calculated. Based on management’s assessment and in compliance with regulatory guidance, as of June 30, 2012 the Company will generally incur partial charge-offs in the amount that a loan’s carrying value exceeds its fair value, less discount for market conditions and costs to dispose, eliminating the need for specific reserves. This will be accomplished by charging the loan off to a level below the fair market value, or appraisal value, of collateral less costs to sell. This method will result in the loan being carried at the fair market value of collateral, less any discount determined necessary based on current market conditions, less costs to dispose of the asset. As a result, the Company experienced significantly higher charge-offs than would have been incurred in prior periods. Management estimates that charge-offs for the six months ended June 30, 2012 were increased by $43,000,000 when compared to methods used over prior periods. In direct correlation with this change in methodology, the historical loss rates have been elevated when compared to prior periods which does affect the reserves held under ASC 450-20. Management believes this is a more conservative method in calculating the allowance for loan losses.

In addition to the quantitative analysis, additional reserves are allocated on loans collectively evaluated for impairment based on additional qualitative factors. The qualitative factors used by management to adjust the historical loss percentage to the anticipated loss allocation, which range from 0 – 8 basis points per factor, include:

Nature and Volume of Loans - Loan growth in the current and subsequent quarters based on the Bank’s targeted growth and strategic plan, coupled with the types of loans booked based on risk management and credit culture, and number of exceptions to loan policy; supervisory loan to value exceptions; etc.

Concentrations of Credit and Changes within Credit Concentrations - Factors considered including the Bank’s overall portfolio makeup and management’s evaluation relating to concentration risk management and the inherent risk associated with the concentrations identified.

Experience, Ability and Depth of Management/Lending Staff - Factors considered include the years of experience of senior and middle management and the lending and loan review staff and turnover of the staff.

Other External Factors (Economic, Legal, Competition, Regulatory, etc.) - Ratios and factors considered include trends in the consumer price index (CPI); unemployment rates; housing price index; housing statistics compared to the prior year; bankruptcy rates; regulatory and legal environment risks and competition.

A summary of the activity in the allowance for loan losses for the three months ended June 30, 2012 and 2011 is as follows:

(Dollars in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage			Installment and Other		Unallocated			Total
June 30, 2012
Balance, beginning of year	$	10,836	$	6,719	$	7,242	$	1,301		$	45	$	2,013		$	28,156
Provision for loan losses		13,000		2,549		7,824		(377	)		79		(75	)		23,000

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Charge-offs		(10,039	)		(2,665	)		(3,890	)		(44	)		(57	)		0		(16,695	)
Recoveries		1,407			200			158			7			2			0		1,774
Balance, end of period	$	15,204		$	6,803		$	11,334		$	887		$	69		$	1,938	$	36,235
June 30, 2011
Balance, beginning of period	$	4,884		$	3,245		$	8,212		$	1,712		$	93		$	252	$	18,398
Provision for loan losses		2,894			4,357			12,138			517			13			1,311		21,230
Charge-offs		(542	)		(2,576	)		(9,218	)		(79	)		(17	)		0		(12,432	)
Recoveries		8			0			0			0			8			0		16
Balance, end of period	$	7,244		$	5,026		$	11,132		$	2,150		$	97		$	1,563	$	27,212

A summary of the activity in the allowance for loan losses for the six months ended June 30, 2012 and 2011 is as follows:

(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Installment and Other			Unallocated		Total
June 30, 2012
Balance, beginning of year	$	13,864		$	9,708		$	17,569		$	933		$	75		$	1,566	$	43,715
Provision for loan losses		21,772			6,399			13,387			215			55			372		42,200
Charge-offs		(21,846	)		(9.977	)		(19,814	)		(272	)		(69	)		0		(51,978	)
Recoveries		1,414			6,730			192			11			8			0		2,298
Balance, end of period	$	15,204		$	6,803		$	11,334		$	887		$	69		$	1,938	$	36,235
June 30, 2011
Balance, beginning of period	$	5,324		$	1,767		$	6,795		$	1,863		$	106		$	165	$	16,020
Provision for loan losses		3,165			5,835			13,600			427			0			1,398		24,425
Charge-offs		(1,253	)		(2,576	)		(9,263	)		(140	)		(24	)		0		(13,256	)
Recoveries		8			0			0			0			15			0		23
Balance, end of period	$	7,244		$	5,026		$	11,132		$	2,150		$	97		$	1,563	$	27,212

The allowance for loan losses totaled $36,235,000 at June 30, 2012, a $7,480,000 decline from December 31, 2011. As of June 30, 2012, the allowance for loan losses to total loans was 4.32% compared to 4.53% as of December 31, 2011, and the allowance for loan losses to nonaccrual loans and restructured loans still accruing improved from 39.17% at December 31, 2011 to 60.65% at June 30, 2012. The increase in the coverage ratio of nonaccrual and restructured loans reflects lower levels of risk assets, particularly the significant decrease in non-performing assets discussed above. As of December 31, 2011, the reserves specifically allocated on impaired loans totaled $29,788,000 on $109,755,000 of loans deemed impaired. The Company has taken partial charge-offs on nearly all impaired loans at June 30, 2012, so that the loan balances reflect the loan’s fair value, less anticipated closing costs. As such, impaired loans generally no longer had specific reserves allocated to them, as the anticipated loss has already been recorded as a charge-off. At June 30, 2012, the reserves specifically allocated on impaired loans totaled $2,075,000 on $59,059,000 of loans meeting the impaired definition.

A summary of relevant asset quality ratios for the three and six months ended June 30, 2012 and 2011 are as follows:

	Three Months Ended						Six Months Ended
	June 30, 2012			June 30, 2011			June 30, 2012			June 30, 2011
Ratio of net charge-offs to average loans outstanding		6.78	%		4.90	%		10.83	%		2.66	%
Provision for loan losses to net charge-offs		154.15	%		170.99	%		84.99	%		184.58	%

Net charge-offs were $49,680,000 for the six months ended June 30, 2012, compared to $13,233,000 for the same period in 2011, and the provision for loan losses to net charge-offs was 84.99% for the six

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months ended June 30, 2012 compared to 184.58% for the same period in 2011. The elevated levels of charge-offs in the first six months of 2012 significantly increased the annualized ratio of charge-offs to average loans outstanding and reduced the provision for loan losses to charge-off ratio in 2012. The majority of the charge-offs remain in the non owner-occupied commercial real estate, owner-occupied commercial real estate and commercial and land development loan portfolios.

The following summarizes the ending loan balance individually or collectively evaluated for impairment based upon loan type, as well as the allowance for loan loss allocation for each at June 30, 2012 and December 31, 2011.

(Dollars in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Installment and Other		Unallocated		Total
June 30, 2012
Loans allocated by:
Individually evaluated for impairment	$	23,676	$	15,540	$	16,934	$	2,906	$	3	$	0	$	59,059
Collectively evaluated for impairment		327,330		38,223		194,783		210,881		7,704		0		778,921
	$	351,006	$	53,763	$	211,717	$	213,787	$	7,707	$	0	$	837,980
Allowance for loan losses allocated by:
Individually evaluated for impairment	$	346	$	776	$	945	$	8	$	0	$	0	$	2,075

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Collectively evaluated for impairment		14,858		6,027		10,389		879		69		1,938		34,160
	$	15,204	$	6,803	$	11,334	$	887	$	69	$	1,938	$	36,235
December 31, 2011
Loans allocated by:
Individually evaluated for impairment	$	33,457	$	21,246	$	53,134	$	1,918	$	0	$	0	$	109,755
Collectively evaluated for impairment		334,553		63,416		224,766		220,873		12,077		0		855,685
	$	368,010	$	84,662	$	277,900	$	222,791	$	12,077	$	0	$	965,440
Allowance for loan losses allocated by:
Individually evaluated for impairment	$	9,851	$	5,295	$	14,591	$	51	$	0	$	0	$	29,788
Collectively evaluated for impairment		4,013		4,413		2,978		882		75		1,566		13,927
	$	13,864	$	9,708	$	17,569	$	933	$	75	$	1,566	$	43,715

Management believes the allocation of the allowance for loan losses between the various loan segments adequately reflects the inherent risk in each portfolio, and is based on the methodology previously discussed. As previously noted, management re-evaluates and makes certain modifications to its methodology in establishing a reserve to better account for risks inherent in the different segments of the portfolio, particularly in light of increased charge-offs, with differences between the different loan segments. Management believes these periodic enhancements to the allowance for loan losses methodology improves the accuracy of quantifying losses presently inherent in the portfolio. Management charges actual loan losses to the reserve and bases the provision for loan losses on the overall analysis taking the methodology into account.

The acquisition and development and commercial and industrial loan segments’ reserve allocations at June 30, 2012 declined from the December 31, 2011 balance due to the extensive partial charge-offs taken in each portfolio. The increase in the commercial real estate loan segment is the direct result of the significant partial charge-offs taken during 2012, which has caused the Company’s historical loss factors to increase and led to higher general reserve allocations on the non-impaired loans.

The unallocated portion of the allowance for loan losses reflects estimated inherent losses within the portfolio that have not been detected. This reserve is due to the risk of error in the specific and general reserve allocation, other potential exposure in the loan portfolio, variances in management’s assessment of national and local economic conditions and other factors management believes appropriate at the time. The unallocated portion of the allowance increased from $1,566,000 at December 31, 2011 to $1,938,000 at June 30, 2012. The unallocated portion of the reserve represents 5.3% of the entire allowance for loan losses at June 30, 2012.

While management believes the Company’s allowance for loan losses is adequate based on information currently available, future adjustments to the reserve and enhancements to the methodology may be necessary due to changes in economic conditions, regulatory guidance, or management’s assumptions as to future delinquencies or loss rates.

Capital Adequacy and Regulatory Matters

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The management of capital in a regulated financial services industry must properly balance return on equity to its stockholders while maintaining sufficient levels of capital and related risk-based regulatory capital ratios to satisfy statutory regulatory requirements. The Company’s capital management strategies have been developed to provide attractive rates of return to its shareholders, while maintaining a well capitalized position of regulatory strength.

Total shareholders’ equity decreased $20,568,000 from $128,197,000 at December 31, 2011 to $107,629,000 at June 30, 2012. The primary reason for the decline was the $18,132,000 net loss posted for the period combined with unrealized losses on securities, net of tax of $2,539,000.

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Prompt corrective action provisions are not applicable to financial holding companies.

In the determination of Tier 1 and Total risk based capital, generally accumulated other comprehensive income (loss) is excluded from capital, as are intangible assets, a portion of mortgage servicing rights and deferred tax assets that are dependent on future taxable income greater than one year from the reporting date. As of June 30, 2012 and December 31, 2011, $10,593,000 and $1,441,000, respectively, of the Company’s deferred tax asset has been disallowed for Tier 1 and Total risk based capital. The increase in the disallowed amount, which results in lower regulatory capital, is primarily the result of two items: increased partial charge-offs and loan loss provision and federal income tax carry back rules. As a result of the increased provisioning and partial charge-offs, the deferred tax asset balance has grown, as these temporary differences are not tax deductible until the loan is fully charged off. In addition, federal income tax rules only allow for a two-year carry back, and the taxable income generated in the two year carry back period was reduced.

The allowance for credit losses, including the allowance for loan losses and reserve for off-balance sheet credit commitments, is included as Tier 2 capital to the extent it does not exceed 1.25% of risk weighted assets. The amount that exceeds 1.25% of risk weighted assets, is disallowed as Tier 2 capital, but also reduces the Company’s risk weighted assets. As of June 30, 2012 and December 31, 2011, $25,404,000 and $31,174,000 of the allowance for credit losses was excluded from Tier 2 capital. The lower disallowed amount was the result of the elevated charge-offs during the quarter which essentially eliminated specific reserves on impaired loans.

As of June 30, 2012 and December 31, 2011, the Bank met the ratios to be considered well capitalized under applicable banking regulations. The Company’s and the Bank’s capital ratios as of June 30, 2012 and December 31, 2011 were as follows:

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											Minimum to Be Well
											Capitalized Under
						Minimum Capital					Prompt Corrective
	Actual					Requirement					Action Provisions
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
June 30, 2012
Total capital to risk weighted assets
Orrstown Financial Services, Inc.	$	106,227		11.7	%	$	72,732		8.0	%		n/a		n/a
Orrstown Bank		103,515		11.4	%		72,685		8.0	%	$	90,856		10.0	%
Tier 1 capital to risk weighted assets
Orrstown Financial Services, Inc.		94,545		10.4	%		36,366		4.0	%		n/a		n/a
Orrstown Bank		91,840		10.1	%		36,342		4.0	%		54,514		6.0	%
Tier 1 capital to average assets
Orrstown Financial Services, Inc.		94,545		6.7	%		56,323		4.0	%		n/a		n/a
Orrstown Bank		91,840		6.5	%		56,365		4.0	%		70,457		5.0	%
December 31, 2011
Total capital to risk weighted assets
Orrstown Financial Services, Inc.	$	134,621		13.0	%	$	83,090		8.0	%		n/a		n/a
Orrstown Bank		127,529		12.3	%		82,899		8.0	%	$	103,624		10.0	%
Tier 1 capital to risk weighted assets
Orrstown Financial Services, Inc.		121,249		11.7	%		41,545		4.0	%		n/a		n/a
Orrstown Bank		114,187		11.0	%		41,450		4.0	%		62,175		6.0	%
Tier 1 capital to average assets
Orrstown Financial Services, Inc.		121,249		8.2	%		58,851		4.0	%		n/a		n/a
Orrstown Bank		114,187		7.8	%		58,682		4.0	%		73,352		5.0	%

As noted above, the Bank’s capital ratios exceed those to be considered well capitalized under applicable banking regulations. The Company routinely evaluates its capital levels in light of its risk profile to assess its capital needs. In March 2012, the Company and the Bank entered into a Written Agreement with the Federal Reserve Bank of Philadelphia and the Bank entered into a Consent Order with the Pennsylvania Department of Banking. In accordance therewith, the Bank has filed a Capital Plan with each of those banking regulators.

In 2009, the Federal Reserve Board notified all bank holding companies that dividends should be eliminated, deferred or reduced if the bank holding company’s net income for the past four quarters, net of dividends paid, is not sufficient to fully fund the dividends; the bank holding company’s prospective rate of earnings retention is not consistent with the bank holding company’s capital need and overall current and prospective financial conditions, or the bank holding company will not meet, or is in danger of not meeting its minimum regulatory capital adequacy ratios. In October 2011, the Company announced it had discontinued its quarterly dividend, which was the result of regulatory guidance from the Federal Reserve indicating that the Company’s dividend application would not be approved. Due to the regulatory restrictions included in the Written Agreement and the Consent Order with the respective regulators, the Company is restricted from paying any dividends or repurchasing any stock without prior regulatory approval. Accordingly, there can be no assurance that we will be permitted to pay a cash dividend or conduct any stock repurchases in the near future.

Liquidity

The primary function of asset/liability management is to assure adequate liquidity and sensitivity to changing interest rates. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that

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sufficient funds will be available to meet their credit needs. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and borrowings from the Federal Home Loan Bank of Pittsburgh (FHLB). While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

In the second quarter of 2012, the FHLB notified that Bank that all borrowings from the FHLB must be secured with acceptable collateral, consisting principally of eligible loans and securities. The FHLB takes delivery of the collateral to further protect their risk of loss.

We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management policy.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is defined as the exposure to interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market rate or price risks. For domestic banks, including the Company, the majority of market risk is related to interest rate risk.

Interest rate sensitivity management requires the maintenance of an appropriate balance between interest sensitive assets and liabilities. Interest bearing assets and liabilities that are maturing or repricing should be adequately balanced to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. The Company has consistently followed a strategy of pricing assets and liabilities according to prevailing market rates while largely matching maturities, within the guidelines of sound marketing and competitive practices. Rate sensitivity is measured by monthly gap analysis, quarterly rate shocks, and periodic simulation.

The Company’s Risk Sensitive Assets (RSA) to Risk Sensitive Liabilities (RSL) ratios have remained fairly consistent since December 31, 2011, and are more asset sensitive than at March 31, 2012. These ratios are reflective of management’s belief that interest rates do not have the ability to fall much further, and as a result, have increased its RSA/RSL ratio. This has been accomplished primarily through maintaining strong liquidity in interest bearing demand accounts. Management anticipates that it will attempt to invest a portion of this liquidity in the upcoming months, which should lower the RSA/RSL ratios.

The following gap summary demonstrates the shift in RSA/RSL (cumulative) position since year end:

	Within 3 Months		Within 6 Months		Within 12 Months		Within 36 Months
June 30, 2012		1.57		1.49		1.36		1.44
March 31, 2012		1.49		1.33		1.36		1.38
December 31, 2011		1.58		1.31		1.21		1.39

Management will closely monitor the Federal Reserve’s monetary policies and will react to any changes quickly in order to maintain a balanced earning assets to interest bearing liabilities ratio.

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Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures:

The Company’s Principal Executive Officer and Principal Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of June 30, 2012. Based on such evaluation, such officers have concluded that, as of June 30, 2012, the Company’s disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiary) required to be included in the Company’s periodic filings under the Exchange Act as it pertains to the consolidated financial statements and internal controls over financial reporting.

(b) Changes in internal controls:

In the Company’s Annual Report on Form 10-K, management noted that the Company had not fully remediated its material weakness in its internal control over financing reporting relating to loan ratings and its impact on the allowance for loan losses. The Company continues to make progress on the remedial action procedures noted in the Annual Report on Form 10-K, which includes the following:

• An independent third party has been contracted to review the Company’s loan ratings to ensure the rating is consistent with the risk represented in the credit, including but not limited to, global debt service coverage ratio, collateral valuations, and strength of guarantors.

• Policies and procedures pertaining to loan ratings and flow through to the allowance for loan losses calculation have been, and are continuing to be, implemented and augmented. In the second quarter of 2012, management began implementing a software package to assist in the allowance for loan losses calculation, and expects to the package to be fully implemented by September 30, 2012.

• Additional plans are being established to address internal control deficiencies, including additional documentation, training and supervision, and periodic reporting to the Company’s Credit Administration and Audit Committees of the Board of Directors. Internal controls surrounding the validation and testing of systems and models relating to loan ratings and allowance for loan losses are in the process of being strengthened.

As of June 30, 2012, the Company continues to implement and test the remediation procedures outlined above. Except as described above, there have been no further changes to the Company’s internal control over financial reporting that occurred since the beginning of the quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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PART II - OTHER INFORMATION

Item 1 - Legal Proceedings

The nature of Orrstown Financial Services, Inc.’s business generates a certain amount of litigation involving matters arising out of the ordinary course of business. Except as described below, in the opinion of management, there are no legal proceedings that might have a material effect on the results of operations, liquidity, or the financial position of the Company at this time.

On May 25, 2012, Southeastern Pennsylvania Transportation Authority (“SEPTA”) filed a putative class action complaint in the United States District Court for the Middle District of Pennsylvania against the Company, the Bank and certain current and former directors and executive officers. The complaint alleges, among other things, that (i) in connection with the Company’s Registration Statement on Form S-3 dated February 23, 2010 and its Prospectus Supplement dated March 23, 2010, and (ii) during the purported class period of March 24, 2010 through October 27, 2011, the Company issued materially false and misleading statements regarding the Company’s lending practices and financial results, including misleading statements concerning the stringent nature of the Bank’s credit practices and underwriting standards, the quality of its loan portfolio, and the intended use of the proceeds from the Company’s March 2010 public offering of common stock. The complaint asserts claims under Sections 11, 12(a) and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and seeks class certification, unspecified money damages, interest, costs, fees and equitable or injunctive relief. Under the Private Securities Litigation Reform Act of 1995 (“PSLRA”), motions for appointment of Lead Plaintiff in this case were due by July 24, 2012. SEPTA was the sole movant and the Court’s ruling on SEPTA’s motion is pending. Pursuant to the PSLRA and the Court’s June 28, 2012 Order, following the appointment of the Lead Plaintiff in this case, the Court will hold a scheduling conference to set deadlines for the filing of an amended complaint (if any), the filing and briefing of the Company’s responsive pleading, and the filing and briefing of the Lead Plaintiff’s motion for class certification. The Company believes that the allegations in the complaint are without merit and intends to defend vigorously against these claims.

Item 1A - Risk Factors

There have been no material changes from the risk factors as disclosed in the Annual Report on Form 10-K for the year ended December 31, 2011 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 with the exception of the following additional Risk Factors.

Pending litigation and legal proceedings and the impact of any finding of liability or damages could adversely impact the Company and its financial condition and results of operations.

We have been named, from time to time, as a defendant in various legal actions or other proceedings arising in connection with our activities as a financial services institution. Certain of the actual or threatened legal actions may include claims for substantial and indeterminate amounts of damages, or may result in other results adverse to us. Substantial legal liability could materially adversely affect our business, financial condition or results of operations or cause us significant reputational harm, which could seriously harm our business. For more information regarding legal proceedings in which we are involved, see “Legal Proceedings” in Part II, Item 1 herein.

We may not be able to attract and retain skilled people.

Our success depends, in large part, on our ability to attract and retain skilled people. We have recently experienced significant turnover among our senior officers. Competition for the best people in most activities engaged in by us can be intense, and we may not be able to hire sufficiently skilled people to fill open and newly created positions or to retain current or future employees. An inability to attract and retain individuals with the necessary skills to fill open positions, or the unexpected loss of services of one or more of our key personnel, could have a material adverse impact on our business due to the loss of their skills, knowledge of our markets, years of industry experience or the difficulty of promptly finding qualified replacement personnel.

- 72 -

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds

For the quarter ended June 30, 2012, there were no repurchases of common equity securities by the Company under the announced Stock Repurchase Plan. In connection with the formal written agreements entered into with the Federal Reserve Bank of Philadelphia and the Pennsylvania Department of Banking, the Company’s Stock Repurchase Plan has been suspended, and the Company does not expect to repurchase shares in the foreseeable future.

The Company did not sell any unregistered securities during the quarter ended June 30, 2012.

Item 3 - Defaults upon Senior Securities

Not applicable

Item 4 - Mine Safety Disclosures

Not applicable

Item 5 - Other Information

None

Item 6 - Exhibits

31.1	Rule 13a - 14(a)/15d-14(a) Certification (Chief Executive Officer)
31.2	Rule 13a - 14(a)/15d-14(a) Certifications (Principal Financial Officer)
32.1	Section 1350 Certifications (Chief Executive Officer)
32.2	Section 1350 Certifications (Principal Financial Officer)
101.LAB	XBRL Taxonomy Extension Label Linkbase *
101.PRE	XBRL Taxonomy Extension Presentation Linkbase *
101.INS	XBRL Instance Document *
101.SCH	XBRL Taxonomy Extension Schema *
101.CAL	XBRL Taxonomy Extension Calculation Linkbase *
101.DEF	XBRL Taxonomy Extension Definition Linkbase *

- 73 -

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.

/s/ Thomas R. Quinn, Jr.

Thomas R. Quinn, Jr., President & CEO

(Principal Executive Officer)

/s/ Philip E. Fague

Philip E. Fague

Senior Executive Vice President and Treasurer

(Principal Financial Officer)

Date: August 9, 2012

- 74 -

ORRSTOWN FINANCIAL SERVICES, INC. AND SUBSIDIARIES

EXHIBIT INDEX

31.1	Rule 13a - 14(a)/15d-14(a) Certification (Chief Executive Officer)
31.2	Rule 13a - 14(a)/15d-14(a) Certifications (Principal Financial Officer)
32.1	Section 1350 Certifications (Chief Executive Officer)
32.2	Section 1350 Certifications (Principal Financial Officer)
101.LAB	XBRL Taxonomy Extension Label Linkbase *
101.PRE	XBRL Taxonomy Extension Presentation Linkbase *
101.INS	XBRL Instance Document *
101.SCH	XBRL Taxonomy Extension Schema *
101.CAL	XBRL Taxonomy Extension Calculation Linkbase *
101.DEF	XBRL Taxonomy Extension Definition Linkbase *

All other exhibits for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.

