HomeTown Bankshares Corp - FORM 10-K

HomeTown Bankshares Corp - FORM 10-K - March 31, 2011

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HomeTown Bankshares Corp Reports

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EX-32 - SECTION 906 CEO AND CFO CERTIFICATION - HomeTown Bankshares Corp	dex32.htm
EX-99.1 - SECTION 906 CEO AND CFO CERTIFICATION - HomeTown Bankshares Corp	dex991.htm
EX-99.2 - TARP CHIEF FINANCIAL OFFICER CERTIFICATION - HomeTown Bankshares Corp	dex992.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - HomeTown Bankshares Corp	dex312.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - HomeTown Bankshares Corp	dex311.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

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

For the fiscal year ended December 31, 2010

¨	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 333-158525

HomeTown Bankshares Corporation

(Exact name of registrant as specified in its charter)


Virginia		26-4549960
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

202 South Jefferson Street Roanoke, Virginia		24011
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code (540) 345-6000

Securities registered pursuant to Section 12(b) of the Act:


Title of each class		Name of each exchange on which registered
None		None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $5.00 per share Par Value

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of June 30, 2010. $22,148,882 based on $8.30 per share.

(Applicable only to corporate registrants) Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date 3,241,547 shares outstanding as of March 30, 2011.

Documents incorporated by reference. Portions of the Corporation’s 2011 Proxy Statement have been incorporated by reference into Part III.

HOMETOWN BANKSHARES CORPORATION

FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2010

TABLE OF CONTENTS

PART I


		Page
Item 1.	Business		1
Item 1A.	Risk Factors		6
Item 1B.	Unresolved Staff Comments		6
Item 2.	Properties		6
Item 3.	Legal Proceedings		6
Item 4.	Reserved		6

PART II

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		6
Item 6.	Selected Financial Data		7
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		7
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk		20
Item 8.	Financial Statements and Supplementary Data		21
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		55
Item 9A.	Controls and Procedures		55
Item 9B.	Other Information		55

PART III

Item 10.	Directors, Executive Officers and Corporate Governance		56
Item 11.	Executive Compensation		56
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		56
Item 13.	Certain Relationships and Related Transactions, and Director Independence		56
Item 14.	Principal Accountant Fees and Services		56

PART IV

Item 15.	Exhibits, Financial Statement Schedules		57

PART I

ITEM 1.

BUSINESS.

Overview and History

General

HomeTown Bankshares Corporation (the “Company”, “HomeTown Bankshares”) was incorporated in the Commonwealth of Virginia on December 8, 2008. On September 4, 2009, the Company acquired all of the outstanding shares of HomeTown Bank in a one for one exchange of stock.

The Company is authorized as a bank holding company. The holding company structure provides greater flexibility that a bank standing alone because it allows expansion and diversification of business activities through subsidiaries or through acquisitions. HomeTown Bankshares Corporation’s business is conducted through its wholly-owned subsidiary, HomeTown Bank.

HomeTown Bank

Hometown Bank (the “Bank”) is a Virginia banking corporation headquartered in Roanoke, Virginia. The Bank was incorporated under the laws of the Commonwealth of Virginia as a state chartered bank in 2004 and began banking operations in November 2005. The Bank was organized to engage in general retail and commercial banking business.

The Bank opened for business on November 14, 2005 and was capitalized by more than 2,000 shareholders who wanted a new local bank dedicated to customer service. These investors provided the initial customer base and are integral to the success of the Bank. Management believes that the key to the Bank’s success lies in providing Bank customers with personalized service from experienced banking professionals while providing innovative, highly competitive and convenient products and services that meet their banking needs.

The Bank is a community-oriented financial institution that provides varied banking services to individuals, small and medium-sized businesses, and larger companies. The Bank provides a full range of services to meet the financial needs of its customers and strives to provide its customers with innovative products while maintaining the prompt response and the high level of service of a community bank. Management believes this operating strategy has particular appeal in the Bank’s market area. Management believes that the combination of local ownership and size allows the Bank to offer services and products specifically tailored to the needs of the community. The Bank’s Principal Office is located at 202 S. Jefferson Street, Roanoke, Virginia. The Bank also maintains a website at www.hometownbankva.com.

Principal Products of the Bank

The Bank currently conducts business from five full-service offices. Three of the full-service offices are located in Roanoke, Virginia, one full-service location is in the Westlake area of Franklin County, Virginia and one full-service location is in Christiansburg, Virginia. The Christiansburg market is also served by a loan production office.

Deposit Services. The Bank offers a full range of deposit services that are typically available in most banks, savings banks and credit unions including checking accounts, savings accounts and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. From the beginning we have focused on convenience, innovation, and value. Many consumers have hailed the very special HomeTown Star banking relationship with its attached, automatic, high yielding sweep feature. They quickly recognized it as a valuable packaging of superior interest-bearing checking, very competitive returns on the sweep without money market account restrictions on access, and the ideal bundle of other banking extras. The transaction accounts and time certificates are tailored to the Bank’s market area at rates competitive to those offered in the area. In addition, the Bank offers its customers Individual Retirement Accounts (IRAs). All deposit accounts are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to the maximum amount allowed by law (generally, $100,000 per depositor, subject to aggregation rules). The Bank solicits such accounts from individuals, businesses, and associations and organizations.

Lending Services. The Bank also offers a full range of short-to-medium term commercial and personal loans. Commercial loans include both secured and unsecured loans for working capital (including inventory andreceivables), business expansion (including acquisition of real estate and improvements), and purchase of equipment and machinery. Consumer loans and lines of credit include secured and unsecured loans for financing automobiles, home improvements, education and personal investments. Additionally, the Bank originates fixed and floating-rate mortgage loans and real estate construction and acquisition loans.

Consumer Residential Mortgage Origination. The Bank, as representative for mortgage companies, originates consumer residential mortgage loans. Loans originated are conforming and non-conforming home mortgages in its market area, as defined below. As part of the Bank’s overall risk management strategy, loans originated and closed by the Mortgage Department are pre-sold to major national mortgage banking or financial institutions and at no time are carried on the Bank’s balance sheet. In addition to creating customer relationships and the opportunity to sell other products and services, the bank receives fee income for this service.

Other Services. Other services offered by the Bank include safe deposit boxes, travelers checks, direct deposit of payroll and social security checks, automatic drafts for various accounts, overdraft protection, check cards, credit cards and merchant card services. The Bank also has become associated with a shared network of automated teller machines (ATMs) that may be used by Bank customers throughout the world. The Bank intends to introduce new products and services as permitted by the regulatory authorities or desired by the public. The Bank remains committed to meeting the challenges that require technology. The Bank provides its customers with access to the latest technological products, such as internet banking, including on-line bill pay. The services allow customers to handle routine transactions using the internet at the Bank’s website www.hometownbankva.com.

Market Area

The Bank’s market area primarily consists of the City of Roanoke, Roanoke County, and the City of Salem,Virginia and contiguous counties, including Bedford, Franklin and Montgomery, Virginia. Total population in the market area equals approximately 300,000. The area is serviced by one daily newspaper, at least 6 weekly, multi-weekly or bi-weekly newspapers and a number of radio and television stations providing diverse media outlets. The City of Roanoke and Roanoke County, the location of three of the Bank’s offices, has the largest population base, with approximately 180,000 persons. The Roanoke market area is diversified by industry group with retail trade, services, transportation, manufacturing, finance, insurance and real estate. Roanoke is a regional center for banking, medicine and the legal and business professional community. Carilion Clinic, Advance Auto Parts, and the Veterans Administration Hospital are among Roanoke’s largest employers. Other major employers include Norfolk Southern Corporation, General Electric Co., Wells Fargo Bank, Roanoke College, and Hollins University.

