Note 5 - Loans and allowance for loan losses

The allowance represents an amount that, in management's judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Management's judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower's ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

Management has an established methodology used to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Bank has segmented certain loans in the portfolio by product type. Within these segments, the Bank has sub-segmented its portfolio by classes within the segments, based on the associated risks within these classes. The classifications set forth below do not correspond directly to the classifications set forth in the call report (Form FFIEC 041). Management has determined that the classifications set forth below are more appropriate for use in identifying and managing risk in the loan portfolio.


Loan Segments: Commercial Commercial real estate	Loan Classes: Commercial and industrial loans Commercial mortgages – owner occupied Commercial mortgages – non-owner occupied Commercial construction

Consumer	Consumer unsecured Consumer secured

Residential	Residential mortgages
	Residential consumer construction

The evaluation also considers the following risk characteristics of each loan portfolio:

Commercial loans carry risks associated with the successful operation of a business because the repayment of these loans may be dependent upon the profitability and cash flows of the business or project. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.
Commercial real estate loans carry risks associated with a real estate project and other risks associated with the ownership of real estate. In addition, for real estate construction loans there is a risk that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.
Consumer loans carry risks associated with the continued credit-worthiness of the borrower and the value of the collateral (e.g., rapidly-depreciating assets such as automobiles), or lack thereof.
Consumer loans are more likely than real estate loans to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy. Unsecured consumer loans carry additional risks associated with the continued credit-worthiness of borrowers who may be unable to meet payment obligations.
Residential mortgage and construction loans carry risks associated with the continued credit- worthiness of the borrower and changes in the value of the collateral. Equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral.

The Bank's internal risk rating system is in place to grade commercial and commercial real estate loans. Category ratings are reviewed periodically by lenders and the credit review area of the Bank based on the borrower's individual situation. Additionally, internal and external monitoring and review of credits are conducted on an annual basis.

Below is a summary and definition of the Bank's risk rating categories:


RATING 1	Excellent
RATING 2	Above Average
RATING 3	Satisfactory
RATING 4	Acceptable / Low Satisfactory
RATING 5	Monitor
RATING 6	Special Mention
RATING 7	Substandard
RATING 8	Doubtful
RATING 9	Loss

Based on the above criteria, we segregate loans into the above categories for special mention, substandard, doubtful and loss from non-classified, or pass rated, loans. We review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these ratings are as follows:

"Pass." These are loans having risk ratings of 1 through 4. Pass loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.
"Monitor." These are loans having a risk rating of 5. Monitor loans have currently acceptable risk but may have the potential for a specific defined weakness in the borrower's operations and the borrower's ability to generate positive cash flow on a sustained basis. The borrower's recent payment history may currently or in the future be characterized by late payments. The Bank's risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.
"Special Mention." These are loans having a risk rating of 6. Special Mention loans have weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank's credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. These loans do warrant more than routine monitoring due to a weakness caused by adverse events.
"Substandard." These are loans having a risk rating of 7. Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Bank's credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Bank.
There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower's performance and financial condition provide evidence that it is probable that the Bank will be unable to collect all amounts due.
"Doubtful." These are loans having a risk rating of 8. Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high.
"Loss." These are loans having a risk rating of 9. Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.

The Bank grants primarily commercial, real estate, and installment loans to customers throughout its market area, which consists primarily of Region 2000 which includes the counties of Amherst, Appomattox, Bedford and Campbell and the cities of Bedford and Lynchburg, Virginia. The real estate portfolio can be affected by the condition of the local real estate market. The commercial and installment loan portfolio can be affected by the local economic conditions.

A summary of loans, net is as follows:


		December 31,
		2011		2010

Commercial	$	59,623	$	62,786
Commercial real estate		150,622		143,428
Consumer		72,488		68,289
Residential		42,067		51,679

Total loans		324,800		326,182

Less allowance for loan losses		5,612		5,467

Net loans	$	319,188	$	320,715

The amount of overdrafts reclassified as loans was $14 and $13 as of December 31, 2011 and 2010, respectively.