* Attached as Exhibits 101 to this Form 10-Q are documents formatted in XBRL (Extensive Business Reporting Language), Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.

- 75 -

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Thomas R. Quinn, Jr., certify that:

1. I have reviewed this quarterly report on Form 10-Q of Orrstown Financial Services, 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 principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our 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 (the registrant’s fourth fiscal quarter in the case of an annual report) 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 registrant's board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of the 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.

Date: August 9, 2012	By:	/s/ Thomas R. Quinn, Jr.
	Thomas R. Quinn, Jr.
	President and CEO
	(Principal Executive Officer)

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Philip E. Fague, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Orrstown Financial Services, 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 principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our 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 (the registrant’s fourth fiscal quarter in the case of an annual report) 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 registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of the 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.

Date: August 9, 2012	By:	/s/ Philip E. Fague
	Philip E. Fague
	Senior Executive Vice President and Treasurer
	(Principal Financial Officer)

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 Orrstown Financial Services, Inc. (the “Company”) on Form 10-Q for the period ending June 30, 2012 as filed with the Securities and Exchange Commission on the date therein specified (the “Report”), I, Thomas R. Quinn, Jr., President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:

(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 period covered by the Report.

Date: August 9, 2012	/s/ Thomas R. Quinn, Jr.
	Thomas R. Quinn, Jr.
	President and Chief Executive Officer

EX-32.2

Exhibit 32.2

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 Orrstown Financial Services, Inc. (the “Company”) on Form 10-Q for the period ending June 30, 2012 as filed with the Securities and Exchange Commission on the date therein specified (the “Report”), I, Philip E. Fague, Senior Executive Vice President and Treasurer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:

(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 period covered by the Report.

Date: August 9, 2012	/s/ Philip E. Fague
	Philip E. Fague
	Senior Executive Vice President and Treasurer

XML

Derivative Instruments and Hedging Activity (Details) (USD $) In Thousands, unless otherwise specified	3 Months Ended	6 Months Ended
	Jun. 30, 2011	Jun. 30, 2011
Summary of unrealized gains (losses) on the derivatives
Unrealized gains on derivatives in cash flow from hedging relationship, beginning of period	$ 530	$ 918
Amount of gains recognized in other comprehensive income on derivative for effective portion of cash flow hedge	252	130
Amount of gain reclassified from accumulated other comprehensive income into interest income	(100)	(235)
Amount of gain recognized as noninterest income for the ineffective portion of the cash flow hedge	(11)	(142)
Unrealized gain on derivative in cash flow from hedging relationship, end of period	$ 671	$ 671

XML

Fair Value Disclosures (Details 2) (USD $) In Thousands, unless otherwise specified	6 Months Ended
	Jun. 30, 2012
Impaired loans [Member]
Summary of additional qualitative information
Fair Value Estimate	$ 45,983
Valuation Techniques	Appraisal of collateral
Foreclosed real estate [Member]
Summary of additional qualitative information
Fair Value Estimate	1,141
Valuation Techniques	Appraisal of collateral
Mortgage servicing rights [Member]
Summary of additional qualitative information
Fair Value Estimate	$ 2,112
Valuation Techniques	Discounted cash flows
Mortgage servicing rights, Unobservable Input, Discount rate	10.70%
Mortgage servicing rights, Unobservable Input, Remaining term	4 years
Management Adjustments on Appraisals for Property Type and Recent Activity [Member] | Foreclosed real estate [Member]
Summary of additional qualitative information
Unobservable Input	Management adjustments for liquidation expenses
Management Adjustments on Appraisals for Property Type and Recent Activity [Member] | Foreclosed real estate [Member] | Maximum [Member]
Summary of additional qualitative information
Mortgage servicing rights, Unobservable Input, Discount rate	10.00%
Management Adjustments on Appraisals for Property Type and Recent Activity [Member] | Foreclosed real estate [Member] | Minimum [Member]
Summary of additional qualitative information
Mortgage servicing rights, Unobservable Input, Discount rate	5.00%
Management Adjustments for Liquidation Expenses [Member] | Impaired loans [Member]
Summary of additional qualitative information
Unobservable Input	Management adjustments for liquidation expenses
Management Adjustments for Liquidation Expenses [Member] | Impaired loans [Member] | Maximum [Member]
Summary of additional qualitative information
Mortgage servicing rights, Unobservable Input, Discount rate	10.00%
Management Adjustments for Liquidation Expenses [Member] | Impaired loans [Member] | Minimum [Member]
Summary of additional qualitative information
Mortgage servicing rights, Unobservable Input, Discount rate	5.00%
Remaining term [Member] | Mortgage servicing rights [Member]
Summary of additional qualitative information
Unobservable Input	Remaining term
Discount rate [Member] | Mortgage servicing rights [Member]
Summary of additional qualitative information
Unobservable Input	Discount rate
Appraisal of collateral [Member] | Management Adjustments on Appraisals for Property Type and Recent Activity [Member] | Impaired loans [Member]
Summary of additional qualitative information
Unobservable Input	Management adjustments on appraisals for property type and recent activity
Appraisal of collateral [Member] | Management Adjustments on Appraisals for Property Type and Recent Activity [Member] | Impaired loans [Member] | Maximum [Member]
Summary of additional qualitative information
Mortgage servicing rights, Unobservable Input, Discount rate	30.00%
Appraisal of collateral [Member] | Management Adjustments on Appraisals for Property Type and Recent Activity [Member] | Impaired loans [Member] | Minimum [Member]
Summary of additional qualitative information
Mortgage servicing rights, Unobservable Input, Discount rate	0.00%
Appraisal of collateral [Member] | Management Adjustments on Appraisals for Property Type and Recent Activity [Member] | Foreclosed real estate [Member]
Summary of additional qualitative information
Unobservable Input	Management adjustments on appraisals for property type and recent activity
Appraisal of collateral [Member] | Management Adjustments on Appraisals for Property Type and Recent Activity [Member] | Foreclosed real estate [Member] | Maximum [Member]
Summary of additional qualitative information
Mortgage servicing rights, Unobservable Input, Discount rate	30.00%
Appraisal of collateral [Member] | Management Adjustments on Appraisals for Property Type and Recent Activity [Member] | Foreclosed real estate [Member] | Minimum [Member]
Summary of additional qualitative information
Mortgage servicing rights, Unobservable Input, Discount rate	0.00%

XML

Fair Value Disclosures (Details) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Level 1 [Member]
Estimated fair value on a recurring basis
Total securities	$ 252
Level 2 [Member]
Estimated fair value on a recurring basis
Total securities	282,826
Level 3 [Member]
Estimated fair value on a recurring basis
Total securities	0
Fair Value, Measurements, Recurring [Member]
Estimated fair value on a recurring basis
Total securities	283,078	310,365
Fair Value, Measurements, Recurring [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	282,757	309,257
Fair Value, Measurements, Recurring [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	321	1,108
Fair Value, Measurements, Recurring [Member] | U.S. Treasury [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	14,983
Fair Value, Measurements, Recurring [Member] | U.S. Government Sponsored Enterprises (GSE) [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	39,992	43,622
Fair Value, Measurements, Recurring [Member] | States and Political Subdivisions [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	40,042	78,051
Fair Value, Measurements, Recurring [Member] | GSE residential mortgage-backed securities [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	187,740	187,584
Fair Value, Measurements, Recurring [Member] | Diversified [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		37
Fair Value, Measurements, Recurring [Member] | Energy [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		141
Fair Value, Measurements, Recurring [Member] | Financial services [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	193	236
Fair Value, Measurements, Recurring [Member] | Other [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	128	323
Fair Value, Measurements, Recurring [Member] | Industrials [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		150
Fair Value, Measurements, Recurring [Member] | Technology [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		221
Fair Value, Measurements, Recurring [Member] | Level 1 [Member]
Estimated fair value on a recurring basis
Total securities	252	1,038
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	252	1,038
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | U.S. Treasury [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	0
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | U.S. Government Sponsored Enterprises (GSE) [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | States and Political Subdivisions [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | GSE residential mortgage-backed securities [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | Diversified [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		37
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | Energy [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		141
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | Financial services [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	124	166
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | Other [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	128	323
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | Industrials [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		150
Fair Value, Measurements, Recurring [Member] | Level 1 [Member] | Technology [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		221
Fair Value, Measurements, Recurring [Member] | Level 2 [Member]
Estimated fair value on a recurring basis
Total securities	282,826	309,327
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	282,757	309,257
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	69	70
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | U.S. Treasury [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	14,983
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | U.S. Government Sponsored Enterprises (GSE) [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	39,992	43,622
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | States and Political Subdivisions [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	40,042	78,051
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | GSE residential mortgage-backed securities [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	187,740	187,584
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | Diversified [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		0
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | Energy [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		0
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | Financial services [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	69	70
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | Other [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | Industrials [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		0
Fair Value, Measurements, Recurring [Member] | Level 2 [Member] | Technology [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | U.S. Treasury [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | U.S. Government Sponsored Enterprises (GSE) [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | States and Political Subdivisions [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | GSE residential mortgage-backed securities [Member] | Debt Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | Diversified [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | Energy [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | Financial services [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | Other [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities	0	0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | Industrials [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		0
Fair Value, Measurements, Recurring [Member] | Level 3 [Member] | Technology [Member] | Equity Securities [Member]
Estimated fair value on a recurring basis
Total securities		$ 0

XML

Loans Receivable and Allowance for Loan Losses (Details 3) (USD $) In Thousands, unless otherwise specified	3 Months Ended		6 Months Ended
	Jun. 30, 2012	Jun. 30, 2011	Jun. 30, 2012	Jun. 30, 2011
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	$ 72,124	$ 31,504	$ 84,667	$ 25,914
Interest Income Recognized	516		848
Commercial real estate [Member] | Owner-occupied [Member]
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	10,336	1,727	10,161	1,380
Interest Income Recognized	4		44
Commercial real estate [Member] | Non-owner occupied [Member]
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	16,911	1,589	18,002	1,747
Interest Income Recognized	293		360
Commercial real estate [Member] | Multi-family [Member]
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	1,175	1,533	1,938	1,052
Interest Income Recognized	0		0
Acquisition and development [Member] | 1-4 family residential construction [Member]
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	1,620	66	1,807	44
Interest Income Recognized	2		2
Acquisition and development [Member] | Commercial and land development [Member]
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	13,358	5,231	15,260	3,487
Interest Income Recognized	116		187
Commercial and industrial [Member]
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	26,742	20,182	35,539	17,027
Interest Income Recognized	72		226
Residential mortgage [Member] | First lien [Member]
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	1,657	466	1,549	467
Interest Income Recognized	27		27
Residential mortgage [Member] | Home equity - term [Member]
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	304	710	398	710
Interest Income Recognized	2		2
Residential mortgage [Member] | Home equity - Lines of credit [Member]
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	19	0	12	0
Interest Income Recognized	0		0
Residential mortgage [Member] | Installment and other loans [Member]
Average recorded investment in impaired loans and related interest income
Average Impaired Balance	2	0	1	0
Interest Income Recognized	$ 0		$ 0

XML

Summary of Significant Accounting Policies (Details) (USD $)	Jun. 30, 2012	Dec. 31, 2011
Summary of Significant Accounting Policies (Textual) [Abstract]
Held to maturity or trading securities	$ 0	$ 0
Debt securities other than temporarily impaired	0	0
Balance of loans serviced for others	309,117,000	299,998,000
Foreclosed real estate totaled	2,337,000	2,165,000
Accumulated other comprehensive income, net of taxes	$ 1,550,000	$ 4,089,000

XML

Fair Value Disclosures (Details Textual) (USD $)	6 Months Ended	12 Months Ended
	Jun. 30, 2012	Dec. 31, 2011
Fair Value Disclosure (Textual) [Abstract]
Fair value liabilities	$ 0	$ 0
Allowance for loan losses	2,075,000	29,788,000
Specific charges to value the real estate owned	449,000	365,000
Lower of cost or fair value reserve	$ 533,000	$ 284,000
Short term borrowing maturity period	90 days

XML

Earnings Per Share (Details) (USD $) In Thousands, except Per Share data, unless otherwise specified	3 Months Ended		6 Months Ended
	Jun. 30, 2012	Jun. 30, 2011	Jun. 30, 2012	Jun. 30, 2011
Earnings per share
Net income (loss)	$ (9,914)	$ (10,623)	$ (18,132)	$ (6,796)
Weighted average shares outstanding	8,065	8,000	8,060	7,994
Impact of common stock equivalents	0	0	0	19
Weighted average shares outstanding (diluted)	8,065	8,000	8,060	8,013
Per share information:
Basic earnings (loss) per share	$ (1.23)	$ (1.33)	$ (2.25)	$ (0.85)
Diluted earnings (loss) per share	$ (1.23)	$ (1.33)	$ (2.25)	$ (0.85)

XML

Loans Receivable and Allowance for Loan Losses (Details 7) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Mar. 31, 2012	Dec. 31, 2011	Jun. 30, 2011	Mar. 31, 2011	Dec. 31, 2010
Summary of allowance for loan loss allocation
Loans, Individually evaluated for impairment	$ 59,059		$ 109,755
Loans, Collectively evaluated for impairment	778,921		855,685
Total Loans	837,980		965,440
Allowance for loan losses, Individually evaluated for impairment	2,075		29,788
Allowance for loan losses, Collectively evaluated for impairment	34,160		13,927
Allowance for loan losses, Total	36,235	28,156	43,715	27,212	18,398	16,020
Commercial Real Estate [Member]
Summary of allowance for loan loss allocation
Loans, Individually evaluated for impairment	23,676		33,457
Loans, Collectively evaluated for impairment	327,330		334,553
Total Loans	351,006		368,010
Allowance for loan losses, Individually evaluated for impairment	346		9,851
Allowance for loan losses, Collectively evaluated for impairment	14,858		4,013
Allowance for loan losses, Total	15,204	10,836	13,864	7,244	4,884	5,324
Acquisition and Development [Member]
Summary of allowance for loan loss allocation
Loans, Individually evaluated for impairment	15,540		21,246
Loans, Collectively evaluated for impairment	38,223		63,416
Total Loans	53,763		84,662
Allowance for loan losses, Individually evaluated for impairment	776		5,295
Allowance for loan losses, Collectively evaluated for impairment	6,027		4,413
Allowance for loan losses, Total	6,803	6,719	9,708	5,026	3,245	1,767
Commercial and Industrial [Member]
Summary of allowance for loan loss allocation
Loans, Individually evaluated for impairment	16,934		53,134
Loans, Collectively evaluated for impairment	194,783		224,766
Total Loans	211,717		277,900
Allowance for loan losses, Individually evaluated for impairment	945		14,591
Allowance for loan losses, Collectively evaluated for impairment	10,389		2,978
Allowance for loan losses, Total	11,334	7,242	17,569	11,132	8,212	6,795
Residential Mortgage [Member]
Summary of allowance for loan loss allocation
Loans, Individually evaluated for impairment	2,906		1,918
Loans, Collectively evaluated for impairment	210,881		220,873
Total Loans	213,787		222,791
Allowance for loan losses, Individually evaluated for impairment	8		51
Allowance for loan losses, Collectively evaluated for impairment	879		882
Allowance for loan losses, Total	887	1,301	933	2,150	1,712	1,863
Unallocated [Member]
Summary of allowance for loan loss allocation
Loans, Individually evaluated for impairment	0		0
Loans, Collectively evaluated for impairment	0		0
Total Loans	0		0
Allowance for loan losses, Individually evaluated for impairment	0		0
Allowance for loan losses, Collectively evaluated for impairment	1,938		1,566
Allowance for loan losses, Total	1,938	2,013	1,566	1,563	252	165
Installment and Other [Member]
Summary of allowance for loan loss allocation
Loans, Individually evaluated for impairment	3		0
Loans, Collectively evaluated for impairment	7,704		12,077
Total Loans	7,707		12,077
Allowance for loan losses, Individually evaluated for impairment	0		0
Allowance for loan losses, Collectively evaluated for impairment	69		75
Allowance for loan losses, Total	$ 69	$ 45	$ 75	$ 97	$ 93	$ 106

XML

Fair Value Disclosures (Details 1) (USD $)	Jun. 30, 2012	Dec. 31, 2011
Summary of assets measured at fair value on a nonrecurring basis
Foreclosed real estate	$ 2,337,000	$ 2,165,000
Level 1 [Member]
Summary of assets measured at fair value on a nonrecurring basis
Mortgage servicing rights	0
Level 2 [Member]
Summary of assets measured at fair value on a nonrecurring basis
Mortgage servicing rights	0
Level 3 [Member]
Summary of assets measured at fair value on a nonrecurring basis
Mortgage servicing rights	2,112,000
Fair Value, Measurements, Nonrecurring [Member]
Summary of assets measured at fair value on a nonrecurring basis
Impaired loans, net	45,983,000	55,726,000
Foreclosed real estate	1,141,000	1,378,000
Mortgage servicing rights	2,112,000	2,253,000
Fair Value, Measurements, Nonrecurring [Member] | Level 1 [Member]
Summary of assets measured at fair value on a nonrecurring basis
Impaired loans, net	0	0
Foreclosed real estate	0	0
Mortgage servicing rights	0	0
Fair Value, Measurements, Nonrecurring [Member] | Level 2 [Member]
Summary of assets measured at fair value on a nonrecurring basis
Impaired loans, net	0	0
Foreclosed real estate	0	0
Mortgage servicing rights	0	0
Fair Value, Measurements, Nonrecurring [Member] | Level 3 [Member]
Summary of assets measured at fair value on a nonrecurring basis
Impaired loans, net	45,983,000	55,726,000
Foreclosed real estate	1,141,000	1,378,000
Mortgage servicing rights	$ 2,112,000	$ 2,253,000

XML

Summary of Significant Accounting Policies

6 Months Ended

Jun. 30, 2012

Summary of Significant Accounting Policies [Abstract]

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations - Orrstown Financial Services, Inc. (the “Company”) is a financial holding company whose primary activity consists of supervising its wholly-owned subsidiary, Orrstown Bank (the “Bank”). The Company operates through its office in Shippensburg, Pennsylvania. Orrstown Bank provides services through its network of offices in Franklin, Cumberland and Perry Counties of Pennsylvania and in Washington County, Maryland. The Bank engages in lending services for commercial loans, residential loans, commercial mortgages and various forms of consumer lending. Deposit services include checking, savings, time and money market deposits. The Bank also provides investment and brokerage services through its Orrstown Financial Advisors division. The Bank has twenty-one branches located in Shippensburg (2), Carlisle (5), Spring Run, Orrstown, Chambersburg (3), Mechanicsburg (2), Camp Hill, Greencastle, Newport (2), Duncannon, and New Bloomfield, Pennsylvania and Hagerstown, Maryland. The Company and its subsidiary are subject to the regulation of certain federal and state agencies and undergo periodic examinations by such regulatory authorities.

Basis of Presentation - The unaudited financial statements of the Company and its subsidiary are presented for the three and six months ended June 30, 2012 and 2011 and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. However, unaudited information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, considered necessary for a fair presentation of the financial position, results of operations and cash flows for the interim period. Information presented at December 31, 2011 is condensed from audited year-end financial statements. For further information, refer to the audited consolidated financial statements and footnotes thereto, included in the Annual Report on Form 10-K for the year ended December 31, 2011.

All significant intercompany transactions and accounts have been eliminated. Operating results for the three and six months ended June 30, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties.

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for losses on loans and foreclosed real estate. Such agencies may require the Company to recognize additions to the allowance based on their judgments concerning information available to them at the time of their examination. Because of these factors, management’s estimate of credit losses inherent in the loan portfolio and the related allowance may change in the near term.

Subsequent Events - GAAP establishes standards for accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. The subsequent events principle sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition in the financial statements, identifies the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and specifies the disclosures that should be made about events or transactions that occur after the balance sheet date. In preparing these financial statements, the Company evaluated the events and transactions that occurred after June 30, 2012, through the date these financial statements were filed with the Securities and Exchange Commission (the “Commission”).

Concentration of Credit Risk - The Company grants agribusiness, commercial, residential and consumer loans to customers in its market area. Although the Company maintains a diversified loan portfolio, a significant portion of its customers’ ability to honor their contracts is dependent upon economic sectors for construction contractors, residential and non-residential building operators, sales finance, sub-dividers and developers. Management evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if collateral is deemed necessary by the Company upon the extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but generally includes real estate and equipment.

The types of securities the Company invests in are included in Note 2, “Securities Available for Sale” and the type of lending the Company engages in are included in Note 3, “Loans Receivable and Allowance for Loan Losses.”

Cash and Cash Equivalents - For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash, balances due from banks and federal funds sold, all of which have original maturities of 90 days or less.

Restricted Investments in Bank Stocks - Restricted investment in bank stocks, which represents required investments in the common stock of correspondent banks, is carried at cost as of June 30, 2012 and December 31, 2011, and consists of common stock of the Federal Reserve Bank of Philadelphia, Atlantic Central Bankers Bank and the Federal Home Loan Bank (“FHLB”) of Pittsburgh stocks.

Management evaluates the restricted investment in bank stocks for impairment in accordance with Accounting Standard Codification (“ASC”) Topic 942, Accounting by Certain Entities (Including Entities with Trade Receivables) That Lend to or Finance the Activities of Others. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the correspondent bank as compared to the capital stock amount for the correspondent bank and the length of time this situation has persisted, (2) commitments by the correspondent bank to make payments required by law or regulation and the level of such payments in relation to the operating performance of the correspondent bank, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the correspondent bank.

Management believes no impairment charge is necessary related to the restricted investment in bank stocks as of June 30, 2012. However, security impairment analysis is completed quarterly and the determination that no impairment had occurred as of June 30, 2012 is no assurance that impairment may not occur in the future.

Interest-Bearing Deposits in Banks - Interest bearing deposits in banks are due on demand or mature within one year and are carried at cost.

Securities - Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. “Trading” securities are recorded at fair value with changes in fair value included in earnings. As of June 30, 2012 and December 31, 2011 the Company had no held to maturity or trading securities. Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

The Company follows the accounting guidance related to recognition and presentation of other-than-temporary impairment (FASB ASC 320-10). This guidance specifies that (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.

The Company had no debt securities it deemed to be other than temporarily impaired at June 30, 2012 and December 31, 2011.

The Company’s securities are exposed to various risks, such as interest rate, market risk, currency and credit risks. Due to the level of risk associated with certain investments and the level of uncertainty related to changes in the value of investments, it is at least reasonably possible that changes in risks in the near term would materially affect investment assets reported in the consolidated financial statements.

For equity securities, when the Company has decided to sell an impaired available-for-sale security and the entity does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed other-than-temporarily impaired in the period in which the decision to sell is made. The Company recognizes an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made.

Loans Held for Sale - Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value (LOCM). Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in non-interest income.

Loans - The Company grants commercial, mortgage, and consumer loans to its customers located principally in south-central Pennsylvania and northern Maryland. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and amortized as a yield adjustment over the respective term of the loan.