Employees

As of December 31, 2010, the Company had 80 full-time equivalent employees. None of its employees are represented by any collective bargaining agreements, and relations with employees are considered positive.

Governmental Monetary Policies

The earnings and growth of the Company are affected not only by general economic conditions, but also by the monetary policies of various governmental regulatory authorities, particularly the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Federal Reserve Board implements national monetary policy by its open market operations in United States government securities, control of the discount rate and establishment of reserve requirements against both member and nonmember financial institutions’ deposits. These actions have a significant effect on the overall growth and distribution of loans, investments and deposits, as well as the rates earned on loans, or paid on deposits. Management of the Company is unable to predict the effect of possible significant changes in monetary policies upon the future operating results of the Company.

Competition

The Company competes as a financial intermediary with other commercial banks, savings banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in the Roanoke market area and elsewhere. Many of the Company’s nonbank competitors are not subject to the same extensive federal regulations that govern federally insured banks and state regulations governing state chartered banks. As a result, such nonbank competitors may have certain advantages over the Company in providing certain services.

Virginia law permits statewide branching by banks. Consequently, the Company’s market area is a highly competitive, highly branched banking market. Competition in the market area for loans to individuals, small businesses, and professional concerns, the Company’s target market, is keen, and pricing is important. Most of the Company’s competitors have substantially greater resources and lending limits than the Company and offer certain

services, such as extensive and established branch networks and trust services that the Company is not currently providing. Moreover, larger institutions operating in the Roanoke market area have access to borrowed funds at a lower cost than are presently available to the Company. Deposit competition is strong and comes from institutions in the market, U.S. Government securities, private issuers of debt obligations and suppliers of other investment alternatives for depositors, among other sources.

Supervision and Regulation

HomeTown Bankshares Corporation

HomeTown Bankshares is a bank holding company organized under the Federal Bank Holding Company Act (“BHCA”), which is administered by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). HomeTown Bankshares is required to file an annual report with the Federal Reserve and may be required to furnish additional information pursuant to the BHCA. The Federal Reserve is authorized to examine HomeTown Bankshares and its subsidiary. With some limited exceptions, the BHCA requires a bank holding company to obtain prior approval from the Federal Reserve before acquiring or merging with a bank or before acquiring more than 5% of the voting shares of a bank unless it already controls a majority of shares.

On September 18, 2009, as part of the Capital Purchase Program (CPP) established by the U.S. Department of the Treasury (“Treasury”) under the Emergency Economic Stabilization Act of 2008 (the “EESA”), the Company entered into a Purchase Agreement with Treasury pursuant to which the Company issued and sold to Treasury 10,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share (the “Series A Preferred Stock”), and a warrant to purchase up to 374 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, having a liquidation preference of $1,000 per share (the “Series B Preferred Stock”). This warrant was exercised immediately. Cumulative dividends on the Series A Preferred Stock accrue on the liquidation preference at a rate of 5% per annum for the first five years, and at a rate of 9% per annum thereafter. Cumulative dividends on the Series B Preferred Stock accrue on the liquidation preference at a rate of 9% per annum.

Under the CPP, the Company and the Named Executive Officers amended certain employment agreements and benefit plans and arrangements to the extent necessary to be in compliance with the executive compensation and corporate governance requirements of Section 111(b) of the EESA as implemented by any guidance or regulation under Section 111(b) of EESA that was issued and in effect as of the closing date of the transaction. Section 7001 of ARRA amends Section 111 of EESA to provide that participants in the CPP are subject to the standards established by the Secretary, and directs the Secretary to require each CPP recipient to meet appropriate standards for executive compensation and corporate governance. On June 15, 2009, the Treasury issued an interim final rule, Trouble Asset Relief Program (TARP) Standards For Compensation and Corporate Governance, to provide guidance on the executive compensation and corporate governance provisions of the EESA as amended by the ARRA.

The Bank Holding Company Act. Under the BHCA, a bank holding company is generally prohibited from engaging in nonbanking activities unless the Federal Reserve has found those activities to be incidental to banking. Bank holding companies also may not acquire more than 5% of the voting shares of any company engaged in nonbanking activities.

The Virginia Banking Act. The Virginia Banking Act requires all Virginia bank holding companies to register with the Virginia State Corporation Commission (the “Commission”). HomeTown Bankshares is required to report to the Commission with respect to financial condition, operations and management. The Commission may also make examinations of any bank holding company and its subsidiaries.

The Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act (“GLBA”) permits significant combinations among different sectors of the financial services industry, allows for expansion of financial service activities by bank holding companies and offers financial privacy protections to consumers. GLBA preempts most state laws that prohibit financial holding companies from engaging in insurance activities. GLBA permits affiliations between banks and securities firms in the same holding company structure, and it permits financial holding companies to directly engage in a broad range of securities and merchant banking activities. HomeTown Bankshares is not a financial holding company.

The Sarbanes-Oxley Act. The Sarbanes-Oxley Act (“SOX”) enacted sweeping reforms of the federal securities laws intended to protect investors by improving the accuracy and reliability of corporate disclosures. It impacts all companies with securities registered under the Securities Exchange Act of 1934, including HomeTown Bankshares. SOX creates increased responsibilities for chief executive officers and chief financial officers with respect to the content of filings with the Securities and Exchange Commission. Section 404 of SOX and related Securities and Exchange Commission rules focused increased scrutiny by internal and external auditors on HomeTown Bankshares’s systems of internal controls over financial reporting, which is designed to insure that those internal controls are effective in both design and operation. SOX sets out enhanced requirements for audit committees, including independence and expertise, and it includes stronger requirements for auditor independence and limits the types of non-audit services that auditors can provide. Finally, SOX contains additional and increased civil and criminal penalties for violations of securities laws.

Capital Requirements. The Federal Reserve has adopted risk-based capital guidelines that are applicable to HomeTown Bankshares. The guidelines provide that the Company must maintain a minimum ratio of 8% of qualified total capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit). At least half of total capital must be comprised of Tier 1 capital, for a minimum ratio of Tier 1 capital to risk-weighted assets of 4%. In addition, the Federal Reserve has established minimum leverage ratio guidelines of 4% for banks that meet certain specified criteria. The leverage ratio is the ratio of Tier 1 capital to total average assets, less intangibles. HomeTown Bankshares is expected to be a source of capital strength for its subsidiary bank, and regulators can undertake a number of enforcement actions against HomeTown Bankshares if its subsidiary bank becomes undercapitalized. HomeTown Bankshares’s bank subsidiary is well capitalized and fully in compliance with capital guidelines. However, regulatory capital requirements relate to earnings and asset quality, among other factors. Bank regulators could choose to raise capital requirements for banking organizations beyond current levels.

Emergency Economic Stabilization Act of 2008. On October 14, 2008, the U. S. Treasury announced the Troubled Asset Relief Program (TARP) under the Emergency Economic Stabilization Act of 2008. In the program, the Treasury was authorized to purchase up to $250 million of senior preferred shares in qualifying U. S. banks, savings and loan associations, and bank and savings and loan holding companies. The amount of TARP funds was later increased up to $350 million.