The Company's officers, directors and their related interests have various types of loan relationships with the Bank. The total outstanding balances of these related party loans at December 31, 2011 and 2010 were $8,914 and $6,663 respectively. During 2011, new loans and advances amounted to $4,645 and repayments amounted to $2,394. The terms and interest rates of these loans are similar to those for comparable loans with other borrowers of the Bank.

The following tables set forth information regarding impaired and non-accrual loans as of December 31, 2011 and 2010:


Financing Receivables on Non-Accrual Status
(*Dollars in Thousands*)

		As of December 31,
		2011			2010
Commercial	$	3,570		$	756
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		1,610			1,157
Commercial Mortgages-Non-Owner Occupied		2,793			2,504
Commercial Construction		782			923
Consumer
Consumer Unsecured		-			83
Consumer Secured		415			1,153
Residential:
Residential Mortgages		1,205			1,725
Residential Consumer Construction		-			65

Totals	$	10,375	$	8,366


					Impaired Loans
				For the Year Ended December 31, 2011
				Unpaid			Average			Interest
		Recorded		Principal	Related		Recorded			Income
2011		Investment		Balance	Allowance		Investment			Recognized
With No Related Allowance Recorded:
Commercial	$	3,357	$	3,570	$	-	$	8,978	$	118
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		2,211		3,108		-		2,457		124
Commercial Mortgage Non-Owner
Occupied		4,880		5,170		-		5,418		227
Commercial Construction		1,103		1,103		-		984		38
Consumer
Consumer Unsecured		-		-		-		-		-
Consumer Secured		293		642		-		330		6
Residential
Residential Mortgages		862		1,007		-		633		15
Residential Consumer Construction		-		-		-		33		-

With An Allowance Recorded:
Commercial	$	2,968	$	3,052	$	440	$	2,170	$	106
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		2,516		2,686		555		3,815		137
Commercial Mortgage Non-Owner
Occupied		2,590		3,129		228		1,858		117
Commercial Construction		1,700		1,964		275		2,454		42
Consumer
Consumer Unsecured		-		-		-		286		-
Consumer Secured		942		1,021		357		699		49
Residential
Residential Mortgages		1,922		2,180		128		1,847		89
Residential Consumer Construction		-		-		-		-		-

Totals:
Commercial	$	6,325	$	6,622	$	440	$	11,147	$	224
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		4,727		5,794		555		6,272		261
Commercial Mortgage Non-Owner
Occupied		7,470		8,299		228		7,275		344
Commercial Construction		2,803		3,067		275		3,438		80
Consumer
Consumer Unsecured		-		-		-		286		-
Consumer Secured		1,235		1,663		357		1,029		55
Residential
Residential Mortgages		2,784		3,187		128		2,480		104
Residential Consumer Construction		-		-		-		33		-
	$	25,344	$	28,632	$	1,983	$	31,960	$	1,068


					Impaired Loans
				For the Year Ended December 31, 2010
				Unpaid			Average			Interest
		Recorded		Principal	Related		Recorded			Income
2010		Investment		Balance	Allowance		Investment			Recognized
With No Related Allowance Recorded:
Commercial	$	14,598	$	14,787	$	-	$	14,794	$	687
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		2,703		2,729		-		2,740		177
Commercial Mortgage Non-Owner
Occupied		5,955		6,569		-		6,035		171
Commercial Construction		864		864		-		876		45
Consumer
Consumer Unsecured		-		-		-		-		-
Consumer Secured		366		660		-		371		13
Residential
Residential Mortgages		403		613		-		406		8
Residential Consumer Construction		65		68		-		66		1

With An Allowance Recorded:
Commercial	$	1,371	$	1,371	$	195	$	1,388	$	82
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		5,114		5,144		1,218		5,184		177
Commercial Mortgage Non-Owner
Occupied		1,125		1,132		53		1,141		21
Commercial Construction		3,208		3,355		437		3,252		103
Consumer
Consumer Unsecured		572		589		75		578		15
Consumer Secured		456		456		195		461		25
Residential
Residential Mortgages		1,772		1,923		257		1,794		124
Residential Consumer Construction		-		-		-		-		-