For all classes of loans, the accrual of interest income on loans, including impaired loans, ceases when principal or interest is past due 90 days or more or immediately if, in the opinion of management, full collection is unlikely. Interest will continue to accrue on loans past due 90 days or more if the collateral is adequate to cover principal and interest, and the loan is in the process of collection. Interest accrued, but not collected, as of the date of placement on nonaccrual status, is reversed and charged against current interest income, unless fully collateralized. Subsequent payments received are either applied to the outstanding principal balance or recorded as interest income, depending upon management’s assessment of the ultimate collectability of principal. Loans are returned to accrual status, for all loan classes, when all the principal and interest amounts contractually due are brought current, the loan has performed in accordance with the contractual terms of the note for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is reasonably assured. Past due status is based on contractual terms of the loan.

Loans, the terms of which are modified, are classified as troubled debt restructurings if a concession was granted, for legal or economic reasons, related to a debtor’s financial difficulties. Concessions granted under a troubled debt restructuring typically involve a temporary deferral of scheduled loan payments, an extension of a loan’s stated maturity date, temporary reduction in interest rates, or granting of an interest rate below market rates given the risk of the transaction. If a modification occurs while the loan is on accruing status, it will continue to accrue interest under the modified terms. Nonaccrual troubled debt restructurings are restored to accrual status if scheduled principal and interest payments, under the modified terms, are current for six months after modification, and the borrower continues to demonstrate its ability to meet the modified terms. Troubled debt restructurings are evaluated individually for impairment if they have been restructured during the most recent calendar year, or if they are not performing according to their modified terms.

Allowance for Loan Losses - The allowance for loan losses is reestablished as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

Loans Serviced - The Bank administers secondary market mortgage programs available through the FHLB of Pittsburgh and the Federal National Mortgage Association and offers residential mortgage products and services to customers. The Bank originates single-family residential mortgage loans for immediate sale in the secondary market, and retains the servicing of those loans. At June 30, 2012 and December 31, 2011 the balance of loans serviced for others was $309,117,000 and $299,998,000.

Transfers of Financial Assets - Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Foreclosed Real Estate - Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at the lower of carrying value or fair value less estimated costs to sell the underlying collateral. Capitalized costs include accrued interest and any costs that significantly improve the value of the properties. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of its carrying amount or fair value less estimated costs to sell. Foreclosed real estate totaled $2,337,000 and $2,165,000 as of June 30, 2012 and December 31, 2011 and is included in other assets.

Stock Compensation Plans - The Company has stock option plans that cover employees and non-employee directors. Stock compensation accounting guidance (FASB ASC 718, Compensation - Stock Compensation) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost is measured based on the grant date fair value of the stock award, including a Black-Scholes model for stock options. Compensation cost for all stock awards are calculated and recognized over the employees’ service period, generally defined as the vesting period.

Income Taxes - The Company accounts for Income Taxes in accordance with income tax accounting guidance (FASB ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. The Company recognizes interest and penalties, if any, on income taxes as a component of income tax expense.

Treasury Stock - Common stock shares repurchased are recorded as treasury stock at cost.

Earnings Per Share - Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect the additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate solely to outstanding stock options.

Treasury shares are not deemed outstanding for earnings per share calculations.

Comprehensive Income - Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains on securities available for sale, and unrealized losses related to factors other than credit on debt securities and unrealized gains and losses on cash flow hedges.

The component of accumulated other comprehensive income, net of taxes, at June 30, 2012 and December 31, 2011 consisted of unrealized gains on securities available for sale and totaled $1,550,000 and $4,089,000.

Fair Value of Financial Instruments - Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

Segment Reporting - The Company only operates in one significant segment - Community Banking. The Company’s non-banking activities are insignificant to the consolidated financial statements.

Recent Accounting Pronouncements - In April 2011, the FASB issued ASU 2011-2, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. This guidance clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for the purpose of recording an impairment charge and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-2, that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. As allowed by the guidance, the Company adopted the provisions of ASU 2011-2 in the quarter ending June 30, 2011. See further discussion in Note 3 - Loans Receivable and Allowance for Loan Losses.

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. The ASU requires certain disclosures about transfers between Level 1 and Level 2 of the fair value hierarchy, sensitivity of fair value measurements categorized within Level 3 of the fair value hierarchy, and categorization by level of items that are reported at cost but are required to be disclosed at fair value. The disclosures are to be applied prospectively in the first interim and annual periods beginning after December 15, 2011. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which defers certain provisions of ASU 2011-05, Presentation of Comprehensive Income. One of ASU 2011-05’s provisions requires entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented (for both interim and annual financial statements). Accordingly, this requirement is indefinitely deferred by ASU 2011-12 and will be further deliberated by the FASB at a future date. ASUs 2011-05 and 2011-12 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and should be applied retrospectively for all periods presented in the financial statements. The Company adopted the provisions of this guidance which are incorporated in these consolidated financial statements.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The ASU requires new disclosures regarding the nature of an entity’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. The new disclosures are designed to make GAAP financial statements more comparable to those prepared under International Financial Reporting Standards. The new disclosures entail presenting information about both gross and net exposures. The new disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein; retrospective application is required. The Company has not yet completed its evaluation of this ASU; however, since the provisions of ASU 2011-11 are disclosure-related, the Company’s adoption of this ASU is not expected to have an impact to its financial condition or results of operations.

XML

Earnings Per Share (Details Textual) (Stock options [Member])	3 Months Ended		6 Months Ended
	Jun. 30, 2012	Jun. 30, 2011	Jun. 30, 2012	Jun. 30, 2011
Stock options [Member]
Earning Per Share (Textual) [Abstract]
Shares of common stock were not considered in computing diluted earnings per share	314,000	371,000	330,000	289,000

XML

Securities Available for Sale (Details Textual) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2012 Securities	Jun. 30, 2011	Jun. 30, 2012 Securities	Jun. 30, 2011	Dec. 31, 2011 Securities
Securities Available for Sale (Textual) [Abstract]
Number of Securities held	29		29		35
Securities Available for Sale (Additional Textual) [Abstract]
Gross losses on securities available for sale	$ 111,000	$ 31,000	$ 140,000	$ 73,000
Gross gains on the sale of securities	2,706,000	500,000	4,966,000	921,000
Securities with fair value	$ 238,976,000		$ 238,976,000		$ 283,501,000
States and Political Subdivisions [Member]
Securities Available for Sale (Textual) [Abstract]
Number of Securities held	3		3		2
Mortgage-backed securities issued by U.S. Treasuries and Government Sponsored Enterprises (GSE) [Member]
Securities Available for Sale (Textual) [Abstract]
Number of Securities held	4		4		20
Equity Securities [Member]
Securities Available for Sale (Textual) [Abstract]
Number of Securities held	2		2		18

XML

Securities Available for Sale (Details 2) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Schedule of amortized cost and fair values of securities available for sale by contractual maturity
Due in one year or less, amortized cost	$ 4,150
Due after one year through five years, amortized cost	43,122
Due after five years through ten years, amortized cost	22,309
Due after ten years, amortized cost	24,071
GSE residential mortgage-backed securities, amortized cost	186,736
Total debt securities, amortized cost	280,388
Equity securities, amortized cost	305	1,260
Available for sale Securities, Total	280,693	304,073
Due in one year or less, fair value	4,179
Due after one year through five years, fair value	43,222
Due after five years through ten years, fair value	22,728
Due after ten years, fair value	24,888
GSE residential mortgage-backed securities, fair value	187,740
Available-for-sale Securities, Debt Securities, fair value	282,757
Equity securities, fair value	321	1,108
Available for Sale securities, Total	$ 283,078	$ 310,365

XML

Financial Instruments with Off-Balance-Sheet Risk (Details) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Revolving, open ended home equity loans [Member]
Commitments and conditional obligations
Contract or Notional Amount	$ 78,027	$ 80,197
1-4 family residential construction loans [Member]
Commitments and conditional obligations
Contract or Notional Amount	1,586	2,021
Commercial real estate, construction and land development loans [Member]
Commitments and conditional obligations
Contract or Notional Amount	2,931	31,788
Commercial, industrial and other loans [Member]
Commitments and conditional obligations
Contract or Notional Amount	69,106	91,530
Standby letters of credit [Member]
Commitments and conditional obligations
Contract or Notional Amount	$ 17,832	$ 25,751

XML

Loans Receivable and Allowance for Loan Losses (Details) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	$ 837,980	$ 965,440
Commercial real estate [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	351,006	368,010
Commercial real estate [Member] | Owner-occupied [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	170,948	199,646
Commercial real estate [Member] | Non-owner occupied [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	149,819	141,037
Commercial real estate [Member] | Multi-family [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	30,239	27,327
Acquisition and development [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	53,763	84,662
Acquisition and development [Member] | 1-4 family residential construction [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	4,610	7,098
Acquisition and development [Member] | Commercial and land development [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	49,153	77,564
Commercial and industrial [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	211,717	277,900
Residential mortgage [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	213,787	222,791
Residential mortgage [Member] | First lien [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	117,642	104,327
Residential mortgage [Member] | Home equity - term [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	14,826	37,513
Residential mortgage [Member] | Home equity - Lines of credit [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	81,319	80,951
Installment and other loans [Member]
Summary of loan portfolio, excluding residential loans held for sale, broken out by classes
Total Loans	$ 7,707	$ 12,077

XML

Loans Receivable and Allowance for Loan Losses (Details 1) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Bank's ratings based on its internal risk rating system
Total Loans	$ 837,980	$ 965,440
Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	651,864	724,163
Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	74,250	83,947
Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	52,807	47,575
Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	55,774	100,028
Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	3,285	9,727
Commercial real estate [Member]
Bank's ratings based on its internal risk rating system
Total Loans	351,006	368,010
Acquisition and development [Member]
Bank's ratings based on its internal risk rating system
Total Loans	53,763	84,662
Commercial and industrial [Member]
Bank's ratings based on its internal risk rating system
Total Loans	211,717	277,900
Commercial and industrial [Member] | Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	158,368	190,675
Commercial and industrial [Member] | Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	27,874	19,859
Commercial and industrial [Member] | Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	8,541	14,232
Commercial and industrial [Member] | Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	15,196	50,047
Commercial and industrial [Member] | Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	1,738	3,087
Residential mortgage [Member]
Bank's ratings based on its internal risk rating system
Total Loans	213,787	222,791
Installment and other loans [Member]
Bank's ratings based on its internal risk rating system
Total Loans	7,707	12,077
Installment and other loans [Member] | Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	7,656	12,075
Installment and other loans [Member] | Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	42	0
Installment and other loans [Member] | Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	6	2
Installment and other loans [Member] | Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	3	0
Installment and other loans [Member] | Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	0	0
Owner-occupied [Member] | Commercial real estate [Member]
Bank's ratings based on its internal risk rating system
Total Loans	170,948	199,646
Owner-occupied [Member] | Commercial real estate [Member] | Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	138,056	161,695
Owner-occupied [Member] | Commercial real estate [Member] | Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	14,141	19,820
Owner-occupied [Member] | Commercial real estate [Member] | Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	10,727	8,321
Owner-occupied [Member] | Commercial real estate [Member] | Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	7,834	8,828
Owner-occupied [Member] | Commercial real estate [Member] | Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	190	982
Non-owner occupied [Member] | Commercial real estate [Member]
Bank's ratings based on its internal risk rating system
Total Loans	149,819	141,037
Non-owner occupied [Member] | Commercial real estate [Member] | Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	107,427	93,379
Non-owner occupied [Member] | Commercial real estate [Member] | Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	11,596	19,689
Non-owner occupied [Member] | Commercial real estate [Member] | Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	15,330	7,785
Non-owner occupied [Member] | Commercial real estate [Member] | Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	15,466	16,661
Non-owner occupied [Member] | Commercial real estate [Member] | Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	0	3,523
Multi-family [Member] | Commercial real estate [Member]
Bank's ratings based on its internal risk rating system
Total Loans	30,239	27,327
Multi-family [Member] | Commercial real estate [Member] | Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	18,014	14,896
Multi-family [Member] | Commercial real estate [Member] | Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	7,812	7,581
Multi-family [Member] | Commercial real estate [Member] | Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	4,227	1,387
Multi-family [Member] | Commercial real estate [Member] | Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	186	1,328
Multi-family [Member] | Commercial real estate [Member] | Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	0	2,135
1-4 family residential construction [Member] | Acquisition and development [Member]
Bank's ratings based on its internal risk rating system
Total Loans	4,610	7,098
1-4 family residential construction [Member] | Acquisition and development [Member] | Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	1,647	3,361
1-4 family residential construction [Member] | Acquisition and development [Member] | Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	436	724
1-4 family residential construction [Member] | Acquisition and development [Member] | Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	533	831
1-4 family residential construction [Member] | Acquisition and development [Member] | Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	1,269	2,182
1-4 family residential construction [Member] | Acquisition and development [Member] | Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	725	0
Commercial and land development [Member] | Acquisition and development [Member]
Bank's ratings based on its internal risk rating system
Total Loans	49,153	77,564
Commercial and land development [Member] | Acquisition and development [Member] | Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	16,304	28,513
Commercial and land development [Member] | Acquisition and development [Member] | Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	9,482	16,274
Commercial and land development [Member] | Acquisition and development [Member] | Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	9,821	13,713
Commercial and land development [Member] | Acquisition and development [Member] | Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	12,914	19,064
Commercial and land development [Member] | Acquisition and development [Member] | Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	632	0
First lien [Member] | Residential mortgage [Member]
Bank's ratings based on its internal risk rating system
Total Loans	117,642	104,327
First lien [Member] | Residential mortgage [Member] | Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	111,245	102,398
First lien [Member] | Residential mortgage [Member] | Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	1,783	0
First lien [Member] | Residential mortgage [Member] | Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	1,787	596
First lien [Member] | Residential mortgage [Member] | Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	2,827	1,333
First lien [Member] | Residential mortgage [Member] | Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	0	0
Home equity - term [Member] | Residential mortgage [Member]
Bank's ratings based on its internal risk rating system
Total Loans	14,826	37,513
Home equity - term [Member] | Residential mortgage [Member] | Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	14,568	36,290
Home equity - term [Member] | Residential mortgage [Member] | Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	50	0
Home equity - term [Member] | Residential mortgage [Member] | Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	166	638
Home equity - term [Member] | Residential mortgage [Member] | Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	42	585
Home equity - term [Member] | Residential mortgage [Member] | Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	0	0
Home equity - Lines of credit [Member] | Residential mortgage [Member]
Bank's ratings based on its internal risk rating system
Total Loans	81,319	80,951
Home equity - Lines of credit [Member] | Residential mortgage [Member] | Pass [Member]
Bank's ratings based on its internal risk rating system
Total Loans	78,579	80,881
Home equity - Lines of credit [Member] | Residential mortgage [Member] | Special Mention [Member]
Bank's ratings based on its internal risk rating system
Total Loans	1,034	0
Home equity - Lines of credit [Member] | Residential mortgage [Member] | Non-Impaired Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	1,669	70
Home equity - Lines of credit [Member] | Residential mortgage [Member] | Impaired - Substandard [Member]
Bank's ratings based on its internal risk rating system
Total Loans	37	0
Home equity - Lines of credit [Member] | Residential mortgage [Member] | Doubtful [Member]
Bank's ratings based on its internal risk rating system
Total Loans	$ 0	$ 0

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Consolidated Statements of Cash Flows (USD $) In Thousands, unless otherwise specified	6 Months Ended
	Jun. 30, 2012	Jun. 30, 2011
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$ (18,132)	$ (6,796)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Amortization of premiums on securities available for sale	3,505	2,787
Depreciation and amortization	1,294	1,391
Provision for loan losses	42,200	24,425
Net change in loans held for sale	(2,272)	(2,252)
Net (gain) loss on disposal of other real estate owned	79	(30)
Write-down of other real estate owned	343	181
Deferred income taxes	(2,538)	(3,791)
Investment securities gains	(4,826)	(848)
Gain on sale of rate swap	0	(118)
Earnings on cash surrender value of life insurance	(432)	(521)
Decrease in accrued interest receivable	955	30
Increase (decrease) in accrued interest payable	(425)	26
Other, net	(9,644)	(1,307)
Net cash provided by operating activities	10,107	13,177
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in interest bearing deposits with banks and short term investments	(19,686)	(2,660)
Sales of available for sale securities	93,846	36,679
Maturities, repayments and calls of available for sale securities	38,444	29,359
Purchases of available for sale securities	(107,587)	(52,539)
Net proceeds (purchases) of restricted investments in bank stocks	263	(533)
Net (increase) decrease in loans	75,617	(48,546)
Investment in limited partnerships	0	(55)
Purchases of bank premises and equipment	(781)	(600)
Proceeds from disposal of other real estate owned	1,536	388
Proceeds from sale of rate swap	0	118
Purchases of bank owned life insurance	0	(500)
Net cash provided (used) by investing activities	81,642	(38,889)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits	(72,518)	71,819
Net increase (decrease) in short term purchased funds	(7,520)	(24,972)
Payments on long-term debt	(15,656)	(20,425)
Dividends paid	0	(3,677)
Proceeds from issuance of common stock	103	474
Purchase of treasury stock	0	(54)
Net proceeds from issuance of treasury stock	0	47
Net cash provided (used) by financing activities	(95,591)	23,212
Net decrease in cash and cash equivalents	(3,832)	(2,500)
Cash and cash equivalents at beginning of period	19,630	19,200
Cash and cash equivalents at end of period	15,798	16,700
Cash paid during the period for:
Interest	4,755	5,638
Income taxes	1,267	3,591
Supplemental schedule of noncash investing activities:
Other real estate acquired in settlement of loans	$ 2,130	$ 556

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Loans Receivable and Allowance for Loan Losses (Details 2) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	$ 4,914	$ 85,514
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	4,914	96,822
Impaired Loans with a Specific Allowance, Related Allowance	2,075	29,788
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	54,145	24,241
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	100,753	26,426
Commercial real estate [Member] | Owner-occupied [Member]
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	0	5,016
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	0	5,200
Impaired Loans with a Specific Allowance, Related Allowance	0	1,762
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	8,024	4,794
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	11,162	4,838
Commercial real estate [Member] | Non-owner occupied [Member]
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	1,274	16,682
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	1,274	20,472
Impaired Loans with a Specific Allowance, Related Allowance	346	6,876
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	14,192	3,502
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	25,667	4,071
Commercial real estate [Member] | Multi-family [Member]
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	0	3,129
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	0	5,117
Impaired Loans with a Specific Allowance, Related Allowance	0	1,213
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	186	334
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	2,969	334
Acquisition and development [Member] | 1-4 family residential construction [Member]
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	725	2,182
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	725	3,715
Impaired Loans with a Specific Allowance, Related Allowance	413	926
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	1,269	0
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	3,756	0
Acquisition and development [Member] | Commercial and land development [Member]
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	632	10,657
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	632	13,899
Impaired Loans with a Specific Allowance, Related Allowance	363	4,369
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	12,914	8,407
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	28,420	9,712
Commercial and industrial [Member]
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	1,830	46,685
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	1,830	47,256
Impaired Loans with a Specific Allowance, Related Allowance	945	14,591
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	15,104	6,449
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	25,636	6,551
Residential mortgage [Member] | First lien [Member]
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	453	1,122
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	453	1,122
Impaired Loans with a Specific Allowance, Related Allowance	8	9
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	2,374	211
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	2,826	211
Residential mortgage [Member] | Home equity - term [Member]
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	0	41
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	0	41
Impaired Loans with a Specific Allowance, Related Allowance	0	42
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	42	544
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	277	709
Residential mortgage [Member] | Home equity - lines of credit [Member]
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	0
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	0
Impaired Loans with a Specific Allowance, Related Allowance	0
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	37
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	37
Residential mortgage [Member] | Installment and other loans [Member]
Impaired loans by class
Impaired Loans with a Specific Allowance, Recorded Investment (Book Balance)	0
Impaired Loans with a Specific Allowance, Unpaid Principal Balance (Legal Balance)	0
Impaired Loans with a Specific Allowance, Related Allowance	0
Impaired Loans with No Specific Allowance, Recorded Investment (Book Balance)	3
Impaired Loans with No Specific Allowance, Unpaid Principal Balance (Legal Balance)	$ 3

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Derivative Instruments and Hedging Activity (Details Textual) (USD $)	6 Months Ended		3 Months Ended
	Jun. 30, 2012	Jun. 30, 2011	Mar. 31, 2011 Interest rate swap [Member]	Dec. 31, 2011 Interest rate swap [Member]	Dec. 31, 2010 Interest rate swap [Member] Swap
Derivative Instruments and Hedging Activity (Textual) [Abstract]
Number of interest rate swaps held					2
Gain on sale of interest rate swaps	$ 0	$ 118,000	$ 118,000
Interest rate swaps remaining				$ 0

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Consolidated Balance Sheets (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Assets
Cash and due from banks	$ 15,798	$ 19,630
Federal funds sold	0	0
Cash and cash equivalents	15,798	19,630
Interest bearing deposits with banks	109,725	90,039
Restricted investments in bank stock	11,495	11,758
Securities available for sale	283,078	310,365
Loans held for sale	4,825	2,553
Loans	837,980	965,440
Less: Allowance for loan losses	(36,235)	(43,715)
Net Loans	806,570	924,278
Premises and equipment, net	26,983	27,183
Cash surrender value of life insurance	24,579	24,147
Goodwill and intangible assets	936	1,041
Accrued interest receivable	3,593	4,548
Other assets	45,718	31,108
Total assets	1,328,475	1,444,097
Deposits:
Non-interest bearing	118,062	111,930
Interest bearing	1,026,322	1,104,972
Total deposits	1,144,384	1,216,902
Short-term borrowings	27,493	35,013
Long-term debt	38,142	53,798
Accrued interest and other liabilities	10,827	10,187
Total liabilities	1,220,846	1,315,900
Shareholders' Equity
Preferred Stock, $1.25 par value per share; 500,000 shares authorized; no shares issued or outstanding	0	0
Common stock, no par value - $ 0.05205 stated value per share 50,000,000 shares authorized; 8,066,073 and 8,055,787 shares issued; 8,065,261 and 8,054,975 shares outstanding	420	419
Additional paid - in capital	122,616	122,514
Retained earnings (accumulated deficit)	(16,937)	1,195
Accumulated other comprehensive income	1,550	4,089
Treasury stock - common, 812 and 812 shares, at cost	(20)	(20)
Total shareholders' equity	107,629	128,197
Total liabilities and shareholders' equity	$ 1,328,475	$ 1,444,097

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Financial Instruments with off-Balance-Sheet Risk (Details Textual) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2012	Jun. 30, 2011	Jun. 30, 2012	Jun. 30, 2011	Dec. 31, 2011
Financial Instruments with Off-Balance-Sheet Risk (Textual) [Abstract]
Reserve for off-balance sheet credit exposures	$ 851,000		$ 851,000		$ 782,000
Charged to other noninterest expense	(34,000)	250,000	69,000	250,000
Sum total of loans sold under the MPF Program			132,735,000
Limited recourse debt	$ 8,420,000		$ 8,420,000

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Consolidated Statements of Changes in Shareholders' Equity (USD $) In Thousands, unless otherwise specified	Total	Common Stock	Additional Paid-In Capital	Retained Earnings (Accumulated Deficit)	Accumulated Other Comprehensive Income (Loss)	Treasury Stock
Beginning Balance at Dec. 31, 2010	$ 160,484	$ 416	$ 121,508	$ 38,680	$ (88)	$ (32)
Net income (loss)	(6,796)	0	0	(6,796)	0	0
Total other comprehensive income (loss), net of taxes	2,963	0	0	0	2,963	0
Cash dividends ($0.46 per share)	(3,677)	0	0	(3,677)	0	0
Stock-based compensation plans:
Issuance of stock	474	1	473	0	0	0
Purchase of treasury stock (2,232)	(54)	0	0	0	0	(54)
Issuance of treasury stock (2,719 shares)	47	0	(19)	0	0	66
Ending Balance at Jun. 30, 2011	153,441	417	121,962	28,207	2,875	(20)
Beginning Balance at Dec. 31, 2011	128,197	419	122,514	1,195	4,089	(20)
Net income (loss)	(18,132)	0	0	(18,132)	0	0
Total other comprehensive income (loss), net of taxes	(2,539)	0	0	0	(2,539)	0
Stock-based compensation plans:
Issuance of stock	69	1	68	0	0	0
Purchase of treasury stock (2,232)	0
Compensation expense	23	0	23	0	0	0
Issuance of stock under dividend reinvestment plan (1,407 shares)	11	0	11	0	0	0
Ending Balance at Jun. 30, 2012	$ 107,629	$ 420	$ 122,616	$ (16,937)	$ 1,550	$ (20)