American Recovery and Reinvestment Act of 2009. The ARRA was enacted in 2009 and includes a wide range of programs to stimulate economic recovery. In addition, it also imposed new executive compensation and corporate governance obligations on TARP Capital Purchase Program recipients. Because HomeTown Bankshares participated in TARP it must comply with these requirements.

The Dodd-Frank Act

The financial regulatory reform legislation “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the Dodd-Frank Act) was signed into law on July 21, 2010. The Dodd-Frank Act implements financial regulatory reform across the entire financial landscape and has far-reaching provisions including among other things:

•

Create a new agency, the Consumer Financial Protection Bureau, responsible for implementing, examining and enforcing compliance with federal consumer financial laws for institutions with more than $10 billion of assets and, to a lesser extent, smaller institutions. As a smaller institution, most consumer protection aspects of the Dodd-Frank Act will continue to be applied to the Corporation by the Federal Reserve and to the Bank by the FDIC.

•

Apply the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies.

•

Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminate the ceiling on the size of the Deposit Insurance Fund and increase the floor of the size of the Deposit Insurance Fund.

•

Require loan originators to retain 5 percent of any loan sold or securitized, unless it is a “qualified residential mortgage”, which must still be defined by the regulators. FHA, VA and Rural Housing Service loans are specifically exempted from the risk retention requirements.

•

Implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders that apply to all public companies not just financial institutions.

•

Make permanent the $250,000 limit for federal deposit insurance and increase the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000 and provide unlimited federal deposit insurance until December 31, 2012 for non-interest bearing demand transaction accounts at all insured depository institutions.

•

Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.

•

Amend the Electronic Fund Transfer Act (EFTA) to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.

The Dodd-Frank Act is the largest piece of financial legislation ever passed, exceeding 2,000 pages in length. Many provisions of the Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company, its customers, or the financial industry as a whole. Provisions in the legislation that affect the payment of interest on demand deposits and interchange fees are likely to increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate.

HomeTown Bank

The Bank is under the supervision of, and subject to regulation and examination by, the Federal Reserve Board and the Bureau of Financial Institutions of the Virginia State Corporation Commission. The Bank is also covered by deposit insurance through the FDIC and is subject to their regulations. As such, the Bank is subject to various statutes and regulations administered by these agencies that govern, among other things, required reserves, investments, loans, lending limits, acquisitions of fixed assets, interest rates payable on deposits, transactions among affiliates and the Bank, the payment of dividends, mergers and consolidations, and establishment of branch offices.

Deposit Insurance. HomeTown Bank has deposits that are insured by the FDIC. The FDIC maintains a Bank Insurance Fund (“BIF”) that is funded by risk-based insurance premium assessments on insured depository institutions. Assessments are determined based upon several factors, including the level of regulatory capital and the results of regulatory examinations. FDIC may adjust assessments if the insured institution’s risk profile changes or if the size of the BIF declines in relation to the total amount of insured deposits. It is anticipated that assessments will increase in the future, to offset demands on the BIF from banks that fail in the troubled economy and due to the anticipated growth of the Bank.

On October 3, 2008, the FDIC announced that deposits at FDIC-insured institutions would be insured up to at least $250,000. It has been extended to December 31, 2013. On January 1, 2014 the FDIC deposit insurance is scheduled to return to $100,000 per depositor, except for certain retirement accounts for which coverage will remain at $250,000. The FDIC announced its Transaction Account Guarantee Program on October 14, 2008. The Transaction Account Guarantee Program, which is a part of the Temporary Liquidity Guarantee Program, provides full coverage for non-interest bearing deposit accounts for FDIC-insured institutions that elected to participate. HomeTown Bank elected to participate in this program, and its BIF assessments will increase to reflect the additional FDIC coverage. After giving primary regulators an opportunity to first take action, FDIC may initiate an enforcement action against any depository institution it determines is engaging in unsafe or unsound actions or which is in an unsound condition, and the FDIC may terminate that institution’s deposit insurance.

Capital Requirements. The same capital requirements that are discussed above with relation to HomeTown Bankshares are applied to HomeTown Bank by the Federal Reserve. Federal Reserve guidelines provide that banks experiencing internal growth or making acquisitions are expected to maintain strong capital positions well above minimum levels, without reliance on intangible assets. Also, capital requirements can be increased based on earnings and asset quality concerns as well as other issues.

Mergers and Acquisitions. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 authorizes the Federal Reserve Board to permit adequately capitalized and adequately managed bank holding companies to acquire all or substantially all of the assets of an out-of-state bank or bank holding company, subject to certain conditions, including nationwide and state concentration limits. Banks also are able to branch across state lines, provided certain conditions are met, including that applicable state law must expressly permit such interstate branching. Virginia law permits branching across state lines, provided there is reciprocity with the state in which the out-of-state bank is based.

Community Reinvestment Act (“CRA”). The Company is also subject to the requirements of the CRA. The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. Each financial institution’s efforts in meeting community credit needs currently are evaluated as part of the examination process pursuant to a number of assessment factors. These factors also are considered in evaluating mergers, acquisitions and applications to open branches.

Safety and Soundness. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” all such terms are defined under uniform regulations defining such capital levels issued by each of the federal banking agencies.

Activities and Investments of Insured State-Chartered Banks. The activities and equity investments of FDIC insured, state-chartered banks are generally limited to those that are permissible for national banks. Under regulations dealing with equity investments, an insured state bank generally may not directly or indirectly acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. An insured state bank is not prohibited from, among other things, (i) acquiring or retaining a majority interest in a subsidiary, (ii) investing as a limited partner in a limited partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank’s total assets, (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors’, trustees’ and officers’ liability insurance coverage or bankers’ blanket bond group insurance coverage for insured depository institutions, and (iv) acquiring or retaining the voting shares of a depository institution if certain requirements are met. In addition, an insured state-chartered bank may not, directly, or indirectly through a subsidiary, engage as “principal” in any activity that is not permissible for a national bank unless the FDIC has determined that such activities would pose no risk to the insurance fund of which it is a member and the bank is in compliance with applicable regulatory capital requirements. Any insured state-chartered bank directly or indirectly engaged in any activity that is not permitted for a national bank must cease the impermissible activity.

Regulatory Enforcement Authority. Applicable banking laws include substantial enforcement powers available to federal banking regulators. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions, including the filing of misleading or untimely reports with regulatory authorities, may provide the basis for enforcement action.

USA Patriot Act. The USA Patriot Act became effective on October 26, 2001, and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. Among other provisions, the USA Patriot Act permits financial institutions, upon providing notice to the United States Treasury, to share information with one another in order to better identify and report to the federal government concerning activities that may involve money laundering or terrorists’ activities. Interim rules implementing the USA Patriot Act were issued effective March 4, 2002. The USA Patriot Act is considered a significant banking law in terms of information disclosure regarding certain customer transactions. Although it does create a reporting obligation, the Company does not expect the USA Patriot Act to materially affect its products, services or other business activities.

Consumer Laws and Regulations. There are a number of laws and regulations that regulate banks’ consumer loan and deposit transactions. Among these are the Truth in Lending Act, the Truth in Savings Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, and the Fair Debt Collections Practices Act. HomeTown Bank is required to comply with these laws and regulations in its dealing with customers.

ACCESS TO FILINGS

The Company files annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other filings with the SEC. The public may read and copy any documents the Company files at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company’s SEC filings can also be obtained on the SEC’s website on the internet at http://www.sec.gov. Also, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K are posted on the Company’s website at http://www.hometownbankva.com as soon as reasonably practical after filing electronically with the SEC.

