STOCK BASED COMPENSATION PLAN

Our 2006 Stock Option and Incentive Compensation Plan, which is stockholder approved, authorizes us to grant restricted stock and incentive or non-qualified stock options to key employees and directors for a total of 763,935 shares of our common stock. We believe that the ability to award stock options and other forms of stock-based incentive compensation can assist us in attracting and retaining key employees. Stock-based incentive compensation is also a means to align the interests of key employees with those of our stockholders by providing awards intended to reward recipients for our long-term growth. Options to purchase shares generally vest over periods of one to five years and expire ten years after the date of grant. We issue new shares of common stock upon the exercise of stock options. If options or awards granted under the 2006 Plan expire or terminate for any reason without having been exercised in full or released from restriction, the corresponding shares shall again be available for option or award for the purposes of the Plan. At June 30, 2013, options and restricted stock available for future grant under the 2006 Plan totaled 54,240.

Stock Options – The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model that uses various weighted-average assumptions. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected volatility is based on the fluctuation in the price of a share of stock over the period for which the option is being valued and the expected life of the options granted represents the period of time the options are expected to be outstanding.

The weighted-average assumptions for options granted during the six months ended June 30, 2013 and the resulting estimated weighted average fair value per share is presented below.

	June 30, 2013
Assumptions:
Risk-free interest rate		1.90	%
Expected dividend yield		-	%
Expected life (years)		10
Expected common stock market price volatility		64	%
Estimated fair value per share	$	1.82

A summary of option activity under the 2006 Plan for the period ended June 30, 2013 is presented below:

	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
							(Dollars In Thousands)
Outstanding, beginning of period		392,740	$	9.16
Granted during period		118,000		2.52
Forfeited during period		(9,550)		4.51
Exercised during period		-		-
Outstanding, end of period		501,190	$	7.68		7.0	$	312

Eligible for exercise at period end		200,688	$	14.28		4.7	$	42

There were no options exercised, modified or settled in cash during the periods ended June 30, 2013 and 2012. Management expects all outstanding unvested options will vest.

Compensation cost related to options granted under the 2006 Plan that was charged against earnings for the periods ended June 30, 2013 and 2012 was $73,000 and $55,000. As of June 30, 2013 there was $427,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 2006 Plan. That cost is expected to be recognized over a weighted-average period of 3.5 years.

Restricted Stock – On June 28, 2013, we granted 20,500 shares of restricted common stock at the current market price of $3.39. The restricted stock will vest over a five year period and will become fully vested on June 28, 2018, provided that the recipient has continued to perform substantial services for the Bank through that date. Any dividends declared on the restricted stock prior to vesting will be retained and paid only on the date of vesting. The transfer restrictions will expire upon the occurrence of a change of control event or upon the recipient’s death or disability. On the same date, we entered into an agreement with the recipient of the newly issued restricted stock to terminate 17,250 unvested shares of long-term restricted stock that had been awarded to him on February 7, 2013. Upon the sale of our Senior Preferred Shares by the U.S. Treasury on April 29, 2013 at a discount to face amount, the 17,250 shares had become subject to permanent restrictions on transfer by the holder, who elected to terminate the shares.

On September 19, 2012 our board of directors adopted the 2012 Non-Employee Director Equity Compensation Program (the “Director Program”). The Director Program enables us to compensate non-employee directors for their service with stock awards. We currently do not pay cash compensation to non-employee directors pursuant to agreements with bank regulatory agencies. The board has reserved 200,000 of the shares authorized for issuance under our shareholder approved 2006 Stock Option and Incentive Compensation Plan for stock awards under the Director Program.

The Director Program provides that each non-employee director elected or continuing in office on the date of each annual meeting of the Corporation’s shareholders will automatically receive an award of restricted stock on that date having a value of $30,000, based on the closing sale price per share of the Corporation’s common stock on the award date, rounded up to the next whole number. Accordingly, on May 15, 2013, the Company’s eight non-employee directors each received an award of 9,934 restricted shares, or 79,472 shares in total, that vest at the close of business on the day immediately preceding the date of the 2014 annual meeting of the Corporation’s shareholders, provided that the recipient has continued to serve as a member of the Board as of the date of vesting. The recipient may not transfer, pledge or dispose of the restricted stock until the close of business on the day immediately preceding the first anniversary of the award date. The transfer restrictions will also expire upon the occurrence of a Change of Control, as defined in the Plan, or upon the recipient’s death or disability. If a director ceases to serve as a member of the board for any reason, that director will automatically forfeit any unvested shares subject to an award. Any dividends declared on the restricted stock prior to vesting will be retained and paid only on the date the transfer restrictions expire.

A summary of changes in our non-vested restricted shares for the six months ended June 30, 2013 is presented below:

	Non-vested Shares		Weighted Average Grant Date Fair Value

Outstanding, beginning of period		32,964	$	3.64
Granted during period		122,972		3.05
Vested during period		(55,132)		3.38
Terminated during period		(17,250)		2.84
Forfeited during period		-		-
Outstanding, end of period		83,554	$	3.10

Compensation cost related to restricted stock granted under the 2006 Plan that was charged against earnings for the periods ended June 30, 2013 and 2012 was $187,000 and $37,000, respectively. As of June 30, 2013 there was $259,000 of total unrecognized compensation cost related to non-vested shares granted under the Plan. That cost is expected to be recognized over the remaining vesting period of 2.0 years.