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Loans Receivable and Allowance for Loan Losses (Details 5) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	$ 773,569	$ 875,020
30-59 Days Past Due	3,762	6,150
60-89 Days Past Due	2,457	573
90+ (still accruing) Days Past Due	1,275	0
Total Past Due	7,494	6,723
Non-Accrual	56,917	83,697
Total Loans	837,980	965,440
Commercial real estate [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Total Loans	351,006	368,010
Acquisition and development [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Total Loans	53,763	84,662
Commercial and industrial [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	193,329	246,696
30-59 Days Past Due	206	1,341
60-89 Days Past Due	602	15
90+ (still accruing) Days Past Due	255	0
Total Past Due	1,063	1,356
Non-Accrual	17,325	29,848
Total Loans	211,717	277,900
Residential mortgage [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Total Loans	213,787	222,791
Installment and other loans [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	7,633	11,932
30-59 Days Past Due	46	141
60-89 Days Past Due	15	2
90+ (still accruing) Days Past Due	0	0
Total Past Due	61	143
Non-Accrual	13	2
Total Loans	7,707	12,077
Owner-occupied [Member] | Commercial real estate [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	161,362	188,679
30-59 Days Past Due	434	2,135
60-89 Days Past Due	782	0
90+ (still accruing) Days Past Due	346	0
Total Past Due	1,562	2,135
Non-Accrual	8,024	8,832
Total Loans	170,948	199,646
Non-owner occupied [Member] | Commercial real estate [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	136,239	122,816
30-59 Days Past Due	122	75
60-89 Days Past Due	0	0
90+ (still accruing) Days Past Due	0	0
Total Past Due	122	75
Non-Accrual	13,458	18,146
Total Loans	149,819	141,037
Multi-family [Member] | Commercial real estate [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	29,188	23,864
30-59 Days Past Due	198	0
60-89 Days Past Due	400	0
90+ (still accruing) Days Past Due	267	0
Total Past Due	865	0
Non-Accrual	186	3,463
Total Loans	30,239	27,327
1-4 family residential construction [Member] | Acquisition and development [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	2,808	4,916
30-59 Days Past Due	391	0
60-89 Days Past Due	0	0
90+ (still accruing) Days Past Due	142	0
Total Past Due	533	0
Non-Accrual	1,269	2,182
Total Loans	4,610	7,098
Commercial and land development [Member] | Acquisition and development [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	34,699	59,121
30-59 Days Past Due	721	440
60-89 Days Past Due	27	0
90+ (still accruing) Days Past Due	159	0
Total Past Due	907	440
Non-Accrual	13,547	18,003
Total Loans	49,153	77,564
First lien [Member] | Residential mortgage [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	112,460	100,215
30-59 Days Past Due	1,443	1,637
60-89 Days Past Due	604	547
90+ (still accruing) Days Past Due	106	0
Total Past Due	2,153	2,184
Non-Accrual	3,029	1,928
Total Loans	117,642	104,327
Home equity - term [Member] | Residential mortgage [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	14,688	35,998
30-59 Days Past Due	72	283
60-89 Days Past Due	0	9
90+ (still accruing) Days Past Due	0	0
Total Past Due	72	292
Non-Accrual	66	1,223
Total Loans	14,826	37,513
Home equity - Lines of credit [Member] | Residential mortgage [Member]
Loan portfolio summarized by aging categories of performing loans and nonaccrual loans
Current	81,163	80,783
30-59 Days Past Due	129	98
60-89 Days Past Due	27	0
90+ (still accruing) Days Past Due	0	0
Total Past Due	156	98
Non-Accrual	0	70
Total Loans	$ 81,319	$ 80,951

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Earnings Per Share (Tables)

6 Months Ended

Jun. 30, 2012

Earnings Per Share [Abstract]

Earnings per share

Earnings per share for the three and six months ended June 30, 2012 and June 30, 2011 were as follows:

(In thousands, except per share data)	Three Months Ended						Six Months Ended
	June 30, 2012			June 30, 2011			June 30, 2012			June 30, 2011
Net income (loss)	$	(9,914	)	$	(10,623	)	$	(18,132	)	$	(6,796	)
Weighted average shares outstanding		8,065			8,000			8,060			7,994
Impact of common stock equivalents		0			0			0			19
Weighted average shares outstanding (diluted)		8,065			8,000			8,060			8,013
Per share information:
Basic earnings (loss) per share	$	(1.23	)	$	(1.33	)	$	(2.25	)	$	(0.85	)
Diluted earnings (loss) per share		(1.23	)		(1.33	)		(2.25	)		(0.85	)

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Loans Receivable and Allowance for Loan Losses (Details 6) (USD $) In Thousands, unless otherwise specified	3 Months Ended		6 Months Ended
	Jun. 30, 2012	Jun. 30, 2011	Jun. 30, 2012	Jun. 30, 2011
Activity in the allowance for loan losses
Balance, beginning of year	$ 28,156	$ 18,398	$ 43,715	$ 16,020
Provision for loan losses	23,000	21,230	42,200	24,425
Charge-offs	(16,695)	(12,432)	(51,978)	(13,256)
Recoveries	1,774	16	2,298	23
Balance, end of Period	36,235	27,212	36,235	27,212
Commercial Real Estate [Member]
Activity in the allowance for loan losses
Balance, beginning of year	10,836	4,884	13,864	5,324
Provision for loan losses	13,000	2,894	21,772	3,165
Charge-offs	(10,039)	(542)	(21,846)	(1,253)
Recoveries	1,407	8	1,414	8
Balance, end of Period	15,204	7,244	15,204	7,244
Acquisition and Development [Member]
Activity in the allowance for loan losses
Balance, beginning of year	6,719	3,245	9,708	1,767
Provision for loan losses	2,549	4,357	6,399	5,835
Charge-offs	(2,665)	(2,576)	(9,977)	(2,576)
Recoveries	200	0	673	0
Balance, end of Period	6,803	5,026	6,803	5,026
Commercial and Industrial [Member]
Activity in the allowance for loan losses
Balance, beginning of year	7,242	8,212	17,569	6,795
Provision for loan losses	7,824	12,138	13,387	13,600
Charge-offs	(3,890)	(9,218)	(19,814)	(9,263)
Recoveries	158	0	192	0
Balance, end of Period	11,334	11,132	11,334	11,132
Residential Mortgage [Member]
Activity in the allowance for loan losses
Balance, beginning of year	1,301	1,712	933	1,863
Provision for loan losses	(377)	517	215	427
Charge-offs	(44)	(79)	(272)	(140)
Recoveries	7	0	11	0
Balance, end of Period	887	2,150	887	2,150
Unallocated [Member]
Activity in the allowance for loan losses
Balance, beginning of year	2,013	252	1,566	165
Provision for loan losses	(75)	1,311	372	1,398
Charge-offs	0	0	0	0
Recoveries	0	0	0	0
Balance, end of Period	1,938	1,563	1,938	1,563
Installment and Other [Member]
Activity in the allowance for loan losses
Balance, beginning of year	45	93	75	106
Provision for loan losses	79	13	55	0
Charge-offs	(57)	(17)	(69)	(24)
Recoveries	2	8	8	15
Balance, end of Period	$ 69	$ 97	$ 69	$ 97

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Fair Value Disclosures (Tables)

6 Months Ended

Jun. 30, 2012

Fair Value Disclosures [Abstract]

Summary of assets measured at fair value on a recurring basis

The Company had no fair value liabilities at June 30, 2012 and December 31, 2011. A summary of assets at June 30, 2012 and December 31, 2011, measured at estimated fair value on a recurring basis was as follows:

(Dollars in Thousands)	Level 1		Level 2		Level 3		Total Fair Value Measurements
June 30, 2012
Securities available for sale:
U.S. Treasury	$	0	$	14,983	$	0	$	14,983
U.S. Government Sponsored Enterprises (GSE)		0		39,992		0		39,992
States and political subdivisions		0		40,042		0		40,042
GSE residential mortgage-backed securities		0		187,740		0		187,740
Total debt securities		0		282,757		0		282,757
Equity securities:
Financial services		124		69		0		193
Other		128		0		0		128
Total equity securities		252		69		0		321
Total securities	$	252	$	282,826	$	0	$	283,078
December 31, 2011
Securities available for sale:
U.S. Government Sponsored Enterprises (GSE)	$	0	$	43,622	$	0	$	43,622
States and political subdivisions		0		78,051		0		78,051
GSE residential mortgage-backed securities		0		187,584		0		187,584
Total debt securities		0		309,257		0		309,257
Equity securities:
Diversified		37		0		0		37
Energy		141		0		0		141
Financial services		166		70		0		236
Industrials		150		0		0		150
Technology		221		0		0		221
Other		323		0		0		323
Total equity securities		1,038		70		0		1,108
Total securities	$	1,038	$	309,327	$	0	$	310,365

Summary of assets measured at fair value on a nonrecurring basis

A summary of assets at June 30, 2012 and December 31, 2011 measured at fair value on a nonrecurring basis is as follows:

(Dollars in Thousands)	Level 1		Level 2		Level 3		Total Fair Value Measurements
June 30, 2012
Impaired loans, net	$	0	$	0	$	45,983	$	45,983
Foreclosed real estate		0		0		1,141		1,141
Mortgage servicing rights		0		0		2,112		2,112
December 31, 2011
Impaired loans, net	$	0	$	0	$	55,726	$	55,726
Foreclosed real estate		0		0		1,378		1,378
Mortgage servicing rights		0		0		2,253		2,253

Summary of additional qualitative information

The following table presents additional qualitative information about assets measured on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:

	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range
June 30, 2012
Impaired loans	$	45,983	Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	0% - 30% discount
				Management adjustments for liquidation expenses	5% - 10% discount
Foreclosed real estate		1,141	Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	0% - 30% discount
				Management adjustments for liquidation expenses	5% - 10% discount
Mortgage servicing rights		2,112	Discounted cash flows	Remaining term Discount rate	4.0 years 10.70%

Financial statements at estimated fair value

The estimated fair values of the Company’s financial statements were as follows at June 30, 2012 and December 31, 2011:

(Dollars in thousands)	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
June 30, 2012:
Financial Assets
Cash and due from banks	$	15,798	$	15,798	$	15,798	$	0	$	0
Interest bearing deposits with banks		109,725		109,725		109,725		0		0
Restricted investments in bank stock		11,495		11,495		0		0		11,495
Securities available for sale		283,078		283,078		252		282,826		0
Loans held for sale		4,825		4,825		0		4,825		0
Loans, net of allowance for loan losses		801,745		813,627		0		0		813,627
Accrued interest receivable		3,593		3,593		0		1,059		2,534
Mortgage servicing rights		2,112		2,112		0		0		2,112
Financial Liabilities
Deposits		1,144,384		1,148,716		0		1,148,716		0
Short-term borrowings		27,493		27,493		0		27,493		0
Long-term debt		38,142		39,384		0		39,384		0
Accrued interest payable		482		482		0		482		0
Off-balance sheet instruments		0		0		0		0		0
December 31, 2011:
Financial Assets
Cash and due from banks	$	19,630	$	19,630
Interest bearing deposits with banks		90,039		90,039
Restricted investments in bank stock		11,758		11,758
Securities available for sale		310,365		310,365
Loans held for sale		2,553
Loans, net of allowance for loan losses		921,725		925,923
Accrued interest receivable		4,548		4,548
Mortgage servicing rights		2,253		2,253
Financial Liabilities
Deposits	$	1,216,902	$	1,222,058
Short-term borrowings		35,013		35,013
Long-term debt		53,798		54,998
Accrued interest payable		907		907
Off-balance sheet instruments		0		0

XML

Consolidated Statements of Changes in Shareholders' Equity (Parenthetical) (USD $)	6 Months Ended
	Jun. 30, 2012	Jun. 30, 2011
Consolidated Statements of Changes in Shareholders' Equity [Abstract]
Cash dividends per share		$ 0.46
Issuance of stock, shares	8,879	0
Purchase of treasury stock, shares		2,232
Issuance of treasury stock, shares		2,719
Issuance of stock under dividend reinvestment plan, shares	1,407

XML

Consolidated Balance Sheets (Parenthetical) (USD $)	Jun. 30, 2012	Dec. 31, 2011
Consolidated Balance Sheets [Abstract]
Preferred Stock, par value	$ 1.25	$ 1.25
Preferred Stock, shares authorized	500,000	500,000
Preferred Stock, shares issued	0	0
Preferred Stock, shares outstanding	0	0
Common stock, par value	$ 0	$ 0
Common stock, stated value	$ 0.05205	$ 0.05205
Common stock, shares authorized	50,000,000	50,000,000
Common stock, shares issued	8,066,073	8,055,787
Common stock, shares outstanding	8,065,261	8,054,975
Treasury stock - common, shares	812	812

XML

Summary of Significant Accounting Policies (Policies)

6 Months Ended

Jun. 30, 2012

Summary of Significant Accounting Policies [Abstract]

Nature of Operations

Nature of Operations - Orrstown Financial Services, Inc. (the “Company”) is a financial holding company whose primary activity consists of supervising its wholly-owned subsidiary, Orrstown Bank (the “Bank”). The Company operates through its office in Shippensburg, Pennsylvania. Orrstown Bank provides services through its network of offices in Franklin, Cumberland and Perry Counties of Pennsylvania and in Washington County, Maryland. The Bank engages in lending services for commercial loans, residential loans, commercial mortgages and various forms of consumer lending. Deposit services include checking, savings, time and money market deposits. The Bank also provides investment and brokerage services through its Orrstown Financial Advisors division. The Bank has twenty-one branches located in Shippensburg (2), Carlisle (5), Spring Run, Orrstown, Chambersburg (3), Mechanicsburg (2), Camp Hill, Greencastle, Newport (2), Duncannon, and New Bloomfield, Pennsylvania and Hagerstown, Maryland. The Company and its subsidiary are subject to the regulation of certain federal and state agencies and undergo periodic examinations by such regulatory authorities.

Basis of Presentation

Basis of Presentation - The unaudited financial statements of the Company and its subsidiary are presented for the three and six months ended June 30, 2012 and 2011 and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. However, unaudited information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, considered necessary for a fair presentation of the financial position, results of operations and cash flows for the interim period. Information presented at December 31, 2011 is condensed from audited year-end financial statements. For further information, refer to the audited consolidated financial statements and footnotes thereto, included in the Annual Report on Form 10-K for the year ended December 31, 2011.

All significant intercompany transactions and accounts have been eliminated. Operating results for the three and six months ended June 30, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

Use of Estimates

Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties.

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for losses on loans and foreclosed real estate. Such agencies may require the Company to recognize additions to the allowance based on their judgments concerning information available to them at the time of their examination. Because of these factors, management’s estimate of credit losses inherent in the loan portfolio and the related allowance may change in the near term.

Subsequent Events

Subsequent Events - GAAP establishes standards for accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. The subsequent events principle sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition in the financial statements, identifies the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and specifies the disclosures that should be made about events or transactions that occur after the balance sheet date. In preparing these financial statements, the Company evaluated the events and transactions that occurred after June 30, 2012, through the date these financial statements were filed with the Securities and Exchange Commission (the “Commission”).

Concentration of Credit Risk

Concentration of Credit Risk - The Company grants agribusiness, commercial, residential and consumer loans to customers in its market area. Although the Company maintains a diversified loan portfolio, a significant portion of its customers’ ability to honor their contracts is dependent upon economic sectors for construction contractors, residential and non-residential building operators, sales finance, sub-dividers and developers. Management evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if collateral is deemed necessary by the Company upon the extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but generally includes real estate and equipment.

The types of securities the Company invests in are included in Note 2, “Securities Available for Sale” and the type of lending the Company engages in are included in Note 3, “Loans Receivable and Allowance for Loan Losses.”

Cash and Cash Equivalents

Cash and Cash Equivalents - For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash, balances due from banks and federal funds sold, all of which have original maturities of 90 days or less.

Restricted Investments in Bank Stocks

Restricted Investments in Bank Stocks - Restricted investment in bank stocks, which represents required investments in the common stock of correspondent banks, is carried at cost as of June 30, 2012 and December 31, 2011, and consists of common stock of the Federal Reserve Bank of Philadelphia, Atlantic Central Bankers Bank and the Federal Home Loan Bank (“FHLB”) of Pittsburgh stocks.

Management evaluates the restricted investment in bank stocks for impairment in accordance with Accounting Standard Codification (“ASC”) Topic 942, Accounting by Certain Entities (Including Entities with Trade Receivables) That Lend to or Finance the Activities of Others. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the correspondent bank as compared to the capital stock amount for the correspondent bank and the length of time this situation has persisted, (2) commitments by the correspondent bank to make payments required by law or regulation and the level of such payments in relation to the operating performance of the correspondent bank, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the correspondent bank.

Management believes no impairment charge is necessary related to the restricted investment in bank stocks as of June 30, 2012. However, security impairment analysis is completed quarterly and the determination that no impairment had occurred as of June 30, 2012 is no assurance that impairment may not occur in the future.

Interest-Bearing Deposits in Banks

Interest-Bearing Deposits in Banks - Interest bearing deposits in banks are due on demand or mature within one year and are carried at cost.

Securities

Securities - Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. “Trading” securities are recorded at fair value with changes in fair value included in earnings. As of June 30, 2012 and December 31, 2011 the Company had no held to maturity or trading securities. Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

The Company follows the accounting guidance related to recognition and presentation of other-than-temporary impairment (FASB ASC 320-10). This guidance specifies that (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.

The Company had no debt securities it deemed to be other than temporarily impaired at June 30, 2012 and December 31, 2011.

The Company’s securities are exposed to various risks, such as interest rate, market risk, currency and credit risks. Due to the level of risk associated with certain investments and the level of uncertainty related to changes in the value of investments, it is at least reasonably possible that changes in risks in the near term would materially affect investment assets reported in the consolidated financial statements.

For equity securities, when the Company has decided to sell an impaired available-for-sale security and the entity does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed other-than-temporarily impaired in the period in which the decision to sell is made. The Company recognizes an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made.

Loans Held for Sale

Loans Held for Sale - Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value (LOCM). Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in non-interest income.

Loans

Loans - The Company grants commercial, mortgage, and consumer loans to its customers located principally in south-central Pennsylvania and northern Maryland. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and amortized as a yield adjustment over the respective term of the loan.

For all classes of loans, the accrual of interest income on loans, including impaired loans, ceases when principal or interest is past due 90 days or more or immediately if, in the opinion of management, full collection is unlikely. Interest will continue to accrue on loans past due 90 days or more if the collateral is adequate to cover principal and interest, and the loan is in the process of collection. Interest accrued, but not collected, as of the date of placement on nonaccrual status, is reversed and charged against current interest income, unless fully collateralized. Subsequent payments received are either applied to the outstanding principal balance or recorded as interest income, depending upon management’s assessment of the ultimate collectability of principal. Loans are returned to accrual status, for all loan classes, when all the principal and interest amounts contractually due are brought current, the loan has performed in accordance with the contractual terms of the note for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is reasonably assured. Past due status is based on contractual terms of the loan.

Loans, the terms of which are modified, are classified as troubled debt restructurings if a concession was granted, for legal or economic reasons, related to a debtor’s financial difficulties. Concessions granted under a troubled debt restructuring typically involve a temporary deferral of scheduled loan payments, an extension of a loan’s stated maturity date, temporary reduction in interest rates, or granting of an interest rate below market rates given the risk of the transaction. If a modification occurs while the loan is on accruing status, it will continue to accrue interest under the modified terms. Nonaccrual troubled debt restructurings are restored to accrual status if scheduled principal and interest payments, under the modified terms, are current for six months after modification, and the borrower continues to demonstrate its ability to meet the modified terms. Troubled debt restructurings are evaluated individually for impairment if they have been restructured during the most recent calendar year, or if they are not performing according to their modified terms.

Allowance for Loan Losses

Allowance for Loan Losses - The allowance for loan losses is reestablished as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

Loans Serviced

Loans Serviced - The Bank administers secondary market mortgage programs available through the FHLB of Pittsburgh and the Federal National Mortgage Association and offers residential mortgage products and services to customers. The Bank originates single-family residential mortgage loans for immediate sale in the secondary market, and retains the servicing of those loans. At June 30, 2012 and December 31, 2011 the balance of loans serviced for others was $309,117,000 and $299,998,000.

Transfers of Financial Assets

Transfers of Financial Assets - Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Foreclosed Real Estate

Foreclosed Real Estate - Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at the lower of carrying value or fair value less estimated costs to sell the underlying collateral. Capitalized costs include accrued interest and any costs that significantly improve the value of the properties. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of its carrying amount or fair value less estimated costs to sell. Foreclosed real estate totaled $2,337,000 and $2,165,000 as of June 30, 2012 and December 31, 2011 and is included in other assets.

Stock Compensation Plans

Stock Compensation Plans - The Company has stock option plans that cover employees and non-employee directors. Stock compensation accounting guidance (FASB ASC 718, Compensation - Stock Compensation) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost is measured based on the grant date fair value of the stock award, including a Black-Scholes model for stock options. Compensation cost for all stock awards are calculated and recognized over the employees’ service period, generally defined as the vesting period.

Income Taxes

Income Taxes - The Company accounts for Income Taxes in accordance with income tax accounting guidance (FASB ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. The Company recognizes interest and penalties, if any, on income taxes as a component of income tax expense.

Treasury Stock

Treasury Stock - Common stock shares repurchased are recorded as treasury stock at cost.

Earnings Per Share

Earnings Per Share - Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect the additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate solely to outstanding stock options.

Treasury shares are not deemed outstanding for earnings per share calculations.

Comprehensive Income

Comprehensive Income - Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains on securities available for sale, and unrealized losses related to factors other than credit on debt securities and unrealized gains and losses on cash flow hedges.

The component of accumulated other comprehensive income, net of taxes, at June 30, 2012 and December 31, 2011 consisted of unrealized gains on securities available for sale and totaled $1,550,000 and $4,089,000.

Fair Value of Financial Instruments

Fair Value of Financial Instruments - Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

Segment Reporting

Segment Reporting - The Company only operates in one significant segment - Community Banking. The Company’s non-banking activities are insignificant to the consolidated financial statements.

Recent Accounting Pronouncements

Recent Accounting Pronouncements - In April 2011, the FASB issued ASU 2011-2, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. This guidance clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for the purpose of recording an impairment charge and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-2, that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. As allowed by the guidance, the Company adopted the provisions of ASU 2011-2 in the quarter ending June 30, 2011. See further discussion in Note 3 - Loans Receivable and Allowance for Loan Losses.