Totals:
Commercial	$	15,969	$	16,158	$	195	$	16,182	$	769
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		7,817		7,873		1,218		7,924		354
Commercial Mortgage Non-Owner
Occupied		7,080		7,701		53		7,176		192
Commercial Construction		4,072		4,219		437		4,128		148
Consumer
Consumer Unsecured		572		589		75		578		15
Consumer Secured		822		1,116		195		832		38
Residential
Residential Mortgages		2,175		2,536		257		2,200		132
Residential Consumer Construction		65		68		-		66		1
	$	38,572	$	40,260	$	2,430	$	39,086	$	1,649

The following tables sets forth the allowance for loan losses activity for the years ended December 31, 2011, 2010, and 2009:


		Allowance for Credit Losses and Recorded Investment in Financing Receivables
				For the Year Ended December 31, 2011

				Commercial
2011		Commercial		Real Estate				Consumer				Residential				Total

Allowance for Credit Losses:

Beginning Balance	$	473		$	2,897			$	1,207			$	890			$	5,467
Charge-offs		(702	)		(2,738	)			(817	)			(459	)			(4,716	)
Recoveries		16			3				31				4				54
Provision		1,105			2,515				1,065				122				4,807
Ending Balance	$	892		$	2,677			$	1,486			$	557			$	5,612

Ending Balance: Individually
evaluated for impairment	$	440		$	1,058			$	357			$	128			$	1,983

Ending Balance: Collectively
evaluated for impairment		452			1,619				1,129				429				3,629


Totals:	$	892		$	2,677			$	1,486			$	557			$	5,612

Financing Receivables:

Ending Balance: Individually
evaluated for impairment	$	6,325		$	15,000			$	1,235			$	2,784			$	25,344

Ending Balance: Collectively
evaluated for impairment		53,298			135,622				71,253				39,283				299,456

Totals:	$	59,623		$	50,622		$	72,488			$	42,067			$	324,800


		Allowance for Credit Losses and Recorded Investment in Financing Receivables
				For the Year Ended December 31, 2010
				Commercial
2010		Commercial		Real Estate		Consumer			Residential		Total
Allowance for Credit Losses:
Ending Balance: Individually
evaluated for impairment	$	195	$	1,708		$	270		$	257	$	2,430
Ending Balance: Collectively
evaluated for impairment		278		1,189			937			633		3,037

Totals:	$	473	$	2,897		$	1,207		$	890	$	5,467
Financing Receivables:
Ending Balance: Individually
evaluated for impairment		15,969		18,969			1,394			2,240		38,572
Ending Balance: Collectively
evaluated for impairment		46,817		124,459			66,895		49,439			287,610
Totals:	$	62,786	$	143,428	$	68,289		$	51,679		$	326,182


Allowance for loan losses:
Beginning balance, January 1, 2009	$	2,859
Provision for losses		4,151
Charge-offs		(2,797	)
Recoveries		75
Ending balance, December 31, 2009	$	4,288


Age Analysis of Past Due Financing Receivables as of December 31, 2011
														Recorded
					Greater								Total	Investment
		30-59 Days	60-89 Days		than			Total Past					Financing	> 90 Days &
2011		Past Due	Past Due		90		Days	Due			Current		Receivables	Accruing
Commercial	$	532	$	26	$	3,570		$	4,128	$	55,495	$	59,623	$	-

Commercial Real Estate:
Commercial Mortgages-Owner
Occupied		2,614		130		1,610			4,354		56,400		60,754		-
Commercial Mortgages-Non-
Owner Occupied		504		72		2,793			3,369		74,520		77,889		-

Commercial Construction		782		-		424			1,206		10,773		11,979		-
Consumer:
Consumer Unsecured		6		-		-			6		3,231		3,237		-
Consumer Secured		202		277		415			894		68,357		69,251		-
Residential:
Residential Mortgages		523		162		863			1,548		37,884		39,432		-
Residential Consumer
Construction		-		-		-			-		2,635		2,635		-