ITEM 1A.

RISK FACTORS.

Not Required.

ITEM 1B.

UNRESOLVED STAFF COMMENTS.

Not Required.

ITEM 2.

PROPERTIES.

As of March 30, 2011, the Company through its wholly owned subsidiary HomeTown Bank (the “Bank”), conducted its business from the following six locations: i) 202 S. Jefferson Street Roanoke, Virginia (the “Downtown Office”), which also serves as the Bank’s main office and operations processing center ii) a branch office located at 13400 Booker T. Washington Highway, Moneta, Virginia (the “Smith Mountain Lake Office”); iii) a branch office at 4225 Colonial Avenue, Roanoke, Virginia (the “Colonial Avenue at 419 Office”); iv) a branch office at 3521 Franklin Road, Roanoke, Virginia (the “South Roanoke Office”); v) a branch office at 1540 Roanoke Street, Christiansburg, Virginia (the “Christiansburg Office”) and vi) a loan production and administrative office at 1655 Roanoke Street, Christiansburg, Virginia.

The Downtown Office. The Bank leases certain space located at 202 S. Jefferson Street, Roanoke, Virginia. The lease is for a period of 10 years, 11 months from the date of the lease with options to renew the lease for two periods of five years. The Downtown Branch opened on November 14, 2005.

The Smith Mountain Lake Office. The Bank purchased the Smith Mountain Lake branch on February 14, 2006 and received regulatory approval and opened the office on May 8, 2006.

The Colonial Avenue at 419 Office. The Bank purchased the property for the Colonial Avenue at 419 office on August 31, 2006 and received regulatory approval and opened the Colonial Avenue at 419 Branch on March 22, 2007.

The South Roanoke Office. The Bank has leased real property and improvements thereto located at 3521 Franklin Road, Roanoke, Virginia. The Bank received regulatory approval and opened a branch at this location on July 9, 2007.

The Christiansburg Office. The Bank leased real property and improvements thereto located at 1540 Roanoke Street, Christiansburg, Virginia on April 30, 2008 and received regulatory approval and opened a branch at this location on June 19, 2008. This office operates under the name “NewRiver Bank, a branch of HomeTown Bank”. The lease is for a term of five years with 1 five year renewal option.

The Christiansburg Loan Production and Administrative Office. The Bank has leased real property and improvements thereto located at 1655 Roanoke Street, Christiansburg, Virginia. This office is for loan production purposes and also provides administrative support for our New River Valley operations. The lease is for a term of five years with 1 five year renewal option.

ITEM 3.

LEGAL PROCEEDINGS.

The Bank is not involved in any pending legal proceedings at this time, other than routine litigation incidental to its business.

ITEM 4.

RESERVED.

PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Shares of the Company’s Common Stock are neither listed on any stock exchange nor quoted on the Nasdaq Stock Market and trades infrequently. Shares of Common Stock have periodically been sold in a limited number of privately negotiated transactions. Based on information available to it, the Company believes that from January 1, 2010 to December 31, 2010, the selling price of shares of Common Stock ranged from $8.60 to $4.50. There may, however, have been other transactions at other prices not known to the Company.


	2010				2009
Quarter Ended	High Close		Low Close		High Close		Low Close
March 31	$	7.00	$	5.65	$	6.51	$	6.50
June 30	$	8.60	$	6.25	$	7.00	$	6.01
September 30	$	8.25	$	6.00	$	7.70	$	7.00
December 31	$	7.50	$	4.50	$	8.05	$	7.00

As of March 30, 2011, there were 3,241,547 shares of Common Stock outstanding, which shares are held by 1,979 shareholders of record. No dividends have been paid on the Common Stock to date.

The Company is subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. Additionally, the Company intends to follow a policy of keeping retained earnings, if any, for the purpose of increasing net worth and reserves of the Company during its initial years of operation in order to promote the Company’s growth and ability to compete in its market area. As a result, the Company does not anticipate paying a cash dividend on its Common Stock in 2011.

Under the Company’s shareholder approved equity compensation plan, there are 467,793 shares of common stock to be issued upon exercise of outstanding options. These shares have a weighted-average exercise price of $10.09 per share. The number of shares remaining for future issuance is 57,640. Refer to Part II, Item 8, Note 11 for a detail discussion of the stock options that are outstanding.

ITEM 6.

SELECTED FINANCIAL DATA.

Not Required.

ITEM 7.

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

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 21 E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as “we expect,” “we believe” or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:

•

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;

•

interest rate fluctuations;

•

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

•

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

•

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

•

changes in laws and regulations applicable to us;

•

changes in general economic and business conditions;

•

competition within and from outside the banking industry;

•

problems with our technology,

•

changing trends in customer profiles and behavior, and

•

new products and services in the banking industry.

Although Management believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of our knowledge of our 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.

Critical Accounting Policies

The financial condition and results of operations presented in the consolidated financial statements, accompanying notes to the consolidated financial statements and management’s discussion and analysis are, to a large degree, dependent upon the Company’s accounting policies. 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 accounting policies to the portrayal and understanding of the Company’s financial condition and results of

operations. These 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. See also Note 1 of the Notes to Consolidated Financial Statements.

Management monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan. Management 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.

Management evaluates various loans individually for impairment. 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, we make estimates of losses for groups of loans grouped by similar characteristics, including the type of loan, the assigned loan classification 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 is 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 our allowance for loan losses 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. We recognize 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.

General

Management’s discussion and analysis is intended to assist the reader in evaluating and understanding the financial condition and results of operations of Hometown Bankshares Corporation and subsidiary (the Company) as of and for the years ending December 31, 2010 and 2009. This discussion should be read in connection with the Company’s Consolidated Financial Statements and the accompanying Notes thereto included in this Form 10-K.

The Company initiated its banking operations through its wholly-owned subsidiary, HomeTown Bank, on November 14, 2005 with the opening of its main office at 202 S. Jefferson Street, Roanoke, Virginia. The bank has experienced consistent growth over the last five years.

As the Company continues to grow, it expects changes in financial condition and operating results should become more favorable overall, but the changes less dynamic. Many new banks experience a period of operating losses until the growth and balancing of interest income from loans and investments and interest expense from deposits and borrowings along with cost control, will generate operating income.

The primary source of the Company’s revenue is net interest income, which represents the difference between interest income on earning assets and interest expense on liabilities used to fund those assets. Earning assets are comprised of loans, investment securities and federal funds sold. Interest bearing liabilities are comprised of interest bearing deposit accounts, federal funds purchased, securities sold under agreements to repurchase, and Federal Home Loan Bank borrowings.

The Business

HomeTown Bank, the Company’s wholly owned subsidiary, provides a full complement of consumer and commercial banking services to its primary service area which includes the City of Roanoke, Roanoke County, and

the City of Salem, Virginia and contiguous counties, including Bedford, Franklin and Montgomery, Virginia. We place an emphasis on personal service and offer a broad range of commercial and retail banking products and services including checking, savings and time deposits, individual retirement accounts, residential and commercial mortgages, home equity loans, consumer installment loans, commercial loans, lines and letters of credit. In addition to its main office, the Bank has branch offices in Franklin County, Virginia at Westlake, in Roanoke County at the intersection of Colonial Avenue and Virginia Route 419, in Roanoke City on Franklin Road in South Roanoke. In July 2008, the Bank opened two offices in Christiansburg, Virginia, a branch office and a loan production and administrative support office for operations in the New River Valley market. These two offices operate under the name NewRiver Bank, a branch of Hometown Bank.