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. The ASU requires certain disclosures about transfers between Level 1 and Level 2 of the fair value hierarchy, sensitivity of fair value measurements categorized within Level 3 of the fair value hierarchy, and categorization by level of items that are reported at cost but are required to be disclosed at fair value. The disclosures are to be applied prospectively in the first interim and annual periods beginning after December 15, 2011. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which defers certain provisions of ASU 2011-05, Presentation of Comprehensive Income. One of ASU 2011-05’s provisions requires entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented (for both interim and annual financial statements). Accordingly, this requirement is indefinitely deferred by ASU 2011-12 and will be further deliberated by the FASB at a future date. ASUs 2011-05 and 2011-12 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and should be applied retrospectively for all periods presented in the financial statements. The Company adopted the provisions of this guidance which are incorporated in these consolidated financial statements.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The ASU requires new disclosures regarding the nature of an entity’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. The new disclosures are designed to make GAAP financial statements more comparable to those prepared under International Financial Reporting Standards. The new disclosures entail presenting information about both gross and net exposures. The new disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein; retrospective application is required. The Company has not yet completed its evaluation of this ASU; however, since the provisions of ASU 2011-11 are disclosure-related, the Company’s adoption of this ASU is not expected to have an impact to its financial condition or results of operations.

XML

Document and Entity Information	6 Months Ended
	Jun. 30, 2012	Aug. 01, 2012
Document and Entity Information [Abstract]
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Jun. 30, 2012
Document Fiscal Year Focus	2012
Document Fiscal Period Focus	Q2
Entity Registrant Name	ORRSTOWN FINANCIAL SERVICES INC
Entity Central Index Key	0000826154
Current Fiscal Year End Date	--12-31
Entity Filer Category	Accelerated Filer
Entity Common Stock, Shares Outstanding		8,065,261

XML

Securities Available for Sale (Tables)

6 Months Ended

Jun. 30, 2012

Securities Available for Sale [Abstract]

Gross unrealized losses and fair value of the Company's available for sale securities

At June 30, 2012 and December 31, 2011, the investment securities portfolio was comprised exclusively of securities classified as “available for sale”, resulting in investment securities being carried at fair value. The amortized cost and fair values of investment securities available for sale at June 30, 2012 and December 31, 2011 were:

(Dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
June 30, 2012
U.S. Treasury	$	14,994	$	0	$	11	$	14,983
U.S. Government Sponsored Enterprises (GSE)		39,855		171		34		39,992
States and political subdivisions		38,803		1,254		15		40,042
GSE residential mortgage-backed securities		186,736		1,211		207		187,740
Total debt securities		280,388		2,636		267		282,757
Equity securities		305		27		11		321
Totals	$	280,693	$	2,663	$	278	$	283,078

(Dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
December 31, 2011
U.S. Government Sponsored Enterprises (GSE)	$	41,563	$	2,081	$	22	$	43,622
States and political subdivisions		75,232		2,852		33		78,051
GSE residential mortgage-backed securities		186,018		1,783		217		187,584
Total debt securities		302,813		6,716		272		309,257
Equity securities		1,260		41		193		1,108
Totals	$	304,073	$	6,757	$	465	$	310,365

The following table shows gross unrealized losses and fair value of the Company’s available for sale securities that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2012 and December 31, 2011:

	Less Than 12 Months				12 Months or More				Total
(Dollars in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
June 30, 2012
U.S. Treasury	$	14,983	$	11	$	0	$	0	$	14,983	$	11
U.S. Government Sponsored Enterprises (GSE)		16,682		34		0		0		16,682		34
States and political subdivisions		2,063		15		0		0		2,063		15
GSE residential mortgage-backed securities		46,095		169		4,134		38		50,229		207
Total debt securities		79,823		229		4,134		38		83,957		267
Equity securities		0		0		68		11		68		11
Total temporarily impaired securities	$	79,823	$	229	$	4,202	$	49	$	84,025	$	278
December 31, 2011
U.S. Government Sponsored Enterprises (GSE)	$	8,685	$	22	$	0	$	0	$	8,685	$	22
States and political subdivisions		0		0		1,467		33		1,467		33
GSE residential mortgage-backed securities		45,019		217		0		0		45,019		217
Total debt securities		53,704		239		1,467		33		55,171		272
Equity securities		751		193		0		0		751		193
Total temporarily impaired securities	$	54,455	$	432	$	1,467	$	33	$	55,922	$	465

Schedule of amortized cost and fair values of securities available for sale by contractual maturity

The amortized cost and fair values of securities available for sale at June 30, 2012 by contractual maturity are shown below. Contractual maturities will differ from expected maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale
(Dollars in thousands)	Amortized Cost		Fair Value
Due in one year or less	$	4,150	$	4,179
Due after one year through five years		43,122		43,222
Due after five years through ten years		22,309		22,728
Due after ten years		24,071		24,888
GSE residential mortgage-backed securities		186,736		187,740
Total debt securities		280,388		282,757
Equity securities		305		321
	$	280,693	$	283,078

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Consolidated Statements of Operations (USD $) In Thousands, except Per Share data, unless otherwise specified	3 Months Ended		6 Months Ended
	Jun. 30, 2012	Jun. 30, 2011	Jun. 30, 2012	Jun. 30, 2011
Interest and dividend income
Interest and fees on loans	$ 10,044	$ 12,383	$ 21,150	$ 24,818
Interest and dividends on investment securities
Taxable	1,029	2,364	2,337	4,459
Tax-exempt	474	769	1,088	1,540
Short-term investments	82	21	143	45
Total interest and dividend income	11,629	15,537	24,718	30,862
Interest expense
Interest on deposits	1,862	2,359	3,840	4,884
Interest on short-term borrowings	41	95	93	218
Interest on long-term debt	180	273	397	562
Total interest expense	2,083	2,727	4,330	5,664
Net interest income	9,546	12,810	20,388	25,198
Provision for loan losses	23,000	21,230	42,200	24,425
Net interest income after provision for loan losses	(13,454)	(8,420)	(21,812)	773
Noninterest income
Service charges on deposit accounts	1,543	1,645	3,062	3,130
Other service charges, commissions and fees	284	327	598	697
Trust department income	1,116	1,034	2,252	2,046
Brokerage income	421	484	784	888
Mortgage banking activities	727	636	1,212	1,332
Earnings on life insurance	250	250	498	580
Merchant processing revenue	0	285	0	540
Other income (loss)	91	79	(14)	224
Investment securities gains	2,595	469	4,826	848
Total noninterest income	7,027	5,209	13,218	10,285
Noninterest expense
Salaries and employee benefits	4,977	4,176	9,634	9,008
Occupancy expense	513	477	1,027	1,039
Furniture and equipment	727	692	1,405	1,373
Data processing	134	349	263	661
Telephone	182	165	342	341
Advertising and bank promotions	308	296	681	554
FDIC Insurance	710	762	1,231	1,312
Professional services	751	546	1,552	868
Taxes other than income	230	205	464	410
Collection expense	579	177	1,297	331
OREO expense	100	40	476	78
Intangible asset amortization	52	53	105	105
Other operating expenses	1,470	1,784	3,139	3,081
Total noninterest expenses	10,733	9,722	21,616	19,161
Income (loss) before income tax (benefit)	(17,160)	(12,933)	(30,210)	(8,103)
Income tax expense (benefit)	(7,246)	(2,310)	(12,078)	(1,307)
Net income (loss)	$ (9,914)	$ (10,623)	$ (18,132)	$ (6,796)
Per share information:
Basic earnings (loss) per share	$ (1.23)	$ (1.33)	$ (2.25)	$ (0.85)
Diluted earnings (loss) per share	$ (1.23)	$ (1.33)	$ (2.25)	$ (0.85)
Dividends per share	$ 0.00	$ 0.23	$ 0.00	$ 0.46

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Derivative Instruments and Hedging Activity

6 Months Ended

Jun. 30, 2012

Derivative Instruments and Hedging Activity [Abstract]

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY

NOTE 4. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY

As of December 31, 2010, the Company had two interest rate swap agreements related to fixed rate loans. The Company used these interest rate swaps to reduce interest rate risks and to manage interest income. By entering into these agreements, the Company converted floating rate assets into fixed rate assets. These interest rate swap agreements were considered cash flow hedge derivative instruments that qualified for hedge accounting. A portion of the amount was included in other comprehensive income and was reclassified from other comprehensive income to the appropriate income statement line item as net settlements occurred.

During the three months ended March 31, 2011, the Company sold one of its interest rate swaps and recognized an $118,000 gain on the sale, which was included as ineffective, once it no longer qualified as a hedge. The second interest rate swap was sold in the third quarter of 2011 and as of December 31, 2011, there were no interest rate swaps remaining.

A roll forward of the unrealized gains (losses) on the derivatives, and the effects on the Company’s income statement for the three and six months ended June 30, 2011 was as follows:

(Dollars in thousands)	Three Months Ended June 30, 2011			Six Months Ended June  30, 2011
Unrealized gains on derivatives in cash flow from hedging relationship, beginning of period	$	530		$	918
Amount of gain recognized in other comprehensive income on derivative for effective portion of cash flow hedge		252			130
Amount of gain reclassified from accumulated other comprehensive income into interest income		(100	)		(235	)
Amount of gain recognized as noninterest income for the ineffective portion of the cash flow hedge		(11	)		(142	)
Unrealized gains on derivatives in cash flow from hedging relationship, end of period	$	671		$	671

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Loans Receivable and Allowance for Loan Losses

6 Months Ended

Jun. 30, 2012

Loans Receivable and Allowance for Loan Losses [Abstract]

LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

NOTE 3. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The Company’s loan portfolio is broken down into segments to an appropriate level of disaggregation to allow management to monitor the performance by the borrower and to monitor the yield on the portfolio. Management has incorporated the provisions of ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Loan Losses, resulting in a refinement in its portfolio segregation. Consistent with the standard, the segments were further broken down into classes, to allow for differing risk characteristics within a segment.

The risks associated with lending activities differ among the various loan classes, and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans, and general economic conditions. All of these factors may adversely impact the borrower’s ability to repay its loans, and impact the associated collateral.

The Company has various types of commercial real estate loans which have differing levels of credit risk associated with them. Owner-occupied commercial real estate loans are generally dependent upon the successful operation of the borrower’s business, with the cash flows generated from the business being the primary source of repayment of the loan. If the business suffers a downturn in sales or profitability, the borrower’s ability to repay the loan could be in jeopardy.

Non-owner occupied and multi-family commercial real estate loans present a different credit risk to the Company than owner-occupied commercial real estate, as the repayment of the loan is dependent upon the borrower’s ability to generate a sufficient level of occupancy to produce rental income that exceeds debt service requirements and operating expenses. Lower occupancy or lease rates may result in a reduction in cash flows, which hinder the ability of the borrower to meet debt service requirements, and may result in lower collateral values. The Company generally recognizes greater risk is inherent in these credit relationships as compared to owner-occupied loans mentioned above in its loan pricing.

Acquisition and development loans consist of 1-4 family residential construction and commercial and land development loans. The risk of loss on these loans is largely dependent on the Company’s ability to assess the property’s value at the completion of the project, which should exceed the property’s construction costs. During the construction phase, a number of factors could potentially negatively impact the collateral value, including cost overruns, delays in completing the project, competition, and real estate market conditions which may change based on the supply of similar properties in the area. In the event the collateral value at the completion of the project is not sufficient to cover the outstanding loan balance, the Company must rely upon other repayment sources, including the guarantors of the project or other collateral securing the loan.

Commercial and industrial loans include advances to local and regional businesses for general commercial purposes and include permanent and short-term working capital, machinery and equipment financing, and may be either in the form of lines of credit or term loans. Although commercial and industrial loans may be unsecured to our highest rated borrowers, the majority of these loans are secured by the borrower’s accounts receivable, inventory and machinery and equipment. In a majority of these loans, the collateral also includes the business real estate or the business owner’s personal real estate or assets. Commercial and industrial loans present credit exposure to the Company as they are more susceptible to risk of loss during a downturn in the economy, as borrowers may have greater difficulty in meeting their debt service requirements and the value of the collateral may decline. The Company attempts to mitigate this risk through its underwriting standards, including evaluating the credit worthiness of the borrower and to the extent available, credit ratings on the business. Additionally, monitoring of the loans through annual renewals and meetings with the borrowers are common. However, these procedures cannot eliminate the risk of loss associated with commercial and industrial lending.

The Company originates loans to its retail customers, including fixed-rate and adjustable rate first lien mortgage loans with the underlying 1-4 family owner-occupied residential property securing the credit. The Company’s risk exposure is minimized in these types of loans through the evaluation of the credit worthiness of the borrower, including credit scores and debt-to-income ratios, and underwriting standards which limit the loan-to-value ratio to generally no more than 80% upon loan origination, unless the borrower obtains private mortgage insurance.

Home equity loans, including term loans and lines of credit, present a slightly higher risk to the Company than 1-4 family first liens, as these loans can be first or second liens on 1-4 family owner-occupied residential property, but can have loan-to-value ratios of no greater than 90% of the value of the real estate taken as collateral. The credit worthiness of the borrower is considered including credit scores and debt-to-income ratios, which generally cannot exceed 38%.

Installment and other loans’ credit risk are mitigated through the Company’s underwriting standards, including the evaluation of the credit worthiness of the borrower, including credit scores and debt-to-income ratios, and if secured, the collateral value of the assets. As these loans can be unsecured or secured by assets the value of which may depreciate quickly or may fluctuate, they present a greater risk to the Company than 1-4 family residential loans.

The loan portfolio, excluding residential loans held for sale, broken out by classes, as of June 30, 2012 and December 31, 2011 was as follows:

(Dollars in thousands)	June 30, 2012		December 31, 2011
Commercial real estate:
Owner-occupied	$	170,948	$	199,646
Non-owner occupied		149,819		141,037
Multi-family		30,239		27,327
Acquisition and development:
1-4 family residential construction		4,610		7,098
Commercial and land development		49,153		77,564
Commercial and industrial		211,717		277,900
Residential mortgage:
First lien		117,642		104,327
Home equity - term		14,826		37,513
Home equity - Lines of credit		81,319		80,951
Installment and other loans		7,707		12,077
	$	837,980	$	965,440

In order to monitor ongoing risk associated with its loan portfolio and specific credits within the segments, management uses an eight point internal grading system. The first four rating categories, representing the lowest risk to the Bank, are combined and given a “Pass” rating. The “Special Mention” category includes loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Bank’s position at some future date. These assets pose elevated risk, but their weakness does not yet justify a more severe, or criticized rating. Management generally follows regulatory definitions in assigning criticized ratings to loans, including substandard, doubtful or loss. “Substandard” loans are classified as they have a well-defined weakness, or weaknesses that jeopardize liquidation of the debt. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. “Substandard” loans include loans that management has determined not to be impaired, as well as loans considered to be impaired. A “doubtful” loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset; its classification of loss is deferred. “Loss” assets are considered uncollectible, as the underlying borrowers are often in bankruptcy, have suspended debt repayments, or ceased business operations. Once a loan is classified as “Loss”, there is little prospect of collecting the loan’s principal or interest and it is generally written off.

The Bank has a loan review policy and program which is designed to reduce and control risk in the lending function. The Credit Administration Committee, comprised of members of the Board, is charged with the overall credit quality and risk exposure of the Company’s loan portfolio. This includes the monitoring of the lending activities of all Bank personnel with respect to underwriting and processing new loans and the timely follow-up and corrective action for loans showing signs of deterioration in quality. The loan review program provides the Bank with an internal (through an outsourced third party beginning in 2011), independent review of the Bank’s loan portfolio on an ongoing basis. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as extended delinquencies, bankruptcy, repossession or death of the borrower occurs, which heightens awareness as to a possible credit event.

Loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of $1,000,000. Loan review documentation is submitted to the Credit Administration Committee quarterly with a formal review and rating as presented by independent loan review personnel. In addition, all relationships greater than $250,000 rated Substandard, Doubtful or Loss are reviewed by the Credit Administration Committee on a quarterly basis, with reaffirmation of the rating as recommended by the Bank’s Problem Loan Committee or independent loan review personnel. In addition to the policy and procedure guidelines noted above, the Company expanded its review coverage during the last three quarters of 2011 in light of softness in overall economic conditions and deterioration of underlying collateral securing lending relationships. As a result, all commercial real estate, construction and development loans, and commercial loans in excess of $500,000, representing over 75% coverage of these portfolios, have been reviewed. The Company will continue with this expanded review throughout 2012.

The following summarizes the Bank’s ratings based on its internal risk rating system as of June 30, 2012 and December 31, 2011:

(Dollars in thousands)	Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		Total
June 30, 2012:
Commercial real estate:
Owner-occupied	$	138,056	$	14,141	$	10,727	$	7,834	$	190	$	170,948
Non-owner occupied		107,427		11,596		15,330		15,466		0		149,819
Multi-family		18,014		7,812		4,227		186		0		30,239
Acquisition and development:
1-4 family residential construction		1,647		436		533		1,269		725		4,610
Commercial and land development		16,304		9,482		9,821		12,914		632		49,153
Commercial and industrial		158,368		27,874		8,541		15,196		1,738		211,717
Residential mortgage:
First lien		111,245		1,783		1,787		2,827		0		117,642
Home equity - term		14,568		50		166		42		0		14,826
Home equity - Lines of credit		78,579		1,034		1,669		37		0		81,319
Installment and other loans		7,656		42		6		3		0		7,707
	$	651,864	$	74,250	$	52,807	$	55,774	$	3,285	$	837,980
December 31, 2011:
Commercial real estate:
Owner-occupied	$	161,695	$	19,820	$	8,321	$	8,828	$	982	$	199,646
Non-owner occupied		93,379		19,689		7,785		16,661		3,523		141,037
Multi-family		14,896		7,581		1,387		1,328		2,135		27,327
Acquisition and development:
1-4 family residential construction		3,361		724		831		2,182		0		7,098
Commercial and land development		28,513		16,274		13,713		19,064		0		77,564
Commercial and industrial		190,675		19,859		14,232		50,047		3,087		277,900
Residential mortgage:
First lien		102,398		0		596		1,333		0		104,327
Home equity - term		36,290		0		638		585		0		37,513
Home equity - Lines of credit		80,881		0		70		0		0		80,951
Installment and other loans		12,075		0		2		0		0		12,077
	$	724,163	$	83,947	$	47,575	$	100,028	$	9,727	$	965,440

Classified loans may also be evaluated for impairment. For commercial real estate, acquisition and development and commercial and industrial loans, a loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Generally, loans that are more than 90 days past due are deemed impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed, to determine if the loan should be placed in nonaccrual status. Nonaccrual loans in the commercial and commercial real estate portfolios are, by definition, deemed to be impaired. Impairment is measured on a loan-by-loan basis for commercial, construction and restructured loans by either the present value of the expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For loans that are deemed to be impaired for extended periods of time, periodic updates on fair values are obtained, which may include updated appraisals. The updated fair values will be incorporated into the impairment analysis as of the next reporting period. In the event an updated appraisal that requires a higher impairment reserve is received after a reporting period, but prior to the issuance of the financial statements, an evaluation is made as to the significance of the difference and whether the amounts need to be reflected in the financial statements not yet issued.

Loan charge-offs, which may include partial charge-offs, are taken on an impaired loan that is collateral dependent if the loan’s carrying balance exceeds its collateral’s appraised value; the loan has been identified as uncollectible; and it is deemed to be a confirmed loss. Typically, impaired loans with a charge-off or partial charge-off will continue to be considered impaired, unless the note is split into two, and management expects the performing note to continue to perform and is adequately secured. The second, or non-performing note, would be charged-off. As of the periods presented, the Company has no loans to borrowers that resulted from splitting impaired loans into multiple notes. Generally, an impaired loan with a partial charge-off will continue to have an impairment reserve on it after the partial charge-off, if factors warrant.

As of June 30, 2012 and December 31, 2011, nearly all of the Company’s impaired loans’ extent of impairment was measured based on the estimated fair value of the collateral securing the credit, except for certain troubled debt restructurings not in nonaccrual status. By definition, troubled debt restructurings are considered impaired. For real estate loans, collateral generally consists of commercial real estate, but in the case of commercial and industrial loans, it would also consist of accounts receivable, inventory, equipment or other business assets. Commercial and industrial loans may also have real estate collateral.

At the time a real estate-secured loan is deemed impaired, management determines whether an updated certified appraisal of the real estate is necessary to assist in determining the extent of an impairment reserve, if any. The decision for requiring an updated appraisal takes into consideration the age of the most recent appraisal, the loan-to-value ratio based on the original certified appraisal, the Company’s recent experience and knowledge of market conditions, recent list prices or broker opinions, the condition of the property, and environmental factors. If market conditions have changed significantly from the date of the most recent appraisal, an updated appraisal will be obtained. As of October 1, 2011, the Company amended its policy, which now requires annual updated appraisals for criticized loans in excess of $250,000. In many cases the “as is value” provided in the appraisal is used as the fair value of the collateral in determining impairment, unless circumstances, such as subsequent improvements, approvals, or other circumstances dictate that another value provided by the appraiser is more appropriate.

Generally impaired loans secured by real estate were measured at fair value using certified real estate appraisals that had been completed within the last year. Appraised values are further discounted for estimated costs to sell the property and other selling considerations to arrive at the property’s fair value. In those situations in which it is determined an updated appraisal is not required for loans individually evaluated for impairment, fair values are based on one or a combination of the following approaches. In those situations in which a combination of approaches is considered, the one that carries the most consideration will be the one management believes is warranted. The approaches are as follows:

• Original appraisal - if the original appraisal provides a strong loan-to-value (generally 70% or lower) and, after consideration of market conditions and knowledge of the property and area, it is determined by the Credit Administration staff that there has not been a significant deterioration in the collateral value, the original certified appraised value may be used. Discounts as deemed appropriate for selling costs are factored into the appraised value in arriving at fair value.

• Discounted cash flows - In limited cases, discounted cash flows may be used on projects in which the collateral is liquidated to reduce the borrowings outstanding, and is also used to validate collateral values derived from other approaches.

Collateral on certain impaired loans is not limited to real estate, and consists of accounts receivable, inventory, equipment or other business assets. Estimated fair values are determined based on borrowers’ financial statements, inventory ledgers, accounts receivable agings or appraisals from individuals with knowledge in the business. Stated balances are generally discounted for the age of the financial information or the quality of the assets. In determining fair value, liquidation discounts are applied to this collateral based on existing loan evaluation policies.

The Company distinguishes Substandard loans on both an impaired and non-impaired basis, as it places less emphasis on a loan’s classification, and increased reliance on whether the loan was performing in accordance with the contractual terms. “Substandard” classification does not automatically meet the definition of “impaired”. A Substandard credit is one that is inadequately protected by current sound worth or paying capacity of the obligor or the collateral pledged, if any. Extensions of credit so classified have well-defined weaknesses which may jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of Substandard credits, does not have to exist in individual extensions of credit classified Substandard. As a result, the Company revised its methodology in its evaluation of certain accruing commercial real estate, acquisition and development and commercial and industrial loans rated “Substandard” to be collectively evaluated for impairment as opposed to evaluating these loans individually for impairment. Although we believe these loans have well defined weaknesses and meet the definition of “Substandard”, they are generally performing and management has concluded that it is likely it will be able to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.

Larger groups of smaller balance homogenous loans are collectively evaluated for impairment. Generally, the Bank does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

The following summarizes impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required as of June 30, 2012 and December 31, 2011. In the first quarter of 2012, the Company began to more aggressively charge off specific reserve allocations on impaired loans rather than to carry related allowances. At December 31, 2011, specific reserves related to anticipated closing costs, additional market discounts on appraisal values and specific reserves identified during periods subsequent to the balance sheet. Allowances established at June 30, 2012 generally pertain to those credits in which an updated appraisal is pending, and the partial charge-off will be recorded when received.