Total	$	5,163	$	667	$	9,675		$	15,505	$	309,295	$	324,800	$	-



Age Analysis of Past Due Financing Receivables as of December 31, 2010
														Recorded
					Greater								Total	Investment
		30-59 Days	60-89 Days		than			Total Past					Financing	> 90 Days &
2010		Past Due	Past Due		90		Days	Due			Current		Receivables	Accruing
Commercial	$	726	$	180	$	576		$	1,482	$	61,304	$	62,786	$	-

Commercial Real Estate:
Commercial Mortgages-Owner
Occupied		1,390		299		553			2,242		62,120		64,362		-
Commercial Mortgages-Non-
Owner Occupied		1,169		253		2,503			3,925		62,619		66,544		-

Commercial Construction		-		-		923			923		11,599		12,522		-
Consumer:
Consumer Unsecured		8		-		83			91		2,824		2,915		-
Consumer Secured		564		230		731			1,525		63,849		65,374		-
Residential:
Residential Mortgages		1,072		68		793			1,933		39,7834		41,767		-
Residential Consumer
Construction		-		-		65			65		9,847		9,912		-

Total	$	4,929	$	1,030	$	6,227		$	12,186	$	313,996	$	326,182	$	-


						Credit Loss Disclosures
				Credit Quality Information - by Class
						December 31, 2011
2011						Special
		Pass		Monitor		Mention	Substandard		Doubtful			Totals
Commercial	$	47,021	$	3,978	$	2,901	$	5,723	$	-	$	59,623
Commercial Real Estate:
Commercial Mortgages-Owner
Occupied		48,622		3,003		4,696		4,283		150		60,754
Commercial Mortgages-Non-Owner
Occupied		63,934		3,326		3,159		7,470		-		77,889
Commercial Construction		9,000		176		-		2,803		-		11,979
Consumer
Consumer Unsecured		3,237		-		-		-		-		3,237
Consumer Secured		67,295		488		304		1,164		-		69,251
Residential:
Residential Mortgages		35,543		557		548		2,784		-		39,432
Residential Consumer Construction		2,635		-		-		-		-		2,635

Totals	$	277,287	$	11,528	$	11,608	$	24,227	$	150	$	324,800

						Credit Loss Disclosures
				Credit Quality Information - by Class
						December 31, 2010
2010						Special
		Pass		Monitor		Mention	Substandard		Doubtful			Totals
Commercial	$	41,328	$	2,732	$	9,471	$	9,075	$	180	$	62,786
Commercial Real Estate:
Commercial Mortgages-Owner
Occupied		50,485		5,535		1,378		6,814		150		64,362
Commercial Mortgages-Non-Owner
Occupied		52,004		2,337		6,354		5,849		-		66,544
Commercial Construction		7,571		855		1,446		2,650		-		12,522
Consumer
Consumer Unsecured		2,805		-		1		34		75		2,915
Consumer Secured		63,225		475		349		1,325		-		65,374
Residential:
Residential Mortgages		38,504		77		-		3,014		172		41,767
Residential Consumer Construction		9,475		-		372		65		-		9,912

Totals	$	265,397	$	12,011	$	19,371	$	28,826	$	577	$	326,182

Troubled Debt Restructurings (TDRs)


For the Year Ended December 31, 2011
		Pre-	Post	-
		Modification		Modification
		Outstanding		Outstanding
Troubled Debt	Number of	Recorded		Recorded
Restructurings	Contracts	Investment		Investment

Commercial Real Estate	5	$2,718	$	2,718

The five contracts referenced above were modified in the form of interest rate reductions. After modification, each loan was individually reevaluated for impairment. As a result of the evaluation, it was determined that there was no additional impact to the allowance for loan loss.

For the Year Ended December 31, 2011


Troubled Debt
Restructurings That	Number
Subsequently	of		Recorded
Defaulted	Contracts		Investment

Commercial	2	$	3,596
Consumer	1		30
Total	3	$	3,626