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 September 30, 2011

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:  0-24159

MIDDLEBURG FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Virginia (State or other jurisdiction of incorporation or organization)	54-1696103 (I.R.S. Employer Identification No.)
111 West Washington Street Middleburg, Virginia (Address of principal executive offices)	20117 (Zip Code)

(703) 777-6327

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  R 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  R No  £

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

Large accelerated filer £	Accelerated filer R
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 Exchange Act).

Yes  £ No  R

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.   6,996,932 shares of Common Stock as of November 4, 2011.

MIDDLEBURG FINANCIAL CORPORATION

INDEX

Part I.    Financial Information			Page No.
	Item 1.	Financial Statements
		Consolidated Balance Sheets	4
		Consolidated Statements of Operations	5
		Consolidated Statements of Changes in Shareholders’ Equity	6
		Consolidated Statements of Cash Flows	7
		Notes to Consolidated Financial Statements	9
	Item 2.	Management’s Discussion and Analysis of Financial
		Condition and Results of Operations	36
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	57
	Item 4.	Controls and Procedures	59
Part II.     Other Information
			59
	Item 1.	Legal Proceedings
	Item 1A.	Risk Factors	59
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	59
	Item 3.	Defaults upon Senior Securities	60
	Item 4.	Removed and Reserved	60
	Item 5.	Other Information	60
	Item 6.	Exhibits	60
Signatures			61

3

PART I.  FINANCIAL INFORMATION

Item 1.  FINANCIAL STATEMENTS

MIDDLEBURG FINANCIAL CORPORATION
Consolidated Balance Sheets
(In thousands, except for share and per share data)
	(Unaudited)
	September 30,		December 31,
	2011		2010
ASSETS
Cash and due from banks	$	5,334	$	21,955
Interest-bearing deposits with other institutions		36,024		42,769
Total cash and cash equivalents		41,358		64,724
Securities available for sale		303,014		252,042
Loans held for sale		66,910		59,361
Restricted securities, at cost		7,227		6,296
Loans receivable, net of allowance for loan losses of $15,124 at
September 30, 2011 and $14,967 at December 31, 2010		660,689		644,345
Premises and equipment, net		21,464		21,112
Goodwill and identified intangibles		6,244		6,360
Other real estate owned, net of valuation allowance of
$1,057 at September 30, 2011 and $1,486 at December 31, 2010		6,096		8,394
Prepaid federal deposit insurance		4,227		5,154
Accrued interest receivable and other assets		36,427		36,779
TOTAL ASSETS	$	1,153,656	$	1,104,567
LIABILITIES
Deposits:
Non-interest-bearing demand deposits	$	145,393	$	130,488
Savings and interest-bearing demand deposits		455,893		436,718
Time deposits		308,410		323,100
Total deposits		909,696		890,306
Securities sold under agreements to repurchase		31,286		25,562
Short-term borrowings		12,864		13,320
FHLB Borrowings		77,912		62,912
Subordinated notes		5,155		5,155
Accrued interest payable and other liabilities		9,170		7,319
Commitments and contingent liabilities		-		-
TOTAL LIABILITIES		1,046,083		1,004,574
SHAREHOLDERS' EQUITY
Common stock ($2.50 par value; 20,000,000 shares authorized,
7,000,824 issued; 6,996,932 and 6,925,437 outstanding at
September 30, 2011 and December 31, 2010, respectively)		17,331		17,314
Capital surplus		43,274		43,058
Retained earnings		40,373		37,593
Accumulated other comprehensive income (loss)		4,327		(1,012	)
Total Middleburg Financial Corporation shareholders' equity		105,305		96,953
Non-controlling interest in consolidated subsidiary		2,268		3,040
TOTAL SHAREHOLDERS' EQUITY		107,573		99,993
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	1,153,656	$	1,104,567
See accompanying notes to the consolidated financial statements.

4

MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Operations
(In thousands, except for per share data)
	Unaudited						Unaudited
	For the Nine Months						For the Three Months
	Ended September 30,						Ended September 30,
	2011			2010			2011			2010
INTEREST AND DIVIDEND INCOME
Interest and fees on loans	$	29,378		$	30,661		$	9,912		$	9,832
Interest and dividends on securities available for sale
Taxable		4,877			3,194			1,727			1,166
Tax-exempt		1,757			1,914			592			621
Dividends		108			75			36			32
Interest on deposits in banks and federal funds sold		90			99			30			36
Total interest and dividend income		36,210			35,943			12,297			11,687
INTEREST EXPENSE
Interest on deposits		6,927			9,410			2,287			3,160
Interest on securities sold under agreements to
repurchase		209			144			84			63
Interest on short-term borrowings		174			245			58			134
Interest on long-term debt		914			1,298			312			372
Total interest expense		8,224			11,097			2,741			3,729
NET INTEREST INCOME		27,986			24,846			9,556			7,958
Provision for loan losses		2,565			11,350			1,024			9,130
NET INTEREST INCOME (LOSS) AFTER PROVISION
FOR LOAN LOSSES		25,421			13,496			8,532			(1,172	)
NONINTEREST INCOME
Service charges on deposit accounts		1,553			1,396			538			487
Trust services income		2,813			2,497			963			807
Gains on loans held for sale		12,286			11,621			5,501			5,147
Gains on securities available for sale, net		263			757			141			288
Total other-than-temporary impairment losses		(33	)		(857	)		(16	)		(557	)
Portion of (gain) loss recognized in other
comprehensive income		11			(117	)		(5	)		(169	)
Net impairment losses		(22	)		(974	)		(21	)		(726	)
Commissions on investment sales		552			453			187			142
Fees on mortgages held for sale		325			1,311			84			477
Other service charges, commissions and fees		347			353			98			97
Bank-owned life insurance		385			391			123			136
Other operating income		111			221			6			42
Total noninterest income		18,613			18,026			7,620			6,897
NONINTEREST EXPENSE
Salaries and employees' benefits		23,837			22,046			8,708			7,665
Net occupancy and equipment expense		5,016			4,651			1,700			1,557
Advertising		887			685			446			257
Computer operations		1,073			1,008			365			340
Other real estate owned		1,639			1,171			689			666
Other taxes		607			598			205			201
Federal deposit insurance expense		1,009			1,521			244			368
Other operating expenses		5,198			6,916			1,720			3,333
Total noninterest expense		39,266			38,596			14,077			14,387
Income (loss) before income taxes		4,768			(7,074	)		2,075			(8,662	)
Income tax expense (benefit)		1,072			(3,135	)		454			(3,297	)
NET INCOME (LOSS)		3,696			(3,939	)		1,621			(5,365	)
Net (income) loss attributable to non-
controlling interest		128			(311	)		(223	)		(423	)
Net income (loss) attributable to Middleburg
Financial Corporation	$	3,824		$	(4,250	)	$	1,398		$	(5,788	)
Earnings (loss) per share:
Basic	$	0.55		$	(0.61	)	$	0.20		$	(0.83	)
Diluted	$	0.55		$	(0.61	)	$	0.20		$	(0.83	)
Dividends per common share	$	0.15		$	0.30		$	0.05		$	0.10
See accompanying notes to the consolidated financial statements.

5

Middleburg Financial Corporation
Consolidated Statement of Changes in Shareholders' Equity
For the Nine Months Ended June 30, 2011 and 2010
(In Thousands, Except Share Data)
(Unaudited)
	Middleburg Financial Corporation Shareholders
										Accumulated
										Other									Total
	Common			Capital			Retained			Comprehensive			Comprehensive			Noncontrolling			Comprehensive
	Stock			Surplus			Earnings			Income (Loss)			Income (Loss)			Interest			(Loss) Income			Total
Balances - December 31, 2009	$	17,273		$	42,807		$	42,706		$	(2,474	)				$	3,047					$	103,359
Comprehensive income
Net income (loss)								(4,250	)				$	(4,250	)		311		$	(3,939	)		(3,939	)
Other comprehensive income net of tax:
Unrealized holding gains arising during the
period (net of tax, $2,051)											3,983			3,983						3,983			3,983
Reclassification adjustment (net of tax, $257)											(500	)		(500	)					(500	)		(500	)
Unrealized losses on securities
for which other-than-temporary impairment
has been recognized in earnings (net of tax, $ 371)											720			720						720			720
Total other comprehensive income											4,203			4,203			-		$	4,203			4,203
Total comprehensive income (loss)													$	(47	)		311		$	264			264
Cash dividends declared								(2,078	)														(2,078	)
Exercise of stock options (2,750 shares)		7			22																		29
Vesting of restricted stock awards (3,650 shares)		9			(9	)																	-
Distributions to non-controlling interest																	(254	)					(254	)
Share-based compensation		-			110																		110
Balances - September 30, 2010	$	17,289		$	42,930		$	36,378		$	1,729					$	3,104					$	101,430
Balances - December 31, 2010	$	17,314		$	43,058		$	37,593		$	(1,012	)				$	3,040					$	99,993
Comprehensive income
Net income (loss)								3,824					$	3,824			(128	)	$	3,696			3,696
Other comprehensive income net of tax:
Unrealized holding gains arising during the
period (net of tax, $3,035)											5,891			5,891			-			5,891			5,891
Reclassification adjustment (net of tax, $89)											(174	)		(174	)		-			(174	)		(174	)
Unrealized losses on securities
for which other-than-temporary impairment
has been recognized in earnings (net of tax, $7)											15			15			-			15			15
Unrealized (loss) on interest rate swap (net of tax, 203)											(393	)		(393	)		-			(393	)		(393	)
Total other comprehensive income											5,339			5,339			-			5,339			5,339
Total comprehensive income (loss)													$	9,163			(128	)	$	9,035			9,035
Cash dividends declared								(1,044	)														(1,044	)
Vesting of restricted stock awards (7,923 shares)		19			(19	)																	-
Cancellation of restricted stock (946 shares)		(2	)		(12	)																	(14	)
Distributions to non-controlling interest																	(644	)					(644	)
Share-based compensation		-			247																		247
Balances - September 30, 2011	$	17,331		$	43,274		$	40,373		$	4,327					$	2,268					$	107,573

See accompanying notes to the consolidated financial statements.

6

MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(In Thousands)
	Unaudited
	For the nine months ended
	September 30,			September 30,
	2011			2010
Cash Flows From Operating Activities
Net income  (loss)	$	3,696		$	(3,939	)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization		1,391			1,323
Equity in (undistributed earnings) of affiliate		(21	)		145
Provision for loan losses		2,565			11,350
Net (gain) on securities available for sale		(263	)		(757	)
Other than temporary impairment loss		22			974
Net loss (gain) on disposal of assets		45			(7	)
Premium amortization on securities, net		2,029			1,583
Origination of loans held for sale		(470,006	)		(555,310	)
Proceeds from sales of loans held for sale		474,743			534,489
Net (gains) on mortgages held for sale		(12,286	)		(11,621	)
Share-based compensation		247			110
Net loss on sale of other real estate owned		336			185
Valuation adjustment on other real estate owned		774			760
Decrease in prepaid FDIC insurance		927			1,418
Changes in assets and liabilities:
(Increase) in other assets		(3,303	)		(5,226	)
Increase in other liabilities		1,851			1,261
Net cash provided by (used in) operating activities	$	2,747		$	(23,262	)
Cash Flows from Investing Activities
Proceeds from maturity, principal paydowns
and calls of securities available for sale	$	42,050		$	39,656
Proceeds from sale of securities
available for sale		26,154			56,502
Purchase of securities available for sale		(112,259	)		(161,152	)
Purchase of restricted stock		(931	)		- -
Proceeds from disposition of fixed assets		57			- -
Purchases of bank premises and equipment		(1,430	)		(546	)
Net (increase) in loans		(20,641	)		(19,247	)
Proceeds from sale of other real estate owned		2,917			1,049
Purchase of bank-owned life insurance		- -			(682	)
Net cash (used in) investing activities	$	(64,083	)	$	(84,420	)

See Accompanying Notes to Consolidated Financial Statements.

7

MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(Continued)
(In Thousands)
	For the nine months ended
	September 30,			September 30,
	2011			2010
Cash Flows from Financing Activities
Net increase in non-interest-bearing and interest-
bearing demand deposits and savings accounts	$	34,080		$	41,664
Net (decrease) increase in certificates of deposit		(14,690	)		49,628
Increase in securities sold under agreements
to repurchase		5,724			8,217
Proceeds from short-term borrowings		67,470			83,395
Payments on short-term borrowings		(67,926	)		(65,058	)
Proceeds from FHLB borrowings		40,000			17,912
Payments on FHLB borrowings		(25,000	)		- -
Distributions to non-controlling interest		(644	)		(254	)
Payment of dividends on common stock		(1,044	)		(2,078	)
Net proceeds from issuance of common stock		- -			29
Net cash provided by financing activities	$	37,970		$	133,455
(Decrease) increase in cash and and cash equivalents		(23,366	)		25,773
Cash and Cash Equivalents
Beginning		64,724			43,210
Ending	$	41,358		$	68,983
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest	$	8,345		$	11,144
Income taxes	$	450		$	-
Supplemental Disclosure of Noncash Transactions
Unrealized gain on securities available for sale	$	8,685		$	6,367
Change in market value of interest rate swap	$	(596	)	$	-
Transfer of loans to other real estate owned	$	2,266		$	3,625
Loans originated from sale of other real estate owned	$	533		$	-
See accompanying notes to the consolidated financial statements.

8

MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDAIRIES

Notes to Consolidated Financial Statements

For the Nine Months Ended September 30, 2011 and 2010

(Unaudited)

Note 1.                                General

In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position at September 30, 2011 and December 31, 2010, the results of operations for the three and nine months ended September 30, 2011 and 2010, and, changes in shareholders’ equity and cash flows for the nine months ended September 30, 2011 and 2010, in accordance with accounting principles generally accepted in the United States of America.  The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2010 (the “2010 Form 10-K”) of Middleburg Financial Corporation (the “Company”).  The results of operations for the three and nine month periods ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year.

In preparing these financial statements, management has evaluated subsequent events and transactions for potential recognition or disclosure through the date these financial statements were issued.  Management has concluded there were no additional material subsequent events to be disclosed at this time.

Note 2.                                Stock–Based Compensation Plan

As of September 30, 2011, the Company sponsored one stock-based compensation plan (the 2006 Equity Compensation Plan), which provides for the granting of stock options, stock appreciation rights, stock awards, performance share awards, incentive awards and stock units.  The 2006 Equity Compensation Plan was approved by the Company’s shareholders at the Annual Meeting held on April 26, 2006 and has succeeded the Company’s 1997 Stock Incentive Plan.  Under the plan, the Company may grant stock-based compensation to its directors, officers, employees and other persons the Company determines have contributed to the profits or growth of the Company.  The Company may grant awards of up to 255,000 shares of common stock under the 2006 Equity Compensation Plan.

The Company granted 54,500 shares of restricted stock to executive officers and certain other employees on May 1, 2011.  The terms of the grant awards provide for 100% cliff vesting on December 31, 2016 but vesting may be accelerated on a graduated basis if certain predefined performance targets are met during the service period.  As of September 30, 2011, no shares were vested under these awards.  Service-based stock awards are entitled to voting and dividend rights on all shares granted as of the grant date. Under the terms of these grant awards, unearned restricted stock grants are forfeited if the employee leaves the Company prior to vesting.

Additionally, 1,063 shares of service-based restricted stock were issued to the Chairman of the Board of Directors on May 1, 2011.  The shares will vest at 100% on May 1, 2012.

The Company recognized $247,000 for stock-based compensation expenses for the nine months ended September 30, 2011.

9

The following table summarizes stock options awarded under the 2006 Equity Compensation Plan and remaining unexercised options under the 1997 Stock Incentive Plan at the end of the reporting period.

	September 30, 2011
				Weighted
				Average				Aggregate
				Exercise				Intrinsic
	Shares			Price				Value
Outstanding at beginning of year		165,915		$	20.18
Granted		--			--
Exercised		--			--
Forfeited		(5,744	)		(14.00	)
Outstanding at end of period		160,171		$	20.40		$	--

As of the end of the reporting period, 130,086 options were vested and exercisable representing 100,000 shares issued under the original 1997 plan and 30,086 vested options under the 2006 Plan.  At September 30, 2011 the weighted average exercise price of these stock options was greater than the aggregate market price.  The weighted average remaining contractual term for options outstanding and exercisable at September 30, 2011 was 2.6 years.  As of September 30, 2011 there was $27,000 of total unrecognized compensation expense related to stock option awards under the 2006 Equity Compensation Plan.

The following table summarizes restricted stock awarded under the 2006 Equity Compensation Plan at the end of the reportable period.

	September 30, 2011
				Weighted
				Average				Aggregate
				Grant-Date				Intrinsic
	Shares			Fair Value				Value
Outstanding at beginning of year		38,580		$	15.13
Granted		55,563			15.06
Vested		(7,923	)		(18.38	)
Forfeited		--			--
Non-vested at end of period		86,220		$	14.79		$	1,293,000

The weighted average remaining contractual term for non-vested restricted stock at September 30, 2011 was 3.32 years.  As of September 30, 2011, there was $1,162,000 of total unrecognized compensation expense related to the non-vested restricted stock awards under the 2006 Equity Compensation Plan.

10

Note 3.                                Securities

Amortized costs and fair values of securities available for sale at September 30, 2011 are summarized as follows:

	September 30, 2011
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
Available for Sale
U.S. government agencies	$	7,219	$	307	$	(2	)	$	7,524
Obligations of states and
political subdivisions		63,153		2,329		(78	)		65,404
Mortgage-backed securities:
Agency		184,456		6,024		(197	)		190,283
Non-agency		29,931		40		(693	)		29,278
Corporate preferred stock		68		-		(31	)		37
Corporate securities		10,612		10		(383	)		10,239
Trust-preferred securities		501		-		(252	)		249
Total	$	295,940	$	8,710	$	(1,636	)	$	303,014

Amortized costs and fair values of securities available for sale at December 31, 2010 are summarized as follows:

	December 31, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
Available for Sale
U.S. government agencies	$	4,699	$	17	$	(67	)	$	4,649
Obligations of states and
political subdivisions		61,187		174		(2,221	)		59,140
Mortgage-backed securities:
Agency		150,952		1,722		(370	)		152,304
Non-agency		26,168		150		(237	)		26,081
Corporate preferred stock		39		-		(26	)		13
Corporate securities		9,609		7		(84	)		9,532
Trust-preferred securities		998		-		(675	)		323
Total	$	253,652	$	2,070	$	(3,680	)	$	252,042

The amortized cost and fair value of securities available for sale as of September 30, 2011, by contractual maturity are shown below.  Maturities may differ from contractual maturities in corporate and mortgage-backed securities because the securities and mortgages underlying the securities may be called or repaid without any penalties.  Therefore, these securities are not included in the maturity categories in the following maturity summary.

11

	September 30, 2011
	Amortized		Fair
	Cost		Value
	(In thousands)
Due in one year or less	$	3,020	$	3,036
Due after one year through
five years		13,098		13,275
Due after five years through
ten years		34,525		35,945
Due after ten years		30,341		30,911
Mortgage-backed securities		214,387		219,561
Corporate preferred stock		68		37
Trust preferred securities		501		249
Total	$	295,940	$	303,014

Proceeds from the sale of securities during the nine months ended September 30, 2011 were $26.2 million and net gains of $263,000 were realized on those sales.  The tax expense applicable to the net realized gains amounted to $89,000.  Additionally, $22,000 in losses on securities with other than temporary impairment was recognized during the nine months ended September 30, 2011.

The carrying value of securities pledged to qualify for fiduciary powers, to secure public monies and for other purposes as required by law amounted to $124.4 million at September 30, 2011.

At September 30, 2011, investments in an unrealized loss position that were temporarily impaired are as follows:

	September 30, 2011 (In thousands)
	Less than Twelve Months					Twelve Months or Greater					Total
			Gross					Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
2011	Value		Losses			Value		Losses			Value		Losses
U.S. government agencies	$	390	$	(1	)	$	55	$	(1	)	$	445	$	(2	)
Obligations of states and
political subdivisions		42		-			2,217		(78	)		2,259		(78	)
Mortgage backed securities:
Agency		9,294		(197	)		-		-			9,294		(197	)
Non-agency		15,708		(175	)		4,804		(518	)		20,512		(693	)
Corporate preferred stock		-		-			8		(31	)		8		(31	)
Corporate securities		4,928		(72	)		2,159		(311	)		7,087		(383	)
Trust-preferred securities		-		-			249		(252	)		249		(252	)
Total	$	30,362	$	(445	)	$	9,492	$	(1,191	)	$	39,854	$	(1,636	)

At December 31, 2010, investments in an unrealized loss position that were temporarily impaired are as follows:

12

	December 31, 2010 (In thousands)
	Less than Twelve Months					Twelve Months or Greater					Total
			Gross					Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
2010	Value		Losses			Value		Losses			Value		Losses
U.S. government agencies	$	3,408	$	(67	)	$	-	$	-		$	3,408	$	(67	)
Obligations of states and
political subdivisions		40,579		(1,	)		4,266		(345	)		44,845		(2,221	)
Mortgage backed securities:
Agency		50,338		(370	)		-		-			50,338		(370	)
Non-agency		18,341		(237	)		-		-			18,341		(237	)
Corporate preferred stock		-		-			12		(26	)		12		(26	)
Corporate securities		9,385		(84	)		-		-			9,385		(84	)
Trust-preferred securities		-		-			323		(675	)		323		(675	)
Total	$	122,051	$	(2,634	)	$	4,601	$	(1,046	)	$	126,652	$	(3,680	)

A total of 50 securities have been identified by the Company as temporarily impaired at September 30, 2011.  Of the 50 securities, 47 are investment grade and 3 are speculative grade.  Agency, non-agency mortgage-backed securities, and municipal securities make up the majority of temporarily impaired securities at September 30, 2011.  The speculative grade securities are asset backed securities that are collateralized by trust preferred issuances of financial institutions.  Market prices change daily and are affected by conditions beyond the control of the Company.  Although the Company has the ability to hold these securities until the temporary loss is recovered, decisions by management may necessitate a sale before the loss is fully recovered.  No such sales are anticipated or required as of September 30, 2011.  Investment decisions reflect the strategic asset/liability objectives of the Company.  The investment portfolio is analyzed frequently by the Company and managed to provide an overall positive impact to the Company’s income statement and balance sheet.

Trust preferred securities

Trust preferred securities were evaluated within the scope of EITF 99-20 (ASC 320 Investments – Debt and Equity Securities) for potential impairment. The Company reviews current available information in estimating the future cash flows of these securities and determines whether there have been favorable or adverse changes in estimated cash flows from the cash flows previously projected.  The Company considers the structure and term of the pool and the financial condition of the underlying issuers.  Specifically, the evaluation incorporates factors such as interest rates and appropriate risk premiums, the timing and amount of interest and principal payments and the allocation of payments to the various note classes.  Current estimates of cash flows are based on the most recent trustee reports, announcements of deferrals or defaults, expected future default rates and other relevant market information.  The Company analyzed the cash flow characteristics of these securities.

All of the pooled trust preferred securities in the Company’s portfolio have floating rate coupons. In performing the present value analysis of expected cash flows, we incorporate expected deferral and default rates. The deferral/default assumptions for each pooled trust preferred security were developed by reviewing the underlying collateral or issuing banks. The present value of expected future cash flows is discounted at the effective purchase yield, which in the case of the floating rate securities is equal to the credit spread at time of purchase plus the current 3-month LIBOR rate.    We then compare the present value to the current book value for purposes of determining if there is an other-than-temporary

13

impairment (“OTTI”).  The discount rate used to determine OTTI for all periods is the effective purchase yield or the credit spread at time of purchase plus the 3-month LIBOR rate.