	Impaired Loans with a Specific Allowance						Impaired Loans with No Specific Allowance
(Dollars in thousands)	Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)		Related Allowance		Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)
June 30, 2012
Commercial real estate:
Owner-occupied	$	0	$	0	$	0	$	8,024	$	11,162
Non-owner occupied		1,274		1,274		346		14,192		25,667
Multi - family		0		0		0		186		2,969
Acquisition and development:
1-4 family residential construction		725		725		413		1,269		3,756
Commercial and land development		632		632		363		12,914		28,420
Commercial and industrial		1,830		1,830		945		15,104		25,636
Residential mortgage:
First lien		453		453		8		2,374		2,826
Home equity - term		0		0		0		42		277
Home equity - lines of credit		0		0		0		37		37
Installment and other loans		0		0		0		3		3
	$	4,914	$	4,914	$	2,075	$	54,145	$	100,753
December 31, 2011
Commercial real estate:
Owner-occupied	$	5,016	$	5,200	$	1,762	$	4,794	$	4,838
Non-owner occupied		16,682		20,472		6,876		3,502		4,071
Multi - family		3,129		5,117		1,213		334		334
Acquisition and development:
1-4 family residential construction		2,182		3,715		926		0		0
Commercial and land development		10,657		13,899		4,369		8,407		9,712
Commercial and industrial		46,685		47,256		14,591		6,449		6,551
Residential mortgage:
First lien		1,122		1,122		9		211		211
Home equity - term		41		41		42		544		709
	$	85,514	$	96,822	$	29,788	$	24,241	$	26,426

The following summarizes the average recorded investment in impaired loans and related interest income recognized on loans deemed impaired as of June 30:

	Three Months Ended June 30,
	2012				2011
(Dollars in thousands)	Average Impaired Balance		Interest Income Recognized		Average Impaired Balance
Commercial real estate:
Owner-occupied	$	10,336	$	4	$	1,727
Non-owner occupied		16,911		293		1,589
Multi-family		1,175		0		1,533
Acquisition and development:
1-4 family residential construction		1,620		2		66
Commercial and land development		13,358		116		5,231
Commercial and industrial		26,742		72		20,182
Residential mortgage:
First lien		1,657		27		466
Home equity - term		304		2		710
Home equity - lines of credit		19		0		0
Installment and other loans		2		0		0
Total	$	72,124	$	516	$	31,504

	Six Months Ended June 30,
	2012				2011
(Dollars in thousands)	Average Impaired Balance		Interest Income Recognized		Average Impaired Balance
Commercial real estate:
Owner-occupied	$	10,161	$	44	$	1,380
Non-owner occupied		18,002		360		1,747
Multi-family		1,938		0		1,052
Acquisition and development:
1-4 family residential construction		1,807		2		44
Commercial and land development		15,260		187		3,487
Commercial and industrial		35,539		226		17,027
Residential mortgage:
First lien		1,549		27		467
Home equity - term		398		2		710
Home equity - lines of credit		12		0		0
Installment and other loans		1		0		0
Total	$	84,667	$	848	$	25,914

The following presents impaired loans that are troubled debt restructurings, as well as the number of loans modified as of June 30, 2012 and December 31, 2011:

	Troubled Debt Restructurings At Period End				New Troubled Debt Restructurings Six Months Ended June 30,
(Dollars in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
June 30, 2012
Accruing:
Commercial real estate:
Non-owner occupied		2	$	2,008		0	$	0
Commercial and industrial		2		334		0		0
Residential mortgage:
First lien		1		453		0		0
Home equity - lines of credit		1		37		1		37
		6		2,832		1		37
Nonaccruing:
Commercial real estate:
Owner-occupied		2		709		0		0
Non-owner occupied		1		193		0		0
Acquisition and development:
Commercial and land development		4		1,671		0		0
Commercial and industrial		9		3,709		1		203
Residential mortgage:
First lien		1		299		1		299
		17		6,581		2		502
		23	$	9,413		3	$	539

	Troubled Debt Restructurings At Period End				New Troubled Debt Restructurings Year Ending December 31, 2011
(Dollars in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
December 31, 2011
Accruing:
Commercial real estate:
Owner-occupied		1	$	924		1	$	924
Non-owner occupied		2		2,039		2		2,039
Acquisition and development:
1-4 family residential construction		0		0		0		0
Commercial and land development		2		1,061		2		1,061
Commercial and industrial		10		23,434		10		23,434
Residential mortgage:
First lien		1		459		0		0
		16		27,917		15		27,458
Nonaccruing:
Commercial real estate:
Owner-occupied		1		54		1		54
Non-owner occupied		1		221		1		221
Acquisition and development:
Commercial and land development		3		3,179		3		3,179
Commercial and industrial		10		5,648		10		5,648
Residential mortgage:
Home equity - term		1		544		0		0
		16		9,646		15		9,102
		32	$	37,563		30	$	36,560

The loans presented above were considered troubled debt restructurings as the result of the Company agreeing to below market interest rates for the risk of the transaction, allowing the loan to remain on interest only status, or for residential mortgage loans, agreeing to a temporary reduction in interest rates for periods not exceeding 12 months in order to assist the borrowers to improve cash flows during such periods.

Troubled debt restructurings included in nonaccrual status at June 30, 2012 were designated as such either due to the borrower defaulting on the modified terms within the past twelve months, or management’s determination the borrower would not be able to continue to meet debt service requirements for a sustainable period of time or where newly restructured debts had not yet reached a minimum of 6 months of performance according to modifications. As of June 30, 2012, 17 loans totaling $6,581,000 were in default of their restructured terms.

No additional commitments have been made to borrowers whose loans are considered troubled debt restructurings.

Management further monitors the performance and credit quality of the loan portfolio by analyzing the length of time a portfolio is past due, by aggregating loans based on its delinquencies. The following table presents the classes of the loan portfolio summarized by aging categories of performing loans and nonaccrual loans as of June 30, 2012 and December 31, 2011:

			Days Past Due
	Current		30-59		60-89		90+ (still accruing)		Total Past Due		Non- Accrual		Total Loans
June 30, 2012
Commercial real estate:
Owner-occupied	$	161,362	$	434	$	782	$	346	$	1,562	$	8,024	$	170,948
Non-owner-occupied		136,239		122		0		0		122		13,458		149,819
Multi-family		29,188		198		400		267		865		186		30,239
Acquisition and development:
1-4 family residential construction		2,808		391		0		142		533		1,269		4,610
Commercial and land development		34,699		721		27		159		907		13,547		49,153
Commercial and industrial		193,329		206		602		255		1,063		17,325		211,717
Residential mortgage:
First lien		112,460		1,443		604		106		2,153		3,029		117,642
Home equity - term		14,688		72		0		0		72		66		14,826
Home equity - Lines of credit		81,163		129		27		0		156		0		81,319
Installment and other loans		7,633		46		15		0		61		13		7,707
	$	773,569	$	3,762	$	2,457	$	1,275	$	7,494	$	56,917	$	837,980
December 31, 2011
Commercial real estate:
Owner-occupied	$	188,679	$	2,135	$	0	$	0	$	2,135	$	8,832	$	199,646
Non-owner-occupied		122,816		75		0		0		75		18,146		141,037
Multi-family		23,864		0		0		0		0		3,463		27,327
Acquisition and development:
1-4 family residential construction		4,916		0		0		0		0		2,182		7,098
Commercial and land development		59,121		440		0		0		440		18,003		77,564
Commercial and industrial		246,696		1,341		15		0		1,356		29,848		277,900
Residential mortgage:
First lien		100,215		1,637		547		0		2,184		1,928		104,327
Home equity - term		35,998		283		9		0		292		1,223		37,513
Home equity - Lines of credit		80,783		98		0		0		98		70		80,951
Installment and other loans		11,932		141		2		0		143		2		12,077
	$	875,020	$	6,150	$	573	$	0	$	6,723	$	83,697	$	965,440

The Bank maintains the allowance for loan losses at a level believed adequate by management to absorb losses inherent in the portfolio. It is established and maintained through a provision for loan losses charged to earnings. Quarterly, management assesses the adequacy of the allowance for loan losses utilizing a defined methodology, which considers specific credit evaluation of impaired loans as discussed above, past loan loss historical experience, and qualitative factors. Management believes the approach properly addresses the requirements of ASC Section 310-10-35 for loans individually identified as impaired, and ASC Subtopic 450-20 for loans collectively evaluated for impairment, and other bank regulatory guidance.

For each loan class presented above, general allowances are provided for loans that are collectively evaluated for impairment, which is based on quantitative factors, principally historical loss trends for the respective loan class, adjusted for qualitative factors. Effective December 31, 2011, the historical loss factor was based on average charge-offs for the last eight quarters and applied to the entire pool of loans, excluding those loans evaluated for impairment under ASC 310-10-35. In addition, an additional adjustment to the historical loss factors is made to account for delinquency and other potential risk not elsewhere defined within the Allowance for Loan and Lease Loss methodology. The refinement to the methodology was made as management determined that the most recent eight quarters loss history as adjusted based on other portfolio analysis and applied to an entire pool of loans is a better reflection of the losses inherent on non-impaired loans within the portfolio. In making this determination, management considered current economic and real estate conditions, trends in historical charge-off percentages at the Company as well as peers, and feedback from regulators.

In addition to the changes mentioned under ASC 450-20, the Company refined its methodology under ASC 310-10-35 in the manner in which partial charge offs are calculated. Based on management’s assessment and in compliance with regulatory guidance, the Company will generally incur partial charge offs in total by the amount a loan’s carrying value exceeds its fair value, less discount for market conditions and costs to dispose, eliminating the need for specific reserves. This will be accomplished by charging the loan off to a level below the fair market value, or appraisal value, of collateral less costs to sell. This method will result in the loan being carried at the fair market value of collateral, less any discounted determined necessary based on current market conditions, less costs to dispose of the asset. As a result, the Company experienced significantly higher charge-offs than would have been incurred in prior periods. Management estimates that charge-offs for the six months ended June 30, 2012 were increased by $43,000,000 when compared to methods used over prior periods. In direct correlation with this change in methodology, the historical loss rates have been elevated when compared to prior periods which does affect the reserves held under ASC 450-20. Management believes this is a more conservative method for calculating the allowance for loan losses.

In addition to the quantitative analysis, additional reserves are allocated on loans collectively evaluated for impairment based on additional qualitative factors. The qualitative factors used by management to adjust the historical loss percentage to the anticipated loss allocation, which range from 0 – 8 basis points per factor, include:

Nature and Volume of Loans - Loan growth in the current and subsequent quarters based on the Bank’s targeted growth and strategic plan, coupled with the types of loans booked based on risk management and credit culture, and number of exceptions to loan policy; supervisory loan to value exceptions etc.

Concentrations of Credit and Changes within Credit Concentrations - Factors considered including the Bank’s overall portfolio makeup and managements evaluation relating to concentration risk management and the inherent risk associated with the concentrations identified.

Experience, Ability and Depth of Management/Lending staff - Factors considered include the years experience of Senior and Middle Management and the lending and loan review staff and turnover of the staff.

Other External Factors (Economic, Legal, Competition, Regulatory etc.) - Ratios and factors considered include trends in the consumer price index (CPI); unemployment rates; housing price index; housing statistics compared to the prior year; bankruptcy rates; regulatory and legal environment risks and competition.

Activity in the allowance for loan losses for three months ended June 30, 2012 and 2011 is as follows:

(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Installment and Other			Unallocated			Total
June 30, 2012
Balance, beginning of period	$	10,836		$	6,719		$	7,242		$	1,301		$	45		$	2,013		$	28,156
Provision for loan losses		13,000			2,549			7,824			(377	)		79			(75	)		23,000
Charge-offs		(10,039	)		(2,665	)		(3,890	)		(44	)		(57	)		0			(16,695	)
Recoveries		1,407			200			158			7			2			0			1,774
Balance, end of period	$	15,204		$	6,803		$	11,334		$	887		$	69		$	1,938		$	36,235

(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Installment and Other			Unallocated		Total
June 30, 2011
Balance, beginning of period	$	4,884		$	3,245		$	8,212		$	1,712		$	93		$	252	$	18,398
Provision for loan losses		2,894			4,357			12,138			517			13			1,311		21,230
Charge-offs		(542	)		(2,576	)		(9,218	)		(79	)		(17	)		0		(12,432	)
Recoveries		8			0			0			0			8			0		16
Balance, end of period	$	7,244		$	5,026		$	11,132		$	2,150		$	97		$	1,563	$	27,212

Activity in the allowance for loan losses for six months ended June 30, 2012 and 2011 is as follows:

(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Installment and Other			Unallocated		Total
June 30, 2012
Balance, beginning of period	$	13,864		$	9,708		$	17,569		$	933		$	75		$	1,566	$	43,715
Provision for loan losses		21,772			6,399			13,387			215			55			372		42,200
Charge-offs		(21,846	)		(9,977	)		(19,814	)		(272	)		(69	)		0		(51,978	)
Recoveries		1,414			673			192			11			8			0		2,298
Balance, end of period	$	15,204		$	6,803		$	11,334		$	887		$	69		$	1,938	$	36,235
June 30, 2011
Balance, beginning of period	$	5,324		$	1,767		$	6,795		$	1,863		$	106		$	165	$	16,020
Provision for loan losses		3,165			5,835			13,600			427			0			1,398		24,425
Charge-offs		(1,253	)		(2,576	)		(9,263	)		(140	)		(24	)		0		(13,256	)
Recoveries		8			0			0			0			15			0		23
Balance, end of period	$	7,244		$	5,026		$	11,132		$	2,150		$	97		$	1,563	$	27,212

The following summarizes the ending loan balance individually evaluated for impairment based upon loan segment, as well as the related allowance for loan loss allocation for each at June 30, 2012 and December 31, 2011:

(Dollars in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Installment and Other		Unallocated		Total
June 30, 2012
Loans allocated by:
Individually evaluated for impairment	$	23,676	$	15,540	$	16,934	$	2,906	$	3	$	0	$	59,059
Collectively evaluated for impairment		327,330		38,223		194,783		210,881		7,704		0		778,921
	$	351,006	$	53,763	$	211,717	$	213,787	$	7,707	$	0	$	837,980
Allowance for loan losses allocated by:
Individually evaluated for impairment	$	346	$	776	$	945	$	8	$	0	$	0	$	2,075
Collectively evaluated for impairment		14,858		6,027		10,389		879		69		1,938		34,160
	$	15,204	$	6,803	$	11,334	$	887	$	69	$	1,938	$	36,235
December 31, 2011
Loans allocated by:
Individually evaluated for impairment	$	33,457	$	21,246	$	53,134	$	1,918	$	0	$	0	$	109,755
Collectively evaluated for impairment		334,553		63,416		224,766		220,873		12,077		0		855,685
	$	368,010	$	84,662	$	277,900	$	222,791	$	12,077	$	0	$	965,440
Allowance for loan losses allocated by:
Individually evaluated for impairment	$	9,851	$	5,295	$	14,591	$	51	$	0	$	0	$	29,788
Collectively evaluated for impairment		4,013		4,413		2,978		882		75		1,566		13,927
	$	13,864	$	9,708	$	17,569	$	933	$	75	$	1,566	$	43,715

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Financial Instruments with Off-Balance-Sheet Risk (Tables)

6 Months Ended

Jun. 30, 2012

Financial Instruments with Off-Balance-Sheet Risk [Abstract]

Commitments and conditional obligations

	Contract or Notional Amount
(Dollars in thousands)	June 30, 2012		December 31, 2011
Commitments to fund:
Revolving, open ended home equity loans	$	78,027	$	80,197
1-4 family residential construction loans		1,586		2,021
Commercial real estate, construction and land development loans		2,931		31,788
Commercial, industrial and other loans		69,106		91,530
Standby letters of credit		17,832		25,751

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Loans Receivable and Allowance for Loan Losses (Tables)

6 Months Ended

Jun. 30, 2012

Loans Receivable and Allowance for Loan Losses [Abstract]

Summary of loan portfolio, excluding residential loans held for sale, broken out by classes

The loan portfolio, excluding residential loans held for sale, broken out by classes, as of June 30, 2012 and December 31, 2011 was as follows:

(Dollars in thousands)	June 30, 2012		December 31, 2011
Commercial real estate:
Owner-occupied	$	170,948	$	199,646
Non-owner occupied		149,819		141,037
Multi-family		30,239		27,327
Acquisition and development:
1-4 family residential construction		4,610		7,098
Commercial and land development		49,153		77,564
Commercial and industrial		211,717		277,900
Residential mortgage:
First lien		117,642		104,327
Home equity - term		14,826		37,513
Home equity - Lines of credit		81,319		80,951
Installment and other loans		7,707		12,077
	$	837,980	$	965,440

Bank's ratings based on its internal risk rating system

The following summarizes the Bank’s ratings based on its internal risk rating system as of June 30, 2012 and December 31, 2011:

(Dollars in thousands)	Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		Total
June 30, 2012:
Commercial real estate:
Owner-occupied	$	138,056	$	14,141	$	10,727	$	7,834	$	190	$	170,948
Non-owner occupied		107,427		11,596		15,330		15,466		0		149,819
Multi-family		18,014		7,812		4,227		186		0		30,239
Acquisition and development:
1-4 family residential construction		1,647		436		533		1,269		725		4,610
Commercial and land development		16,304		9,482		9,821		12,914		632		49,153
Commercial and industrial		158,368		27,874		8,541		15,196		1,738		211,717
Residential mortgage:
First lien		111,245		1,783		1,787		2,827		0		117,642
Home equity - term		14,568		50		166		42		0		14,826
Home equity - Lines of credit		78,579		1,034		1,669		37		0		81,319
Installment and other loans		7,656		42		6		3		0		7,707
	$	651,864	$	74,250	$	52,807	$	55,774	$	3,285	$	837,980
December 31, 2011:
Commercial real estate:
Owner-occupied	$	161,695	$	19,820	$	8,321	$	8,828	$	982	$	199,646
Non-owner occupied		93,379		19,689		7,785		16,661		3,523		141,037
Multi-family		14,896		7,581		1,387		1,328		2,135		27,327
Acquisition and development:
1-4 family residential construction		3,361		724		831		2,182		0		7,098
Commercial and land development		28,513		16,274		13,713		19,064		0		77,564
Commercial and industrial		190,675		19,859		14,232		50,047		3,087		277,900
Residential mortgage:
First lien		102,398		0		596		1,333		0		104,327
Home equity - term		36,290		0		638		585		0		37,513
Home equity - Lines of credit		80,881		0		70		0		0		80,951
Installment and other loans		12,075		0		2		0		0		12,077
	$	724,163	$	83,947	$	47,575	$	100,028	$	9,727	$	965,440

Impaired loans by class

The following summarizes impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required as of June 30, 2012 and December 31, 2011. In the first quarter of 2012, the Company began to more aggressively charge off specific reserve allocations on impaired loans rather than to carry related allowances. At December 31, 2011, specific reserves related to anticipated closing costs, additional market discounts on appraisal values and specific reserves identified during periods subsequent to the balance sheet. Allowances established at June 30, 2012 generally pertain to those credits in which an updated appraisal is pending, and the partial charge-off will be recorded when received.

	Impaired Loans with a Specific Allowance						Impaired Loans with No Specific Allowance
(Dollars in thousands)	Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)		Related Allowance		Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)
June 30, 2012
Commercial real estate:
Owner-occupied	$	0	$	0	$	0	$	8,024	$	11,162
Non-owner occupied		1,274		1,274		346		14,192		25,667
Multi - family		0		0		0		186		2,969
Acquisition and development:
1-4 family residential construction		725		725		413		1,269		3,756
Commercial and land development		632		632		363		12,914		28,420
Commercial and industrial		1,830		1,830		945		15,104		25,636
Residential mortgage:
First lien		453		453		8		2,374		2,826
Home equity - term		0		0		0		42		277
Home equity - lines of credit		0		0		0		37		37
Installment and other loans		0		0		0		3		3
	$	4,914	$	4,914	$	2,075	$	54,145	$	100,753
December 31, 2011
Commercial real estate:
Owner-occupied	$	5,016	$	5,200	$	1,762	$	4,794	$	4,838
Non-owner occupied		16,682		20,472		6,876		3,502		4,071
Multi - family		3,129		5,117		1,213		334		334
Acquisition and development:
1-4 family residential construction		2,182		3,715		926		0		0
Commercial and land development		10,657		13,899		4,369		8,407		9,712
Commercial and industrial		46,685		47,256		14,591		6,449		6,551
Residential mortgage:
First lien		1,122		1,122		9		211		211
Home equity - term		41		41		42		544		709
	$	85,514	$	96,822	$	29,788	$	24,241	$	26,426

Average recorded investment in impaired loans and related interest income

The following summarizes the average recorded investment in impaired loans and related interest income recognized on loans deemed impaired as of June 30:

	Three Months Ended June 30,
	2012				2011
(Dollars in thousands)	Average Impaired Balance		Interest Income Recognized		Average Impaired Balance
Commercial real estate:
Owner-occupied	$	10,336	$	4	$	1,727
Non-owner occupied		16,911		293		1,589
Multi-family		1,175		0		1,533
Acquisition and development:
1-4 family residential construction		1,620		2		66
Commercial and land development		13,358		116		5,231
Commercial and industrial		26,742		72		20,182
Residential mortgage:
First lien		1,657		27		466
Home equity - term		304		2		710
Home equity - lines of credit		19		0		0
Installment and other loans		2		0		0
Total	$	72,124	$	516	$	31,504

	Six Months Ended June 30,
	2012				2011
(Dollars in thousands)	Average Impaired Balance		Interest Income Recognized		Average Impaired Balance
Commercial real estate:
Owner-occupied	$	10,161	$	44	$	1,380
Non-owner occupied		18,002		360		1,747
Multi-family		1,938		0		1,052
Acquisition and development:
1-4 family residential construction		1,807		2		44
Commercial and land development		15,260		187		3,487
Commercial and industrial		35,539		226		17,027
Residential mortgage:
First lien		1,549		27		467
Home equity - term		398		2		710
Home equity - lines of credit		12		0		0
Installment and other loans		1		0		0
Total	$	84,667	$	848	$	25,914

Troubled debt restructurings

The following presents impaired loans that are troubled debt restructurings, as well as the number of loans modified as of June 30, 2012 and December 31, 2011:

	Troubled Debt Restructurings At Period End				New Troubled Debt Restructurings Six Months Ended June 30,
(Dollars in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
June 30, 2012
Accruing:
Commercial real estate:
Non-owner occupied		2	$	2,008		0	$	0
Commercial and industrial		2		334		0		0
Residential mortgage:
First lien		1		453		0		0
Home equity - lines of credit		1		37		1		37
		6		2,832		1		37
Nonaccruing:
Commercial real estate:
Owner-occupied		2		709		0		0
Non-owner occupied		1		193		0		0
Acquisition and development:
Commercial and land development		4		1,671		0		0
Commercial and industrial		9		3,709		1		203
Residential mortgage:
First lien		1		299		1		299
		17		6,581		2		502
		23	$	9,413		3	$	539

	Troubled Debt Restructurings At Period End				New Troubled Debt Restructurings Year Ending December 31, 2011
(Dollars in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
December 31, 2011
Accruing:
Commercial real estate:
Owner-occupied		1	$	924		1	$	924
Non-owner occupied		2		2,039		2		2,039
Acquisition and development:
1-4 family residential construction		0		0		0		0
Commercial and land development		2		1,061		2		1,061
Commercial and industrial		10		23,434		10		23,434
Residential mortgage:
First lien		1		459		0		0
		16		27,917		15		27,458
Nonaccruing:
Commercial real estate:
Owner-occupied		1		54		1		54
Non-owner occupied		1		221		1		221
Acquisition and development:
Commercial and land development		3		3,179		3		3,179
Commercial and industrial		10		5,648		10		5,648
Residential mortgage:
Home equity - term		1		544		0		0
		16		9,646		15		9,102
		32	$	37,563		30	$	36,560