Discussion of Operations

Hometown Bankshares currently operates five deposit offices and one loan production office. The main office and South Roanoke office in Roanoke City, the Colonial Avenue at 419 office in Roanoke County, the Smith Mountain Lake office in Franklin County at the Westlake community, and the branch office and loan production and administrative office of NewRiver Bank in Christiansburg, Virginia.

The Company operates in a highly competitive market for commercial banking and financial services as the Roanoke Valley is a banking and financial services hub for much of southwest Virginia.

The primary source of the Company’s revenue is net interest income, which represents the difference between interest income on earning assets and interest expense on liabilities used to fund those assets. Earning assets include loans, securities, interest bearing bank certificates of deposit and federal funds sold. Interest bearing liabilities include deposits and borrowings.

The Company has grown aggressively over the last five years with five new offices opened in the first four years. The Company planned to expand its infrastructure rapidly to best serve its customer base and build its geographic footprint. In order to utilize the capacity of our offices generated by this growth, the Company has also aggressively grown loans and deposits and maintained a loan to deposit ratio in excess of 100% for much of this time. Loan growth was reduced in 2010 resulting in the loan to deposit ratio of 86.2 percent at December 31, 2010 compared to 92.0 percent the previous year. As a result of moderating loan growth, liquidity has increased. In addition to asset sources of liquidity, the Company has available $19 million of federal funds lines of credit and $7.4 million in Federal Home Loan Bank lines of credit immediately available. The Company is approved to borrow 20% of total assets from the Federal Home Loan Bank provided qualifying collateral is pledged.

Overview of Operations

The Company recorded a net loss available to common share holders of $4.5 million or $1.38 per basic and diluted share for the year ended December 31, 2010 compared to net income available to common shareholders of $323 thousand, or $.10 per basic and diluted share for the year ended December 31, 2009. The loss in 2010 is due to provision for loan losses of $6.5 million compared to $725 thousand in 2009.

The provision for loan losses increased from $725 thousand in 2009 to $6.5 million in 2010 an increase of $5.7 million or 790%. At December 31, 2010, the valuation allowance related to impaired loans totaled $1.5 million compared to $538 thousand at December 31, 2009.

Net interest income continued to improve, increasing $2.7 million or 34% in 2010 to $10.7 million compared to $8.0 million in 2009. This is due to significant growth in the volume of earning assets along with a substantial drop in our cost of funds. Average earning assets increased from $268.5 million in 2009 to $330.8 million in 2010, an increase of 23.2%. In 2010, noninterest income decreased $66 thousand to $847 thousand from $913 thousand in 2009, a decrease of 7.2%. The decrease in noninterest income is due to a $160 thousand gain on sale on securities in 2009. There were no sales of securities in 2010.

The increases in net interest income and noninterest income, net of securities gains, were offset by increases in most noninterest expense categories. Salaries and employee benefits increased by $554 thousand or 14% compared to 2009. Occupancy and equipment expense increased from $1.2 million in 2009 to $1.3 million in 2010, an increase of 9%.

Summary of Financial Condition

Total assets at December 31, 2010 were $353.1 million; an increase of $15.3 million or 4.5%, from $337.8 at December 31, 2009.

Cash and cash equivalents decreased by $2.6 million to $4.5 million at December 31, 2010, a decrease of 36.5%.

Federal funds sold increased 5% to $20.9 million at December 31, 2010.

Securities available-for-sale increased $5.3 million to $51.6 million at December 31, 2010 from $46.4 million at December 31, 2009.

Loans, net of allowance for loan losses, increased from $249.8 million at December 31, 2009 to $258.9 million as of December 31, 2010, an increase of $9.1 million or 3.6%. Loans as a percentage of assets declined to 73.3% at December 31, 2010 compared to 73.9% at December 31, 2009.

Company premises and equipment, net of accumulated depreciation increased $575 thousand, or 7.0%, to $8.8 million.

Total liabilities at December 31, 2010 were $323.5 million an increase of $19.4 million, or 6.4%, from $304.0 million at December 31, 2009. Total deposits, the primary component of total liabilities, were $300.5 million at December 31, 2010, an increase of $28.8 million or 10.6%, from $271.6 million as of December 31, 2009. This increase in deposits is attributed to the Company’s continuing marketing initiatives implemented during the year, as well as our continued sucessful entry into the New River Valley market.

Total stockholders’ equity amounted to $29.7 million at December 31, 2010 compared to $33.8 million at December 31, 2009, a decrease of $4.1 million or 12.2%. Stockholders’ equity has been reduced by other comprehensive loss and the 2010 net loss. The Company had a net loss before dividends accumulated on preferred stock of $3.9 million for the year ended December 31, 2010.

Management believes the Company has sufficient capital to fund its operations until the Company begins to generate profits on a consistent basis, but there can be no assurance that this will be the case.

At December 31, 2010, the Company was in compliance with all regulatory capital requirements. Management believes that the Company has sufficient liquidity on a short-term basis to meet any funding needs it may have, and expects that its long term liquidity needs can be achieved through deposit growth, however there can be no assurance that such growth will develop. The Company expects to continue to moderate loan growth in 2011 which will have a positive affect on liquidity.

Non-performing Assets

Following is a breakdown of our nonperforming loans by assets type:


(Dollars in thousands)	2010		2009		2008		2007		2006
Real Estate:
Construction and land development	$	2,390	$	2,386	$	2,259	$	—	$	—
Residential 1-4 families		875		806		771		207
Commercial real estate		—		1,204		—		—		—
Commercial loans		419		44		—		—		—
Loans to individuals		—		38		—		—		—

Total Nonperforming Loans	$	3,684	$	4,478	$	3,030	$	207	$	—
Other real estate owned		2,976		707		251		—		—

Total nonperforming assets	$	6,660	$	5,185	$	3,281	$	207	$	—

Non-performing assets consist of loans past-due ninety days or more, non-accrual loans and repossessed and foreclosed assets. The Company had $6.7 million in non-performing assets at December 31, 2010. Loans classified as impaired totaled $26.8 million at December 31, 2010 and the Company established a valuation allowance of $1.5 million for these impaired loans. Impaired loans at December 31, 2009 were $20.8 million and the Company established a valuation allowance of $538 thousand for these impaired loans.

The increase in the level of impaired loans was due to weakening financial performance of selected borrowers and is not concentrated in any single industry. Of the $26.8 million in impaired loans at December 31, 2010, $7.9 million are for land acquisition, development and commercial construction, $9.3 million represents owner occupied commercial real estate loans and $7.2 million are for residential real estate secured loans, primarily rental of single family and multi-family housing units.

At December 31, 2009, $8.9 million of impaired loans were for land acquisition, development and commercial construction, $6.7 million represents owner occupied commercial real estate loans and $4.6 million are for residential real estate secured loans, primarily rental of single family and multi-family housing units

Allowance for Loan Losses

The allowance for loan losses is increased by charges to income and decreased by charge-offs, net of recoveries. Management’s periodic evaluation of the adequacy of the allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions.

The allowance for loan losses increased from $2.9 million at December 31, 2009 to $5.2 million at December 31, 2010. This increase was due to increases in both specific and general reserves, dictated by increased impaired loans, increased charged off loans and deterioration in qualitative factors.