The Company reviewed the list of issuers underlying each trust preferred security as of September 30, 2011, and ranked each bank in order of expectations for future defaults and deferrals. We reviewed data on each bank such as earnings, capital ratios, credit metrics and loan loss reserves. We then assigned a default rate to each ranking, then the default rates were applied to each bank that was performing as of the reporting date.  Finally, we summed the defaults and divided by the total remaining performing collateral in each pool. For Trust Preferred IV, the expected default rate was 50 basis points, for Trust Preferred V, the expected default rate was 0 basis points, for Trust Preferred XXII, the expected default rate was 75 basis points, and for MM Community Funding Class A, the expected default rate was 150 basis points.  MM Community Funding Class B was sold during the period and is not presented in the tables below.

In connection with the preparation of the financial statements included in this Form 10-Q and using the evaluation procedures described above, the Company identified three securities with other-than-temporary impairment within its portfolio.  During the nine months ended September 30, 2011, the Company recognized credit related impairment losses of $22,000 compared to $974,000 for the nine months ended September 30, 2010 related to these securities.  Additionally, two securities previously recognized as other than temporarily impaired were sold during the nine months ended September 30, 2011.  These securities had a cumulative other-than-temporary impairment related to credit loss of $1.5 million.  An additional $16,000 loss was recognized in earnings upon sale of these two securities.

The following table provides further information on the Company’s trust preferred securities that are considered other-than-temporarily impaired as of September 30, 2011 (in thousands):

						Cumulative	Amount
		Current				Other	of OTTI	(1)	(2)		Expected
		Moody's	Par	Book	Fair	Comprehensive	Related to	Excess	Inst.	Deferrals/	Default	Expected	Lag
Security	Class	Rating	Value	Value	Value	Loss	Credit Loss	Subord.	Perf.	Defaults	Rate	Recovery	Years
MM Community Funding   LTD	A	B1	208	188	125	$                   63	20	126.56%	7	25.32%	1.50%	15%	2
Trust Preferred XXII	D	C	1,979	-	-	-	1,979	-39.52%	57	32.70%	0.75%	15%	2
Trust Preferred V	Mez	Caa3	304	69	6	63	367	-760.20%	-	100.00%	0.00%	15%	2
			$   2,491	$     257	$     131	$                 126	$         2,366
(1)  Excess subordination.  See explanation in text below tables.
(2)  Number of institutions in class performing.

The Company also has the following investment in a trust preferred security not considered other than-temporarily impaired as of September 30, 2011 (in thousands):

Cumulative

Current

Other

(1)

Expected

Tranche

Moody's

Par

Book

Fair

Comprehensive

Institutions

Excess

Deferrals/

Default

Expected

Lag

Security

Level

Rating

Value

Value

Value

Loss

Performing

Subord.

Defaults

Rate

Recovery

Years

Trust Preferred IV

Mez

Ca

$      244

$     244

$     118

$                 126

4

19.42%

27.10%

0.50%

15%

2

$      244

$     244

$     118

$                 126

(1)  Excess subordination.  See explanation in text below tables.

Both of the preceding tables present data on the excess subordination existing in each of the trust preferred issuances included in the Company’s investment portfolio.  Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are pari passu and senior to the class owned by the Company. Negative excess subordination indicates that there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to the classes owned by the Company.

The credit deferral/default assumptions utilized in the Company’s OTTI analysis methodology and included in the above tables considers specific collateral underlying each trust preferred security.

The following table presents a roll-forward of the credit loss component amount of OTTI recognized in earnings:

OTTI Credit Losses Recognized in Earnings
Rollforward
Amount recognized through December 31, 2010	$	3,871
Additions related to intial impairments		-
Additions related to subsequent impairments		22
Deductions for bonds sold during period (1)		(1,527	)
Net impairment losses recognized in earnings through September 30, 2011	$	2,366

(1) Two securities were sold during March, 2011 with a combined cumulative OTTI related to credit loss of $1,527,000.  An additional $16,000 was recognized as a loss in earnings upon sale of these bonds.

At September 30, 2011, the Company concluded that no other adverse change in cash flows occurred during the quarter and did not consider any other securities other-than-temporarily impaired.  Based on this analysis and because the Company does not intend to sell these securities and it is  more likely than not the Company will not be required to sell these securities before recovery of amortized cost basis, which may be at maturity; and, for debt securities related to corporate securities, determined that there was no other adverse change in the cash flows as viewed by a market participant, the Company does not consider the investments in these assets to be other than temporarily impaired at September 30, 2011.  However, there is a risk that the Company’s continuing reviews could result in recognition of other-than-temporary impairment charges in the future.

14

Note 4.                                Loan Portfolio

The Company segregates its loan portfolio into three primary loan segments:  Real Estate Loans, Commercial Loans, and Consumer Loans.  Real estate loans are further segregated into the following classes: construction loans, loans secured by farmland, loans secured by 1-4 family residential real estate, and other real estate loans.  Other real estate loans include commercial real estate loans.  The consolidated loan portfolio was composed of the following on the dates indicated:

	September 30, 2011					December 31, 2010
	Outstanding		Percent of			Outstanding		Percent of
	Balance		Total Portfolio			Balance		Total Portfolio
	(In Thousands)					(In Thousands)
Real estate loans:
Construction	$	48,572		7.2	%	$	68,110		10.3	%
Secured by farmland		10,377		1.5			11,532		1.7
Secured by 1-4 family residential		239,738		35.5			242,620		36.8
Other real estate loans		273,823		40.5			268,262		40.7
Commercial loans		91,296		13.5			56,385		8.6
Consumer loans		12,007		1.8			12,403		1.9
		675,813		100.0	%		659,312		100.0	%
Less allowance for loan losses		15,124					14,967
Net loans	$	660,689				$	644,345

Loans presented in the table above exclude loans held for sale.  The Company had $66.9 million and $59.4 million in mortgages held for sale at September 30, 2011 and December 31, 2010, respectively.

The following table presents a contractual aging of the recorded investment in past due loans by class of loans as of September 30, 2011 and December 31, 2010.

	September 30, 2011 (In thousands)
	30-59 Days		60-89 Days		90 Days		Total Past				Total
	Past Due		Past Due		Or Greater		Due		Current		Loans
Real estate loans:
Construction	$	1,440	$	-	$	2,789	$	4,229	$	44,343	$	48,572
Secured by farmland		415		-		-		415		9,962		10,377
Secured by 1-4 family residential		6,502		1,340		10,313		18,155		221,583		239,738
Other real estate loans		899		3,375		1,719		5,993		267,830		273,823
Commercial loans		1,863		221		203		2,287		89,009		91,296
Consumer loans		6		-		-		6		12,001		12,007
		-		-		-		-		-		-
Total	$	11,125	$	4,936	$	15,024	$	31,085	$	644,728	$	675,813

	December 31, 2010 (In thousands)
	30-59 Days		60-89 Days		90 Days		Total Past				Total
	Past Due		Past Due		Or Greater		Due		Current		Loans
Real estate loans:
Construction	$	83	$	7,423	$	1,791	$	9,297	$	58,813	$	68,110
Secured by farmland		-		-		-		-		11,532		11,532
Secured by 1-4 family residential		2,938		-		7,729		10,667		231,953		242,620
Other real estate loans		4,438		3,887		1,385		9,710		258,552		268,262
Commercial loans		1,801		28		243		2,072		54,313		56,385
Consumer loans		22		41		242		305		12,098		12,403
		-		-		-		-		-		-
Total	$	9,282	$	11,379	$	11,390	$	32,051	$	627,261	$	659,312

The following table presents the recorded investment in nonaccrual loans and loans past due ninety days or more and still accruing by class of loans as of September 30, 2011 and December 31, 2010:

15

	September 30, 2011				December 31, 2010
			Past due 90				Past due 90
			days or more				days or more
	Nonaccrual		and still accruing		Nonaccrual		and still accruing
	(In Thousands)
Real estate loans:
Construction	$	4,229	$	-	$	8,871	$	-
Secured by farmland		-		-		-		-
Secured by 1-4 family residential		16,063		1,561		10,817		676
Other real estate loans		8,046		-		7,509		218
Commercial loans		2,147		-		1,950		12
Consumer loans		-		-		239		3
Total	$	30,485	$	1,561	$	29,386	$	909

If interest on nonaccrual loans had been accrued, such income would have approximated $1.5 million and $1.2 million for the nine months ended September 30, 2011 and 2010 respectively.

The Company utilizes an internal asset classification system as a means of measuring and monitoring credit risk in the loan portfolio.  Under the Company’s classification system, problem and potential problem loans are classified as “Special Mention”, “Substandard”, “Doubtful” and “Loss”.

Special Mention:  Loans classified as special mention have potential weaknesses that deserve management’s close attention.  If left uncorrected, the potential weaknesses may result in the deterioration of the repayment prospects for the credit.

Substandard:  Loans classified as substandard have a well-defined weakness that jeopardizes the liquidation of the debt.  Either the paying capacity of the borrower or the value of the collateral may be inadequate to protect the Company from potential losses.

Doubtful:  Loans classified as doubtful have a very high possibility of loss.  However, because of important and reasonably specific pending factors, classification as a loss is deferred until a more exact status may be determined.

Loss: Loans are classified as loss when they are deemed uncollectable and are charged off immediately.

The following tables present a summary of loan classifications by class of loan as of September 30, 2011 and December 31, 2010:

	September 30, 2011 (In Thousands)
			Real Estate		Real Estate
	Real Estate		Secured by		Secured by 1-4		Other Real
	Construction		Farmland		Family Residential		Estate Loans		Commercial		Consumer		Total
Pass	$	26,615	$	9,565		206,466	$	239,591	$	84,218	$	11,928	$	578,383
Special Mention		6,524		812		9,939		20,836		4,478		66		42,655
Substandard		14,402		-		21,685		13,143		2,299		13		51,542
Doubtful		1,031		-		1,648		253		301		-		3,233
Loss		-		-		-		-		-		-		-
Ending Balance	$	48,572	$	10,377		239,738	$	273,823	$	91,296	$	12,007	$	675,813

16

	December 31, 2010 (In thousands)
			Real Estate		Real Estate
	Real Estate		Secured by		Secured by 1-4		Other Real
	Construction		Farmland		Family Residential		Estate Loans		Commercial		Consumer		Total
Pass	$	31,744	$	10,070		212,531	$	244,982	$	50,660	$	12,016	$	562,003
Special Mention		15,580		1,462		14,810		13,067		3,394		92		48,405
Substandard		20,561		-		14,616		9,939		2,331		295		47,742
Doubtful		225		-		663		274		-		-		1,162
Loss		-		-		-		-		-		-		-
Ending Balance	$	68,110	$	11,532		242,620	$	268,262	$	56,385	$	12,403	$	659,312

The following table presents loans identified as impaired by class of loan as of and for the nine months ended September 30, 2011:

	September 30, 2011  (In thousands)
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Real estate loans:
Construction	$	3,300	$	3,960	$	-	$	4,248	$	-
Secured by farmland		-		-		-		-		-
Secured by 1-4 family residential		3,894		4,487		-		4,254		-
Other real estate loans		2,987		3,030		-		3,978		-
Commercial loans		1,723		1,723		-		1,721		-
Consumer loans		-		-		-		-		-
Total with no related allowance		11,904		13,200		-		14,201		-
With an allowance recorded:
Real estate loans:
Construction		929		959		416		930		-
Secured by farmland		-		-		-		-		-
Secured by 1-4 family residential		12,573		14,377		3,030		13,248		8
Other real estate loans		5,059		5,059		1,033		4,540		-
Commercial loans		424		446		406		426		-
Consumer loans		-		-		-		-		-
Total with a related allowance		18,985		20,841		4,885		19,144		8
Total	$	30,889	$	34,041	$	4,885	$	33,345	$	8

The following table presents loans identified as impaired by class of loan as of and for the year ended December 31, 2010:

17

	December 31, 2010 (In thousands)
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Real estate loans:
Construction	$	3,415	$	3,415	$	-	$	3,470	$	4
Secured by farmland		-		-		-		-
Secured by 1-4 family residential		5,450		6,281		-		5,992		-
Other real estate loans		1,303		1,303		-		1,316		-
Commercial loans		1,823		1,844		-		2,032		-
Consumer loans		-		-		-		28		-
Total with no related allowance		11,991		12,843		-		12,838		4
With an allowance recorded:
Real estate loans:
Construction		5,755		6,366		1,876		6,108		-
Secured by farmland		-		-		-		-
Secured by 1-4 family residential		5,422		6,518		1,099		6,076		-
Other real estate loans		7,056		7,201		2,010		7,235		48
Commercial loans		127		127		108		128		-
Consumer loans		239		239		239		240		-
Total with a related allowance		18,599		20,452		5,332		19,787		48
Total	$	30,590	$	33,295	$	5,332	$	32,625	$	52

The “Recorded Investment” amounts in the tables above represent the outstanding principal balance on each loan represented in the tables plus any accrued interest receivable on such loans.  The “Unpaid Principal Balance” represents the outstanding principal balance on each loan represented in the tables plus any amounts that have been charged off on each loan.

Troubled Debt Restructurings

Included in certain loan categories in the impaired loans table above are troubled debt restructurings (“TDR’s”) that were classified as impaired.  The total balance of TDR’s at September 30, 2011 was $8.4 million of which $8.0 million were included in the Company’s non-accrual loan totals at that date and $404,000 represented loans performing as agreed to the restructured terms. This compares with $4.5 million in total restructured loans at December 31, 2010, an increase of $3.9 million or 86.7%.  The amount of the valuation allowance related to total TDR’s was $1.5 million and $532,000 as of September 30, 2011 and December 31, 2010 respectively.

The $8.0 million in nonaccrual TDR’s as of September 30, 2011 is comprised of $572,000 million in real estate construction loans, $3.9 million in 1-4 family real estate loans, $2.3 million in non-residential real estate loans, $764,000 in commercial loans, and $416,000 in consumer loans.  The $404,000 in TDR’s which were performing as agreed under restructured terms as of September 30, 2011 is represented by  two 1-4 family real estate loans.  The Company considers all loans classified as TDR’s to be impaired as of September 30, 2011.

As a result of adopting the amendments in ASU 2011-02, “Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” The Company reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they are considered TDRs under the amended guidance using review procedures in effect at that time.

18

The following table presents by class of loan, information related to loans modified in a TDR during the nine and three months ended September 30, 2011:

	Loans modified as TDR's
	For the nine months ended
	September 30, 2011
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
Class of Loan	Contracts		Investment		Investment
	(In thousands)
Real estate loans:
Construction		-	$	-	$	-
Secured by farmland		-		-		-
Secured by 1-4 family residential		4		284		293
Other real estate loans		5		5,282		5,282
Total real estate loans		9		5,566		5,575
Commercial loans		-		-		-
Consumer loans		-		-		-
Total		9	$	5,566	$	5,575
	Loans modified as TDR's
	For the three months ended
	September 30, 2011
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
Class of Loan	Contracts		Investment		Investment
	(In thousands)
Real estate loans:
Construction		-	$	-	$	-
Secured by farmland		-		-		-
Secured by 1-4 family residential		4		284		293
Other real estate loans		-		-		-
Total real estate loans		4		284		293
Commercial loans		-		-		-
Consumer loans		-		-		-
Total		4	$	284	$	293

During the nine months ended September 30, 2011, the Company modified nine loans that were considered to be TDR’s.  We extended the term and lowered the interest rate for all nine loans.

During the nine months ended September 30, 2011, the Company identified as a TDR one loan for which the allowance for loan losses had previously been measured under a general allowance methodology. Upon identifying this loan as a TDR, the Company evaluated it for impairment. The accounting amendments require prospective application of the impairment measurement guidance for those loans newly identified as impaired. As of September 30, 2011, the recorded investment in the loan for which the allowance was previously measured under a general allowance methodology and is now considered impaired and measured under a specific allowance methodology was $293,000, and the allowance for loan losses associated with that loan, on the basis of a current evaluation of loss was $127,000.

19

As of September 30, 2011, $5.3 million of loans restructured as TDR’s during the nine month period are included in the Company’s non-accrual loans total.  The balance of the loans identified as TDR’s during that period are reflected as non-performing assets which are performing as agreed under the restructured terms.

No loans modified in as TDR’s from October 1, 2010 through September 30, 2011 subsequently defaulted (i.e. 90 days or more past due following a restructuring) during the nine and three months ended September 30, 2011.

Management considers troubled debt restructurings and subsequent defaults in restructured loans in the determination of the adequacy of the Company’s allowance for loan losses.  When identified as a TDR, a loan is evaluated for potential loss based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs if the loan is collateral dependent.  Loans identified as TDR’s frequently are on non-accrual status at the time of the restructuring and, in some cases, partial charge-offs may have already been taken against the loan and a specific allowance may have already been established for the loan.  As a result of any modification as a TDR, the specific reserve associated with the loan may be increased.  Additionally, loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future defaults.  If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment.  As a result, any specific allowance may be increased, adjustments may be made in the allocation of the total allowance balance, or partial charge-offs may be taken to further write-down the carrying value of the loan.  Management exercises significant judgment in developing estimates for potential losses associated with TDR’s.

20

Note 5.                                Allowance for Loan Losses

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by loan class and, for the ending loan balances, based on impairment evaluation method as of September 30, 2011 and December 31, 2010.  A rollforward of the changes in the allowance for loan losses balance by class of loan is also presented for the period ended September 30, 2011.

	September 30, 2011 (In Thousands)
				Real Estate		Real Estate
	Real Estate			Secured by		Secured by 1-4			Other Real
	Construction			Farmland		Family Residential			Estate Loans			Commercial			Consumer			Total
Allowance for loan losses:
Balance at December 31, 2010	$	4,684		$	107	$	3,965		$	4,771		$	1,055		$	385		$	14,967
Chargeoffs		(363	)		-		(1,417	)		(396	)		(82	)		(314	)		(2,572	)
Recoveries		28			-		13			78			23			22			164
Provision		(2,137	)		3		4,389			(279	)		547			42			2,565
Balance at September 30, 2011	$	2,212		$	110	$	6,950		$	4,174		$	1,543		$	135		$	15,124
Ending allowance balance:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	416		$	-	$	3,031		$	1,033		$	405		$	-		$	4,885
Collectively evaluated for impairment		1,796			110		3,919			3,141			1,138			135			10,239
Total ending allowance balance	$	2,212		$	110	$	6,950		$	4,174		$	1,543		$	135		$	15,124
Ending loan recorded investment balances:
Individually evaluated for impairment	$	4,229		$	-	$	16,466		$	8,046		$	2,147		$	-		$	30,889
Collectively evaluated for impairment		44,343			10,377		223,272			265,777			89,149			12,007			644,924
Total ending loans balance	$	48,572		$	10,377	$	239,738		$	273,823		$	91,296		$	12,007		$	675,813

	December 31, 2010 (In thousands)
			Real Estate		Real Estate
	Real Estate		Secured by		Secured by 1-4		Other Real
	Construction		Farmland		Family Residential		Estate Loans		Commercial		Consumer		Total
Ending allowance balance:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,876	$	-	$	1,099	$	2,010	$	108	$	239	$	5,332
Collectively evaluated for impairment		2,808		107		2,866		2,761		947		146		9,635
Total ending allowance balance	$	4,684	$	107	$	3,965	$	4,771	$	1,055	$	385	$	14,967
Ending recorded investment balances:
Individually evaluated for impairment	$	9,170	$	-	$	10,872	$	8,359	$	1,950	$	239	$	30,590
Collectively evaluated for impairment		58,940		11,532		231,748		259,903		54,435		12,164		628,722
Total ending loans balance	$	68,110	$	11,532	$	242,620	$	268,262	$	56,385	$	12,403	$	659,312

Changes in the allowance for loan losses for the year ended December 31, 2010 is summarized as follows:

21

	Year
	Ended
	December 31, 2010
Balance, beginning of year	$	9,185
Provision for loan losses		12,005
Charge-offs:
Real estate loans:
Construction		1,226
Secured by 1-4 family residential		3,256
Other real estate loans		460
Commercial loans		942
Consumer loans		500
Total charge-offs	$	6,384
Recoveries:
Real estate loans:
Construction	$	-
Secured by 1-4 family residential		37
Other real estate loans		4
Commercial loans		68
Consumer loans		52
Total recoveries	$	161
Net charge-offs		6,223
Balance, end of period	$	14,967

Note 6.                      Earnings (loss) Per Share

The following table shows the weighted average number of common shares used in computing earnings per share and the effect on the weighted average number of shares of potential dilutive common stock.  Potential dilutive common stock has no effect on income available to common shareholders.

22

	Nine months ended
	September 30, 2011				September 30, 2010
			Per share				Per share
	Shares		Amount		Shares		Amount
Basic earnings (loss) per share		6,968,999	$	0.55		6,931,239	$	(0.61	)
Effect of dilutive securities:
stock options and grants		2,296				0
Diluted earnings (loss) per share		6,971,295	$	0.55		6,931,239	$	(0.61	)
	Three months ended
	September 30, 2011				September 30, 2010
			Per share				Per share
	Shares		Amount		Shares		Amount
Basic earnings (loss)  per share		6,996,932	$	0.20		6,934,366	$	(0.83	)
Effect of dilutive securities:
stock options and grants		1,562				0
Diluted earnings (loss) per share		6,998,494	$	0.20		6,934,366	$	(0.83	)

At September 30, 2011 and 2010, stock options, restricted grants and warrants representing 318,111 and 225,684 shares, respectively, were not included in the calculation of earnings per share because they would have been anti-dilutive.

Note 7.                                Segment Reporting

The Company operates in a decentralized fashion in three principal business activities: retail banking services; wealth management services; and mortgage banking services.  Revenue from retail banking activities consists primarily of interest earned on loans and investment securities and service charges on deposit accounts.

Revenue from the wealth management activities is comprised of fees based upon the market value of the accounts under administration as well as commission on investment transactions.  The wealth management services are conducted by Middleburg Trust Company and the investment services department of Middleburg Bank.

Revenue from the mortgage banking activities is comprised of interest earned on loans and fees received as a result of the mortgage origination process.  The Company recognizes gains on the sale of loans as part of other income.  The mortgage banking services are conducted by Southern Trust Mortgage, LLC.

Middleburg Bank and the Company have assets in custody with Middleburg Trust Company and accordingly pay Middleburg Trust Company a monthly fee.  Middleburg Bank also pays interest to Middleburg Trust Company and Southern Trust Mortgage on deposit accounts that each company has at Middleburg Bank.  Southern Trust Mortgage has an outstanding line of credit of $5.0 million and a participation agreement of $75.0 million for which it pays interest to Middleburg Bank on any

23

outstanding balance.  Middleburg Bank provides office space and data processing services to Southern Trust Mortgage for which it receives rental and fee income.  Transactions related to these relationships are eliminated to reach consolidated totals.

The following table presents segment information for the nine months ended September 30, 2011 and 2010, respectively.