Loan portfolio summarized by aging categories of performing loans and nonaccrual loans

Management further monitors the performance and credit quality of the loan portfolio by analyzing the length of time a portfolio is past due, by aggregating loans based on its delinquencies. The following table presents the classes of the loan portfolio summarized by aging categories of performing loans and nonaccrual loans as of June 30, 2012 and December 31, 2011:

			Days Past Due
	Current		30-59		60-89		90+ (still accruing)		Total Past Due		Non- Accrual		Total Loans
June 30, 2012
Commercial real estate:
Owner-occupied	$	161,362	$	434	$	782	$	346	$	1,562	$	8,024	$	170,948
Non-owner-occupied		136,239		122		0		0		122		13,458		149,819
Multi-family		29,188		198		400		267		865		186		30,239
Acquisition and development:
1-4 family residential construction		2,808		391		0		142		533		1,269		4,610
Commercial and land development		34,699		721		27		159		907		13,547		49,153
Commercial and industrial		193,329		206		602		255		1,063		17,325		211,717
Residential mortgage:
First lien		112,460		1,443		604		106		2,153		3,029		117,642
Home equity - term		14,688		72		0		0		72		66		14,826
Home equity - Lines of credit		81,163		129		27		0		156		0		81,319
Installment and other loans		7,633		46		15		0		61		13		7,707
	$	773,569	$	3,762	$	2,457	$	1,275	$	7,494	$	56,917	$	837,980
December 31, 2011
Commercial real estate:
Owner-occupied	$	188,679	$	2,135	$	0	$	0	$	2,135	$	8,832	$	199,646
Non-owner-occupied		122,816		75		0		0		75		18,146		141,037
Multi-family		23,864		0		0		0		0		3,463		27,327
Acquisition and development:
1-4 family residential construction		4,916		0		0		0		0		2,182		7,098
Commercial and land development		59,121		440		0		0		440		18,003		77,564
Commercial and industrial		246,696		1,341		15		0		1,356		29,848		277,900
Residential mortgage:
First lien		100,215		1,637		547		0		2,184		1,928		104,327
Home equity - term		35,998		283		9		0		292		1,223		37,513
Home equity - Lines of credit		80,783		98		0		0		98		70		80,951
Installment and other loans		11,932		141		2		0		143		2		12,077
	$	875,020	$	6,150	$	573	$	0	$	6,723	$	83,697	$	965,440

Activity in the allowance for loan losses

Activity in the allowance for loan losses for three months ended June 30, 2012 and 2011 is as follows:

(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Installment and Other			Unallocated			Total
June 30, 2012
Balance, beginning of period	$	10,836		$	6,719		$	7,242		$	1,301		$	45		$	2,013		$	28,156
Provision for loan losses		13,000			2,549			7,824			(377	)		79			(75	)		23,000
Charge-offs		(10,039	)		(2,665	)		(3,890	)		(44	)		(57	)		0			(16,695	)
Recoveries		1,407			200			158			7			2			0			1,774
Balance, end of period	$	15,204		$	6,803		$	11,334		$	887		$	69		$	1,938		$	36,235

(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Installment and Other			Unallocated		Total
June 30, 2011
Balance, beginning of period	$	4,884		$	3,245		$	8,212		$	1,712		$	93		$	252	$	18,398
Provision for loan losses		2,894			4,357			12,138			517			13			1,311		21,230
Charge-offs		(542	)		(2,576	)		(9,218	)		(79	)		(17	)		0		(12,432	)
Recoveries		8			0			0			0			8			0		16
Balance, end of period	$	7,244		$	5,026		$	11,132		$	2,150		$	97		$	1,563	$	27,212

Activity in the allowance for loan losses for six months ended June 30, 2012 and 2011 is as follows:

(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Installment and Other			Unallocated		Total
June 30, 2012
Balance, beginning of period	$	13,864		$	9,708		$	17,569		$	933		$	75		$	1,566	$	43,715
Provision for loan losses		21,772			6,399			13,387			215			55			372		42,200
Charge-offs		(21,846	)		(9,977	)		(19,814	)		(272	)		(69	)		0		(51,978	)
Recoveries		1,414			673			192			11			8			0		2,298
Balance, end of period	$	15,204		$	6,803		$	11,334		$	887		$	69		$	1,938	$	36,235
June 30, 2011
Balance, beginning of period	$	5,324		$	1,767		$	6,795		$	1,863		$	106		$	165	$	16,020
Provision for loan losses		3,165			5,835			13,600			427			0			1,398		24,425
Charge-offs		(1,253	)		(2,576	)		(9,263	)		(140	)		(24	)		0		(13,256	)
Recoveries		8			0			0			0			15			0		23
Balance, end of period	$	7,244		$	5,026		$	11,132		$	2,150		$	97		$	1,563	$	27,212

Summary of allowance for loan loss allocation

The following summarizes the ending loan balance individually evaluated for impairment based upon loan segment, as well as the related allowance for loan loss allocation for each at June 30, 2012 and December 31, 2011:

(Dollars in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Installment and Other		Unallocated		Total
June 30, 2012
Loans allocated by:
Individually evaluated for impairment	$	23,676	$	15,540	$	16,934	$	2,906	$	3	$	0	$	59,059
Collectively evaluated for impairment		327,330		38,223		194,783		210,881		7,704		0		778,921
	$	351,006	$	53,763	$	211,717	$	213,787	$	7,707	$	0	$	837,980
Allowance for loan losses allocated by:
Individually evaluated for impairment	$	346	$	776	$	945	$	8	$	0	$	0	$	2,075
Collectively evaluated for impairment		14,858		6,027		10,389		879		69		1,938		34,160
	$	15,204	$	6,803	$	11,334	$	887	$	69	$	1,938	$	36,235
December 31, 2011
Loans allocated by:
Individually evaluated for impairment	$	33,457	$	21,246	$	53,134	$	1,918	$	0	$	0	$	109,755
Collectively evaluated for impairment		334,553		63,416		224,766		220,873		12,077		0		855,685
	$	368,010	$	84,662	$	277,900	$	222,791	$	12,077	$	0	$	965,440
Allowance for loan losses allocated by:
Individually evaluated for impairment	$	9,851	$	5,295	$	14,591	$	51	$	0	$	0	$	29,788
Collectively evaluated for impairment		4,013		4,413		2,978		882		75		1,566		13,927
	$	13,864	$	9,708	$	17,569	$	933	$	75	$	1,566	$	43,715

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Financial Instruments with Off-Balance-Sheet Risk

6 Months Ended

Jun. 30, 2012

Financial Instruments with Off-Balance-Sheet Risk [Abstract]

FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

NOTE 7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

	Contract or Notional Amount
(Dollars in thousands)	June 30, 2012		December 31, 2011
Commitments to fund:
Revolving, open ended home equity loans	$	78,027	$	80,197
1-4 family residential construction loans		1,586		2,021
Commercial real estate, construction and land development loans		2,931		31,788
Commercial, industrial and other loans		69,106		91,530
Standby letters of credit		17,832		25,751

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, equipment, residential real estate, and income-producing commercial properties.

Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company holds collateral supporting those commitments when deemed necessary by management. The current amount of liability, as of June 30, 2012 and December 31, 2011, for guarantees under standby letters of credit issued was not material.

The Company currently maintains a reserve in other liabilities totaling $851,000 and $782,000 at June 30, 2012 and December 31, 2011 for off-balance sheet credit exposures that currently are not funded, based on historical loss experience of the related loan class. For the three months ended June 30, 2012 and 2011, ($34,000) and $250,000 was charged to other noninterest expense for this exposure, and for the six months ended June 30, 2012 and 2011, the amount expensed was $69,000 and $250,000.

The Company has sold loans to the Federal Home Loan Bank of Chicago as part of its Mortgage Partnership Finance Program (“MPF Program”). Under the terms of the MPF Program, there is limited recourse back to the Company for loans that do not perform in accordance with the terms of the loan agreement. Each loan that is sold under the program is “credit enhanced” such that the individual loan’s rating is raised to “AA,” as determined by the Federal Home Loan Bank of Chicago. The sum of each individual total of loans sold under the MPF Program was $132,735,000, with limited recourse back to the Company on these loans of $8,420,000. Many of the loans sold under the MPF Program have primary mortgage insurance, which reduces the Company’s overall exposure.

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Shareholders' Equity and Regulatory Capital

6 Months Ended

Jun. 30, 2012

Shareholders' Equity and Regulatory Capital [Abstract]

SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL

NOTE 5. SHAREHOLDERS’ EQUITY AND REGULATORY CAPITAL

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to financial holding companies.

Quantitative measures established by regulators to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (as set forth in the following table) of total and Tier 1 capital (as defined in regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes that, as of June 30, 2012 and December 31, 2011 the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of June 30, 2012, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since the notification that management believes have changed the Bank’s category. The Company and the Bank’s actual capital ratios as of June 30, 2012 and December 31, 2011 are also presented in the table.

	Actual					Minimum Capital Requirement					Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
June 30, 2012
Total capital to risk weighted assets
Orrstown Financial Services, Inc.	$	106,227		11.7	%	$	72,732		8.0	%		n/a		n/a
Orrstown Bank		103,515		11.4	%		72,685		8.0	%	$	90,856		10.0	%
Tier 1 capital to risk weighted assets
Orrstown Financial Services, Inc.		94,545		10.4	%		36,366		4.0	%		n/a		n/a
Orrstown Bank		91,840		10.1	%		36,342		4.0	%		54,514		6.0	%
Tier 1 capital to average assets
Orrstown Financial Services, Inc.		94,545		6.7	%		56,323		4.0	%		n/a		n/a
Orrstown Bank		91,840		6.5	%		56,365		4.0	%		70,457		5.0	%
December 31, 2011
Total capital to risk weighted assets
Orrstown Financial Services, Inc.	$	134,621		13.0	%	$	83,090		8.0	%		n/a		n/a
Orrstown Bank		127,529		12.3	%		82,899		8.0	%	$	103,624		10.0	%
Tier 1 capital to risk weighted assets
Orrstown Financial Services, Inc.		121,249		11.7	%		41,545		4.0	%		n/a		n/a
Orrstown Bank		114,187		11.0	%		41,450		4.0	%		62,175		6.0	%
Tier 1 capital to average assets
Orrstown Financial Services, Inc.		121,249		8.2	%		58,851		4.0	%		n/a		n/a
Orrstown Bank		114,187		7.8	%		58,682		4.0	%		73,352		5.0	%

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Earnings Per Share

6 Months Ended

Jun. 30, 2012

Earnings Per Share [Abstract]

EARNINGS PER SHARE

NOTE 6. EARNINGS PER SHARE

Earnings per share for the three and six months ended June 30, 2012 and June 30, 2011 were as follows:

(In thousands, except per share data)	Three Months Ended						Six Months Ended
	June 30, 2012			June 30, 2011			June 30, 2012			June 30, 2011
Net income (loss)	$	(9,914	)	$	(10,623	)	$	(18,132	)	$	(6,796	)
Weighted average shares outstanding		8,065			8,000			8,060			7,994
Impact of common stock equivalents		0			0			0			19
Weighted average shares outstanding (diluted)		8,065			8,000			8,060			8,013
Per share information:
Basic earnings (loss) per share	$	(1.23	)	$	(1.33	)	$	(2.25	)	$	(0.85	)
Diluted earnings (loss) per share		(1.23	)		(1.33	)		(2.25	)		(0.85	)

Stock options for 314,000 and 371,000 shares of common stock were not considered in computing diluted earnings per share for the three months ended June 30, 2012 and 2011, and stock options for 330,000 and 289,000 shares of common stock were not considered for the six months ended June 30, 2012 and 2011 as they were anti-dilutive.

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Fair Value Disclosures

6 Months Ended

Jun. 30, 2012

Fair Value Disclosures [Abstract]

FAIR VALUE DISCLOSURES

NOTE 8. FAIR VALUE DISCLOSURES

Fair value measurements under generally accepted accounting principles defines fair value, describes a framework for measuring fair value and requires disclosures about fair value measurements by establishing a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets in which the assets and liabilities are traded and the reliability and transparency of the assumptions used to determine fair value.

The three levels are defined as follows: Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar instruments in markets that are not active or by model-based techniques in which all significant inputs are observable in the market for the asset or liability, for substantially the full term of the financial instrument. Level 3 – the valuation methodology is derived from model-based techniques in which at least one significant input is unobservable to the fair value measurement and based on the Company’s own assumptions about market participants’ assumptions.

Following is a description of the valuation methodologies used for instruments measured on a recurring basis at estimated fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Securities

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, securities are classified within Level 2 and fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. All of the Company’s securities are classified as available for sale.

The Company had no fair value liabilities at June 30, 2012 and December 31, 2011. A summary of assets at June 30, 2012 and December 31, 2011, measured at estimated fair value on a recurring basis was as follows:

(Dollars in Thousands)	Level 1		Level 2		Level 3		Total Fair Value Measurements
June 30, 2012
Securities available for sale:
U.S. Treasury	$	0	$	14,983	$	0	$	14,983
U.S. Government Sponsored Enterprises (GSE)		0		39,992		0		39,992
States and political subdivisions		0		40,042		0		40,042
GSE residential mortgage-backed securities		0		187,740		0		187,740
Total debt securities		0		282,757		0		282,757
Equity securities:
Financial services		124		69		0		193
Other		128		0		0		128
Total equity securities		252		69		0		321
Total securities	$	252	$	282,826	$	0	$	283,078
December 31, 2011
Securities available for sale:
U.S. Government Sponsored Enterprises (GSE)	$	0	$	43,622	$	0	$	43,622
States and political subdivisions		0		78,051		0		78,051
GSE residential mortgage-backed securities		0		187,584		0		187,584
Total debt securities		0		309,257		0		309,257
Equity securities:
Diversified		37		0		0		37
Energy		141		0		0		141
Financial services		166		70		0		236
Industrials		150		0		0		150
Technology		221		0		0		221
Other		323		0		0		323
Total equity securities		1,038		70		0		1,108
Total securities	$	1,038	$	309,327	$	0	$	310,365

Certain financial 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 financial 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 loan, less estimated costs to sell. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The value of the 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 management adjusts the appraisal value, 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’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans with an allocation to the allowance for loan losses are measured at fair value on a nonrecurring basis; however not all impaired loans have an allocation to the allowance for loan losses. Any fair value adjustments are recorded in the period incurred as a provision for loan losses on the consolidated statement of income. Specific allocations to the allowance for loan losses were $2,075,000 and $29,788,000 at June 30, 2012 and December 31, 2011.

Foreclosed Real Estate

Other real estate property acquired through foreclosure is initially recorded at the fair value of the property at the transfer date less estimated selling cost. Subsequently, other real estate owned is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based upon an independent third-party appraisal of the property or occasionally upon a recent sales offer. Specific charges to value the real estate owned at the lower of cost or fair value on properties held at June 30, 2012 and December 31, 2011 were $449,000 and $365,000.

Mortgage Servicing Rights

The fair value of mortgage servicing rights is estimated to be equal to its carrying value, unless the quarterly valuation model calculates the present value of the estimated net servicing income as less than its carrying value, in which case a lower of cost or fair value charge is taken. As of June 30, 2012 and December 31, 2011, a $533,000 and $284,000 lower of cost or fair value reserve existed on the mortgage servicing rights portfolio.

A summary of assets at June 30, 2012 and December 31, 2011 measured at fair value on a nonrecurring basis is as follows:

(Dollars in Thousands)	Level 1		Level 2		Level 3		Total Fair Value Measurements
June 30, 2012
Impaired loans, net	$	0	$	0	$	45,983	$	45,983
Foreclosed real estate		0		0		1,141		1,141
Mortgage servicing rights		0		0		2,112		2,112
December 31, 2011
Impaired loans, net	$	0	$	0	$	55,726	$	55,726
Foreclosed real estate		0		0		1,378		1,378
Mortgage servicing rights		0		0		2,253		2,253

The following table presents additional qualitative information about assets measured on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:

	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range
June 30, 2012
Impaired loans	$	45,983	Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	0% - 30% discount
				Management adjustments for liquidation expenses	5% - 10% discount
Foreclosed real estate		1,141	Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	0% - 30% discount
				Management adjustments for liquidation expenses	5% - 10% discount
Mortgage servicing rights		2,112	Discounted cash flows	Remaining term Discount rate	4.0 years 10.70%

Fair values of financial instruments

The Company meets the requirements for disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

In addition to those disclosed above, the following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein:

Cash and Due from Banks, Federal Funds Sold, Short-Term Investments and Interest Bearing Deposits with Banks

The carrying amounts of cash and due from banks, short-term investments and interest bearing deposits with banks and federal funds sold approximate their fair value.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value. These loans typically consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale.

Loans Receivable

For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered in the market for loans with similar terms to borrowers of similar credit quality.

Restricted Investment in Bank Stock

These investments are carried at cost. The Company is required to maintain minimum investment balances in these stocks, which are not actively traded and therefore have no readily determinable market value.

Deposit Liabilities

The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposits and IRAs are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market to a schedule of aggregated expected maturities on time deposits.

Short-Term Borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Long-Term Debt

The fair value of the Company’s fixed rate long-term borrowings is estimated using a discounted cash flow analysis based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements. The carrying amounts of variable-rate long-term borrowings approximate their fair values at the reporting date.

Accrued Interest

The carrying amounts of accrued interest approximate their fair values.

Off-Balance-Sheet Instruments

The Company generally does not charge commitment fees. Fees for standby letters of credit and other off-balance-sheet instruments are not significant.

The estimated fair values of the Company’s financial statements were as follows at June 30, 2012 and December 31, 2011:

(Dollars in thousands)	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
June 30, 2012:
Financial Assets
Cash and due from banks	$	15,798	$	15,798	$	15,798	$	0	$	0
Interest bearing deposits with banks		109,725		109,725		109,725		0		0
Restricted investments in bank stock		11,495		11,495		0		0		11,495
Securities available for sale		283,078		283,078		252		282,826		0
Loans held for sale		4,825		4,825		0		4,825		0
Loans, net of allowance for loan losses		801,745		813,627		0		0		813,627
Accrued interest receivable		3,593		3,593		0		1,059		2,534
Mortgage servicing rights		2,112		2,112		0		0		2,112
Financial Liabilities
Deposits		1,144,384		1,148,716		0		1,148,716		0
Short-term borrowings		27,493		27,493		0		27,493		0
Long-term debt		38,142		39,384		0		39,384		0
Accrued interest payable		482		482		0		482		0
Off-balance sheet instruments		0		0		0		0		0
December 31, 2011:
Financial Assets
Cash and due from banks	$	19,630	$	19,630
Interest bearing deposits with banks		90,039		90,039
Restricted investments in bank stock		11,758		11,758
Securities available for sale		310,365		310,365
Loans held for sale		2,553
Loans, net of allowance for loan losses		921,725		925,923
Accrued interest receivable		4,548		4,548
Mortgage servicing rights		2,253		2,253
Financial Liabilities
Deposits	$	1,216,902	$	1,222,058
Short-term borrowings		35,013		35,013
Long-term debt		53,798		54,998
Accrued interest payable		907		907
Off-balance sheet instruments		0		0

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Loans Receivable and Allowance for Loan Losses (Details 4) (USD $) In Thousands, unless otherwise specified	6 Months Ended	12 Months Ended
	Jun. 30, 2012 Contract	Dec. 31, 2011 Contract
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	23	32
Troubled Debt Restructurings, Recorded Investment	$ 9,413	$ 37,563
New Troubled Debt Restructurings, Number of Contracts	3	30
New Troubled Debt Restructurings, Recorded Investment	539	36,560
Accruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	6	16
Troubled Debt Restructurings, Recorded Investment	2,832	27,917
New Troubled Debt Restructurings, Number of Contracts	1	15
New Troubled Debt Restructurings, Recorded Investment	37	27,458
Nonaccruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	17	16
Troubled Debt Restructurings, Recorded Investment	6,581	9,646
New Troubled Debt Restructurings, Number of Contracts	2	15
New Troubled Debt Restructurings, Recorded Investment	502	9,102
Commercial and industrial [Member] | Accruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	2	10
Troubled Debt Restructurings, Recorded Investment	334	23,434
New Troubled Debt Restructurings, Number of Contracts	0	10
New Troubled Debt Restructurings, Recorded Investment	0	23,434
Commercial and industrial [Member] | Nonaccruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	9	10
Troubled Debt Restructurings, Recorded Investment	3,709	5,648
New Troubled Debt Restructurings, Number of Contracts	1	10
New Troubled Debt Restructurings, Recorded Investment	203	5,648
Owner-occupied [Member] | Commercial real estate [Member] | Accruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts		1
Troubled Debt Restructurings, Recorded Investment		924
New Troubled Debt Restructurings, Number of Contracts		1
New Troubled Debt Restructurings, Recorded Investment		924
Owner-occupied [Member] | Commercial real estate [Member] | Nonaccruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	2	1
Troubled Debt Restructurings, Recorded Investment	709	54
New Troubled Debt Restructurings, Number of Contracts	0	1
New Troubled Debt Restructurings, Recorded Investment	0	54
Non-owner occupied [Member] | Commercial real estate [Member] | Accruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	2	2
Troubled Debt Restructurings, Recorded Investment	2,008	2,039
New Troubled Debt Restructurings, Number of Contracts	0	2
New Troubled Debt Restructurings, Recorded Investment	0	2,039
Non-owner occupied [Member] | Commercial real estate [Member] | Nonaccruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	1	1
Troubled Debt Restructurings, Recorded Investment	193	221
New Troubled Debt Restructurings, Number of Contracts	0	1
New Troubled Debt Restructurings, Recorded Investment	0	221
1-4 family residential construction [Member] | Acquisition and development [Member] | Accruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts		0
Troubled Debt Restructurings, Recorded Investment		0
New Troubled Debt Restructurings, Number of Contracts		0
New Troubled Debt Restructurings, Recorded Investment		0
Commercial and land development [Member] | Acquisition and development [Member] | Accruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts		2
Troubled Debt Restructurings, Recorded Investment		1,061
New Troubled Debt Restructurings, Number of Contracts		2
New Troubled Debt Restructurings, Recorded Investment		1,061
Commercial and land development [Member] | Acquisition and development [Member] | Nonaccruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	4	3
Troubled Debt Restructurings, Recorded Investment	1,671	3,179
New Troubled Debt Restructurings, Number of Contracts	0	3
New Troubled Debt Restructurings, Recorded Investment	0	3,179
First lien [Member] | Residential mortgage [Member] | Accruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	1	1
Troubled Debt Restructurings, Recorded Investment	453	459
New Troubled Debt Restructurings, Number of Contracts	0	0
New Troubled Debt Restructurings, Recorded Investment	0	0
First lien [Member] | Residential mortgage [Member] | Nonaccruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	1
Troubled Debt Restructurings, Recorded Investment	299
New Troubled Debt Restructurings, Number of Contracts	1
New Troubled Debt Restructurings, Recorded Investment	299
Home equity - term [Member] | Residential mortgage [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts	1
Troubled Debt Restructurings, Recorded Investment	37
New Troubled Debt Restructurings, Number of Contracts	1
New Troubled Debt Restructurings, Recorded Investment	37
Home equity - term [Member] | Residential mortgage [Member] | Nonaccruing [Member]
Troubled debt restructurings
Troubled Debt Restructurings, Number of Contracts		1
Troubled Debt Restructurings, Recorded Investment		544
New Troubled Debt Restructurings, Number of Contracts		0
New Troubled Debt Restructurings, Recorded Investment		$ 0

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Shareholders' Equity and Regulatory Capital (Tables)

6 Months Ended

Jun. 30, 2012

Shareholders' Equity and Regulatory Capital [Abstract]

Bank's actual capital ratios

As of June 30, 2012, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since the notification that management believes have changed the Bank’s category. The Company and the Bank’s actual capital ratios as of June 30, 2012 and December 31, 2011 are also presented in the table.