Net Interest Income and Net Interest Margin

Net interest income, the primary source of the Company’s earnings, is the excess of interest income, derived from earning assets classified as loans, securities, certificates of deposit and federal funds sold, over and above interest expense, which are amounts due from the Company’s interest bearing liabilities including customer deposits, time certificates, federal funds purchased and FHLB advances. The amount of net interest income is primarily dependent upon the volume and mix of these earning assets and interest bearing liabilities. Interest rate changes can also impact the amount of net interest income, but usually to a lesser extent. Management develops pricing and marketing strategies to maximize net interest income while maintaining related assets and liabilities accounts within guideline policies as established by the Company’s Board of Directors. Sources of non-interest income include service charges on deposit accounts, mortgage brokerage fees and other miscellaneous income.

The net interest margin represents net interest income divided by average earning assets. It reflects the average effective rate that the Company earned on its earning assets. Net interest margin is affected by changes in both average interest rates and average volumes of interest earning assets and interest bearing liabilities.

Net interest income, increased 34.3% to $10.7 million in 2010, from $8.0 million in 2009. The increase was due primarily to the decrease in the Company’s funding costs as higher priced deposits re-priced to lower rates in 2010. The loan portfolio maintained strong ratios as a percentage of assets and deposits of 73.3% and 86.2%, respectively, at December 31, 2010, as compared to 73.9% and 92%, respectively, at December 31, 2009. The net interest margin increased significantly to 3.25% for 2010 from 2.98% for 2009. The average rate on earning assets decreased 28 basis points from 5.17% for 2009 to 4.89% for 2010. In comparison, the average rate on interest-bearing liabilities decreased 60 basis points from 2.44% in 2009 to 1.84% in 2010.

The following table illustrates average balances of total interest-earning assets and total interest bearing liabilities for 2010, 2009 and 2008, showing the average distribution of assets, liabilities, shareholders’ equity and related income, expense and corresponding weighted-average yields and rates. The average balances used in these tables and other statistical data were calculated using daily average balances. We have no tax exempt assets for the periods presented.

Average Balances, Interest Income and Expense, Yields and Rates


	2010								2009								2008
(Dollars in thousands)	Average Balance			Interest Income/ Expense		Yield/ Rate			Average Balance			Interest Income/ Expense		Yield/ Rate			Average Balance			Interest Income/ Expense		Yield/ Rate
Assets:
Federal funds sold	$	16,607		$	45		0.27	%	$	10,215		$	23		0.23	%	$	1,324		$	22		1.66	%
Deposits in banks		433			—		0.00	%		128			—		0.00	%		16			—		0.00	%
Securities, taxable		48,060			1,720		3.55	%		19,144			833		4.35	%		7,876			359		4.56	%
Restricted equity securities		2,660			59		2.20	%		2,023			43		2.13	%		1,657			76		4.59	%
Loans		263,011			14,362		5.46	%		236,956			12,986		5.48	%		166,833			10,329		6.19	%

Total earnings assets		330,771			16,186		4.89	%		268,466			13,885		5.17	%		177,707			10,786		6.07	%
Less: Allowance for loan losses		(3,891	)							(2,532	)							(1,783	)
Total non-earning assets		22,824								19,852								11,556


Total Assets	$	349,704							$	285,786							$	187,480


Liabilities and shareholders’ equity
Interest bearing deposits:
Checking	$	37,575		$	406		1.08	%	$	32,496		$	406		1.25	%	$	31,647		$	826		2.61	%
Money market savings		54,133			747		1.38	%		23,234			316		1.36	%		17,970			475		2.64	%
Regular savings		9,222			156		1.69	%		2,591			41		1.58	%		382			4		0.96	%
Time Deposits		167,037			3,568		2.14	%		163,191			4,518		2.77	%		84,556			3,589		4.24	%
Short term borrowings		428			4		0.93	%		806			8		0.87	%		2,012			58		2.86	%
FHLB borrowings		27,292			557		2.01	%		19,146			595		3.10	%		16,481			596		3.62	%

Total interest bearing liabilities		295,687			5,438		1.84	%		241,464			5,884		2.44	%		153,049			5,548		3.62	%
Non-interest bearing liabilities:
Demand deposits		21,304								14,157								9,910
Other liabilities		1,485								1,842								1,598
Total liabilities		318,476								257,463								164,557

Stockholders’ equity		31,228								28,323								22,923

Total Liabilities and Stockholders’ Equity	$	349,704							$	285,786							$	187,480

Net interest income				$	10,748							$	8,001							$	5,238

Interest rate spread							3.05	%							2.73	%							2.45	%

Interest expense to average earning assets							1.64	%							2.19	%							3.12	%

Net interest margin							3.25	%							2.98	%							2.95	%

Rate and Volume Analysis


	2010 Compared to 2009									2009 Compared to 2008
(Dollars in thousands)	Increase (Decrease)			Change Due To:						Increase (Decrease)			Change Due To:
(Dollars in thousands)	Increase (Decrease)			Rate			Volume			Increase (Decrease)			Rate			Volume
Interest income:
Federal funds sold	$	22		$	5$			17		$	1		$	(33	)	$	34
Deposits in banks					—			—			—			—			—
Securities, taxable		887			(173	)		1,060			474			(17	)		(491	)
Restricted equity securities		16			(1	)		17			(33	)		(47	)		14
Loans		1,376			(90	)		1,466			2,657			(1,292	)		3,949


Total interest income		2,301			(259	)		2,560			3,099			(1,389	)		4,488

Interest expense:
Interest bearing liabilities:
Checking		0			(59	)		59			(420	)		(442	)		22
Money market savings		431			5			426			(159	)		(272	)		113
Regular savings		115			3			112			37			4			33
Time Deposits		(950	)		(664	)		(286	)		929			(1,559	)		2,488
Short term borrowings		(4	)		(4	)		0			(50	)		(27	)		(23	)
FHLB borrowings		(38	)		(243	)		205			(1	)		(91	)		90


Total interest bearing liabilities		(446	)		(962	)		516			336			(2,387	)		2,723


Net interest income	$	2,747		$	703		$	2,044		$	2,763		$	(998	)	$	1,765

Noninterest Income

Noninterest income includes service charges on deposit accounts, brokerage fees on non-portfolio mortgage loans, gains on securities sales, and rental income from tenants leasing offices at the Colonial Avenue at 419 location. Noninterest income decreased to $847 thousand in 2010 from $913 thousand in 2009 primarily due to the gain on sales of securities in 2009, there were no securities sales in 2010. Due to the low mortgage loan interest rates in 2010, a high volume of homeowners refinanced their mortgages resulting in a significant increase in our mortgage loan brokerage fee income in 2010 compared to 2009.

Non-Interest Income


	Period Ended December 31,
(Dollars in thousands)	2010		2009
Service charges on deposit accounts	$	294	$	315
Mortgage loan brokerage fees		175		122
Rental Income		134		106
Gain on sale of investment securities		—		160
Other Income		244		210

Total non-interest income	$	847	$	913

Noninterest Expense

Non-interest expense includes, among other things, salaries and benefits, occupancy costs, advertising and marketing, FDIC insurance, professional fees, depreciation, data processing, telecommunications and miscellaneous expenses.