	For the Nine Months Ended												For the Nine Months Ended
	September 30, 2011												September 30, 2010
	Retail		Wealth		Mortgage			Intercompany					Retail			Wealth			Mortgage			Intercompany
	Banking		Management		Banking			Eliminations			Consolidated		Banking			Management			Banking			Eliminations			Consolidated
(In Thousands)
Revenues:
Interest income	$	35,076	$	8	$	2,008		$	(882	)	$	36,210	$	35,075		$	7		$	1,809		$	(948	)	$	35,943
Trust and investment
fee income		-		2,813		-			-			2,813		-			2,546			-			(49	)		2,497
Other income		2,480		552		12,770			(2	)		15,800		2,065			445			13,026			(7	)		15,529
Total operating income		37,556		3,373		14,778			(884	)		54,823		37,140			2,998			14,835			(1,004	)		53,969
Expenses:
Interest expense		8,051		-		1,055			(882	)		8,224		10,854			-			1,204			(961	)		11,097
Salaries and employee benefits		10,878		2,268		10,691			-			23,837		9,729			2,332			9,985			-			22,046
Provision for loan losses		2,641		-		(76	)		-			2,565		11,122			-			228			-			11,350
Other		11,094		962		3,375			(2	)		15,429		13,063			766			2,764			(43	)		16,550
Total operating expenses		32,664		3,230		15,045			(884	)		50,055		44,768			3,098			14,181			(1,004	)		61,043
Income (loss) before income taxes
and non-controlling interest		4,892		143		(267	)		-			4,768		(7,628	)		(100	)		654			-			(7,074	)
Income tax expense (benefit)		986		86		-			-			1,072		(3,171	)		36			-			-			(3,135	)
Net Income (loss)		3,906		57		(267	)		-			3,696		(4,457	)		(136	)		654			-			(3,939	)
Non-controlling interest in
(income)/loss of consolidated subsidiary		-		-		128			-			128		-			-			(311	)		-			(311	)
Net income (loss) attributable to
Middleburg Financial Corporation	$	3,906	$	57	$	(139	)	$	-		$	3,824	$	(4,457	)	$	(136	)	$	343		$	-		$	(4,250	)
Total assets	$	1,139,348	$	12,378	$	77,177		$	(75,247	)	$	1,153,656	$	1,079,410		$	15,677		$	88,905		$	(72,528	)	$	1,111,464
Capital expenditures	$	1,276	$	3	$	151					$	1,430	$	508		$	13		$	25		$	-		$	546
Goodwill and other intangibles	$	-	$	4,377	$	1,867		$	-		$	6,244	$	-		$	4,536		$	1,867		$	-		$	6,403

The following table presents segment information for the three months ended September 30, 2011 and 2010, respectively.

24

	For the Three Months Ended													For the Three Months Ended
	September 30, 2011													September 30, 2010
	Retail		Wealth		Mortgage			Intercompany						Retail			Wealth		Mortgage			Intercompany
	Banking		Management		Banking			Eliminations			Consolidated			Banking			Management		Banking			Eliminations			Consolidated
(In Thousands)
Revenues:
Interest income	$	11,956	$	2	$	683		$	(344	)	$	12,297		$	11,706		$	3	$	343		$	(365	)	$	11,687
Trust and investment
fee income		-		963		-			-			963			-			855		-			(48	)		807
Other income		869		187		5,602			(1	)		6,657			385			156		5,573			(24	)		6,090
Total operating income		12,825		1,152		6,285			(345	)		19,917			12,091			1,014		5,916			(437	)		18,584
Expenses:
Interest expense		2,684		-		401			(344	)		2,741			3,595			-		514			(380	)		3,729
Salaries and employee benefits		3,952		726		4,030			-			8,708			3,151			794		3,720			-			7,665
Provision for loan losses		1,100		-		(76	)		-			1,024			9,120			-		10			-			9,130
Other		3,708		321		1,341			(1	)		5,369			5,904			82		793			(57	)		6,722
Total operating expenses		11,444		1,047		5,696			(345	)		17,842			21,770			876		5,037			(437	)		27,246
Income (loss) before income taxes
and non-controlling interest		1,381		105		589			-			2,075			(9,679	)		138		879			-			(8,662	)
Income tax expense (benefit)		381		73		-			-			454			(3,357	)		60		-			-			(3,297	)
Net Income (loss)		1,000		32		589			-			1,621			(6,322	)		78		879			-			(5,365	)
Non-controlling interest in
(income)/loss of consolidated subsidiary		-		-		(223	)		-			(223	)							(423	)		-			(423	)
Net income (loss) attributable to
Middleburg Financial Corporation	$	1,000	$	32	$	366		$	-		$	1,398		$	(6,322	)	$	78	$	456		$	-		$	(5,788	)
Total assets	$	1,139,348	$	12,378	$	77,177		$	(75,247	)	$	1,153,656		$	1,079,410		$	15,677	$	88,905		$	(72,528	)	$	1,111,464
Capital expenditures	$	585	$	-	$	151		$	-		$	736		$	78		$	1	$	4		$	-		$	83
Goodwill and other intangibles	$	-	$	4,377	$	1,867		$	-		$	6,244		$	-		$	4,536	$	1,867		$	-		$	6,403

Note 8.                                Defined Benefit Pension Plan

The Company has a noncontributory, defined benefit pension plan covering substantially all full-time employees of Middleburg Bank and Middleburg Trust Company.  Benefit accruals and eligibility for the plan were frozen as of September 30, 2009. This had the effect of reducing the Projected Benefit Obligation by an estimated $1,577,000, which was recorded as a curtailment gain in 2009.  The Company funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.

The defined benefit pension plan has been amended to be terminated and the amendment has been submitted to the Internal Revenue Service (the “IRS”) for approval. The Pension Benefit Guaranty Corporation (“the “PBGC”) was notified of the termination and the PBGC review period expired without comment.  Although the IRS application for termination approval is in process, and it is the intention of the Company to distribute the assets of the plan to participants during the fourth quarter of 2011, the date of IRS approval is unknown and there can be no assurance that the plan will be terminated or that assets will be completely distributed during 2011.

The table below reflects the components of the Net Periodic Benefit Cost related to the Company’s defined benefit pension plan for the indicated periods.

25

	Nine months ended September 30,
	2011			2010
	(In Thousands)
Interest cost	$	137		$	240
Expected return on plan assets		(44	)		(291	)
Amortization of unrecognized  net actuarial  loss		914			--
Net periodic benefit cost (income)	$	1,007		$	(51	)

	Three months ended September 30,
	2011			2010
	(In Thousands)
Interest cost	$	46		$	80
Expected return on plan assets		(15	)		(97	)
Amortization of unrecognized  net actuarial  loss		305			--
Net periodic benefit cost (income)	$	336		$	(17	)

Note 9.                                Capital Purchase Program

During 2009, the Company participated in the Capital Purchase Program established by the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008 and issued 22,000 shares of preferred stock to the Treasury as well as a warrant (“the Warrant”) to purchase 208,202 shares of the Company’s common stock at an initial exercise price of $15.85 per share.  As a result of the completion of the Company’s public stock offering in August 2009, the number of shares of common stock underlying the Warrant was reduced by one-half to 104,101.  On December 23, 2009, the Company redeemed all of the shares of preferred stock issued to the Treasury.  Pursuant to the purchase agreement with the Treasury, the Company may repurchase the Warrant now that it has fully redeemed its Preferred Stock.  The price for the purchase of the Warrant is subject to negotiation and there can be no assurance that the Warrant will be repurchased.  At this time, the Company has not repurchased the Warrant and the Warrant remains outstanding to the Treasury.  The Company expects the Treasury to sell the Warrant through an auction process in the near future.

Note 10. Fair Value Measurements

The Company adopted ASC 820, Fair Value Measurements, on January 1, 2008 to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  ASC 820 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions.  The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:

Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level II: Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date.  The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.

26

Level III: Assets and liabilities that have little to no pricing observability as of the reported date.  These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

Measured on recurring basis

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

Securities available for sale

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

Derivatives

Derivatives are recorded at fair value on a recurring basis.  Third party vendors compile prices from various sources and may determine the fair value of identical or similar instruments by using pricing models that consider observable market data (Level II).

27

The following tables present the balances of financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010.

	September 30, 2011 (In thousands)
	Total		Level I		Level II		Level III
Assets:
U.S. government agency
securities	$	7,524	$	-	$	7,524	$	-
Obligations of states and
political subdivision		65,404		-		65,404		-
Mortgage-backed securities:
Agency		190,283		-		190,283		-
Non-agency		29,278		-		29,278		-
Corporate preferred stock		37		-		37		-
Corporate securities		10,239		-		10,239		-
Trust preferred securities		249		-		249		-
Liabilities:
Derivative financial instruments	$	284	$	-	$	284		-

	December 31, 2010 (In thousands)
	Total		Level I		Level II		Level III
Assets:
U.S. government agency
securities	$	4,649	$	-	$	4,649	$	-
Obligations of states and
political subdivision		59,140		-		59,140		-
Mortgage-backed securities:
Agency		152,304		-		152,304		-
Non-agency		26,081		-		26,081		-
Corporate preferred stock		13		-		13		-
Corporate securities		9,532		-		9,532		-
Trust preferred securities		323		-		323		-
Derivative financial instruments		312		-		312		-

There were no assets measured at fair value on a recurring basis using significant unobservable inputs (Level III) for the nine months ended September 30, 2011.  Additionally, there were no changes in unrealized gains and losses recorded in earnings for the periods ended September 30, 2011 or December 31, 2010 for Level III assets that were still held at September 30, 2011 and December 31, 2010.

Measured on nonrecurring basis

Certain financial assets and certain financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on a recurring basis but are subject to fair value adjustments in certain circumstances.  Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or impairment of individual assets.

28

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 consolidated financial statements:

Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. These loans currently 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 (Level II).  As such, the Company records any fair value adjustments on a nonrecurring basis.  No nonrecurring fair value adjustments were recorded on loans held for sale during the nine or three months ended September 30, 2011.  Gains and losses on the sale of loans are recorded within income from mortgage banking on the consolidated statements of operations.

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 the present value of expected future cash flows discounted at the loan’s effective interest rate, the observable market price of the loan, or the fair value of the underlying collateral.  Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable.  The vast majority of the collateral is real estate.  The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level II).  However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level III. As of September 30, 2011, four impaired loans with a net balance of $463,000 were categorized as having a Level III valuation due to the date of the last appraisal.  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 III).  Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Impaired loans for which no further loss is expected are not considered to be measured at fair value on a nonrecurring basis.  Any fair value adjustments as a result of the evaluation process are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.

When collateral-dependent loans are performing in accordance with the original terms of their contract, the Company continues to use the appraisal that was done at origination as the basis for the collateral value.  When collateral-dependent loans are considered non-performing, they are assessed to determine the next appropriate course of action:  either foreclosure or modification with forbearance agreement.  The loans would then be re-appraised prior to foreclosure or before a forbearance agreement is executed.  Thereafter, collateral for loans under a forbearance agreement may be re-appraised as the circumstances warrant.  This process does not vary by loan type.

The Company’s procedure to monitor the value of collateral for collateral dependent impaired loans between the receipt of an original appraisal and an updated appraisal is to review tax assessment records when they change annually, to obtain on a judgmental basis, independent real estate evaluations, and to monitor the general level and direction of movement of regional real estate market conditions.  At the time of any change in tax assessment, an appropriate adjustment is made to the existing appraised value and any resulting initial or additional fair value adjustment is made at that time.  

29

Information considered in a determination not to order an updated appraisal includes the availability and reliability of tax assessment records, the results of any independent real estate evaluation, and significant changes in capitalization rates for income properties since the original appraisal.  Other facts and circumstances on a case by case basis may be considered relative to a decision to order or not to order an updated appraisal.  If, in the judgment of management, a reliable collateral value estimate can not be obtained by an alternative method, an updated appraisal is obtained.

Circumstances that may warrant a re-appraisal for non-performing (impaired) loans might include foreclosure proceedings or a material adverse change in the borrower’s condition or that of the collateral underlying the loan.  Examples include bankruptcy filing by the debtor or guarantors, loss of a major tenant in an income property, or a significant increase in capitalization rates for income properties.  In some cases, management may decide that an updated appraisal for a non-performing loan is not necessary.  In such cases, an estimate of the fair value of the collateral for the loans would be made by management by reference to current tax assessment records, a current independent real estate evaluation, the latest appraised value, and knowledge of collateral value fluctuations in a loan’s market area.

For the purpose of the evaluation of the adequacy of our allowance for loan losses, new appraisals are discounted 10% for selling costs when determining the amount of the specific reserve.  Thereafter, for collateral dependent impaired loans, we consider each loan on a case-by-case basis to determine whether or not the recorded values are appropriate given current market conditions.  When warranted, new appraisals or independent real estate evaluations are obtained.  If an appraisal is less than 12 months old, the only adjustment made to appraised values is the 10% discount for selling costs.  If an appraisal is older than 12 months, management will use judgment based on knowledge of current market values and specific facts surrounding any particular property to determine if an additional valuation adjustment may be necessary.

For real estate-secured impaired loans, if the Company does not have an adequate appraisal a new one is ordered to determine fair value.  An appraisal that would be considered adequate for real estate-secured loans is one that is less than 12 months or one that is more than 12 months old but alternative methods with which to monitor the collateral value exist, such as reference to frequently updated tax assessments, or independent real estate evaluations.  Appraisals that would be considered inadequate for real estate-secured loans include appraisals older than 12 months and with a property located in a jurisdiction that does not reassess property values on a regular basis, or with a property to which substantial changes have been made since the last assessment. If the loan is secured by assets other than real estate and an appraisal is neither available nor feasible, the loan is treated as unsecured.

It is the Company’s policy to account for partially charged-off loans consistently both before and after updated appraisals are obtained.  Partially charged-off loans are placed in non-accrual status and remain in that status until the borrower has made a minimum of six consecutive monthly payments on a timely basis and there is evidence that the borrower has the ability to repay the balance of the loan plus accrued interest in full.   Partially charged-off loans are not automatically returned to accrual status when updated appraisals are obtained.

     Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.

30

The following table summarizes the Company’s financial assets that were measured at fair value on a nonrecurring basis as of September 30, 2011 and December 31, 2010:

	September 30, 2011 (In thousands)
	Total		Level I		Level II		Level III
Assets:
Loans held for sale	$	66,910	$	-	$	66,910	$	-
Impaired loans		14,100		-		13,637		463
	December 31, 2010 (In thousands)
Description	Total		Level I		Level II		Level III
Assets:
Loans held for sale	$	59,361	$	-	$	59,361	$	-
Impaired loans		13,267		-		12,528		739

Other Real Estate Owned

The value of other real estate owned (“OREO”) is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level II).  For other real estate owned properties, the Company’s policy is to obtain “as-is” appraisals on an annual basis as opposed to “as-completed” appraisals.  This approach provides current values without regard to completion of any construction or renovation that may be in process on OREO properties.  Accordingly, the Company considers the valuations to be Level II valuations even though some properties may be in process of renovation or construction.  As of September 30, 2011, the Company had one OREO property considered to be in construction with a carrying value of approximately $1.1 million.

For the purpose of OREO valuations, appraisals are discounted 10% for selling and holding costs and it is the policy of the Company to obtain annual appraisals for properties held in OREO.

Any fair value adjustments are recorded in the period incurred as “Other real estate owned expenses” on the consolidated statements of operations.

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

	September 30, 2011 (In thousands)
	Total		Level I		Level II		Level III
Assets:
Other real estate owned	$	6,096	$	-	$	6,096	$	-
	December 31, 2010 (In thousands)
Description	Total		Level I		Level II		Level III
Assets:
Other real estate owned	$	8,394	$	-	$	8,394	$	-

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company’s various financial instruments.  In cases where quoted market prices are not available, fair values are based on

31

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.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.  U.S. generally accepted accounting principles excludes certain financial instruments and all non-financial instruments from its disclosure requirements.  Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents

For those cash equivalents, the carrying amount is a reasonable estimate of fair value.

Loans, Net and Loans Held for Sale

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.  The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality.  Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were utilized as estimates for fair value.

Accrued Interest Receivable and Payable

The carrying amounts of accrued interest approximate fair values.

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date.  For all other deposits, the fair value is determined using the discounted cash flow method.  The discount rate used is equal to the rate currently offered on similar products.

Securities Sold Under Agreements to Repurchase and Short-Term Debt

The carrying amounts approximate fair values.

FHLB Borrowings, Long-Term and Subordinated Debt

For variable rate long-term debt, fair values are based on carrying values.  For fixed rate debt, fair values are estimated based on observable market prices and discounted cash flow analysis using interest rates for borrowings of similar remaining maturities and characteristics.  The fair values of the Company's Subordinated Debentures are estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.

Off-Balance-Sheet Financial Instruments

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the

32

difference between current levels of interest rates and the committed rates.  The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.  At September 30, 2011 and December 31, 2010, the fair values of loan commitments and standby letters of credit were deemed immaterial; therefore, they have not been included in the table below.

The estimated fair values, and related carrying amounts, of the Company's financial instruments are as follows as of the indicated dates:

	September 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
	(In thousands)
Financial assets:
Cash and cash equivalents	$	41,358	$	41,358	$	64,724	$	64,724
Securities		303,014		303,014		252,042		252,042
Loans		727,599		749,547		703,706		723,629
Accrued interest receivable		3,669		3,669		3,655		3,655
Interest rate swap		-		-		312		312
Financial liabilities:
Deposits	$	909,696	$	899,965	$	890,306	$	869,606
Securities sold under agreements
to repurchase		31,286		31,286		25,562		25,562
Short-term debt		12,864		12,864		13,320		13,320
FHLB borrowings		77,912		79,038		62,912		63,512
Trust preferred capital notes		5,155		5,229		5,155		5,167
Accrued interest payable		757		757		879		879
Interest rate swap		284		284		-		-

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

Note 11.                      Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are

33

effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years.  The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

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

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

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

The Securities Exchange Commission (SEC) issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting.”  The rule requires companies to submit financial statements in extensible business reporting language (XBRL)format with their SEC filings on a phased-in schedule.  Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010.  All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011.  The Company complied with this Rule beginning with the filing of the June 30, 2011 Form 10-Q.

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

34

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

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

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

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

35

In August 2011, the SEC issued Final Rule No. 33-9250, “Technical Amendments to Commission Rules and Forms related to the FASB’s Accounting Standards Codification.”  The SEC has adopted technical amendments to various rules and forms under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940.  These revisions were necessary to conform those rules and forms to the FASB Accounting Standards Codification.  The technical amendments include revision of certain rules in Regulation S-X, certain items in Regulation S-K, and various rules and forms prescribed under the Securities Act, Exchange Act and Investment Company Act.  The Release was effective as of August 12, 2011.  The adoption of the release did not have a material impact on the Company’s consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, “Intangible – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment.”  The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350.  The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent.  Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount.  The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued.  The Company is currently assessing the impact that ASU 2011-08 will have on its consolidated financial statements.

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

The following discussion and analysis of the financial condition at September 30, 2011 and results of operations of the Company for the three and nine months ended September 30, 2011 and 2010 should be read in conjunction with the Company’s Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included in this report and in the 2010 Form 10-K.  It should also be read in conjunction with the “Caution About Forward Looking Statements” section at the end of this discussion.

Overview

The Company is headquartered in Middleburg, Virginia and conducts its primary operations through two wholly owned subsidiaries, Middleburg Bank and Middleburg Investment Group, Inc., and a majority owned subsidiary, Southern Trust Mortgage, LLC.  Middleburg Bank is a community bank serving the Virginia counties of Loudoun, Fairfax, Fauquier and western Prince William as well as the town of Williamsburg, Virginia and the city of Richmond, Virginia.  The Bank operates seven financial service centers and two limited service facilities. Middleburg Investment Group is a non-bank holding

36

company that was formed in the fourth quarter of 2005.  It has one wholly-owned subsidiary, Middleburg Trust Company which is headquartered in Richmond, Virginia, and maintains offices in Williamsburg, Virginia and in several of Middleburg Bank’s facilities.  Southern Trust Mortgage is a regional mortgage company headquartered in Virginia Beach, Virginia and maintains offices in Virginia, Maryland, Georgia, North Carolina and South Carolina.

The Company operates under a business model that makes all of its financial and wealth management services available to its clients at all of its financial service centers.  Financial service centers are larger than most traditional retail banking branches in order to allow commercial, mortgage, retail and wealth management personnel and services to be readily available to serve clients.  By working together in the financial service center and the market, the team at each financial service center becomes more effective in expanding relationships with current clients and new clients.  The Company’s goal is to assist in the creation, preservation and ultimate transfer of the wealth of its clients.

The Company generates a significant amount of its income from the net interest income earned by Middleburg Bank.  Net interest income is the difference between interest income and interest expense.  Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon.  Middleburg Bank’s cost of money is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon.  The quality of the assets further influences the amount of interest income lost on non-accrual loans and the amount of additions to the allowance for loan losses.  Middleburg Bank also generates income from fees on deposits and loans.

Middleburg Investment Group’s subsidiary, Middleburg Trust Company, generates fee income by providing trust and investment management services to its clients.  Investment management and trust fees are generally based upon the value of assets under administration and, therefore, can be significantly affected by fluctuation in the values of securities caused by changes in the capital markets.

Southern Trust Mortgage generates fees from the origination and sale of mortgage loans. Southern Trust Mortgage also maintains a real estate construction portfolio and receives interest and fee income from these loans, which, net of interest expense, is included in net interest income.

Net income attributable to the Company for the nine months ended September 30, 2011 increased to $3.8 million from a net loss of $4.3 million during the same period in 2010.  Net income attributable to the Company for the third quarter increased to $1.4 million from a net loss of $5.8 million during the third quarter of 2010.  Earnings per fully diluted share for the nine months ended September 30, 2011 was $0.55 per share versus a net loss of $0.61 per share for the same period in 2010 and $0.20 per share for the quarter ended September 30, 2011 versus a net loss of $0.83 per share for the quarter ended September 30, 2010.

Annualized return on total average assets for the nine months ended September 30, 2011 was 0.46%, compared to -0.55% for the same period in 2010.  Annualized return on total average equity of Middleburg Financial Corporation, which excludes the non-controlling interest in Southern Trust Mortgage, for the nine months ended September 30, 2011, was 5.07%, compared to -5.54% for the first nine months of 2010.

As a result of the evaluation of the adequacy of the reserve for loan losses, the Company increased its reserve for loan losses by $157,000 during the nine months ended September 30, 2011 from the balance at December 31, 2010.  The provision for loan losses was $2.6 million for the nine months ended September 30, 2011 versus $11.4 million for the nine months ended September 30, 2010 and $1.0 million for the quarter ended September 30, 2011 versus $9.1 million for the quarter ended September 30, 2010.

37

Net interest income for the nine months ended September 30, 2011 was $28.0 million compared to $24.8 million for the nine months ended September 30, 2010.  Total non-interest income increased $587,000 to $18.6 million for the nine months ended September 30, 2011 from $18.0 million for the nine months ended September 30, 2010.  Total non-interest expenses increased approximately $670,000 to $39.3 million for the nine months ended September 30, 2011 from $38.6 million for the same period in 2010.

Net interest income for the three months ended September 30, 2011 was $9.6 million compared to $8.0 million for the three months ended September 30, 2010.  Total non-interest income increased by $723,000 to $7.6 million for the three months ended September 30, 2011 compared to $6.9 million for the three months ended September 30, 2010. Total non-interest expenses decreased approximately $310,000 to $14.1 million for the quarter ended September 30, 2011 from $14.4 million for the same period in 2010.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law.  The Dodd-Frank Act contains significant modifications to the current bank regulatory structure and requires various federal agencies to adopt a broad range of new implementing rules and regulations throughout 2011 and beyond.  While not determinable at this time, the impact of the Dodd-Frank Act and the rules and regulations that will be promulgated thereunder could significantly affect our operations, increase our operating costs and divert management resources.  Other than the potential impact of this legislation, the Company is not aware of any current recommendations by any regulatory authorities that, if implemented, would have a material effect on the registrant’s liquidity, capital resources or results of operations.

Critical Accounting Policies

General

The financial condition and results of operations presented in the Consolidated Financial Statements, the accompanying Notes to Consolidated Financial Statements and this section are, to a large degree, dependent upon the accounting policies of the Company.  The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change.

Presented below is discussion of those accounting policies that management believes are the most important (“Critical Accounting Policies”) to the portrayal and understanding of the Company’s financial condition and results of operations.  The Critical Accounting Policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain.  In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.