	Actual					Minimum Capital Requirement					Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
June 30, 2012
Total capital to risk weighted assets
Orrstown Financial Services, Inc.	$	106,227		11.7	%	$	72,732		8.0	%		n/a		n/a
Orrstown Bank		103,515		11.4	%		72,685		8.0	%	$	90,856		10.0	%
Tier 1 capital to risk weighted assets
Orrstown Financial Services, Inc.		94,545		10.4	%		36,366		4.0	%		n/a		n/a
Orrstown Bank		91,840		10.1	%		36,342		4.0	%		54,514		6.0	%
Tier 1 capital to average assets
Orrstown Financial Services, Inc.		94,545		6.7	%		56,323		4.0	%		n/a		n/a
Orrstown Bank		91,840		6.5	%		56,365		4.0	%		70,457		5.0	%
December 31, 2011
Total capital to risk weighted assets
Orrstown Financial Services, Inc.	$	134,621		13.0	%	$	83,090		8.0	%		n/a		n/a
Orrstown Bank		127,529		12.3	%		82,899		8.0	%	$	103,624		10.0	%
Tier 1 capital to risk weighted assets
Orrstown Financial Services, Inc.		121,249		11.7	%		41,545		4.0	%		n/a		n/a
Orrstown Bank		114,187		11.0	%		41,450		4.0	%		62,175		6.0	%
Tier 1 capital to average assets
Orrstown Financial Services, Inc.		121,249		8.2	%		58,851		4.0	%		n/a		n/a
Orrstown Bank		114,187		7.8	%		58,682		4.0	%		73,352		5.0	%

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Securities Available for Sale (Details) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Amortized cost and fair values of investment securities available for sale
Available for sale equity securities, amortized cost	$ 305	$ 1,260
Available for sale securities, totals	280,693	304,073
Available-for-sale securities, unrealized gains, totals	2,663	6,757
Available for sale securities, unrealized losses, totals	278	465
Available for sale securities, debt securities, fair value	282,757
Available for sale securities, equity securities, fair value	321	1,108
Available for sale equity securities, totals	283,078	310,365
Debt Securities [Member]
Amortized cost and fair values of investment securities available for sale
Available for sale debt securities, amortized cost	280,388	302,813
Available-for-sale securities, unrealized gains, totals	2,636	6,716
Available for sale securities, unrealized losses, totals	267	272
Available for sale securities, debt securities, fair value	282,757	309,257
Equity Securities [Member]
Amortized cost and fair values of investment securities available for sale
Available-for-sale securities, unrealized gains, totals	27	41
Available for sale securities, unrealized losses, totals	11	193
U.S. Treasury [Member]
Amortized cost and fair values of investment securities available for sale
Available for sale debt securities, amortized cost	14,994
Available for sale securities, debt securities, fair value	14,983
U.S. Treasury [Member] | Debt Securities [Member]
Amortized cost and fair values of investment securities available for sale
Available-for-sale securities, unrealized gains, totals	0
Available for sale securities, unrealized losses, totals	11
U.S. Government Sponsored Enterprises (GSE) [Member]
Amortized cost and fair values of investment securities available for sale
Available for sale debt securities, amortized cost	39,855	41,563
Available for sale securities, debt securities, fair value	39,992	43,622
U.S. Government Sponsored Enterprises (GSE) [Member] | Debt Securities [Member]
Amortized cost and fair values of investment securities available for sale
Available-for-sale securities, unrealized gains, totals	171	2,081
Available for sale securities, unrealized losses, totals	34	22
States and Political Subdivisions [Member]
Amortized cost and fair values of investment securities available for sale
Available for sale debt securities, amortized cost	38,803	75,232
Available for sale securities, debt securities, fair value	40,042	78,051
States and Political Subdivisions [Member] | Debt Securities [Member]
Amortized cost and fair values of investment securities available for sale
Available-for-sale securities, unrealized gains, totals	1,254	2,852
Available for sale securities, unrealized losses, totals	15	33
GSE residential mortgage-backed securities [Member]
Amortized cost and fair values of investment securities available for sale
Available for sale debt securities, amortized cost	186,736	186,018
Available for sale securities, debt securities, fair value	187,740	187,584
GSE residential mortgage-backed securities [Member] | Debt Securities [Member]
Amortized cost and fair values of investment securities available for sale
Available-for-sale securities, unrealized gains, totals	1,211	1,783
Available for sale securities, unrealized losses, totals	$ 207	$ 217

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Fair Value Disclosures (Details 3) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Financial Assets
Cash and due from banks	$ 15,798	$ 19,630
Interest bearing deposits with banks	109,725	90,039
Restricted investments in bank stock	11,495	11,758
Securities available for sale	283,078	310,365
Loans held for sale	4,825	2,553
Loans, net of allowance for loan losses	806,570	924,278
Accrued interest receivable	3,593	4,548
Financial Liabilities
Deposits	1,144,384	1,216,902
Short-term borrowings	27,493	35,013
Long-term debt	38,142	53,798
Level 1 [Member]
Financial Assets
Cash and due from banks	15,798
Interest bearing deposits with banks	109,725
Restricted investments in bank stock	0
Securities available for sale	252
Loans held for sale	0
Loans, net of allowance for loan losses	0
Accrued interest receivable	0
Mortgage servicing rights	0
Financial Liabilities
Deposits	0
Short-term borrowings	0
Long-term debt	0
Accrued interest payable	0
Off-balance sheet instruments	0
Level 2 [Member]
Financial Assets
Cash and due from banks	0
Interest bearing deposits with banks	0
Restricted investments in bank stock	0
Securities available for sale	282,826
Loans held for sale	4,825
Loans, net of allowance for loan losses	0
Accrued interest receivable	1,059
Mortgage servicing rights	0
Financial Liabilities
Deposits	1,148,716
Short-term borrowings	27,493
Long-term debt	39,384
Accrued interest payable	482
Off-balance sheet instruments	0
Level 3 [Member]
Financial Assets
Cash and due from banks	0
Interest bearing deposits with banks	0
Restricted investments in bank stock	11,495
Securities available for sale	0
Loans held for sale	0
Loans, net of allowance for loan losses	813,627
Accrued interest receivable	2,534
Mortgage servicing rights	2,112
Financial Liabilities
Deposits	0
Short-term borrowings	0
Long-term debt	0
Accrued interest payable	0
Off-balance sheet instruments	0
Carrying Amount [Member]
Financial Assets
Cash and due from banks	15,798	19,630
Interest bearing deposits with banks	109,725	90,039
Restricted investments in bank stock	11,495	11,758
Securities available for sale	283,078	310,365
Loans held for sale	4,825	2,553
Loans, net of allowance for loan losses	801,745	921,725
Accrued interest receivable	3,593	4,548
Mortgage servicing rights	2,112	2,253
Financial Liabilities
Deposits	1,144,384	1,216,902
Short-term borrowings	27,493	35,013
Long-term debt	38,142	53,798
Accrued interest payable	482	907
Off-balance sheet instruments	0	0
Fair Value [Member]
Financial Assets
Cash and due from banks	15,798	19,630
Interest bearing deposits with banks	109,725	90,039
Restricted investments in bank stock	11,495	11,758
Securities available for sale	283,078	310,365
Loans held for sale	4,825
Loans, net of allowance for loan losses	813,627	925,923
Accrued interest receivable	3,593	4,548
Mortgage servicing rights	2,112	2,253
Financial Liabilities
Deposits	1,148,716	1,222,058
Short-term borrowings	27,493	35,013
Long-term debt	39,384	54,998
Accrued interest payable	482	907
Off-balance sheet instruments	$ 0	$ 0

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Shareholders' Equity and Regulatory Capital (Details) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Orrstown Financial Services, Inc. [Member]
Bank's actual capital ratios
Actual, Amount, Total capital to risk weighted assets	$ 106,227	$ 134,621
Actual, Ratio, Total capital to risk weighted assets	11.70%	13.00%
Minimum Capital Requirement, Amount, Total capital to risk weighted assets	72,732	83,090
Minimum Capital Requirement, Ratio, Total capital to risk weighted assets	8.00%	8.00%
Actual, Amount, Tier 1 capital to risk weighted assets	94,545	121,249
Actual, Ratio, Tier 1 capital to risk weighted assets	10.40%	11.70%
Minimum Capital Requirement, Amount, Tier 1 capital to risk weighted assets	36,366	41,545
Minimum Capital Requirement, Ratio, Tier 1 capital to risk weighted assets	4.00%	4.00%
Actual, Amount, Tier 1 capital to average assets	94,545	121,249
Actual, Ratio, Tier 1 capital to average assets	6.70%	8.20%
Minimum Capital Requirement, Amount, Tier 1 capital to average assets	56,323	58,851
Minimum Capital Requirement, Ratio, Tier 1 capital to average assets	4.00%	4.00%
Orrstown Bank [Member]
Bank's actual capital ratios
Actual, Amount, Total capital to risk weighted assets	103,515	127,529
Actual, Ratio, Total capital to risk weighted assets	11.40%	12.30%
Minimum Capital Requirement, Amount, Total capital to risk weighted assets	72,685	82,899
Minimum Capital Requirement, Ratio, Total capital to risk weighted assets	8.00%	8.00%
Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions, Amount, Total capital to risk weighted assets	90,856	103,624
Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions, Ratio, Total capital to risk weighted assets	10.00%	10.00%
Actual, Amount, Tier 1 capital to risk weighted assets	91,840	114,187
Actual, Ratio, Tier 1 capital to risk weighted assets	10.10%	11.00%
Minimum Capital Requirement, Amount, Tier 1 capital to risk weighted assets	36,342	41,450
Minimum Capital Requirement, Ratio, Tier 1 capital to risk weighted assets	4.00%	4.00%
Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions, Amount, Tier 1 capital to risk weighted assets	54,514	62,175
Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions, Ratio, Tier 1 capital to risk weighted assets	6.00%	6.00%
Actual, Amount, Tier 1 capital to average assets	91,840	114,187
Actual, Ratio, Tier 1 capital to average assets	6.50%	7.80%
Minimum Capital Requirement, Amount, Tier 1 capital to average assets	56,365	58,682
Minimum Capital Requirement, Ratio, Tier 1 capital to average assets	4.00%	4.00%
Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions, Amount, Tier 1 capital to average assets	$ 70,457	$ 73,352
Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions, Ratio, Tier 1 capital to average assets	5.00%	5.00%

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Consolidated Statements of Comprehensive Income (Loss) (Unaudited) (USD $) In Thousands, unless otherwise specified	3 Months Ended		6 Months Ended
	Jun. 30, 2012	Jun. 30, 2011	Jun. 30, 2012	Jun. 30, 2011
Consolidated Statements of Comprehensive Income (Loss) [Abstract]
Net income (loss)	$ (9,914)	$ (10,623)	$ (18,132)	$ (6,796)
Other comprehensive income (loss), net of tax:
Unrealized holding gains (losses) on securities available for sale arising during the period	(118)	4,729	919	5,654
Reclassification adjustment for (gains) realized in net income	(2,595)	(469)	(4,826)	(848)
Net unrealized gains (losses)	(2,713)	4,260	(3,907)	4,806
Tax effect	949	(1,491)	1,368	(1,682)
Net unrealized gains (losses), net of tax, securities	(1,764)	2,769	(2,539)	3,124
Unrealized holding gains (losses) in fair value of derivatives used for cash flow hedges	0	140	0	(129)
Reclassification adjustment for (gains) realized in net income	0	0	0	(118)
Net unrealized gains (losses)	0	140	0	(247)
Tax effect	0	(49)	0	86
Net unrealized gains (losses), net of tax, derivatives	0	91	0	(161)
Total other comprehensive income (loss), net of tax and reclassification adjustments	(1,764)	2,860	(2,539)	2,963
Total comprehensive income (loss)	$ (11,678)	$ (7,763)	$ (20,671)	$ (3,833)

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Securities Available for Sale

6 Months Ended

Jun. 30, 2012

Securities Available for Sale [Abstract]

SECURITIES AVAILABLE FOR SALE

NOTE 2. SECURITIES AVAILABLE FOR SALE

At June 30, 2012 and December 31, 2011, the investment securities portfolio was comprised exclusively of securities classified as “available for sale”, resulting in investment securities being carried at fair value. The amortized cost and fair values of investment securities available for sale at June 30, 2012 and December 31, 2011 were:

(Dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
June 30, 2012
U.S. Treasury	$	14,994	$	0	$	11	$	14,983
U.S. Government Sponsored Enterprises (GSE)		39,855		171		34		39,992
States and political subdivisions		38,803		1,254		15		40,042
GSE residential mortgage-backed securities		186,736		1,211		207		187,740
Total debt securities		280,388		2,636		267		282,757
Equity securities		305		27		11		321
Totals	$	280,693	$	2,663	$	278	$	283,078

(Dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
December 31, 2011
U.S. Government Sponsored Enterprises (GSE)	$	41,563	$	2,081	$	22	$	43,622
States and political subdivisions		75,232		2,852		33		78,051
GSE residential mortgage-backed securities		186,018		1,783		217		187,584
Total debt securities		302,813		6,716		272		309,257
Equity securities		1,260		41		193		1,108
Totals	$	304,073	$	6,757	$	465	$	310,365

The following table shows gross unrealized losses and fair value of the Company’s available for sale securities that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2012 and December 31, 2011:

	Less Than 12 Months				12 Months or More				Total
(Dollars in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
June 30, 2012
U.S. Treasury	$	14,983	$	11	$	0	$	0	$	14,983	$	11
U.S. Government Sponsored Enterprises (GSE)		16,682		34		0		0		16,682		34
States and political subdivisions		2,063		15		0		0		2,063		15
GSE residential mortgage-backed securities		46,095		169		4,134		38		50,229		207
Total debt securities		79,823		229		4,134		38		83,957		267
Equity securities		0		0		68		11		68		11
Total temporarily impaired securities	$	79,823	$	229	$	4,202	$	49	$	84,025	$	278
December 31, 2011
U.S. Government Sponsored Enterprises (GSE)	$	8,685	$	22	$	0	$	0	$	8,685	$	22
States and political subdivisions		0		0		1,467		33		1,467		33
GSE residential mortgage-backed securities		45,019		217		0		0		45,019		217
Total debt securities		53,704		239		1,467		33		55,171		272
Equity securities		751		193		0		0		751		193
Total temporarily impaired securities	$	54,455	$	432	$	1,467	$	33	$	55,922	$	465

The Company had 29 securities and 35 securities at June 30, 2012 and December 31, 2011 in which the amortized cost exceeds their values, as discussed below.

U.S. Treasuries and Government Sponsored Enterprises (GSE). Four U.S Treasuries and 20 GSE securities, including mortgage-backed securities, have amortized costs which exceed their fair values, all but one of which are in the less than 12 months category at June 30, 2012. At December 31, 2011, the Company had 15 GSE securities with unrealized losses, all of which were in the less than 12 months category. These unrealized losses have been caused by a rise in interest rates from the time the securities were purchased. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2012 or at December 31, 2011.

State and Political Subdivisions. Three state and political subdivision securities had an amortized cost which exceeded their fair value for less than 12 months at June 30, 2012. At December 31, 2011, two state and political subdivision securities had unrealized losses, both of which were greater than 12 months. These unrealized losses have been caused by a rise in interest rates from the time the securities were purchased. Management considers the investment rating, the state of the issuer of the security and other credit support in determining whether the security is other-than-temporarily impaired. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2012 or at December 31, 2011.

Equity Securities. Two equity securities have cost which exceeds their fair value, both of which had unrealized losses for greater than 12 months at June 30, 2012. At December 31, 2011, 18 equity securities had unrealized losses, all of which had unrealized losses for less than 12 months. These securities are among various industries, including financial, industrial, consumer, energy, health care and a large cap fund, In considering whether the equity securities are other-than-temporarily impaired, management reviews the severity and duration of decline in fair value, research reports, analysts recommendations, credit rating changes, news stories and other relevant information. Management believes the equity securities are not other-than-temporarily impaired and will equal or exceed our cost basis within a reasonable period of time. Since these companies are considered viable and carry the possibility of price appreciation in the future, impairments are considered temporary. The Company recorded no other than temporary impairment expense on equity securities for the three or six months ended June 30, 2012 and 2011.

The amortized cost and fair values of securities available for sale at June 30, 2012 by contractual maturity are shown below. Contractual maturities will differ from expected maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale
(Dollars in thousands)	Amortized Cost		Fair Value
Due in one year or less	$	4,150	$	4,179
Due after one year through five years		43,122		43,222
Due after five years through ten years		22,309		22,728
Due after ten years		24,071		24,888
GSE residential mortgage-backed securities		186,736		187,740
Total debt securities		280,388		282,757
Equity securities		305		321
	$	280,693	$	283,078

Gross gains on the sales of securities were $2,706,000 and $500,000 for the quarters ended June 30, 2012 and 2011. Gross losses on the sales of securities available for sale were $111,000 and $31,000 for the quarters ended June 30, 2012 and 2011. Gross gains on the sales of securities were $4,966,000 and $921,000 for the six months ended June 30, 2012 and 2011. Gross losses on the sales of securities were $140,000 and $73,000 for the six months ended June 30, 2012 and 2011.

Securities with a fair value of $238,976,000 and $283,501,000 at June 30, 2012 and December 31, 2011 were pledged to secure public funds and for other purposes as required or permitted by law.

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Securities Available for Sale (Details 1) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2012	Dec. 31, 2011
Gross unrealized losses and fair value of the Company's available for sale securities
Total temporarily impaired securities, Less than 12 Months, Fair Value	$ 79,823	$ 54,455
Total temporarily impaired securities, 12 Months or More, Fair Value	4,202	1,467
Total temporarily impaired securities, Total, Fair Value	84,025	55,922
Total temporarily impaired securities, Less Than 12 Months, Unrealized Losses	229	432
Total temporarily impaired securities, 12 Months or More, Unrealized Losses	49	33
Total temporarily impaired securities, Total, Unrealized Losses	278	465
Debt Securities [Member]
Gross unrealized losses and fair value of the Company's available for sale securities
Total temporarily impaired securities, Less than 12 Months, Fair Value	79,823	53,704
Total temporarily impaired securities, 12 Months or More, Fair Value	4,134	1,467
Total temporarily impaired securities, Total, Fair Value	83,957	55,171
Total temporarily impaired securities, Less Than 12 Months, Unrealized Losses	229	239
Total temporarily impaired securities, 12 Months or More, Unrealized Losses	38	33
Total temporarily impaired securities, Total, Unrealized Losses	267	272
Equity Securities [Member]
Gross unrealized losses and fair value of the Company's available for sale securities
Total temporarily impaired securities, Less than 12 Months, Fair Value	0	751
Total temporarily impaired securities, 12 Months or More, Fair Value	68	0
Total temporarily impaired securities, Total, Fair Value	68	751
Total temporarily impaired securities, Less Than 12 Months, Unrealized Losses	0	193
Total temporarily impaired securities, 12 Months or More, Unrealized Losses	11	0
Total temporarily impaired securities, Total, Unrealized Losses	11	193
U.S. Treasury [Member] | Debt Securities [Member]
Gross unrealized losses and fair value of the Company's available for sale securities
Total temporarily impaired securities, Less than 12 Months, Fair Value	14,983
Total temporarily impaired securities, 12 Months or More, Fair Value	0
Total temporarily impaired securities, Total, Fair Value	14,983
Total temporarily impaired securities, Less Than 12 Months, Unrealized Losses	11
Total temporarily impaired securities, 12 Months or More, Unrealized Losses	0
Total temporarily impaired securities, Total, Unrealized Losses	11
U.S. Government Sponsored Enterprises (GSE) [Member] | Debt Securities [Member]
Gross unrealized losses and fair value of the Company's available for sale securities
Total temporarily impaired securities, Less than 12 Months, Fair Value	16,682	8,685
Total temporarily impaired securities, 12 Months or More, Fair Value	0	0
Total temporarily impaired securities, Total, Fair Value	16,682	8,685
Total temporarily impaired securities, Less Than 12 Months, Unrealized Losses	34	22
Total temporarily impaired securities, 12 Months or More, Unrealized Losses	0	0
Total temporarily impaired securities, Total, Unrealized Losses	34	22
States and Political Subdivisions [Member] | Debt Securities [Member]
Gross unrealized losses and fair value of the Company's available for sale securities
Total temporarily impaired securities, Less than 12 Months, Fair Value	2,063	0
Total temporarily impaired securities, 12 Months or More, Fair Value	0	1,467
Total temporarily impaired securities, Total, Fair Value	2,063	1,467
Total temporarily impaired securities, Less Than 12 Months, Unrealized Losses	15	0
Total temporarily impaired securities, 12 Months or More, Unrealized Losses	0	33
Total temporarily impaired securities, Total, Unrealized Losses	15	33
GSE residential mortgage-backed securities [Member] | Debt Securities [Member]
Gross unrealized losses and fair value of the Company's available for sale securities
Total temporarily impaired securities, Less than 12 Months, Fair Value	46,095	45,019
Total temporarily impaired securities, 12 Months or More, Fair Value	4,134	0
Total temporarily impaired securities, Total, Fair Value	50,229	45,019
Total temporarily impaired securities, Less Than 12 Months, Unrealized Losses	169	217
Total temporarily impaired securities, 12 Months or More, Unrealized Losses	38	0
Total temporarily impaired securities, Total, Unrealized Losses	$ 207	$ 217

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Loans Receivable and Allowance for Loan Losses (Details Textual) (USD $)	6 Months Ended
	Jun. 30, 2012 Note Loans	Oct. 01, 2011
Loans Receivable and Allowance for Loan Losses (Textual) [Abstract]
Maximum percentage of loan-to-value ratio upon loan origination	80.00%
Maximum percentage of loan-to-value ratios of the value of the real estate taken as collateral	90.00%
Maximum Percentage of credit worthiness of the borrower	38.00%
Minimum amount of loan on which reviews have been made annually	$ 1,000,000
Minimum amount of loan rated as Substandard	250,000
Minimum amount of portfolio loans which have been reviewed	500,000
Minimum percentage of loans which have been reviewed	75.00%
Number of notes split	2
Minimum amount on which annual updated appraisals for criticized loans is required		250,000
Percentage of strong loan-to-value	70.00%
Maximum period for temporary reduction in interest rates	12 months
Total numbers of loan of restructured terms	17
Loans totaling	6,581,000
Increase in charge-offs estimated by management	$ 43,000,000
Historical loss percentage to the anticipated loss allocation minimum	0
Historical loss percentage to the anticipated loss allocation maximum	0.08

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Derivative Instruments and Hedging Activity (Tables)

6 Months Ended

Jun. 30, 2012

Derivative Instruments and Hedging Activity [Abstract]

Summary of unrealized gains (losses) on the derivatives

A roll forward of the unrealized gains (losses) on the derivatives, and the effects on the Company’s income statement for the three and six months ended June 30, 2011 was as follows:

(Dollars in thousands)	Three Months Ended June 30, 2011			Six Months Ended June  30, 2011
Unrealized gains on derivatives in cash flow from hedging relationship, beginning of period	$	530		$	918
Amount of gain recognized in other comprehensive income on derivative for effective portion of cash flow hedge		252			130
Amount of gain reclassified from accumulated other comprehensive income into interest income		(100	)		(235	)
Amount of gain recognized as noninterest income for the ineffective portion of the cash flow hedge		(11	)		(142	)
Unrealized gains on derivatives in cash flow from hedging relationship, end of period	$	671		$	671