Total noninterest expense increased $1.3 million, from $7.7 million in 2009 to $9.0 million in 2010. Salaries and employee benefits expense increased $554 thousand due to additional staff as well as normal salary increases. Occupancy and equipment expense increased from $1.2 million in 2009 to $1.3 million in 2010. The increase in professional fees of $234 thousand in 2010 was primarily due to legal fees and other costs associated with the collection of loans and foreclosure of collateral. The increased level of other real estate owned contributed to the increase in occupancy and equipment expense in 2010. Data processing expense increased $81 thousand for 2010 compared to 2009. FDIC insurance expense increased $115 thousand in 2010 due to an increase in our assessment rate. The Company’s management and staff monitor and control operating expenses to provide adequate operational support and enable growth opportunities.

Non-Interest Expense


	Period Ended December 31,
(Dollars in thousands)	2010			2009
Salaries and employee benefits	$	4,549		$	3,995
Occupancy and equipment expense		1,286			1,185
Advertising and marketing expense		376			303
Professional fees		494			260
Data processing expense		445			364
Bank franchise taxes		203			190
FDIC insurance expense		657			542
Gain on sale of other real estate		(77	)		—
Other expense		1,082			854

Total non-interest expense	$	9,015		$	7,693

Salaries and employee benefits expense includes non-cash expense for stock based compensation of $50 thousand and $54 thousand in 2010 and 2009, respectively. See footnote 11 to the financial statements for additional information.

Income Tax Expense

The Company did not record in its current provision for income tax expense for 2010 or 2009 any income tax benefits due to the operational losses incurred in prior years. The tax benefit of these operational losses may be reflected as a reduction of current tax provisions in future time periods if and when the Company achieves operational profitability.

Loans

Our primary source of income is our lending activities. The following table presents the composition of the Company’s loan portfolio at the dates indicated:

Loan Portfolio


(Dollars In Thousands)	2010		2009		2008		2007		2006
Loans secured by real estate:
Construction and land development	$	36,589	$	46,157	$	43,645	$	22,460	$	5,098
Secured by 1-4 family residential		68,224		53,662		39,448		23,681		14,100
Nonfarm, non 1-4 family residential		119,081		112,174		92,619		65,041		25,369
Loans to farmers		338		370		223		119		124
Commercial loans		34,980		34,849		26,435		19,381		13,496
Loans to individuals		4,894		5,457		8,883		3,121		2,249

Total Loans	$	264,106	$	252,669	$	211,253	$	133,803	$	60,436

Maturities of Loans at December 31, 2010 are as follows:


(Dollars in Thousands)	Fixed Rate		Adjustable Rate		Total
Construction loans Maturing:
Within one year	$	6,839		11,506		18,345
One to five years		10,087		4,977		15,064
After five years		2,339		841		3,180

Total	$	19,265	$	17,324	$	36,589


(Dollars in Thousands)	Fixed Rate		Adjustable Rate		Total
Commercial loans Maturing:
Within one year	$	2,579		15,185		17,764
One to five years		10,091		4,697		14,788
After five years		2,372		56		2,428

Total	$	15,042	$	19,938	$	34,980

Provision and Allowance For Loan Losses

The provision for loan losses increased from $725 thousand in 2009 to $6.5 million in 2010 due primarily to charged offs loans in 2010. In 2010, charged off loans totaled $4.2 million compared $734 thousand in 2009.

The allowance for loan losses represented 1.98% and 1.13% of total outstanding loans at December 31, 2010 and 2009, respectively. The provision for loan losses is based upon management’s estimate of the amount needed to maintain the allowance for loan losses at an adequate level to cover known and inherent risk of loss in the loan portfolio. In determining the provision amount, management gives consideration to current and anticipated economic conditions, the growth and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans, and other factors. At December 31, 2010, the valuation allowance related to impaired loans totaled $1.5 million compared to $538 thousand at December 31, 2009. an increase of $984 thousand in specific reserves. The increase in the allowance for loan losses was primarily due the level of charge offs in 2010. In addition to provisioning for the actual charge offs, the charge off ratio increased from .31% in 2009 to 1.58% in 2010. The charge off ratio is a significant factor in calculating the level of general reserves and this substantial of an increase in the ratio along with an increase in qualitative factors caused a significant increase in this portion of the general reserve.

Management classifies loans as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans classified as impaired totaled $26.8 million at December 31, 2010 and the Company established a valuation allowance of $1.5 million for these impaired loans compared to loans classified as impaired at December 31, 2009 of $20.8 million with a valuation allowance of $538,000.

The following table presents an analysis of the changes in the allowance for loan losses for the periods indicated.

Allowance for Loan Losses


(Dollars In Thousands)	2010			2009			2008			2007			2006
Balance, beginning	$	2,862		$	2,862		$	1,471		$	664		$	16
Provision charged to operating expense		6,453			725			1,648			857			648
Recoveries of amounts charged off		77			9			—			—			—
Loans charged off		(4,164	)		(734	)		(257	)		(50	)		—


Balance, ending	$	5,228		$	2,862		$	2,862		$	1,471		$	664


Ratio of net charge-offs to average loans		1.58	%		0.31	%		0.15	%		0.06	%

The following table presents the allocation of the Allowance for Loan Losses for the periods indicated.


	2010					2009					2008					2007					2006
(Dollars in thousands)	Amount		Percent of loans in each category to total loans			Amount		Percent of loans in each category to total loans			Amount		Percent of loans in each category to total loans			Amount		Percent of loans in each category to total loans			Amount		Percent of loans in each category to total loans
Loans secured by real estate:
Construction and land development	$	1,923		13.85	%	$	780		18.27	%	$	1,395		20.66	%	$	247		16.79	%	$	56		8.44	%
Secured by 1-4 family residential		927		25.83	%		677		21.24	%		398		18.67	%		260		17.70	%		155		23.33	%
Nonfarm, non 1-4 family residential		1,674		45.10	%		1,032		44.39	%		749		43.85	%		716		48.61	%		279		41.98	%
Loans to farmers		6		0.13	%		3		0.15	%		2		0.11	%		1		0.09	%		1		21.00	%
Commercial loans		627		13.24	%		320		13.79	%		251		12.51	%		213		14.48	%		148		22.33	%
Loans to individuals		71		1.85	%		50		2.16	%		67		4.20	%		34		2.33	%		25		3.72	%

Total Loans	$	5,228		100.00	%	$	2,862		100.00	%	$	2,862		100.00	%	$	1,471		100.00	%	$	664		100.00	%

Asset Quality

Interest is accrued on outstanding loan principal balances, unless the Company considers collection to be doubtful. Commercial and unsecured consumer loans are designated as non-accrual when payment is delinquent 90 days or at the point which the Company considers collection doubtful, if earlier. Mortgage loans and most other types of consumer loans past due 90 days or more may remain on accrual status if management determines that concern over our ability to collect principal and interest is not significant. When loans are placed in non-accrual status, previously accrued and unpaid interest is reversed against interest income in the current period and interest is subsequently recognized only to the extent cash is received. Interest accruals are resumed on such loans only when in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.

As of December 31, 2010, the Company had $3,684,000 in non-performing loans, comprised entirely of non-accrual loans, compared to non-performing loans of $4,478,000 comprised of $3,925,000 in non-accrual loans and $553,000 in loans past due 90 days and still accruing interest at December 31, 2009.

Investment Portfolio

At December 31, 2010, 2009 and 2008 all of the Company’s securities were classified as available-for-sale. The composition of the investment portfolio for the years ending December 31, 2010 and 2009 appear in Item 8, Note 2 of this report. The following table presents the composition of the investment portfolio as of December 31, 2008.