Allowance for Loan Losses

Middleburg Bank monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio.  Middleburg Bank maintains policies and procedures that address the systems of controls over the following areas of maintenance of the allowance:  the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

38

Middleburg Bank evaluates various loans individually for impairment as required by applicable accounting standards.  Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management.  The evaluations are based upon discounted expected cash flows or collateral valuations.  If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.  If a loan evaluated individually is not impaired, then the loan is assessed for impairment with a group of loans that have similar characteristics.

For loans without individual measures of impairment, Middleburg Bank makes estimates of losses for groups of loans as required by applicable accounting standards.  Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type.  A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan.  The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans, including:  borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of loan losses.  This estimate of losses is compared to the allowance for loan losses of Middleburg Bank as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made.  If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates.  If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses.  Middleburg Bank recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high.  If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the Consolidated Financial Statements.

Intangibles and Goodwill

The Company had approximately $6.2 million in intangible assets and goodwill at September 30, 2011, a decrease of $116,000 or 1.8% since December 31, 2010.

  On April 1, 2002, the Company acquired Middleburg Investment Advisors for $6.0 million.  Approximately $5.9 million of the purchase price was allocated to intangible assets and goodwill.  In connection with this investment, a purchase price valuation was completed to determine the appropriate allocation to identified intangibles.  The valuation concluded that approximately 42% of the purchase price was related to the acquisition of customer relationships with an amortizable life of 15 years.  Another 19% of the purchase price was allocated to a non-compete agreement with an amortizable life of seven years.  The remainder of the purchase price has been allocated to goodwill.  On January 3, 2011, Middleburg Investment Advisors was consolidated into Middleburg Trust Company and ceased operating as an independent entity.  The goodwill and intangible assets of the former Middleburg Investment Advisors are now reflected in the records of Middleburg Trust Company.  Approximately $942,000 of the $6.2 million in intangible assets and goodwill at September 30, 2011 was attributable directly to the Company’s investment in Middleburg Trust Company.  With the consolidation of Southern Trust Mortgage, the Company recognized $1.9 million in goodwill as part of its equity investment.

39

The purchase price allocation process requires management estimates and judgment as to expectations for the life span of various customer relationships as well as the value that key members of management add to the success of the Company.  For example, customer attrition rates were determined based upon assumptions that the past five years may predict the future.  If the actual attrition rates, among other assumptions, differed from the estimates and judgments used in the purchase price allocation, the amounts recorded in the Consolidated Financial Statements could result in a possible impairment of the intangible assets and goodwill or require acceleration in the amortization expense.

In addition, current accounting standards require that goodwill be tested annually using a two-step process.  The first step is to identify a potential impairment.  The second step measures the amount of the impairment loss, if any.  Processes and procedures have been identified for the two-step process.  The most recent evaluation was conducted as of September 30, 2010.

As of September 30, 2011, the Company recognized two consolidated subsidiaries as reporting units for the purpose of goodwill evaluation and reporting:  Southern Trust Mortgage (“STM”) and Middleburg Investment Group (“MIG”).   MIG is the parent company of Middleburg Trust Company and the former Middleburg Investment Advisors.  The following table shows the allocation of goodwill between the two reporting units and the percentage by which the fair value of each reporting unit as of September 30, 2010 (the most recent fair value evaluation date) exceeded the carrying value as of that date.  Management does not believe the estimated fair values have changed significantly from September 30, 2010 to September 30, 2011.

	Allocation of Goodwill to Reporting Units
			(Dollars in Thousands)
								Percentage by
			(1)			(1)		which Fair Value
	Carrying Value		Carrying Value			Estimated Fair Value		of Reporting
Reporting	of Goodwill		of Reporting Unit			of Reporting Unit		Unit Exeeds
Unit	September 30, 2010		September 30, 2010			September 30, 2010		Carrying Value
STM	$	1,867	$	6,547		$	7,797		19.09	%
MIG		3,422		5,952	(2)		6,790		14.08	%
Total	$	5,289	$	12,499		$	14,587		16.71	%
(1)  Reported amounts reflect only Middleburg Financial Corporation shareholders' ownership interests.
Estimated fair values are as of September 30, 2010. Management does not believe the estimated fair
values have changed significantly from September 30, 2010 to September 30, 2011.
(2) Includes $1.1 million of amortizing intangible assets at September 30, 2010.

Management estimates fair value utilizing multiple methodologies which include discounted cash flows, comparable companies, third-party sale and assets under management analysis. Determining the fair value of the Company’s reporting units requires management to make judgments and assumptions related to various items, including estimates of future operating results, allocations of indirect expenses, and discount rates.  Management believes its estimates and assumptions are reasonable; however, the fair value of each reporting unit could be different in the future if actual results or market conditions differ from the estimates and assumptions used.

40

The Company’s forecasted cash flows for its reporting units assume a stable economic environment and consistent long-term growth in loan originations and assets under management over the projected periods.  Additionally, expenses are assumed to be consistently correlated with projected asset and revenue growth over the time periods projected.  Although we believe the key assumptions underlying the financial forecasts to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond the control of the Company.  Accordingly, there can be no assurance that the forecasted results will be realized and variations from the forecast may be material.  If weak economic conditions continue or worsen for a prolonged period of time, or if the reporting unit loses key personnel, the fair value of the reporting unit may be adversely affected which may result in impairment of goodwill or other intangible assets in the future.  Any changes in the key management estimates or judgments could result in an impairment charge, and such a charge could have an adverse effect on the Company’s financial condition and results of operations.

Tax-Equivalent Interest Income

Tax-equivalent interest income is gross interest income adjusted for the non-taxable interest income earned on loans, municipal securities and corporate securities, which are dividend-received deduction eligible.  The effective tax rate of 34% is used in calculating tax equivalent income related to loans, municipal securities and corporate securities.

Other-Than-Temporary Impairment (OTTI)

Approximately $22,000 in losses related to other-than-temporary impairment on trust-preferred securities was recognized for the nine months ended September 30, 2011 with approximately $21,000 recognized in the third quarter. At September 30, 2011, the Company had $501,000 in trust-preferred securities in its portfolio.

In accordance with applicable accounting guidance, we determine the other-than-temporary impairment for the trust preferred securities in the securities portfolio based on an evaluation of the underlying collateral.  We developed cash flow projections based upon assumptions of default/deferral rates, recovery rates and prepayment rates for the collateral.  The present value of the projected cash flows was calculated by discounting the projected cash flows using the effective yield at purchase in accordance with applicable accounting guidance.  Finally, the present values of the projected cash flows were compared to the carrying values of the securities.  If the present values were less than the carrying value, we determined that the security had an other-than-temporary impairment equal to the difference between the present value and the carrying value of the bond.

The Company may need to recognize additional other-than-temporary impairments related to trust preferred securities during the remainder of 2011.  We evaluate default assumptions and cash flow projections in relation to the credit performance of the collateral that underlies the trust preferred securities.  Should additional deferrals/defaults occur on the collateral, projected cash flows from the collateral could be reduced which could result in additional other-than-temporary impairments in 2011.

Financial Condition

Assets, Liabilities and Shareholders’ Equity

Total assets for the Company were $1.2 billion at September 30, 2011, an increase of $49.1 million or 4.4% compared to total assets at December 31, 2010.  Total average assets increased 6.8% from $1.04 billion for the nine months ended September 30, 2010 to $1.11 billion for the same period in 2011.  Total liabilities were $1.05 billion at September 30, 2011, compared to $1.00 billion at December 31, 2010.  Total average liabilities increased $72.3 million or 7.8% to $1.0 billion for the nine months ended September 30, 2011, compared to $933.3 million for the same period in 2010.  Average shareholders’ equity decreased 1.7% or $1.7 million over the same periods.

41

Loans

Total loans, including loans held for sale at September 30, 2011 were at $743.0 million, higher by $24.1 million from the December 31, 2010 amount of $718.7 million.  Loans held for sale increased to $66.9 million at September 30, 2011, compared to $59.4 million at December 31, 2010, an increase of 12.7% during the period.  The primary reason for the increase in loans held for sale was an increase in mortgage originations during the third quarter of 2011 compared to the fourth quarter of 2010. Southern Trust Mortgage originated $470.0 million in loans for the nine months ended September 30, 2011, compared to $555.4 million for the nine months ended September 30, 2010.  The Company experienced a decrease in real estate construction loans, which were $48.6 million at September 30, 2011, compared to $68.1 million at December 31, 2010.  Real estate mortgage loans of $513.6 million at September 30, 2011 increased from the December 31, 2010 amount of $510.9 million.  Commercial loans, which are primarily loans to businesses, increased to $91.3 million at September 30, 2011, compared to $56.4 million at December 31, 2010.  Net charge-offs were $2.4 million for the nine months ended September 30, 2011 versus $4.7 million for the same period in 2010.  The provision for loan losses for the nine months ended September 30, 2011 was $2.6 million compared to $11.4 million for the same period in 2010 and $1.0 million for the three months ended September 30, 2011 compared to $9.1 million for the three months ended September 30, 2010.  The allowance for loan losses at September 30, 2011 was $15.1 million or 2.24% of total loans outstanding, excluding loans held for sale, compared to $15.0 million and 2.27% at December 31, 2010.

The following table presents information on the Company’s nonperforming assets as of the dates indicated:

42

	Nonperforming Assets
	Middleburg Financial Corporation
	September 30,			December 31,
	2011			2010			2009			2008			2007
	(In thousands)
Nonperforming assets:
Nonaccrual loans	$	30,485		$	29,385		$	8,606		$	6,890		$	6,635
Restructured loans (1)		404			1,254			2,096			-			-
Accruing loans greater than
90 days past due		1,561			909			908			1,117			30
Total nonperforming loans	$	32,450		$	31,548		$	11,610		$	8,007		$	6,665
Foreclosed property		6,096			8,394			6,511			7,597			-
Total nonperforming assets	$	38,546		$	39,942		$	18,121		$	15,604		$	6,665
Allowance for loan losses	$	15,124		$	14,967		$	9,185		$	10,020		$	7,093
Nonperforming loans to
period end portfolio loans		4.80	%		4.78	%		1.80	%		1.19	%		1.03	%
Allowance for loan losses
to nonperforming loans		46.61	%		47.44	%		79.11	%		125.14	%		106.42	%
Nonperforming assets to
period end assets		3.34	%		3.62	%		1.86	%		1.58	%		0.79	%
(1) Amount reflects restructured loans that are not included in nonaccrual loans.

The Company utilizes the ratios included in the above table to evaluate the relative level of nonperforming assets included in the Company’s balance sheet.  Changes in the ratios assist management in evaluating the overall adequacy of the allowance for loan losses and any reserve against other real estate owned.

Our accounting policy for foreclosed property does not include any allowance for loan loss amounts subsequent to the reclassification event which writes the loan down to fair value when moved into foreclosed property.

The following table depicts the transactions, in summary form, that occurred to the allowance for loan losses in each period presented:

43

Allowance for Loan Losses
	Nine Months			Year
	Ended			Ended
	September 30, 2011			December 31, 2010
Balance, beginning of year	$	14,967		$	9,185
Provision for loan losses		2,565			12,005
Charge-offs:
Real estate loans:
Construction		363			1,226
Secured by 1-4 family residential		1,417			3,256
Other real estate loans		396			460
Commercial loans		82			942
Consumer loans		314			500
Total charge-offs	$	2,572		$	6,384
Recoveries:
Real estate loans:
Construction	$	28		$	-
Secured by 1-4 family residential		13			37
Other real estate loans		78			4
Commercial loans		23			68
Consumer loans		22			52
Total recoveries	$	164		$	161
Net charge-offs		2,408			6,223
Balance, end of period	$	15,124		$	14,967
Ratio of allowance for loan losses
to portfolio loans outstanding at end of period		2.24	%		2.27	%
Ratio of net charge offs to average
portfolio loans outstanding during the period		0.48	%		0.88	%

The following table shows the balance of the allowance for loan losses allocated to each major loan type and the percent of loans in each category to total loans as of September 30, 2011 and December 31, 2010:

Allocation of Allowance for Loan Losses
			Percent of loans					Percent of loans
	September 30,		in each category			December 31,		in each category
	2011		to total loans			2010		to total loans
Commercial, financial and agricultural	$	1,653		15.04	%	$	1,162		8.55	%
Real estate construction		2,212		7.19	%		4,684		10.33	%
Real estate mortgage		11,124		75.99	%		8,736		77.49	%
Consumer loans		135		1.78	%		385		3.63	%
Totals	$	15,124		100.00	%	$	14,967		100.00	%

44

Non-performing Loans

Non-performing loans were $32.5 million at September 30, 2011 compared to $31.6 million at December 31, 2010.

Non-accrual loans were $30.5 million at the end of the third quarter compared to $29.4 million as of December 31, 2010, representing an increase of 3.7% during the first nine months of 2011.   The primary reason for the increase in non-accrual loans during the year was because a large credit that was more than 90 days delinquent in the first quarter, was moved to non-accrual status in the second quarter of 2011.

Restructured Loans

Included in the “Nonperforming Assets” table above are troubled debt restructurings (“TDR’s”) that were classified as impaired.  The total balance of TDR’s at September 30, 2011 was $8.4 million of which $8.0 million were included in the Company’s non-accrual loan totals at that date and $404,000 represented loans performing as agreed to the restructured terms. This compares with $4.5 million in total restructured loans at December 31, 2010, an increase of $3.9 million or 86.7%.  The amount of the valuation allowance related to total TDR’s was $1.5 million and $532,000 as of September 30, 2011 and December 31, 2010 respectively.

The $8.0 million in nonaccrual TDR’s as of September 30, 2011 is comprised of $572,000 million in real estate construction loans, $3.9 million in 1-4 family real estate loans, $2.3 million in non-residential real estate loans, $764,000 in commercial loans, and $416,000 in consumer loans.  The $404,000 in TDR’s which were performing as agreed under restructured terms as of September 30, 2011 is represented by  two 1-4 family real estate loans.  The Company considers all loans classified as TDR’s to be impaired as of September 30, 2011.

The Company requires six timely consecutive monthly payments before a restructured loan that has been placed on non-accrual can be returned to accrual status.  No restructured loans were charged off during the quarter or nine month period ended September 30, 2011.  The Company does not utilize formal modification programs or packages when loans are considered for restructuring.  Any loan restructuring is based on the borrower’s circumstances and may include modifications to more than one of the terms and conditions of the loan.

The Company has not performed any commercial real estate or other type of loan workout whereby the existing loan would have been structured into multiple new loans.

Securities

Securities, excluding Federal Reserve and Federal Home Loan Bank stock, increased to $303.0 million at September 30, 2011 compared to $252.0 million at December 31, 2010, an increase of 20.2% during the period. The balance in interest-bearing bank balances decreased to $41.4 million as of September 30, 2011 versus $64.7 million at December 31, 2010.  The Company sold $26.2 million in securities, received proceeds of $42.1 million from maturities and principal payments, and purchased securities of $112.3 million for the nine months ended September 30, 2011.  Approximately $22,000 in losses related to other-than-temporary impairments on trust-preferred securities was recognized for the nine months ended September 30, 2011.  At September 30, 2011, the Company had $501,000 in trust-preferred securities in its portfolio of which $257,000 are considered other-than-temporarily impaired.

45

The Company will continue to maintain its securities portfolio as a source of liquidity and collateral.  At September 30, 2011, the year-to-date tax equivalent yield on the securities portfolio was 3.65%.

Premises and Equipment

Net Premises and equipment increased by $352,000 from $21.1 million at December 31, 2010 to $21.5 million at September 30, 2011.  The increase is the net of the change in accumulated depreciation and additions to premises and equipment during the period.

Goodwill and Other Identified Intangibles

Goodwill and other identified intangibles decreased $116,000 to $6.2 million at September 30, 2011 as the result of amortization of identified intangibles related to the acquisition of Middleburg Investment Advisors.

Other Real Estate Owned

Other real estate owned, net of valuation allowance, decreased by $2.3 million to $6.1 million at September 30, 2011 from $8.4 million at December 31, 2010.  The change in balance is the net of foreclosed real estate loans  added to other real estate owned, valuation adjustments and sales of other real estate owned properties during the period.  During the nine months ended September 30, 2011, the Company received proceeds of $2.9 million from the sale of other real estate owned properties and incurred a net loss of $336,000 on the sales. Valuation adjustments to properties held in OREO were approximately $774,000 during the nine months ended September 30, 2011.

Other Assets

Other assets decreased $352,000 to $36.4 million at September 30, 2011, when compared to December 31, 2010.  The other assets section of the balance sheet includes Bank Owned Life Insurance (BOLI), in the amount of $15.9 million and net deferred tax assets in the amount of $7.0 million at September 30, 2011.

Deposits

Deposits increased by $19.4 million to $909.7 million at September 30, 2011 from $890.3 million at December 31, 2010.  Average deposits for the nine months ended September 30, 2011 increased 4.9% or $40.8 million compared to average deposits for the nine months ended September 30, 2010.  Average interest bearing deposits were $754.7 million for the nine months ended September 30, 2011 compared to $727.2 million for the nine months ended September 30, 2010.

  The Company has an interest bearing product, known as Tredegar Institutional Select, that integrates the use of the cash within client accounts at Middleburg Trust Company for overnight funding at the Bank.  The overall balance of this product was $30.8 million at September 30, 2011 and is reflected in both the savings and interest bearing demand deposits and the “securities sold under agreements to repurchase” amounts on the balance sheet.

Time deposits decreased $14.7 million from December 31, 2010 to $308.4 million at September 30, 2011.  Time deposits include brokered certificates of deposit and CDARS deposits, which decreased $23.1 million or 18.9% to $99.2 million at September 30, 2011 from the December 31, 2010 amount of $122.3 million.  The brokered certificates of deposit have maturities ranging from one month to five years.  Securities sold under agreements to repurchase (“Repo Accounts”) increased $5.7 million from

46

$25.6 million at December 31, 2010 to $31.3 million at September 30, 2011.  The Repo Accounts include certain long-term commercial checking accounts with average balances that typically exceed $100,000 and the Tredegar Institutional Select account which includes accounts maintained by Middleburg Trust Company’s business clients.  All repurchase agreement transactions entered into by the Company are accounted for as collateralized financings and not as sales.

Short-term Borrowings and FHLB Borrowings

The Company had a short term advance from the Federal Home Loan Bank of Atlanta (“FHLB”) of $7.0 million outstanding at September 30, 2011 and no FHLB short term advances outstanding at December 31, 2010.  There were no FHLB overnight advances at September 30, 2011 and December 31, 2010, respectively.  Southern Trust Mortgage has a line of credit with a regional bank that is primarily used to fund its loans held for sale.  At September 30, 2011, this line had an outstanding balance of $5.9 million compared to $13.3 million at December 31, 2010.  The line of credit is based on the London Inter-Bank Offered Rate (“LIBOR”).  Southern Trust Mortgage also has a $5.0 million line of credit and a $75.0 million participation agreement with Middleburg Bank.  The line of credit and the outstanding balance under the participation agreement are eliminated in the consolidation process and are not reflected in the consolidated financial statements of the Company.  FHLB advances increased by $15.0 million at September 30, 2011 to $77.9 million from $62.9 million at December 31, 2010.  The increase was used to fund loan originations and securities purchases.

Other Liabilities

Other liabilities increased by $1.9 million to $9.2 million at September 30, 2011, when compared to December 31, 2010.

Non-controlling Interest in Consolidated Subsidiary

The Company, through Middleburg Bank owns 62.3% of the issued and outstanding membership interest units in Southern Trust Mortgage.  The remaining 37.7% of issued and outstanding membership interest units are owned by other partners.  The ownership interest of these partners is represented in the financial statements as “Non-controlling Interest in Consolidated Subsidiary.”  The non-controlling interest is reflected in total shareholders’ equity.  Southern Trust Mortgage also has preferred stock of $865,000 issued and outstanding at September 30, 2011. The Company, through Middleburg Bank owns 70.4% of the issued and outstanding preferred stock in Southern Trust Mortgage.  The remaining 29.6% of issued and outstanding preferred stock is owned by other partners.  The preferred stock held by these other partners is reflected in other liabilities.

Capital

Total shareholders’ equity, including the non-controlling interest in Southern Trust Mortgage, was $107.6 million at September 30, 2011.  This amount represents an increase of 7.6% from the December 31, 2010 amount of $100.0 million. Middleburg Financial Corporation’s shareholders’ equity, which excludes the non-controlling interest, was $105.3 million at September 30, 2011, compared to $97.0 million at December 31, 2010.  The book value of common shareholders was $15.04 per share at September 30, 2011 and $14.02 at December 31, 2010.  The following table shows the Company’s risk-based capital ratios as of September 30, 2011 and December 31, 2010:

47

	September 30,			December 31,
	2011			2010
Total risk-based capital ratio		14.1	%		14.1	%
Tier 1 risk-based capital ratio		12.9	%		12.8	%
Tier 1 leverage ratio		9.0	%		9.0	%

Results of Operations

Net Interest Income

Net interest income is the Company’s primary source of earnings and represents the difference between interest and fees earned on earning assets and the interest expense paid on deposits and other interest bearing liabilities.

Net interest income for the nine months ended September 30, 2011 was $28.0 million, compared to $24.8 million for the same period in 2010.  Total interest income for the nine months ended September 30, 2011 was $36.2 million compared to $35.9 million for the nine months ended September 30, 2010 representing an increase of 0.7%.  Total interest expense was $8.2 million for the nine months ended September 30, 2011 compared to $11.1 million for the same period in 2010 representing a decrease of 25.9%.  Average earning assets increased by $77.1 million to $1.1 billion for the nine months ended September 30, 2011 from $955.9 million for the nine months ended September 30, 2010.  Average interest bearing liabilities increased by $59.2 million or 7.3% to $873.2 million for the nine months ended September 30, 2011 when compared to the same period in 2010.

Net interest income for the three months ended September 30, 2011 was $9.6 million, compared to $7.9 million for the same period in 2010.  Total interest income for the three months ended September 30, 2011 was $12.3 million compared to $11.7 million for the three months ended September 30, 2010.  Total interest expense was $2.7 million for the three months ended September 30, 2011 compared to $3.7 million for the same period in 2010 representing a decrease of 26.5%.  Average earning assets increased by $68.6 million to $1.07 billion for the three months ended September 30, 2011 from $1.09 billion for the three months ended September 30, 2010.  Average interest bearing liabilities increased by $38.4 million or 4.5% to $895.7 million for the three months ended September 30, 2011 when compared to the same period in 2010.

The following tables reflect an analysis of the Company’s net interest income using the daily average balances of the Company’s assets and liabilities for the periods indicated.  Non-accrual loans are included in the loan balances.

48

	MIDDLEBURG FINANCIAL CORPORATION
	Average Balances, Income and Expenses, Yields and Rates
	Nine Months Ended September 30
				2011								2010
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate (2)			Balance			Expense		Rate (3)
	(Dollars in thousands)
Assets :
Securities:
Taxable	$	224,461		$	4,985		2.97	%	$	145,188		$	3,269		3.01	%
Tax-exempt (1)		55,739			2,662		6.39	%		60,078			2,900		6.45	%
Total securities	$	280,200		$	7,647		3.65	%	$	205,266		$	6,169		4.02	%
Total loans (3)	$	706,995		$	29,378		5.56	%	$	701,446		$	30,661		5.84	%
Interest bearing deposits in
other financial institutions		45,819			90		0.26	%		49,194			99		0.27	%
Total earning assets	$	1,033,014		$	37,115		4.80	%	$	955,906		$	36,929		5.17	%
Less: allowances for credit losses		(14,816	)							(9,742	)
Total nonearning assets		91,379								92,521
Total assets	$	1,109,577							$	1,038,685
Liabilities:
Interest-bearing deposits:
Checking	$	295,782		$	1,506		0.68	%	$	282,245		$	1,748		0.83	%
Regular savings		95,224			567		0.80	%		75,671			544		0.96	%
Money market savings		59,266			293		0.66	%		52,625			323		0.82	%
Time deposits:
$100,000 and over		135,973			1,831		1.80	%		163,380			3,508		2.87	%
Under $100,000		168,470			2,730		2.17	%		153,284			3,287		2.87	%
Total interest-bearing deposits	$	754,715		$	6,927		1.23	%	$	727,205		$	9,410		1.73	%
Short-term borrowings		5,687			174		4.07	%		9,050			245		3.61	%
Securities sold under agreements
to repurchase		32,859			209		0.85	%		24,402			144		0.79	%
Long-term debt		79,844			914		1.53	%		53,236			1,298		3.26	%
Federal Funds Purchased		56			-		0.00	%		15			-		0.00	%
Total interest-bearing liabilities	$	873,161		$	8,224		1.26	%	$	813,908		$	11,097		1.82	%
Non-interest bearing liabilities
Demand Deposits		125,979								112,721
Other liabilities		7,081								6,657
Total liabilities	$	1,006,221							$	933,286
Non-controlling interest		2,458								2,781
Shareholders' equity		100,898								102,618
Total liabilities and shareholders'
equity	$	1,109,577							$	1,038,685
Net interest income				$	28,891							$	25,832
Interest rate spread							3.54	%							3.35	%
Cost of Funds							1.10	%							1.64	%
Interest expense as a percent of
average earning assets							1.06	%							1.55	%
Net interest margin							3.74	%							3.61	%
(1) Income and yields are reported on tax equivalent basis assuming a federal tax rate of 34%.
(2) All yields and rates have been annualized on a 365 day year.
(3) Total average loans include loans on non-accrual status.

49

	MIDDLEBURG FINANCIAL CORPORATION
	Average Balances, Income and Expenses, Yields and Rates
	Three months ended September 30,
				2011								2010
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate (2)			Balance			Expense		Rate (3)
	(Dollars in thousands)
Assets :
Securities:
Taxable	$	242,906		$	1,763		2.88	%	$	172,955		$	1,198		2.75	%
Tax-exempt (1)		57,800			897		6.16	%		60,101			941		6.21	%
Total securities	$	300,706		$	2,660		3.51	%	$	233,056		$	2,139		3.64	%
Total loans (3)	$	724,450		$	9,912		5.43	%	$	716,173		$	9,832		5.45	%
Interest bearing deposits in
other financial institutions		48,355			30		0.25	%		55,721			36		0.25	%
Total earning assets	$	1,073,511		$	12,602		4.66	%	$	1,004,950		$	12,007		4.74	%
Less: allowances for credit losses		(14,956	)							(10,156	)
Total nonearning assets		84,315								93,947
Total assets	$	1,142,870							$	1,088,741
Liabilities:
Interest-bearing deposits:
Checking	$	305,761		$	529		0.69	%	$	280,585		$	569		0.80	%
Regular savings		99,344			175		0.70	%		79,348			173		0.86	%
Money market savings		58,903			98		0.66	%		55,190			101		0.73	%
Time deposits:
$100,000 and over		137,483			593		1.71	%		169,903			1,217		2.84	%
Under $100,000		169,087			892		2.09	%		171,379			1,100		2.55	%
Total interest-bearing deposits	$	770,578		$	2,287		1.18	%	$	756,405		$	3,160		1.66	%
Short-term borrowings		5,576			58		4.13	%		16,341			134		3.25	%
Securities sold under agreements
to repurchase		36,241			84		0.92	%		26,534			63		0.94	%
Long-term debt		83,067			312		1.49	%		58,067			372		2.54	%
Federal funds purchased		239			-		0.00	%		-			-		-
Total interest-bearing liabilities	$	895,701		$	2,741		1.21	%	$	857,347		$	3,729		1.73	%
Non-interest bearing liabilities
Demand deposits		133,365								117,110
Other liabilities		7,376								7,080
Total liabilities	$	1,036,442							$	981,537
Non-controlling interest		2,189								2,947
Shareholders' equity		104,239								104,257
Total liabilities and shareholders'
equity	$	1,142,870							$	1,088,741
Net interest income				$	9,861							$	8,278
Interest rate spread							3.45	%							3.01	%
Cost of Funds							1.06	%							1.59	%
Interest expense as a percent of
average earning assets							1.01	%							1.47	%
Net interest margin							3.64	%							3.27	%
(1) Income and yields are reported on tax equivalent basis assuming a federal tax rate of 34%.
(2) All yields and rates have been annualized on a 365 day year.
(3) Total average loans include loans on non-accrual status.

50

For the nine months ended September 30, 2011, interest and fees from loans was $29.4 million compared to $30.7 million for the nine months ended September 30, 2010.  For the three months ended September 30, 2011, interest and fees from loans was $9.9 million compared to $9.8 million for the three months ended September 30, 2010. The tax equivalent weighted average yield of loans decreased 28 basis points from 5.84% for the nine months ended September 30, 2010 to 5.56% for the nine months ended September 30, 2011.

For the nine month period ended September 30, 2011, interest income from the securities portfolio and invested liquid funds increased by $1.6 million to $6.8 million compared to the same period in 2010.  For the three month period ended September 30, 2011, interest income from the securities portfolio and invested liquid funds increased by $530,000 to $2.4 million compared to the same period in 2010.  The tax equivalent yield on securities for the nine months ended September 30, 2011 decreased 37 basis points to 3.65% compared to 4.02% for the nine months ended September 30, 2010.

Interest expense on deposits was $2.3 million for the three months ended September 30, 2011.  The mix of demand and savings deposits versus time deposits changed slightly to 66.1% in demand and savings deposits, and 33.9% in time deposits at September 30, 2011.  At December 31, 2010, the mix was 63.7% in savings and demand deposits, versus 36.3% in time deposits.     Interest expense on deposits for the nine months ended September 30, 2011 decreased $2.5 million or 26.4% compared to the same period in 2010.  Interest expense on deposits for the three months ended September 30, 2011, decreased $873,000 or 27.6% compared to the same period in 2010.  For the nine months ended September 30, 2011, average deposits increased $40.7 million to $880.7 million, compared to the same period in 2010.

Interest expense for securities sold under agreements to repurchase increased to $209,000 for the nine months ended September 30, 2011 from $144,000 for the nine months ended September 30, 2010.  Interest expense related to short-term borrowings decreased $71,000 from $245,000 for the nine months ended September 30, 2010 to $174,000 for the nine months ended September 30, 2011. Interest expense related to long-term debt decreased $384,000 from $1.3 million for the nine months ended September 30, 2010 to $914,000 for the nine months ended September 30, 2011.

Interest expense for securities sold under agreements to repurchase increased to $84,000 for the three months ended September 30, 2011 from $63,000 for the three months ended September 30, 2010.  Interest expense related to short-term borrowings decreased $76,000 from $134,000 for the three months ended September 30, 2010 to $58,000 for the three months ended September 30, 2011. Interest expense related to long-term debt decreased $60,000 from $372,000 for the three months ended September 30, 2010 to $312,000 for the three months ended September 30, 2011.

The net interest margin, on a tax equivalent basis, was 3.64% for the three months ended September 30, 2011 compared to 3.27% for the three-month period ended September 30, 2010.  The net interest margin was 3.74% for the nine months ended September 30, 2011 compared to 3.61% for the nine months ended September 30, 2010.  The average yield on earning assets was 4.66% for the quarter ended September 30, 2011 compared to  4.74% for the quarter ended September 30, 2010, representing a decrease of 8 basis points from the quarter ended September 30, 2010. The decrease in yields on earning assets from the quarter ended September 30, 2010 reflected a decrease of 13 basis points in the yield of the securities portfolio and a 2 basis point decrease in yields for the loan portfolio.

The Company’s net interest margin is not a measurement under accounting principles generally accepted in the United States, but it is a common measure used by the financial service industry to determine how profitably earning assets are funded.  The net interest margin is calculated by dividing tax equivalent net interest income by total average earning assets.  Because a portion of interest income earned by the Company is non taxable, the tax equivalent net interest income is considered in the

51

calculation of this ratio.  Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense.  The tax rate utilized in calculating the tax benefit is 34.0% for all periods presented.  The reconciliation of tax equivalent net interest income, which is not a measurement under accounting principles generally accepted in the United States, to net interest income is reflected in the table below.

Reconciliation of Net Interest Income to

Tax Equivalent Net Interest Income

	For the nine months ended
	September 30,
	2011		2010
GAAP measures:	(in thousands)
Interest Income – Loans	$	29,378	$	30,661
Interest Income - Investments & Other		6,832		5,282
Interest Expense – Deposits		6,927		9,410
Interest Expense - Other Borrowings		1,297		1,687
Total Net Interest Income	$	27,986	$	24,846
NON-GAAP measures:
Tax Benefit Realized on Non-Taxable Interest Income - Municipal Securities		905		986
Total Tax Benefit Realized on Non-Taxable Interest Income	$	905	$	986
Total Tax Equivalent Net Interest Income	$	28,891	$	25,832

	For the three months ended
	September 30,
	2011		2010
GAAP measures:	(in thousands)
Interest Income – Loans	$	9,912	$	9,832
Interest Income - Investments & Other		2,385		1,855
Interest Expense – Deposits		2,287		3,160
Interest Expense - Other Borrowings		454		569
Total Net Interest Income	$	9,556	$	7,958
NON-GAAP measures:
Tax Benefit Realized on Non-Taxable Interest Income - Municipal Securities		305		320
Total Tax Benefit Realized on Non-Taxable Interest Income	$	305	$	320
Total Tax Equivalent Net Interest Income	$	9,861	$	8,278

When comparing the nine months ended September 30, 2011 to the same period  in 2010, the Company’s total average earning assets increased $77.1 million, while the yield on average earnings assets decreased by 37 basis points.  Average balances in interest checking, regular savings and money market accounts increased by $39.7 million when comparing the nine months ended September 30, 2011 to the same period in 2010.  The weighted average cost of these accounts for the nine months ended September 30, 2011 and 2010 was .70% and 0.85%, respectively.  The average balance of certificates of deposits decreased by $12.2 million when comparing the nine months ended September 30, 2011 to the

52

nine months ended September 30, 2010. The weighted average cost of the Company’s certificates of deposits decreased by 87 basis points to 2.00% for the nine months ended September 30, 2011 versus the nine months ended September 30, 2010.

When comparing the three months ended September 30, 2011 to the same period  in 2010, the Company’s total average earning assets increased $68.6 million, while the yield on average earnings assets decreased by 8 basis points.  Average balances in interest checking, regular savings and money market accounts increased by $48.9 million when comparing the three months ended September 30, 2011 to the same period in 2010.  The weighted average cost of these accounts for the three months ended September 30, 2011 and 2010 was .69% and 0.81%, respectively.  The average balance of certificates of deposits decreased by $34.7 million when comparing the three months ended September 30, 2011 to the three months ended September 30, 2010. The weighted average cost of the Company’s certificates of deposits decreased by 78 basis points to 1.92% for the three months ended September 30, 2011 versus the three months ended September 30, 2010.

Other Income

Other income includes, among other items, fees generated by the retail banking and investment services departments of the Bank as well as by Middleburg Trust Company.  Other income also includes income from the Company’s 62.3% ownership interest in Southern Trust Mortgage, LLC.  Other income increased 3.3% to $18.6 million for the nine months ended September 30, 2011 compared to the same period in 2010 and increased by 10.5% to $7.6 million for the three months ended September 30, 2011 compared to the third quarter of 2010.

Trust and investment service fees earned by Middleburg Trust Company (“MTC”) increased by 19.3% compared to the quarter ended September 30, 2010.  Trust and investment service fees increased by 12.7% when comparing the nine months ended September 30, 2011 to the same period in 2010.  Trust and investment service fees are based primarily upon the market value of the accounts under administration.  Total consolidated assets under administration by MTC were at $1.2 billion at September 30, 2011, a decrease of 1.7% relative to December 31, 2010 and an increase of 20.0% relative to September 30, 2010.

Service charges on deposits increased 10.5% to $538,000 for the three months ended September 30, 2011, compared to the three months ended September 30, 2010.  For the nine months ended September 30, 2011, service charges on deposits increased 11.2% compared to the same period in 2010.

The Company sold $26.2 million in securities and purchased $112.3 million in securities during the nine months ended September 30, 2011.  The Company realized a net gain of $263,000 on the sale of securities in the nine months ended September 30, 2011.  The Company has identified three other-than-temporarily impaired securities in its portfolio and has recognized decreases in the fair market value of the security through earnings. During the nine months ended September 30, 2011, the Company realized a loss of $22,000 related to the other-than-temporarily impaired securities.

Commissions on investment sales increased 31.7% to $187,000 for the three months ended September 30, 2011, compared to $142,000 for the three months ended September 30, 2010.  For the nine months ended September 30, 2011, commissions on investment sales increased 21.8% compared to the nine months ended September 30, 2010.

The revenues and expenses of Southern Trust Mortgage for the nine months ended September 30, 2011 are reflected in the Company’s financial statements on a consolidated basis, with the proportionate

53

share not owned by the Company reported as “Non-controlling Interest in Consolidated Subsidiary.”  Southern Trust Mortgage originated $180.5 million in mortgage loans during the quarter ended September 30, 2011 compared to $217.7 million originated during the quarter ended September 30, 2010. Originations for the nine months ended September 30, 2011 were $470.0 million versus $555.4 million originated during the nine months ended September 30, 2010.  Gains on mortgage loan sales increased by 6.9% when comparing the quarter ended September 30, 2011 to the quarter ended September 30, 2010 and by 5.7% when comparing the nine months ended September 30, 2011 to September 30, 2010.  The increase in gain-on-sale revenue in 2011 was driven by an increase in margins over the prior year.

Income earned from the Bank’s $15.9 million investment in Bank Owned Life Insurance (BOLI) contributed $385,000 to total other income for the nine months ended September 30, 2011.  The Company purchased $6.0 million of BOLI in the third quarter of 2004, $4.8 million in the fourth quarter of 2004, $485,000 in the second quarter of 2007, $453,000 in the fourth quarter of 2009, and $682,000 in the second quarter of 2010 to help subsidize increasing employee benefit costs and expenses related to the restructure of its supplemental retirement plans.

Other service charges, commissions and fees decreased 1.7% to $347,000 for the nine months ended September 30, 2011, compared to $353,000 for the same period in 2010.

Other Expense

Total other expense includes employee-related costs, occupancy and equipment expense and other overhead.  Total other expense decreased by $310,000 from $14.4 million for the three months ended September 30, 2010 to $14.1 million for the three months ended September 30, 2011.  When taken as a percentage of total average assets on an annualized basis, other expense was 4.7% of total average assets for the nine months ended September 30, 2011 versus 5.0% for the same period in 2010.  Total other expense increased $670,000 from $38.6 million for the nine months ended September 30, 2010 to $39.3 million for the nine months ended September 30, 2011.

Salaries and employee benefit expenses increased by $1.8 million or 8.1% when comparing the first nine months of 2011 to the same period ended September 30, 2010.  Salaries and employee benefit expenses also increased $1.0 million or 13.6% when comparing the quarter ended September 30, 2011 to the same period in 2010.

Net occupancy expense increased by $143,000 or 9.2% for the three months ended September 30, 2011 compared to the three months ended September 30, 2010.  For the nine months ended September 30, 2011, net occupancy expense increased $365,000 or 7.9 % to $5.0 million compared to the same period ended September 30, 2010.  The year to date increase is the result of the Company’s growth as well as maintenance and improvements of the Company’s facilities. As growth efforts continue to progress, the Company anticipates higher levels of occupancy expense to be incurred.

Other tax expense increased 1.5% to $607,000 for the nine months ended September 30, 2011 from $598,000 for the nine months ended September 30, 2010.  Other tax expense includes the state franchise tax paid by Middleburg Bank and Middleburg Trust Company in lieu of an income tax.  The tax is based on each subsidiary’s equity capital at January 1st of each year, net of adjustments.

Advertising expense increased $189,000 to $446,000 for the three months ended September 30, 2011 compared to $257,000 for the three months ended September 30, 2010.  For the nine months ended September 30, 2011, advertising expense was $887,000, compared to $685,000 for the nine months ended September 30, 2010.

54

Other real estate owned expense increased by $23,000 to $689,000 for the three months ended September 30, 2011 compared to the three months ended September 30, 2010. The increase in expenses was primarily due to increases in legal expenses related to foreclosure, valuation adjustments and losses on the sales of these assets. For the nine months ended September 30, 2011, other real estate owned expense increased $468,000 to $1.6 million compared to the same period in 2010.

FDIC insurance expense decreased by $124,000 to $244,000 for the three months ended September 30, 2011 compared to the three months ended September 30, 2010.  For the nine months ended September 30, 2011 compared to the same period in 2010, FDIC insurance expense decreased $512,000 or 33.7%. The decrease in FDIC insurance expense for the three and nine month periods occurred because of a change in expense calculation methods implemented by the FDIC during 2011.

Other expenses decreased 24.8% or $1.7 million to $5.2 million for the nine months ended September 30, 2011 compared to the same period in 2010. This decrease reflects restructuring charges and other expenses incurred during the third quarter of 2010 that were not incurred in 2011.

Allowance for Loan Losses

The allowance for loan losses at September 30, 2011 was $15.1 million, or 2.24% of total portfolio loans, compared to $15.0 million, or 2.27% of total portfolio loans at December 31, 2010.  The provision for loan losses was $2.6 million for the nine months ended September 30, 2011, compared to $11.4 million for the nine months ended September 30, 2010.  For the nine months ended September 30, 2011, net loan charge-offs totaled $2.4 million compared to net loan charge-offs of $4.7 million for the same period in 2010.  There were $1.6 million in loans past due 90 days or more and still accruing at September 30, 2011, compared to $909,000 at December 31, 2010.  Non-performing loans were $32.5 million at September 30, 2011, compared to $31.5 million at December 31, 2010.  Management believes that the allowance for loan losses was adequate to cover credit losses inherent in the loan portfolio at September 30, 2011.  Loans classified as loss, doubtful, substandard and special mention are adequately reserved for and are not expected to have a material impact beyond what has been reserved.  Approximately $1.5 million has been included in the allowance for loan losses related to restructured loans.

Non-performing assets decreased from $39.9 million or 3.6% of total assets at December 31, 2010 to $38.5 million or 3.3% of total assets as of September 30, 2011.  The decrease was primarily due to the sale and disposition of Other Real Estate Owned properties during the nine month period.  Non-accrual loans increased from $29.4 million at December 31, 2010 to $30.5 million at September 30, 2011.

Capital Resources

Total shareholders’ equity at September 30, 2011 and December 31, 2010 was $107.6 million and $100.0 million, respectively.  Total common shares outstanding at September 30, 2011 were 6,996,932.

At September 30, 2011, the Company’s tier 1 and total risk-based capital ratios were 12.9% and 14.1%, respectively, compared to 12.8% and 14.1% at December 31, 2010.  The Company’s leverage ratio was 9.0% at September 30, 2011 compared to 9.0% at December 31, 2010.  The Company’s capital structure places it above the well capitalized regulatory guidelines, which enables it to take advantage of business opportunities and indicates it has the resources to protect against risk inherent in its business.

55

Liquidity

Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management.  Liquid assets include cash, interest bearing deposits with banks, federal funds sold, short-term investments, securities classified as available for sale and loans and securities maturing within one year.  As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

The Company also maintains additional sources of liquidity through a variety of borrowing arrangements.  The Company maintains federal funds lines with large regional and money-center banking institutions.  These available lines totaled $24.0 million, none of which were outstanding at September 30, 2011.  At September 30, 2011 and December 31, 2010, the Company had $31.3 million and $25.6 million, respectively, of outstanding borrowings pursuant to repurchase agreements.

The Company has a credit line in at the Federal Home Loan Bank of Atlanta with an available borrowing capacity of $147.0 million as of September 30, 2011.  This line may be utilized for short and/or long-term borrowing.  The Company utilized the credit line for both overnight and long-term funding throughout the first nine months of 2011.  Southern Trust Mortgage has two revolving lines of credit with a regional bank having a combined credit limit of $45.0 million ($25.0 million and $20.0 million).  These lines are primarily used to fund its loans held for sale.    Middleburg Bank guarantees up to $10 million of borrowings on these lines. At September 30, 2011, one line had an outstanding balance of $5.9 million and is included in total short-term borrowings on the Company’s balance sheet.  The second line had no outstanding balance at September 30, 2011.  Short-term and long-term advances averaged $5.7 million and $79.8 million, respectively, for the nine months ended September 30, 2011.

At September 30, 2011, cash, interest bearing deposits with financial institutions, federal funds sold, short-term investments, loans held for sale and securities available for sale were 45.2% of total deposits.

Off-Balance Sheet Arrangements and Contractual Obligations

Commitments to extend credit (excluding standby letters of credit) increased $1.8 million to $85.1 million at September 30, 2011 compared to $83.3 million at December 31, 2010.  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 expected future cash flows.  Standby letters of credit were $1.7 million at September 30, 2011 representing a decrease of $640,000 from December 31, 2010.

Contractual obligations, representing long term debt obligations, operating leases, and capital notes, increased $13.1 million to $109.7 million at September 30, 2011 compared to $96.5 million at December 31, 2010.   These results do not include changes in certificates of deposit and short-term borrowings.  The increase resulted from additional long term debt of $15.0 million assumed during the nine months ended September 30, 2011 and a slight decline in contractual lease obligations.  Additional information on commitments to extend credit, standby letters of credit and contractual obligations is included in the Company’s 2010 Form 10-K.

56

Caution About Forward Looking Statements

Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import.

Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:

· changes in general economic and business conditions in the Company’s market area;

· changes in banking and other laws and regulations applicable to the Company;

· maintaining asset qualities;

· risks inherent in making loans such as repayment risks and fluctuating collateral values;

· changing trends in customer profiles and behavior;

· maintaining cost controls and asset qualities as the Company opens or acquires new branches;

· changes in interest rates and interest rate policies;

· competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;

· the ability to continue to attract low cost core deposits to fund asset growth;

· the ability to successfully manage the Company’s growth or implement its growth strategies if it is unable to identify attractive markets, locations or opportunities to expand in the future;

· reliance on the Company’s management team, including its ability to attract and retain key personnel;

· demand, development and acceptance of new products and services;

· problems with technology utilized by the Company;

· maintaining capital levels adequate to support the Company’s growth; and

· other factors described in Item 1A, “Risk Factors,” included in our quarterly reports on Form 10-Q and the 2010 Form 10-K.

Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices and equity prices.  The Company’s primary market risk exposure is interest rate risk, though it should be noted that the assets under administration by Middleburg Trust Company are affected by equity price risk.  The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process, which is governed by policies established by its Board of Directors that are reviewed and approved annually.  The Board of Directors delegates responsibility for carrying out asset/liability management policies to the Asset/Liability Committee (“ALCO”) of the Bank.  In this capacity, ALCO develops guidelines and strategies that govern the Company’s asset/liability management

57

related activities, based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.

Interest rate risk represents the sensitivity of earnings to changes in market interest rates.  As interest rates change, the interest income and expense streams associated with the Company’s financial instruments also change, affecting net interest income, the primary component of the Company’s earnings.  ALCO uses the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes.  The results of the simulation are dependent upon assumptions and parameters within the model used which change from time to time based on historical interest rate relationships, current market conditions, and anticipated future market conditions.  While ALCO routinely monitors simulated net interest income sensitivity over a rolling two-year horizon, it also employs additional tools to monitor potential longer-term interest rate risk.  The model prepared for September 30, 2011 did not include the assets and liabilities of Southern Trust Mortgage.

The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on the Company’s balance sheet excluding the assets of Southern Trust Mortgage.  The simulation model is prepared and updated four times during each year.  This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon, assuming no balance sheet growth, given a 200 basis point (bp) upward shift and a 200 basis point downward shift in interest rates.  A parallel shift in rates over a 12-month period is assumed.  The following reflects the Company’s net interest income sensitivity analysis as of September 30, 2011 and December 31, 2010.

	Estimated Net Interest Income Sensitivity
Rate Change	As of September 30, 2011	As of December 31, 2010
+ 200 bp	(0.4%)	(6.4%)
- 200 bp	(11.6%)	(12.4%)

At September 30, 2011, the Company’s interest rate risk model indicated that, in a rising rate environment of 200 basis points, net interest income could decrease by 0.4% on average over the next 12 months.  For the same time period the interest rate risk model indicated that in a declining rate environment of 200 basis points, net interest income could decrease by 11.6% on average over the next 12 months.  While these numbers are subjective based upon the assumptions and parameters used within the model, management believes the balance sheet is properly structured to minimize interest rate risk in the future.

Based upon a September 30, 2011 simulation, the Company could expect an average negative impact to net interest income of $145,000 over the next 12 months if rates rise 200 basis points.  If rates were to decline 200 basis points, the Company could expect an average negative impact to net interest income of $4.1 million over the next 12 months.

The preceding sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results.  These hypothetical estimates are based upon numerous assumptions, including the nature and timing of interest rate levels such as yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment or replacement of asset and liability cash flows.  Management routinely monitors these

58

assumptions however the Company cannot make any assurances about the predictive nature of the assumptions, including how customer preferences or competitor influences might change.

Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to factors such as prepayment and refinancing levels likely deviating from those assumed, the varying impact of interest rate change, caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal and external variables.  Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in response to, or in anticipation of, changes in interest rates.

Item 4.  CONTROLS AND PROCEDURES

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended.  Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including Middleburg Bank, Southern Trust Mortgage, Middleburg Investment Group, Middleburg Investment Advisors and Middleburg Trust Company) required to be included in the Company’s periodic filings with the Securities and Exchange Commission.

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting.  There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company, including its subsidiaries, is a party or of which the property of the Company is subject.

Item 1A.  Risk Factors

Our operations are subject to many risks that could adversely affect our future financial condition and performance and, therefore, the market value of our securities. The risk factors that are applicable to us are outlined in our Annual Report on Form 10-K for the year ended December 31, 2010. There have been no material changes in our risk factors from those disclosed in this report.

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

None.

59

Item 3.  Defaults upon Senior Securities

None.

Item 4.  Removed and Reserved

Item 5.  Other Information

None

Item 6.  Exhibits

31.1 Rule 13a-14(a) Certification of Chief Executive Officer

31.2 Rule 13a-14(a) Certification of Chief Financial Officer

32.1 Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. § 1350

10.1 Agreement, dated July 18, 2011, by and between Middleburg Financial Corporation and Joseph L. Boling, attached as Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the SEC on July 20, 2011, incorporated herein by reference.

101 The following materials from the Middleburg Financial Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 formatted in Extensible Business reporting Language (XBRL):  (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Changes in Shareholders’ Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Consolidated Financial Statements.

60

SIGNATURES

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

	MIDDLEBURG FINANCIAL CORPORATION
		(Registrant)
Date:  November 8, 2011	/s/ Gary R. Shook
	Gary R. Shook
	President & Chief Executive Officer
Date:  November 8, 2011	/s/ Raj Mehra
	Raj Mehra
	Executive Vice President
	& Chief Financial Officer

61

EXHIBIT INDEX

Exhibits

31.1	Rule 13a-14(a) Certification of Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
32.1	Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. § 1350
10.1	Agreement, dated July 18, 2011, by and between Middleburg Financial Corporation and Joseph L. Boling, attached as Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the SEC on July 20, 2011, incorporated herein by reference.
101	The following materials from the Middleburg Financial Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 formatted in Extensible Business reporting Language (XBRL):  (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Changes in Shareholders’ Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Consolidated Financial Statements.

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Gary R. Shook, certify that:

1. I have reviewed the Quarterly Report on Form 10-Q of Middleburg Financial Corporation for the period ended September 30, 2011;

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 the registrant’s board of directors (or persons performing the equivalent functions):

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

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

Date:  November 8, 2011

/s/ Gary R. Shook

Gary R. Shook

President & Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Raj Mehra, certify that:

1. I have reviewed the Quarterly Report on Form 10-Q of Middleburg Financial Corporation for the period ended September 30, 2011;

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 the registrant’s board of directors (or persons performing the equivalent functions):

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

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

Date:  November 8, 2011

/s/ Raj Mehra

Raj Mehra

Executive Vice President and

Chief Financial Officer

EX-32.1

Exhibit 32.1

STATEMENT OF CHIEF EXECUTIVE OFFICER AND

CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. § 1350

In connection with the Quarterly Report on Form 10-Q for the period ended September 30, 2011 (the “Form 10-Q”) of Middleburg Financial Corporation (the “Company”), we, Gary R. Shook, Chief Executive Officer of the Company, and Raj Mehra, Chief Financial Officer of the Company, hereby certify pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to our knowledge:

(a) the Form 10-Q fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended; and

(b) the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the periods presented in the Form 10-Q.

By:	/s/ Gary R. Shook	Date:	November 8, 2011
	Gary R. Shook
	Chief Executive Officer
By:	/s/ Raj Mehra	Date:	November 8, 2011
	Raj Mehra
	Chief Financial Officer

XML

Consolidated Balance Sheets (Unaudited) (Parenthetical) (USD $) In Thousands, except Share data	Sep. 30, 2011	Dec. 31, 2010
ASSETS
Loans, allowance for loan losses	$ 15,124	$ 14,967
Other real estate owned, valuation allowance	$ 1,057	$ 1,486
SHAREHOLDERS' EQUITY
Common stock, par value (in dollars per share)	$ 2.50	$ 2.50
Common stock, shares authorized (in shares)	20,000,000	20,000,000
Common stock, shares issued (in shares)	7,000,824	7,000,824
Common stock, shares outstanding (in shares)	6,996,932	6,925,437

XML

Consolidated Statements of Operations (Unaudited) (USD $) In Thousands, except Per Share data	3 Months Ended		9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010	Sep. 30, 2011	Sep. 30, 2010
INTEREST AND DIVIDEND INCOME
Interest and fees on loans	$ 9,912	$ 9,832	$ 29,378	$ 30,661
Interest and dividends on securities available for sale
Taxable	1,727	1,166	4,877	3,194
Tax-exempt	592	621	1,757	1,914
Dividends	36	32	108	75
Interest on deposits in banks and federal funds sold	30	36	90	99
Total interest and dividend income	12,297	11,687	36,210	35,943
INTEREST EXPENSE
Interest on deposits	2,287	3,160	6,927	9,410
Interest on securities sold under agreements to repurchase	84	63	209	144
Interest on short-term borrowings	58	134	174	245
Interest on long-term debt	312	372	914	1,298
Total interest expense	2,741	3,729	8,224	11,097
NET INTEREST INCOME	9,556	7,958	27,986	24,846
Provision for loan losses	1,024	9,130	2,565	11,350
NET INTEREST INCOME (LOSS) AFTER PROVISION FOR LOAN LOSSES	8,532	(1,172)	25,421	13,496
NONINTEREST INCOME
Service charges on deposit accounts	538	487	1,553	1,396
Trust services income	963	807	2,813	2,497
Gains on loans held for sale	5,501	5,147	12,286	11,621
Gains on securities available for sale, net	141	288	263	757
Total other-than-temporary impairment losses	(16)	(557)	(33)	(857)
Portion of (gain) loss recognized in other comprehensive income	(5)	(169)	11	(117)
Net impairment losses	(21)	(726)	(22)	(974)
Commissions on investment sales	187	142	552	453
Fees on mortgages held for sale	84	477	325	1,311
Other service charges, commissions and fees	98	97	347	353
Bank-owned life insurance	123	136	385	391
Other operating income	6	42	111	221
Total noninterest income	7,620	6,897	18,613	18,026
NONINTEREST EXPENSE
Salaries and employees' benefits	8,708	7,665	23,837	22,046
Net occupancy and equipment expense	1,700	1,557	5,016	4,651
Advertising	446	257	887	685
Computer operations	365	340	1,073	1,008
Other real estate owned	689	666	1,639	1,171
Other taxes	205	201	607	598
Federal deposit insurance expense	244	368	1,009	1,521
Other operating expenses	1,720	3,333	5,198	6,916
Total noninterest expense	14,077	14,387	39,266	38,596
Income (loss) before income taxes	2,075	(8,662)	4,768	(7,074)
Income tax expense (benefit)	454	(3,297)	1,072	(3,135)
NET INCOME (LOSS)	1,621	(5,365)	3,696	(3,939)
Net (income) loss attributable to non-controlling interest	(223)	(423)	128	(311)
Net income (loss) attributable to Middleburg Financial Corporation	$ 1,398	$ (5,788)	$ 3,824	$ (4,250)
Earnings (loss) per share:
Basic (in dollars per share)	$ 0.20	$ (0.83)	$ 0.55	$ (0.61)
Diluted (in dollars per share)	$ 0.20	$ (0.83)	$ 0.55	$ (0.61)
Dividends per common share (in dollars per share)	$ 0.05	$ 0.10	$ 0.15	$ 0.30

XML

Document And Entity Information (USD $)	9 Months Ended
	Sep. 30, 2011	Nov. 05, 2011	Jun. 30, 2010
Entity Registrant Name	MIDDLEBURG FINANCIAL CORP
Entity Central Index Key	0000914138
Current Fiscal Year End Date	--12-31
Entity Well-known Seasoned Issuer	No
Entity Voluntary Filers	No
Entity Current Reporting Status	Yes
Entity Filer Category	Accelerated Filer
Entity Public Float			$ 96,183,296
Entity Common Stock, Shares Outstanding		6,996,932
Document Fiscal Year Focus	2011
Document Fiscal Period Focus	Q3
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Sep. 30, 2011

XML

Allowance for Loan Losses

9 Months Ended

Sep. 30, 2011

Allowance for Loan Losses [Abstract]

Allowance for Loan Losses

Note 5.                                Allowance for Loan Losses

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by loan class and, for the ending loan balances, based on impairment evaluation method as of September 30, 2011 and December 31, 2010.  A rollforward of the changes in the allowance for loan losses balance by class of loan is also presented for the period ended September 30, 2011.

	September 30, 2011 (In Thousands)
				Real Estate		Real Estate
	Real Estate			Secured by		Secured by 1-4			Other Real
	Construction			Farmland		Family Residential			Estate Loans			Commercial			Consumer			Total
Allowance for loan losses:
Balance at December 31, 2010	$	4,684		$	107	$	3,965		$	4,771		$	1,055		$	385		$	14,967
Chargeoffs		(363	)		-		(1,417	)		(396	)		(82	)		(314	)		(2,572	)
Recoveries		28			-		13			78			23			22			164
Provision		(2,137	)		3		4,389			(279	)		547			42			2,565
Balance at September 30, 2011	$	2,212		$	110	$	6,950		$	4,174		$	1,543		$	135		$	15,124
Ending allowance balance:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	416		$	-	$	3,031		$	1,033		$	405		$	-		$	4,885
Collectively evaluated for impairment		1,796			110		3,919			3,141			1,138			135			10,239
Total ending allowance balance	$	2,212		$	110	$	6,950		$	4,174		$	1,543		$	135		$	15,124
Ending loan recorded investment balances:
Individually evaluated for impairment	$	4,229		$	-	$	16,466		$	8,046		$	2,147		$	-		$	30,889
Collectively evaluated for impairment		44,343			10,377		223,272			265,777			89,149			12,007			644,924
Total ending loans balance	$	48,572		$	10,377	$	239,738		$	273,823		$	91,296		$	12,007		$	675,813

	December 31, 2010 (In thousands)
			Real Estate		Real Estate
	Real Estate		Secured by		Secured by 1-4		Other Real
	Construction		Farmland		Family Residential		Estate Loans		Commercial		Consumer		Total
Ending allowance balance:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,876	$	-	$	1,099	$	2,010	$	108	$	239	$	5,332
Collectively evaluated for impairment		2,808		107		2,866		2,761		947		146		9,635
Total ending allowance balance	$	4,684	$	107	$	3,965	$	4,771	$	1,055	$	385	$	14,967
Ending recorded investment balances:
Individually evaluated for impairment	$	9,170	$	-	$	10,872	$	8,359	$	1,950	$	239	$	30,590
Collectively evaluated for impairment		58,940		11,532		231,748		259,903		54,435		12,164		628,722
Total ending loans balance	$	68,110	$	11,532	$	242,620	$	268,262	$	56,385	$	12,403	$	659,312

Changes in the allowance for loan losses for the year ended December 31, 2010 is summarized as follows:

	Year
	Ended
	December 31, 2010
Balance, beginning of year	$	9,185
Provision for loan losses		12,005
Charge-offs:
Real estate loans:
Construction		1,226
Secured by 1-4 family residential		3,256
Other real estate loans		460
Commercial loans		942
Consumer loans		500
Total charge-offs	$	6,384
Recoveries:
Real estate loans:
Construction	$	-
Secured by 1-4 family residential		37
Other real estate loans		4
Commercial loans		68
Consumer loans		52
Total recoveries	$	161
Net charge-offs		6,223
Balance, end of period	$	14,967

XML

Fair Value Measurements

9 Months Ended

Sep. 30, 2011

Fair Value Measurements [Abstract]

Fair Value Measurements

Note 10. Fair Value Measurements

The Company adopted ASC 820, Fair Value Measurements, on January 1, 2008 to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  ASC 820 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions.  The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:

Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level II: Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date.  The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.

Level III: Assets and liabilities that have little to no pricing observability as of the reported date.  These items do not have two-way markets and are measured using management's best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

Measured on recurring basis

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

Securities available for sale

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

Derivatives

Derivatives are recorded at fair value on a recurring basis.  Third party vendors compile prices from various sources and may determine the fair value of identical or similar instruments by using pricing models that consider observable market data (Level II).

The following tables present the balances of financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010.

	September 30, 2011 (In thousands)
	Total		Level I		Level II		Level III
Assets:
U.S. government agency
securities	$	7,524	$	-	$	7,524	$	-
Obligations of states and
political subdivision		65,404		-		65,404		-
Mortgage-backed securities:
Agency		190,283		-		190,283		-
Non-agency		29,278		-		29,278		-
Corporate preferred stock		37		-		37		-
Corporate securities		10,239		-		10,239		-
Trust preferred securities		249		-		249		-
Liabilities:
Derivative financial instruments	$	284	$	-	$	284		-

	December 31, 2010 (In thousands)
	Total		Level I		Level II		Level III
Assets:
U.S. government agency
securities	$	4,649	$	-	$	4,649	$	-
Obligations of states and
political subdivision		59,140		-		59,140		-
Mortgage-backed securities:
Agency		152,304		-		152,304		-
Non-agency		26,081		-		26,081		-
Corporate preferred stock		13		-		13		-
Corporate securities		9,532		-		9,532		-
Trust preferred securities		323		-		323		-
Derivative financial instruments		312		-		312		-

There were no assets measured at fair value on a recurring basis using significant unobservable inputs (Level III) for the nine months ended September 30, 2011.  Additionally, there were no changes in unrealized gains and losses recorded in earnings for the periods ended September 30, 2011 or December 31, 2010 for Level III assets that were still held at September 30, 2011 and December 31, 2010.

Measured on nonrecurring basis

Certain financial assets and certain financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on a recurring basis but are subject to fair value adjustments in certain circumstances.  Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or impairment 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 consolidated financial statements:

Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. These loans currently 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 (Level II).  As such, the Company records any fair value adjustments on a nonrecurring basis.  No nonrecurring fair value adjustments were recorded on loans held for sale during the nine or three months ended September 30, 2011.  Gains and losses on the sale of loans are recorded within income from mortgage banking on the consolidated statements of operations.

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 the present value of expected future cash flows discounted at the loan's effective interest rate, the observable market price of the loan, or the fair value of the underlying collateral.  Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable.  The vast majority of the collateral is real estate.  The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level II).  However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level III. As of September 30, 2011, four impaired loans with a net balance of $463,000 were categorized as having a Level III valuation due to the date of the last appraisal.  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 III).  Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Impaired loans for which no further loss is expected are not considered to be measured at fair value on a nonrecurring basis.  Any fair value adjustments as a result of the evaluation process are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.

When collateral-dependent loans are performing in accordance with the original terms of their contract, the Company continues to use the appraisal that was done at origination as the basis for the collateral value.  When collateral-dependent loans are considered non-performing, they are assessed to determine the next appropriate course of action:  either foreclosure or modification with forbearance agreement.  The loans would then be re-appraised prior to foreclosure or before a forbearance agreement is executed.  Thereafter, collateral for loans under a forbearance agreement may be re-appraised as the circumstances warrant.  This process does not vary by loan type.

The Company's procedure to monitor the value of collateral for collateral dependent impaired loans between the receipt of an original appraisal and an updated appraisal is to review tax assessment records when they change annually, to obtain on a judgmental basis, independent real estate evaluations, and to monitor the general level and direction of movement of regional real estate market conditions.  At the time of any change in tax assessment, an appropriate adjustment is made to the existing appraised value and any resulting initial or additional fair value adjustment is made at that time. Information considered in a determination not to order an updated appraisal includes the availability and reliability of tax assessment records, the results of any independent real estate evaluation, and significant changes in capitalization rates for income properties since the original appraisal.  Other facts and circumstances on a case by case basis may be considered relative to a decision to order or not to order an updated appraisal.  If, in the judgment of management, a reliable collateral value estimate can not be obtained by an alternative method, an updated appraisal is obtained.

Circumstances that may warrant a re-appraisal for non-performing (impaired) loans might include foreclosure proceedings or a material adverse change in the borrower's condition or that of the collateral underlying the loan.  Examples include bankruptcy filing by the debtor or guarantors, loss of a major tenant in an income property, or a significant increase in capitalization rates for income properties.  In some cases, management may decide that an updated appraisal for a non-performing loan is not necessary.  In such cases, an estimate of the fair value of the collateral for the loans would be made by management by reference to current tax assessment records, a current independent real estate evaluation, the latest appraised value, and knowledge of collateral value fluctuations in a loan's market area.

For the purpose of the evaluation of the adequacy of our allowance for loan losses, new appraisals are discounted 10% for selling costs when determining the amount of the specific reserve.  Thereafter, for collateral dependent impaired loans, we consider each loan on a case-by-case basis to determine whether or not the recorded values are appropriate given current market conditions.  When warranted, new appraisals or independent real estate evaluations are obtained.  If an appraisal is less than 12 months old, the only adjustment made to appraised values is the 10% discount for selling costs.  If an appraisal is older than 12 months, management will use judgment based on knowledge of current market values and specific facts surrounding any particular property to determine if an additional valuation adjustment may be necessary.

For real estate-secured impaired loans, if the Company does not have an adequate appraisal a new one is ordered to determine fair value.  An appraisal that would be considered adequate for real estate-secured loans is one that is less than 12 months or one that is more than 12 months old but alternative methods with which to monitor the collateral value exist, such as reference to frequently updated tax assessments, or independent real estate evaluations.  Appraisals that would be considered inadequate for real estate-secured loans include appraisals older than 12 months and with a property located in a jurisdiction that does not reassess property values on a regular basis, or with a property to which substantial changes have been made since the last assessment. If the loan is secured by assets other than real estate and an appraisal is neither available nor feasible, the loan is treated as unsecured.

It is the Company's policy to account for partially charged-off loans consistently both before and after updated appraisals are obtained.  Partially charged-off loans are placed in non-accrual status and remain in that status until the borrower has made a minimum of six consecutive monthly payments on a timely basis and there is evidence that the borrower has the ability to repay the balance of the loan plus accrued interest in full.   Partially charged-off loans are not automatically returned to accrual status when updated appraisals are obtained.

     Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.

The following table summarizes the Company's financial assets that were measured at fair value on a nonrecurring basis as of September 30, 2011 and December 31, 2010:

	September 30, 2011 (In thousands)
	Total		Level I		Level II		Level III
Assets:
Loans held for sale	$	66,910	$	-	$	66,910	$	-
Impaired loans		14,100		-		13,637		463
	December 31, 2010 (In thousands)
Description	Total		Level I		Level II		Level III
Assets:
Loans held for sale	$	59,361	$	-	$	59,361	$	-
Impaired loans		13,267		-		12,528		739

Other Real Estate Owned

The value of other real estate owned (“OREO”) is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level II).  For other real estate owned properties, the Company's policy is to obtain “as-is” appraisals on an annual basis as opposed to “as-completed” appraisals.  This approach provides current values without regard to completion of any construction or renovation that may be in process on OREO properties.  Accordingly, the Company considers the valuations to be Level II valuations even though some properties may be in process of renovation or construction.  As of September 30, 2011, the Company had one OREO property considered to be in construction with a carrying value of approximately $1.1 million.

For the purpose of OREO valuations, appraisals are discounted 10% for selling and holding costs and it is the policy of the Company to obtain annual appraisals for properties held in OREO.

Any fair value adjustments are recorded in the period incurred as “Other real estate owned expenses” on the consolidated statements of operations.

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

	September 30, 2011 (In thousands)
	Total		Level I		Level II		Level III
Assets:
Other real estate owned	$	6,096	$	-	$	6,096	$	-
	December 31, 2010 (In thousands)
Description	Total		Level I		Level II		Level III
Assets:
Other real estate owned	$	8,394	$	-	$	8,394	$	-

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company's various financial instruments.  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.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.  U.S. generally accepted accounting principles excludes certain financial instruments and all non-financial instruments from its disclosure requirements.  Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents

For those cash equivalents, the carrying amount is a reasonable estimate of fair value.

Loans, Net and Loans Held for Sale

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.  The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality.  Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were utilized as estimates for fair value.

Accrued Interest Receivable and Payable

The carrying amounts of accrued interest approximate fair values.

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date.  For all other deposits, the fair value is determined using the discounted cash flow method.  The discount rate used is equal to the rate currently offered on similar products.

Securities Sold Under Agreements to Repurchase and Short-Term Debt

The carrying amounts approximate fair values.

FHLB Borrowings, Long-Term and Subordinated Debt

For variable rate long-term debt, fair values are based on carrying values.  For fixed rate debt, fair values are estimated based on observable market prices and discounted cash flow analysis using interest rates for borrowings of similar remaining maturities and characteristics.  The fair values of the Company's Subordinated Debentures are estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.

Off-Balance-Sheet Financial Instruments

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.  The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.  At September 30, 2011 and December 31, 2010, the fair values of loan commitments and standby letters of credit were deemed immaterial; therefore, they have not been included in the table below.

The estimated fair values, and related carrying amounts, of the Company's financial instruments are as follows as of the indicated dates:

	September 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
	(In thousands)
Financial assets:
Cash and cash equivalents	$	41,358	$	41,358	$	64,724	$	64,724
Securities		303,014		303,014		252,042		252,042
Loans		727,599		749,547		703,706		723,629
Accrued interest receivable		3,669		3,669		3,655		3,655
Interest rate swap		-		-		312		312
Financial liabilities:
Deposits	$	909,696	$	899,965	$	890,306	$	869,606
Securities sold under agreements
to repurchase		31,286		31,286		25,562		25,562
Short-term debt		12,864		12,864		13,320		13,320
FHLB borrowings		77,912		79,038		62,912		63,512
Trust preferred capital notes		5,155		5,229		5,155		5,167
Accrued interest payable		757		757		879		879
Interest rate swap		284		284		-		-

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

XML

General

9 Months Ended

Sep. 30, 2011

General [Abstract]

General

Note 1.                                General

In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position at September 30, 2011 and December 31, 2010, the results of operations for the three and nine months ended September 30, 2011 and 2010, and, changes in shareholders' equity and cash flows for the nine months ended September 30, 2011 and 2010, in accordance with accounting principles generally accepted in the United States of America.  The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2010 (the “2010 Form 10-K”) of Middleburg Financial Corporation (the “Company”).  The results of operations for the three and nine month periods ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year.

In preparing these financial statements, management has evaluated subsequent events and transactions for potential recognition or disclosure through the date these financial statements were issued.  Management has concluded there were no additional material subsequent events to be disclosed at this time.

XML

Segment Reporting

9 Months Ended

Sep. 30, 2011

Segment Reporting [Abstract]

Segment Reporting

Note 7.                                Segment Reporting

The Company operates in a decentralized fashion in three principal business activities: retail banking services; wealth management services; and mortgage banking services.  Revenue from retail banking activities consists primarily of interest earned on loans and investment securities and service charges on deposit accounts.

Revenue from the wealth management activities is comprised of fees based upon the market value of the accounts under administration as well as commission on investment transactions.  The wealth management services are conducted by Middleburg Trust Company and the investment services department of Middleburg Bank.

Revenue from the mortgage banking activities is comprised of interest earned on loans and fees received as a result of the mortgage origination process.  The Company recognizes gains on the sale of loans as part of other income.  The mortgage banking services are conducted by Southern Trust Mortgage, LLC.

Middleburg Bank and the Company have assets in custody with Middleburg Trust Company and accordingly pay Middleburg Trust Company a monthly fee.  Middleburg Bank also pays interest to Middleburg Trust Company and Southern Trust Mortgage on deposit accounts that each company has at Middleburg Bank.  Southern Trust Mortgage has an outstanding line of credit of $5.0 million and a participation agreement of $75.0 million for which it pays interest to Middleburg Bank on any outstanding balance.  Middleburg Bank provides office space and data processing services to Southern Trust Mortgage for which it receives rental and fee income.  Transactions related to these relationships are eliminated to reach consolidated totals.

The following table presents segment information for the nine months ended September 30, 2011 and 2010, respectively.

	For the Nine Months Ended												For the Nine Months Ended
	September 30, 2011												September 30, 2010
	Retail		Wealth		Mortgage			Intercompany					Retail			Wealth			Mortgage			Intercompany
	Banking		Management		Banking			Eliminations			Consolidated		Banking			Management			Banking			Eliminations			Consolidated
(In Thousands)
Revenues:
Interest income	$	35,076	$	8	$	2,008		$	(882	)	$	36,210	$	35,075		$	7		$	1,809		$	(948	)	$	35,943
Trust and investment
fee income		-		2,813		-			-			2,813		-			2,546			-			(49	)		2,497
Other income		2,480		552		12,770			(2	)		15,800		2,065			445			13,026			(7	)		15,529
Total operating income		37,556		3,373		14,778			(884	)		54,823		37,140			2,998			14,835			(1,004	)		53,969
Expenses:
Interest expense		8,051		-		1,055			(882	)		8,224		10,854			-			1,204			(961	)		11,097
Salaries and employee benefits		10,878		2,268		10,691			-			23,837		9,729			2,332			9,985			-			22,046
Provision for loan losses		2,641		-		(76	)		-			2,565		11,122			-			228			-			11,350
Other		11,094		962		3,375			(2	)		15,429		13,063			766			2,764			(43	)		16,550
Total operating expenses		32,664		3,230		15,045			(884	)		50,055		44,768			3,098			14,181			(1,004	)		61,043
Income (loss) before income taxes
and non-controlling interest		4,892		143		(267	)		-			4,768		(7,628	)		(100	)		654			-			(7,074	)
Income tax expense (benefit)		986		86		-			-			1,072		(3,171	)		36			-			-			(3,135	)
Net Income (loss)		3,906		57		(267	)		-			3,696		(4,457	)		(136	)		654			-			(3,939	)
Non-controlling interest in
(income)/loss of consolidated subsidiary		-		-		128			-			128		-			-			(311	)		-			(311	)
Net income (loss) attributable to
Middleburg Financial Corporation	$	3,906	$	57	$	(139	)	$	-		$	3,824	$	(4,457	)	$	(136	)	$	343		$	-		$	(4,250	)
Total assets	$	1,139,348	$	12,378	$	77,177		$	(75,247	)	$	1,153,656	$	1,079,410		$	15,677		$	88,905		$	(72,528	)	$	1,111,464
Capital expenditures	$	1,276	$	3	$	151					$	1,430	$	508		$	13		$	25		$	-		$	546
Goodwill and other intangibles	$	-	$	4,377	$	1,867		$	-		$	6,244	$	-		$	4,536		$	1,867		$	-		$	6,403

The following table presents segment information for the three months ended September 30, 2011 and 2010, respectively.

	For the Three Months Ended													For the Three Months Ended
	September 30, 2011													September 30, 2010
	Retail		Wealth		Mortgage			Intercompany						Retail			Wealth		Mortgage			Intercompany
	Banking		Management		Banking			Eliminations			Consolidated			Banking			Management		Banking			Eliminations			Consolidated
(In Thousands)
Revenues:
Interest income	$	11,956	$	2	$	683		$	(344	)	$	12,297		$	11,706		$	3	$	343		$	(365	)	$	11,687
Trust and investment
fee income		-		963		-			-			963			-			855		-			(48	)		807
Other income		869		187		5,602			(1	)		6,657			385			156		5,573			(24	)		6,090
Total operating income		12,825		1,152		6,285			(345	)		19,917			12,091			1,014		5,916			(437	)		18,584
Expenses:
Interest expense		2,684		-		401			(344	)		2,741			3,595			-		514			(380	)		3,729
Salaries and employee benefits		3,952		726		4,030			-			8,708			3,151			794		3,720			-			7,665
Provision for loan losses		1,100		-		(76	)		-			1,024			9,120			-		10			-			9,130
Other		3,708		321		1,341			(1	)		5,369			5,904			82		793			(57	)		6,722
Total operating expenses		11,444		1,047		5,696			(345	)		17,842			21,770			876		5,037			(437	)		27,246
Income (loss) before income taxes
and non-controlling interest		1,381		105		589			-			2,075			(9,679	)		138		879			-			(8,662	)
Income tax expense (benefit)		381		73		-			-			454			(3,357	)		60		-			-			(3,297	)
Net Income (loss)		1,000		32		589			-			1,621			(6,322	)		78		879			-			(5,365	)
Non-controlling interest in
(income)/loss of consolidated subsidiary		-		-		(223	)		-			(223	)							(423	)		-			(423	)
Net income (loss) attributable to
Middleburg Financial Corporation	$	1,000	$	32	$	366		$	-		$	1,398		$	(6,322	)	$	78	$	456		$	-		$	(5,788	)
Total assets	$	1,139,348	$	12,378	$	77,177		$	(75,247	)	$	1,153,656		$	1,079,410		$	15,677	$	88,905		$	(72,528	)	$	1,111,464
Capital expenditures	$	585	$	-	$	151		$	-		$	736		$	78		$	1	$	4		$	-		$	83
Goodwill and other intangibles	$	-	$	4,377	$	1,867		$	-		$	6,244		$	-		$	4,536	$	1,867		$	-		$	6,403

XML

Defined Benefit Pension Plan

9 Months Ended

Sep. 30, 2011

Defined Benefit Pension Plan [Abstract]

Defined Benefit Pension Plan

Note 8.                                Defined Benefit Pension Plan

The Company has a noncontributory, defined benefit pension plan covering substantially all full-time employees of Middleburg Bank and Middleburg Trust Company.  Benefit accruals and eligibility for the plan were frozen as of September 30, 2009. This had the effect of reducing the Projected Benefit Obligation by an estimated $1,577,000, which was recorded as a curtailment gain in 2009.  The Company funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.

The defined benefit pension plan has been amended to be terminated and the amendment has been submitted to the Internal Revenue Service (the “IRS”) for approval. The Pension Benefit Guaranty Corporation (“the “PBGC”) was notified of the termination and the PBGC review period expired without comment.  Although the IRS application for termination approval is in process, and it is the intention of the Company to distribute the assets of the plan to participants during the fourth quarter of 2011, the date of IRS approval is unknown and there can be no assurance that the plan will be terminated or that assets will be completely distributed during 2011.

The table below reflects the components of the Net Periodic Benefit Cost related to the Company's defined benefit pension plan for the indicated periods.

	Nine months ended September 30,
	2011			2010
	(In Thousands)
Interest cost	$	137		$	240
Expected return on plan assets		(44	)		(291	)
Amortization of unrecognized  net actuarial  loss		914			--
Net periodic benefit cost (income)	$	1,007		$	(51	)

	Three months ended September 30,
	2011			2010
	(In Thousands)
Interest cost	$	46		$	80
Expected return on plan assets		(15	)		(97	)
Amortization of unrecognized  net actuarial  loss		305			--
Net periodic benefit cost (income)	$	336		$	(17	)

XML

Earnings Per Share

9 Months Ended

Sep. 30, 2011

Earnings (Loss) Per Share [Abstract]

Earnings Per Share

Note 6.                      Earnings (loss) Per Share

The following table shows the weighted average number of common shares used in computing earnings per share and the effect on the weighted average number of shares of potential dilutive common stock.  Potential dilutive common stock has no effect on income available to common shareholders.

	Nine months ended
	September 30, 2011				September 30, 2010
			Per share				Per share
	Shares		Amount		Shares		Amount
Basic earnings (loss) per share		6,968,999	$	0.55		6,931,239	$	(0.61	)
Effect of dilutive securities:
stock options and grants		2,296				0
Diluted earnings (loss) per share		6,971,295	$	0.55		6,931,239	$	(0.61	)
	Three months ended
	September 30, 2011				September 30, 2010
			Per share				Per share
	Shares		Amount		Shares		Amount
Basic earnings (loss)  per share		6,996,932	$	0.20		6,934,366	$	(0.83	)
Effect of dilutive securities:
stock options and grants		1,562				0
Diluted earnings (loss) per share		6,998,494	$	0.20		6,934,366	$	(0.83	)

At September 30, 2011 and 2010, stock options, restricted grants and warrants representing 318,111 and 225,684 shares, respectively, were not included in the calculation of earnings per share because they would have been anti-dilutive.

XML

Consolidated Statements of Changes in Shareholders' Equity (Unaudited) (Parenthetical) (USD $) In Thousands	9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010
Other comprehensive income, tax:
Unrealized holding gains arising during the period, taxes	$ 3,035	$ 2,051
Reclassification adjustment, taxes	89	257
Unrealized losses on securities, other-than-temporary impairment	7	371
Unrealized loss on interest rate swap, net	$ 203	$ 0
Exercise of stock options (in shares)	0	2,750
Restricted stock awards (in shares)	7,923	3,650
Cancellation of restricted stock (in shares)	946	0

XML

Stock-Based Compensation Plan

9 Months Ended

Sep. 30, 2011

Stock-Based Compensation Plan [Abstract]

Stock-Based Compensation Plan

Note 2.                                Stock–Based Compensation Plan

As of September 30, 2011, the Company sponsored one stock-based compensation plan (the 2006 Equity Compensation Plan), which provides for the granting of stock options, stock appreciation rights, stock awards, performance share awards, incentive awards and stock units.  The 2006 Equity Compensation Plan was approved by the Company's shareholders at the Annual Meeting held on April 26, 2006 and has succeeded the Company's 1997 Stock Incentive Plan.  Under the plan, the Company may grant stock-based compensation to its directors, officers, employees and other persons the Company determines have contributed to the profits or growth of the Company.  The Company may grant awards of up to 255,000 shares of common stock under the 2006 Equity Compensation Plan.

The Company granted 54,500 shares of restricted stock to executive officers and certain other employees on May 1, 2011.  The terms of the grant awards provide for 100% cliff vesting on December 31, 2016 but vesting may be accelerated on a graduated basis if certain predefined performance targets are met during the service period.  As of September 30, 2011, no shares were vested under these awards.  Service-based stock awards are entitled to voting and dividend rights on all shares granted as of the grant date. Under the terms of these grant awards, unearned restricted stock grants are forfeited if the employee leaves the Company prior to vesting.

Additionally, 1,063 shares of service-based restricted stock were issued to the Chairman of the Board of Directors on May 1, 2011.  The shares will vest at 100% on May 1, 2012.

The Company recognized $247,000 for stock-based compensation expenses for the nine months ended September 30, 2011.

The following table summarizes stock options awarded under the 2006 Equity Compensation Plan and remaining unexercised options under the 1997 Stock Incentive Plan at the end of the reporting period.

	September 30, 2011
				Weighted
				Average				Aggregate
				Exercise				Intrinsic
	Shares			Price				Value
Outstanding at beginning of year		165,915		$	20.18
Granted		--			--
Exercised		--			--
Forfeited		(5,744	)		(14.00	)
Outstanding at end of period		160,171		$	20.40		$	--

As of the end of the reporting period, 130,086 options were vested and exercisable representing 100,000 shares issued under the original 1997 plan and 30,086 vested options under the 2006 Plan.  At September 30, 2011 the weighted average exercise price of these stock options was greater than the aggregate market price.  The weighted average remaining contractual term for options outstanding and exercisable at September 30, 2011 was 2.6 years.  As of September 30, 2011 there was $27,000 of total unrecognized compensation expense related to stock option awards under the 2006 Equity Compensation Plan.

The following table summarizes restricted stock awarded under the 2006 Equity Compensation Plan at the end of the reportable period.

	September 30, 2011
				Weighted
				Average				Aggregate
				Grant-Date				Intrinsic
	Shares			Fair Value				Value
Outstanding at beginning of year		38,580		$	15.13
Granted		55,563			15.06
Vested		(7,923	)		(18.38	)
Forfeited		--			--
Non-vested at end of period		86,220		$	14.79		$	1,293,000

The weighted average remaining contractual term for non-vested restricted stock at September 30, 2011 was 3.32 years.  As of September 30, 2011, there was $1,162,000 of total unrecognized compensation expense related to the non-vested restricted stock awards under the 2006 Equity Compensation Plan.

XML

Securities

9 Months Ended

Sep. 30, 2011

Securities [Abstract]

Securities

Note 3.                                Securities

Amortized costs and fair values of securities available for sale at September 30, 2011 are summarized as follows:

	September 30, 2011
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
Available for Sale
U.S. government agencies	$	7,219	$	307	$	(2	)	$	7,524
Obligations of states and
political subdivisions		63,153		2,329		(78	)		65,404
Mortgage-backed securities:
Agency		184,456		6,024		(197	)		190,283
Non-agency		29,931		40		(693	)		29,278
Corporate preferred stock		68		-		(31	)		37
Corporate securities		10,612		10		(383	)		10,239
Trust-preferred securities		501		-		(252	)		249
Total	$	295,940	$	8,710	$	(1,636	)	$	303,014

Amortized costs and fair values of securities available for sale at December 31, 2010 are summarized as follows:

	December 31, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
Available for Sale
U.S. government agencies	$	4,699	$	17	$	(67	)	$	4,649
Obligations of states and
political subdivisions		61,187		174		(2,221	)		59,140
Mortgage-backed securities:
Agency		150,952		1,722		(370	)		152,304
Non-agency		26,168		150		(237	)		26,081
Corporate preferred stock		39		-		(26	)		13
Corporate securities		9,609		7		(84	)		9,532
Trust-preferred securities		998		-		(675	)		323
Total	$	253,652	$	2,070	$	(3,680	)	$	252,042

The amortized cost and fair value of securities available for sale as of September 30, 2011, by contractual maturity are shown below.  Maturities may differ from contractual maturities in corporate and mortgage-backed securities because the securities and mortgages underlying the securities may be called or repaid without any penalties.  Therefore, these securities are not included in the maturity categories in the following maturity summary.

	September 30, 2011
	Amortized		Fair
	Cost		Value
	(In thousands)
Due in one year or less	$	3,020	$	3,036
Due after one year through
five years		13,098		13,275
Due after five years through
ten years		34,525		35,945
Due after ten years		30,341		30,911
Mortgage-backed securities		214,387		219,561
Corporate preferred stock		68		37
Trust preferred securities		501		249
Total	$	295,940	$	303,014

Proceeds from the sale of securities during the nine months ended September 30, 2011 were $26.2 million and net gains of $263,000 were realized on those sales.  The tax expense applicable to the net realized gains amounted to $89,000.  Additionally, $22,000 in losses on securities with other than temporary impairment was recognized during the nine months ended September 30, 2011.

The carrying value of securities pledged to qualify for fiduciary powers, to secure public monies and for other purposes as required by law amounted to $124.4 million at September 30, 2011.

At September 30, 2011, investments in an unrealized loss position that were temporarily impaired are as follows:

	September 30, 2011 (In thousands)
	Less than Twelve Months					Twelve Months or Greater					Total
			Gross					Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
2011	Value		Losses			Value		Losses			Value		Losses
U.S. government agencies	$	390	$	(1	)	$	55	$	(1	)	$	445	$	(2	)
Obligations of states and
political subdivisions		42		-			2,217		(78	)		2,259		(78	)
Mortgage backed securities:
Agency		9,294		(197	)		-		-			9,294		(197	)
Non-agency		15,708		(175	)		4,804		(518	)		20,512		(693	)
Corporate preferred stock		-		-			8		(31	)		8		(31	)
Corporate securities		4,928		(72	)		2,159		(311	)		7,087		(383	)
Trust-preferred securities		-		-			249		(252	)		249		(252	)
Total	$	30,362	$	(445	)	$	9,492	$	(1,191	)	$	39,854	$	(1,636	)

At December 31, 2010, investments in an unrealized loss position that were temporarily impaired are as follows:

	December 31, 2010 (In thousands)
	Less than Twelve Months					Twelve Months or Greater					Total
			Gross					Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
2010	Value		Losses			Value		Losses			Value		Losses
U.S. government agencies	$	3,408	$	(67	)	$	-	$	-		$	3,408	$	(67	)
Obligations of states and
political subdivisions		40,579		(1,	)		4,266		(345	)		44,845		(2,221	)
Mortgage backed securities:
Agency		50,338		(370	)		-		-			50,338		(370	)
Non-agency		18,341		(237	)		-		-			18,341		(237	)
Corporate preferred stock		-		-			12		(26	)		12		(26	)
Corporate securities		9,385		(84	)		-		-			9,385		(84	)
Trust-preferred securities		-		-			323		(675	)		323		(675	)
Total	$	122,051	$	(2,634	)	$	4,601	$	(1,046	)	$	126,652	$	(3,680	)

A total of 50 securities have been identified by the Company as temporarily impaired at September 30, 2011.  Of the 50 securities, 47 are investment grade and 3 are speculative grade.  Agency, non-agency mortgage-backed securities, and municipal securities make up the majority of temporarily impaired securities at September 30, 2011.  The speculative grade securities are asset backed securities that are collateralized by trust preferred issuances of financial institutions.  Market prices change daily and are affected by conditions beyond the control of the Company.  Although the Company has the ability to hold these securities until the temporary loss is recovered, decisions by management may necessitate a sale before the loss is fully recovered.  No such sales are anticipated or required as of September 30, 2011.  Investment decisions reflect the strategic asset/liability objectives of the Company.  The investment portfolio is analyzed frequently by the Company and managed to provide an overall positive impact to the Company's income statement and balance sheet.

Trust preferred securities

Trust preferred securities were evaluated within the scope of EITF 99-20 (ASC 320 Investments – Debt and Equity Securities) for potential impairment. The Company reviews current available information in estimating the future cash flows of these securities and determines whether there have been favorable or adverse changes in estimated cash flows from the cash flows previously projected.  The Company considers the structure and term of the pool and the financial condition of the underlying issuers.  Specifically, the evaluation incorporates factors such as interest rates and appropriate risk premiums, the timing and amount of interest and principal payments and the allocation of payments to the various note classes.  Current estimates of cash flows are based on the most recent trustee reports, announcements of deferrals or defaults, expected future default rates and other relevant market information.  The Company analyzed the cash flow characteristics of these securities.

All of the pooled trust preferred securities in the Company's portfolio have floating rate coupons. In performing the present value analysis of expected cash flows, we incorporate expected deferral and default rates. The deferral/default assumptions for each pooled trust preferred security were developed by reviewing the underlying collateral or issuing banks. The present value of expected future cash flows is discounted at the effective purchase yield, which in the case of the floating rate securities is equal to the credit spread at time of purchase plus the current 3-month LIBOR rate.    We then compare the present value to the current book value for purposes of determining if there is an other-than-temporary impairment (“OTTI”).  The discount rate used to determine OTTI for all periods is the effective purchase yield or the credit spread at time of purchase plus the 3-month LIBOR rate.

The Company reviewed the list of issuers underlying each trust preferred security as of September 30, 2011, and ranked each bank in order of expectations for future defaults and deferrals. We reviewed data on each bank such as earnings, capital ratios, credit metrics and loan loss reserves. We then assigned a default rate to each ranking, then the default rates were applied to each bank that was performing as of the reporting date.  Finally, we summed the defaults and divided by the total remaining performing collateral in each pool. For Trust Preferred IV, the expected default rate was 50 basis points, for Trust Preferred V, the expected default rate was 0 basis points, for Trust Preferred XXII, the expected default rate was 75 basis points, and for MM Community Funding Class A, the expected default rate was 150 basis points.  MM Community Funding Class B was sold during the period and is not presented in the tables below.

In connection with the preparation of the financial statements included in this Form 10-Q and using the evaluation procedures described above, the Company identified three securities with other-than-temporary impairment within its portfolio.  During the nine months ended September 30, 2011, the Company recognized credit related impairment losses of $22,000 compared to $974,000 for the nine months ended September 30, 2010 related to these securities.  Additionally, two securities previously recognized as other than temporarily impaired were sold during the nine months ended September 30, 2011.  These securities had a cumulative other-than-temporary impairment related to credit loss of $1.5 million.  An additional $16,000 loss was recognized in earnings upon sale of these two securities.

The following table provides further information on the Company's trust preferred securities that are considered other-than-temporarily impaired as of September 30, 2011 (in thousands):

						Cumulative	Amount
		Current				Other	of OTTI	(1)	(2)		Expected
		Moody's	Par	Book	Fair	Comprehensive	Related to	Excess	Inst.	Deferrals/	Default	Expected	Lag
Security	Class	Rating	Value	Value	Value	Loss	Credit Loss	Subord.	Perf.	Defaults	Rate	Recovery	Years
MM Community Funding   LTD	A	B1	208	188	125	$                   63	20	126.56%	7	25.32%	1.50%	15%	2
Trust Preferred XXII	D	C	1,979	-	-	-	1,979	-39.52%	57	32.70%	0.75%	15%	2
Trust Preferred V	Mez	Caa3	304	69	6	63	367	-760.20%	-	100.00%	0.00%	15%	2
			$   2,491	$     257	$     131	$                 126	$         2,366
(1)  Excess subordination.  See explanation in text below tables.
(2)  Number of institutions in class performing.

The Company also has the following investment in a trust preferred security not considered other than-temporarily impaired as of September 30, 2011 (in thousands):

Cumulative

Current

Other

(1)

Expected

Tranche

Moody's

Par

Book

Fair

Comprehensive

Institutions

Excess

Deferrals/

Default

Expected

Lag

Security

Level

Rating

Value

Value

Value

Loss

Performing

Subord.

Defaults

Rate

Recovery

Years

Trust Preferred IV

Mez

Ca

$      244

$     244

$     118

$                 126

4

19.42%

27.10%

0.50%

15%

2

$      244

$     244

$     118

$                 126

(1)  Excess subordination.  See explanation in text below tables.

Both of the preceding tables present data on the excess subordination existing in each of the trust preferred issuances included in the Company's investment portfolio.  Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are pari passu and senior to the class owned by the Company. Negative excess subordination indicates that there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to the classes owned by the Company.

The credit deferral/default assumptions utilized in the Company's OTTI analysis methodology and included in the above tables considers specific collateral underlying each trust preferred security.

The following table presents a roll-forward of the credit loss component amount of OTTI recognized in earnings:

OTTI Credit Losses Recognized in Earnings
Rollforward
Amount recognized through December 31, 2010	$	3,871
Additions related to intial impairments		-
Additions related to subsequent impairments		22
Deductions for bonds sold during period (1)		(1,527	)
Net impairment losses recognized in earnings through September 30, 2011	$	2,366

(1) Two securities were sold during March, 2011 with a combined cumulative OTTI related to credit loss of $1,527,000.  An additional $16,000 was recognized as a loss in earnings upon sale of these bonds.

At September 30, 2011, the Company concluded that no other adverse change in cash flows occurred during the quarter and did not consider any other securities other-than-temporarily impaired.  Based on this analysis and because the Company does not intend to sell these securities and it is  more likely than not the Company will not be required to sell these securities before recovery of amortized cost basis, which may be at maturity; and, for debt securities related to corporate securities, determined that there was no other adverse change in the cash flows as viewed by a market participant, the Company does not consider the investments in these assets to be other than temporarily impaired at September 30, 2011.  However, there is a risk that the Company's continuing reviews could result in recognition of other-than-temporary impairment charges in the future.

XML

Recent Accounting Pronouncements

9 Months Ended

Sep. 30, 2011

Recent Accounting Pronouncements [Abstract]

Recent Accounting Pronouncements

Note 11.                      Recent Accounting Pronouncements

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

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

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

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

The Securities Exchange Commission (SEC) issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting.”  The rule requires companies to submit financial statements in extensible business reporting language (XBRL)format with their SEC filings on a phased-in schedule.  Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010.  All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011.  The Company complied with this Rule beginning with the filing of the June 30, 2011 Form 10-Q.

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

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

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

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

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.”  The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity.  The amendments require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income.  In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income.  The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share.  The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011.  Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures.  The Company is currently assessing the impact that ASU 2011-05 will have on its consolidated financial statements. In August 2011, the SEC issued Final Rule No. 33-9250, “Technical Amendments to Commission Rules and Forms related to the FASB's Accounting Standards Codification.”  The SEC has adopted technical amendments to various rules and forms under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940.  These revisions were necessary to conform those rules and forms to the FASB Accounting Standards Codification.  The technical amendments include revision of certain rules in Regulation S-X, certain items in Regulation S-K, and various rules and forms prescribed under the Securities Act, Exchange Act and Investment Company Act.  The Release was effective as of August 12, 2011.  The adoption of the release did not have a material impact on the Company's consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, “Intangible – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment.”  The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350.  The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent.  Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount.  The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity's financial statements for the most recent annual or interim period have not yet been issued.  The Company is currently assessing the impact that ASU 2011-08 will have on its consolidated financial statements.

XML

Loan Portfolio

9 Months Ended

Sep. 30, 2011

Loan Portfolio [Abstract]

Loan Portfolio

Note 4.                                Loan Portfolio

The Company segregates its loan portfolio into three primary loan segments:  Real Estate Loans, Commercial Loans, and Consumer Loans.  Real estate loans are further segregated into the following classes: construction loans, loans secured by farmland, loans secured by 1-4 family residential real estate, and other real estate loans.  Other real estate loans include commercial real estate loans.  The consolidated loan portfolio was composed of the following on the dates indicated:

	September 30, 2011					December 31, 2010
	Outstanding		Percent of			Outstanding		Percent of
	Balance		Total Portfolio			Balance		Total Portfolio
	(In Thousands)					(In Thousands)
Real estate loans:
Construction	$	48,572		7.2	%	$	68,110		10.3	%
Secured by farmland		10,377		1.5			11,532		1.7
Secured by 1-4 family residential		239,738		35.5			242,620		36.8
Other real estate loans		273,823		40.5			268,262		40.7
Commercial loans		91,296		13.5			56,385		8.6
Consumer loans		12,007		1.8			12,403		1.9
		675,813		100.0	%		659,312		100.0	%
Less allowance for loan losses		15,124					14,967
Net loans	$	660,689				$	644,345

Loans presented in the table above exclude loans held for sale.  The Company had $66.9 million and $59.4 million in mortgages held for sale at September 30, 2011 and December 31, 2010, respectively.

The following table presents a contractual aging of the recorded investment in past due loans by class of loans as of September 30, 2011 and December 31, 2010.

	September 30, 2011 (In thousands)
	30-59 Days		60-89 Days		90 Days		Total Past				Total
	Past Due		Past Due		Or Greater		Due		Current		Loans
Real estate loans:
Construction	$	1,440	$	-	$	2,789	$	4,229	$	44,343	$	48,572
Secured by farmland		415		-		-		415		9,962		10,377
Secured by 1-4 family residential		6,502		1,340		10,313		18,155		221,583		239,738
Other real estate loans		899		3,375		1,719		5,993		267,830		273,823
Commercial loans		1,863		221		203		2,287		89,009		91,296
Consumer loans		6		-		-		6		12,001		12,007
		-		-		-		-		-		-
Total	$	11,125	$	4,936	$	15,024	$	31,085	$	644,728	$	675,813

	December 31, 2010 (In thousands)
	30-59 Days		60-89 Days		90 Days		Total Past				Total
	Past Due		Past Due		Or Greater		Due		Current		Loans
Real estate loans:
Construction	$	83	$	7,423	$	1,791	$	9,297	$	58,813	$	68,110
Secured by farmland		-		-		-		-		11,532		11,532
Secured by 1-4 family residential		2,938		-		7,729		10,667		231,953		242,620
Other real estate loans		4,438		3,887		1,385		9,710		258,552		268,262
Commercial loans		1,801		28		243		2,072		54,313		56,385
Consumer loans		22		41		242		305		12,098		12,403
		-		-		-		-		-		-
Total	$	9,282	$	11,379	$	11,390	$	32,051	$	627,261	$	659,312

The following table presents the recorded investment in nonaccrual loans and loans past due ninety days or more and still accruing by class of loans as of September 30, 2011 and December 31, 2010:

	September 30, 2011				December 31, 2010
			Past due 90				Past due 90
			days or more				days or more
	Nonaccrual		and still accruing		Nonaccrual		and still accruing
	(In Thousands)
Real estate loans:
Construction	$	4,229	$	-	$	8,871	$	-
Secured by farmland		-		-		-		-
Secured by 1-4 family residential		16,063		1,561		10,817		676
Other real estate loans		8,046		-		7,509		218
Commercial loans		2,147		-		1,950		12
Consumer loans		-		-		239		3
Total	$	30,485	$	1,561	$	29,386	$	909

If interest on nonaccrual loans had been accrued, such income would have approximated $1.5 million and $1.2 million for the nine months ended September 30, 2011 and 2010 respectively.

The Company utilizes an internal asset classification system as a means of measuring and monitoring credit risk in the loan portfolio.  Under the Company's classification system, problem and potential problem loans are classified as “Special Mention”, “Substandard”, “Doubtful” and “Loss”.

Special Mention:  Loans classified as special mention have potential weaknesses that deserve management's close attention.  If left uncorrected, the potential weaknesses may result in the deterioration of the repayment prospects for the credit.

Substandard:  Loans classified as substandard have a well-defined weakness that jeopardizes the liquidation of the debt.  Either the paying capacity of the borrower or the value of the collateral may be inadequate to protect the Company from potential losses.

Doubtful:  Loans classified as doubtful have a very high possibility of loss.  However, because of important and reasonably specific pending factors, classification as a loss is deferred until a more exact status may be determined.

Loss: Loans are classified as loss when they are deemed uncollectable and are charged off immediately.

The following tables present a summary of loan classifications by class of loan as of September 30, 2011 and December 31, 2010:

	September 30, 2011 (In Thousands)
			Real Estate		Real Estate
	Real Estate		Secured by		Secured by 1-4		Other Real
	Construction		Farmland		Family Residential		Estate Loans		Commercial		Consumer		Total
Pass	$	26,615	$	9,565		206,466	$	239,591	$	84,218	$	11,928	$	578,383
Special Mention		6,524		812		9,939		20,836		4,478		66		42,655
Substandard		14,402		-		21,685		13,143		2,299		13		51,542
Doubtful		1,031		-		1,648		253		301		-		3,233
Loss		-		-		-		-		-		-		-
Ending Balance	$	48,572	$	10,377		239,738	$	273,823	$	91,296	$	12,007	$	675,813

	December 31, 2010 (In thousands)
			Real Estate		Real Estate
	Real Estate		Secured by		Secured by 1-4		Other Real
	Construction		Farmland		Family Residential		Estate Loans		Commercial		Consumer		Total
Pass	$	31,744	$	10,070		212,531	$	244,982	$	50,660	$	12,016	$	562,003
Special Mention		15,580		1,462		14,810		13,067		3,394		92		48,405
Substandard		20,561		-		14,616		9,939		2,331		295		47,742
Doubtful		225		-		663		274		-		-		1,162
Loss		-		-		-		-		-		-		-
Ending Balance	$	68,110	$	11,532		242,620	$	268,262	$	56,385	$	12,403	$	659,312

The following table presents loans identified as impaired by class of loan as of and for the nine months ended September 30, 2011:

	September 30, 2011  (In thousands)
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Real estate loans:
Construction	$	3,300	$	3,960	$	-	$	4,248	$	-
Secured by farmland		-		-		-		-		-
Secured by 1-4 family residential		3,894		4,487		-		4,254		-
Other real estate loans		2,987		3,030		-		3,978		-
Commercial loans		1,723		1,723		-		1,721		-
Consumer loans		-		-		-		-		-
Total with no related allowance		11,904		13,200		-		14,201		-
With an allowance recorded:
Real estate loans:
Construction		929		959		416		930		-
Secured by farmland		-		-		-		-		-
Secured by 1-4 family residential		12,573		14,377		3,030		13,248		8
Other real estate loans		5,059		5,059		1,033		4,540		-
Commercial loans		424		446		406		426		-
Consumer loans		-		-		-		-		-
Total with a related allowance		18,985		20,841		4,885		19,144		8
Total	$	30,889	$	34,041	$	4,885	$	33,345	$	8

The following table presents loans identified as impaired by class of loan as of and for the year ended December 31, 2010:

	December 31, 2010 (In thousands)
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Real estate loans:
Construction	$	3,415	$	3,415	$	-	$	3,470	$	4
Secured by farmland		-		-		-		-
Secured by 1-4 family residential		5,450		6,281		-		5,992		-
Other real estate loans		1,303		1,303		-		1,316		-
Commercial loans		1,823		1,844		-		2,032		-
Consumer loans		-		-		-		28		-
Total with no related allowance		11,991		12,843		-		12,838		4
With an allowance recorded:
Real estate loans:
Construction		5,755		6,366		1,876		6,108		-
Secured by farmland		-		-		-		-
Secured by 1-4 family residential		5,422		6,518		1,099		6,076		-
Other real estate loans		7,056		7,201		2,010		7,235		48
Commercial loans		127		127		108		128		-
Consumer loans		239		239		239		240		-
Total with a related allowance		18,599		20,452		5,332		19,787		48
Total	$	30,590	$	33,295	$	5,332	$	32,625	$	52

The “Recorded Investment” amounts in the tables above represent the outstanding principal balance on each loan represented in the tables plus any accrued interest receivable on such loans.  The “Unpaid Principal Balance” represents the outstanding principal balance on each loan represented in the tables plus any amounts that have been charged off on each loan.

Troubled Debt Restructurings

Included in certain loan categories in the impaired loans table above are troubled debt restructurings (“TDR's”) that were classified as impaired.  The total balance of TDR's at September 30, 2011 was $8.4 million of which $8.0 million were included in the Company's non-accrual loan totals at that date and $404,000 represented loans performing as agreed to the restructured terms. This compares with $4.5 million in total restructured loans at December 31, 2010, an increase of $3.9 million or 86.7%.  The amount of the valuation allowance related to total TDR's was $1.5 million and $532,000 as of September 30, 2011 and December 31, 2010 respectively.

The $8.0 million in nonaccrual TDR's as of September 30, 2011 is comprised of $572,000 million in real estate construction loans, $3.9 million in 1-4 family real estate loans, $2.3 million in non-residential real estate loans, $764,000 in commercial loans, and $416,000 in consumer loans.  The $404,000 in TDR's which were performing as agreed under restructured terms as of September 30, 2011 is represented by  two 1-4 family real estate loans.  The Company considers all loans classified as TDR's to be impaired as of September 30, 2011.

As a result of adopting the amendments in ASU 2011-02, “Receivables (Topic 310) – A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” The Company reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they are considered TDRs under the amended guidance using review procedures in effect at that time.

The following table presents by class of loan, information related to loans modified in a TDR during the nine and three months ended September 30, 2011:

	Loans modified as TDR's
	For the nine months ended
	September 30, 2011
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
Class of Loan	Contracts		Investment		Investment
	(In thousands)
Real estate loans:
Construction		-	$	-	$	-
Secured by farmland		-		-		-
Secured by 1-4 family residential		4		284		293
Other real estate loans		5		5,282		5,282
Total real estate loans		9		5,566		5,575
Commercial loans		-		-		-
Consumer loans		-		-		-
Total		9	$	5,566	$	5,575
	Loans modified as TDR's
	For the three months ended
	September 30, 2011
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
Class of Loan	Contracts		Investment		Investment
	(In thousands)
Real estate loans:
Construction		-	$	-	$	-
Secured by farmland		-		-		-
Secured by 1-4 family residential		4		284		293
Other real estate loans		-		-		-
Total real estate loans		4		284		293
Commercial loans		-		-		-
Consumer loans		-		-		-
Total		4	$	284	$	293

During the nine months ended September 30, 2011, the Company modified nine loans that were considered to be TDR's.  We extended the term and lowered the interest rate for all nine loans.

During the nine months ended September 30, 2011, the Company identified as a TDR one loan for which the allowance for loan losses had previously been measured under a general allowance methodology. Upon identifying this loan as a TDR, the Company evaluated it for impairment. The accounting amendments require prospective application of the impairment measurement guidance for those loans newly identified as impaired. As of September 30, 2011, the recorded investment in the loan for which the allowance was previously measured under a general allowance methodology and is now considered impaired and measured under a specific allowance methodology was $293,000, and the allowance for loan losses associated with that loan, on the basis of a current evaluation of loss was $127,000.

As of September 30, 2011, $5.3 million of loans restructured as TDR's during the nine month period are included in the Company's non-accrual loans total.  The balance of the loans identified as TDR's during that period are reflected as non-performing assets which are performing as agreed under the restructured terms.

No loans modified in as TDR's from October 1, 2010 through September 30, 2011 subsequently defaulted (i.e. 90 days or more past due following a restructuring) during the nine and three months ended September 30, 2011.

Management considers troubled debt restructurings and subsequent defaults in restructured loans in the determination of the adequacy of the Company's allowance for loan losses.  When identified as a TDR, a loan is evaluated for potential loss based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the estimated fair value of the collateral, less any selling costs if the loan is collateral dependent.  Loans identified as TDR's frequently are on non-accrual status at the time of the restructuring and, in some cases, partial charge-offs may have already been taken against the loan and a specific allowance may have already been established for the loan.  As a result of any modification as a TDR, the specific reserve associated with the loan may be increased.  Additionally, loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future defaults.  If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment.  As a result, any specific allowance may be increased, adjustments may be made in the allocation of the total allowance balance, or partial charge-offs may be taken to further write-down the carrying value of the loan.  Management exercises significant judgment in developing estimates for potential losses associated with TDR's.

XML

Consolidated Statements of Changes in Shareholders' Equity (Unaudited) (USD $) In Thousands	Common Stock [Member]	Capital Surplus [Member]	Retained Earnings [Member]	Accumulated Other Comprehensive Income (Loss) [Member]	Comprehensive Income [Member]	Noncontrolling Interest [Member]	Total Comprehensive Income [Member]	Total
Balances at Dec. 31, 2009	$ 17,273	$ 42,807	$ 42,706	$ (2,474)		$ 3,047		$ 103,359
Comprehensive income
Net income (loss)			(4,250)		(4,250)	311	(3,939)	(3,939)
Unrealized holding gains arising during the period				3,983	3,983		3,983	3,983
Reclassification adjustment				(500)	(500)		(500)	(500)
Unrealized losses on securities for which other-than-temporary impairment has been recognized in earnings				720	720		720	720
Total other comprehensive income				4,203	4,203	0	4,203	4,203
Total comprehensive income (loss)					(47)	311	264	264
Cash dividends declared			(2,078)					(2,078)
Exercise of stock options	7	22						29
Vesting of restricted stock awards	9	(9)						0
Distributions to non-controlling interest						(254)		(254)
Share-based compensation	0	110						110
Balances at Sep. 30, 2010	17,289	42,930	36,378	1,729		3,104		101,430
Balances at Dec. 31, 2010	17,314	43,058	37,593	(1,012)		3,040		99,993
Comprehensive income
Net income (loss)			3,824		3,824	(128)	3,696	3,696
Unrealized holding gains arising during the period				5,891	5,891	0	5,891	5,891
Reclassification adjustment				(174)	(174)	0	(174)	(174)
Unrealized losses on securities for which other-than-temporary impairment has been recognized in earnings				15	15	0	15	15
Unrealized (loss) on interest rate swap				(393)	(393)	0	(393)	(393)
Total other comprehensive income				5,339	5,339	0	5,339	5,339
Total comprehensive income (loss)					9,163	(128)	9,035	9,035
Cash dividends declared			(1,044)					(1,044)
Vesting of restricted stock awards	19	(19)						0
Cancellation of restricted stock	(2)	(12)						(14)
Distributions to non-controlling interest						(644)		(644)
Share-based compensation	0	247						247
Balances at Sep. 30, 2011	$ 17,331	$ 43,274	$ 40,373	$ 4,327		$ 2,268		$ 107,573

XML

Consolidated Statements of Cash Flows (Unaudited) (USD $) In Thousands	9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010
Cash Flows From Operating Activities
Net income (loss)	$ 3,696	$ (3,939)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization	1,391	1,323
Equity in (undistributed earnings) of affiliate	(21)	145
Provision for loan losses	2,565	11,350
Net (gain) on securities available for sale	(263)	(757)
Other than temporary impairment loss	22	974
Net loss (gain) on disposal of assets	45	(7)
Premium amortization on securities, net	2,029	1,583
Origination of loans held for sale	(470,006)	(555,310)
Proceeds from sales of loans held for sale	474,743	534,489
Net (gains) on mortgages held for sale	(12,286)	(11,621)
Share-based compensation	247	110
Net loss on sale of other real estate owned	336	185
Valuation adjustment on other real estate owned	774	760
Decrease in prepaid FDIC insurance	927	1,418
Changes in assets and liabilities:
(Increase) in other assets	(3,303)	(5,226)
Increase in other liabilities	1,851	1,261
Net cash provided by (used in) operating activities	2,747	(23,262)
Cash Flows from Investing Activities
Proceeds from maturity, principal paydowns and calls of securities available for sale	42,050	39,656
Proceeds from sale of securities available for sale	26,154	56,502
Purchase of securities available for sale	(112,259)	(161,152)
Purchase of restricted stock	(931)	0
Proceeds from disposition of fixed assets	57	0
Purchases of bank premises and equipment	(1,430)	(546)
Net (increase) in loans	(20,641)	(19,247)
Proceeds from sale of other real estate owned	2,917	1,049
Purchase of bank-owned life insurance	0	(682)
Net cash (used in) investing activities	(64,083)	(84,420)
Cash Flows from Financing Activities
Net increase in non-interest-bearing and interest- bearing demand deposits and savings accounts	34,080	41,664
Net (decrease) increase in certificates of deposit	(14,690)	49,628
Increase in securities sold under agreements to repurchase	5,724	8,217
Proceeds from short-term borrowings	67,470	83,395
Payments on short-term borrowings	(67,926)	(65,058)
Proceeds from FHLB borrowings	40,000	17,912
Payments on FHLB borrowings	(25,000)	0
Distributions to non-controlling interest	(644)	(254)
Payment of dividends on common stock	(1,044)	(2,078)
Net proceeds from issuance of common stock	0	29
Net cash provided by financing activities	37,970	133,455
(Decrease) increase in cash and and cash equivalents	(23,366)	25,773
Cash and Cash Equivalents
Beginning	64,724	43,210
Ending	41,358	68,983
Cash payments for:
Interest	8,345	11,144
Income taxes	450	0
Supplemental Disclosure of Noncash Transactions
Unrealized gain on securities available for sale	8,685	6,367
Change in market value of interest rate swap	(596)	0
Transfer of loans to other real estate owned	2,266	3,625
Loans originated from sale of other real estate owned	$ 533	$ 0

XML

Capital Purchase Program

9 Months Ended

Sep. 30, 2011

Capital Purchase Program [Abstract]

Capital Purchase Program

Note 9.                                Capital Purchase Program

During 2009, the Company participated in the Capital Purchase Program established by the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008 and issued 22,000 shares of preferred stock to the Treasury as well as a warrant (“the Warrant”) to purchase 208,202 shares of the Company's common stock at an initial exercise price of $15.85 per share.  As a result of the completion of the Company's public stock offering in August 2009, the number of shares of common stock underlying the Warrant was reduced by one-half to 104,101.  On December 23, 2009, the Company redeemed all of the shares of preferred stock issued to the Treasury.  Pursuant to the purchase agreement with the Treasury, the Company may repurchase the Warrant now that it has fully redeemed its Preferred Stock.  The price for the purchase of the Warrant is subject to negotiation and there can be no assurance that the Warrant will be repurchased.  At this time, the Company has not repurchased the Warrant and the Warrant remains outstanding to the Treasury.  The Company expects the Treasury to sell the Warrant through an auction process in the near future.

XML

Consolidated Balance Sheets (Unaudited) (USD $) In Thousands	Sep. 30, 2011	Dec. 31, 2010
ASSETS
Cash and due from banks	$ 5,334	$ 21,955
Interest-bearing deposits with other institutions	36,024	42,769
Total cash and cash equivalents	41,358	64,724
Securities available for sale	303,014	252,042
Loans held for sale	66,910	59,361
Restricted securities, at cost	7,227	6,296
Loans receivable, net of allowance for loan losses of $15,124 at September 30, 2011 and $14,967 at December 31, 2010	660,689	644,345
Premises and equipment, net	21,464	21,112
Goodwill and identified intangibles	6,244	6,360
Other real estate owned, net of valuation allowance of $1,057 at September 30, 2011 and $1,486 at December 31, 2010	6,096	8,394
Prepaid federal deposit insurance	4,227	5,154
Accrued interest receivable and other assets	36,427	36,779
TOTAL ASSETS	1,153,656	1,104,567
Deposits:
Non-interest-bearing demand deposits	145,393	130,488
Savings and interest-bearing demand deposits	455,893	436,718
Time deposits	308,410	323,100
Total deposits	909,696	890,306
Securities sold under agreements to repurchase	31,286	25,562
Short-term borrowings	12,864	13,320
FHLB Borrowings	77,912	62,912
Subordinated notes	5,155	5,155
Accrued interest payable and other liabilities	9,170	7,319
Commitments and contingent liabilities
TOTAL LIABILITIES	1,046,083	1,004,574
SHAREHOLDERS' EQUITY
Common stock ($2.50 par value; 20,000,000 shares authorized, 7,000,824 issued; 6,996,932 and 6,925,437 outstanding at September 30, 2011 and December 31, 2010, respectively)	17,331	17,314
Capital surplus	43,274	43,058
Retained earnings	40,373	37,593
Accumulated other comprehensive income (loss)	4,327	(1,012)
Total Middleburg Financial Corporation shareholders' equity	105,305	96,953
Non-controlling interest in consolidated subsidiary	2,268	3,040
TOTAL SHAREHOLDERS' EQUITY	107,573	99,993
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$ 1,153,656	$ 1,104,567