	December 31, 2008
(Dollars in Thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. Government agency securities	$	8,925	$	563	$	—	$	9,488

	$	8,925	$	563	$	—	$	9,488

Securities Available for Sale, Maturity Distribution and Average Yields


(Dollars in thousands)	Amortized Cost		Fair Value		Weighted Average Yield
U.S. government agency securities:
Maturing within 1 year	$	—	$	—		—
Maturing within 1 to 5 years		1,000		1,012		3.00	%
Maturing after 5 years		22,632		22,333		3.67	%
Mortgage backed securities
Maturing within 1 year	$	—	$	—		—
Maturing within 1 to 5 years		—		—		—
Maturing after 5 years		26,343		26,320		2.79	%
Taxable municipal securities
Maturing within 1 year	$	—	$	—		—
Maturing within 1 to 5 years		—		—		—
Maturing after 5 years		2,040		1,938		4.69	%

Total Maturities	$	52,015	$	51,603		3.25	%

Deposits

The Company’s primary source of funds is deposit accounts. The Company’s deposit base is comprised of demand deposits, savings and money market accounts, and time deposits. The Company’s deposits are provided primarily by individuals and businesses located in the Company’s market area. The Company is a member of the Promontory Financial Network and uses its CDARS program to provide FDIC deposit insurance coverage for certificates of deposit in excess of $250 thousand when requested by customers.

Total deposits increased by 10.6% from $271.6 million at December 31, 2009 to $300.5 million at December 31, 2010. The Company’s ability to attract and retain deposits, and our cost of funds, has been, and will continue to be, significantly affected by market conditions.

The following table is a schedule of average balances and average rates paid for each deposit category for the periods presented:

Average Deposits and Rates Paid


	Average Deposits and Rates Paid December 31,
	2010					2009					2008
(Dollars in thousands)	Amount		Rate			Amount		Rate			Amount		Rate
Non-interest bearing deposits	$	21,304				$	14,157				$	9,910
Interest bearing accounts:
Checking		37,575		1.08	%		32,496		1.25	%		31,647		2.61	%
Money market savings		54,133		1.38	%		23,234		1.36	%		17,970		2.64	%
Regular savings		9,222		1.69	%		2,591		1.58	%		382		0.96	%
Time Deposits		167,037		2.14	%		163,191		2.77	%		84,556		4.24	%

Total Interest Bearing		267,967		1.82	%		221,512		2.38	%		134,555		2.86	%

Total	$	289,271				$	235,669				$	144,466

The following table is a schedule of maturities for time deposits of $100,000 or more at the dates indicated:

Maturities of Certificates of Deposits with Balances of $100,000 or More


(Dollars in thousands)	Within 3 months		3 to 6 months		6 to 12 months		Over 1 year		Total		Percent of Total Deposits
At December 31, 2010	$	13,355	$	18,241	$	21,638	$	21,324	$	74,558		24.81	%

The following table is a schedule of the return on average assets and return on average equity for the dates indicated:


	For the years ended
	2010			2009			2008
Return on average assets		-1.11	%		0.17	%		-1.16	%
Return on average equity		-12.40	%		1.75	%		-9.49	%
Average equity to average assets		8.93	%		9.91	%		12.23	%
Dividend payout		—	%		—	%		—	%

Liquidity and Interest Rate Sensitivity

Liquidity is identified as the ability to generate or acquire sufficient amounts of cash when needed and at a reasonable cost to accommodate withdrawals, payments of debt, and increased loan demand. Liquid assets include cash, federal funds sold, securities classified as available for sale as well as 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 the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

The Company’s management, under the direction of the Asset/Liability Committee of the Board of Directors, reviews the mix of monetary assets and liabilities to ensure the Company maintains an adequate level of liquidity at all times. This ensures that the Company’s sources of funds, primarily net fluctuations in customer deposits, investments, securities and correspondent banking relationships, must be balanced with the Company’s obligations, commitments, and operational requirements, to maintain overall liquidity in conjunction with the maximization of interest rate spreads.

The Company’s asset based liquidity position, cash and due from bank balances, federal funds sold and securities available for sale, net of securities pledged and cash balance requirements totaled $60.1 million at December 31, 2010 compared to $61.1 million at December 31, 2009.

Lines of credit available to meet liquidity needs include: $19 million of federal funds lines of credit and $7.4 million in Federal Home Loan Bank lines of credit immediately available. The Company is approved to borrow 20% of our total assets from the Federal Home Loan Bank subject to providing qualifying collateral.

At December 31, 2010, the Company had commitments to originate $14.2 million of loans. Certificates of deposit scheduled to mature in the 12 month period ending December 31, 2011 total $109.5 million. Management believes that a significant portion of such deposits will remain with the Bank.

A financial institution can be exposed to several market risks that may impact its value or future earnings capacity.

These risks include interest rate risk, foreign currency exchange risk, commodity price risk and equity market price risk. Our primary market risk is interest rate risk. Interest rate risk is inherent because as a financial institution, we derive a significant amount of our operating revenue from customer deposits and possible borrowings at various terms and rates. These funds are then invested into earning assets (loans and investments) at various terms and rates.

Interest rate risk is the exposure to fluctuations in our future earnings (earnings at risk) and value (value at risk) resulting from changes in interest rates. This exposure results from differences between the amounts of interest earning assets and interest bearing liabilities that reprice within a specific time period as a result of scheduled maturities and repayment and contractual interest rate changes.

The primary objective of our asset/liability management process is to maximize current and future net interest income within acceptable levels of interest rate risk while satisfying liquidity and capital requirements. Management recognizes that a certain amount of interest rate risk is inherent and appropriate. The goal is to maintain a balance between risk and reward such that net interest income is maximized while risk is maintained at an acceptable level.

Management strives to control the exposure to interest rate volatility and operates under policies and guidelines established by the Board of Directors, who set the level of acceptable risk, by understanding, reviewing and making decisions based on our risk position. In addition, pricing, promotion and product development activities are assessed in an effort to emphasize the loan and deposit term or repricing characteristics that best meet current interest risk objectives. We use a variety of analytical systems and balance sheet tools to manage interest rate risk.

Gap Analysis

Gap analysis tools monitor the “gap” between interest-sensitive assets and interest-sensitive liabilities. We use simulation modeling to forecast future balance sheet and income statement behavior. By studying the effects on net interest income of rising, stable and falling interest rate scenarios and by understanding the dynamic nature of our balance sheet components, the Company can position itself to take advantage of anticipated interest rate movements. We evaluate the securities, loans and deposit portfolios to manage our interest rate risk position.

Table 10 “Interest Sensitivity” indicates that, on a cumulative basis through twelve months, rate sensitive liabilities exceeded rate sensitive assets, resulting in an liability sensitive position at December 31, 2010 of $127.8 million for a cumulative gap ratio of -38.10%, which benefits us in a falling rate environment but hurts us in a rising rate environment. An asset interest sensitivity gap results when interest-sensitive assets exceed interest-sensitive liabilities for a specific repricing “horizon”. The gap is negative when interest-sensitive liabilities exceed interest-sensitive assets, as was the case at December 31, 2010, with respect to the one year time horizon. For a company with a negative gap, such as us, falling interest rates would be expected to have a positive effect on net interest income and rising rates would be expected to have the opposite effect. The table below reflects the balances of interest earning assets and interest bearing liabilities at the earlier of their repricing or maturity dates. Amounts of fixed rate loans are reflected at the earlier of their contractual maturity date or their contractual repricing date. Time deposits are reflected in the deposits’ maturity dates. Borrowed funds are reflected in the earliest contractual repricing interval. Interest bearing liabilities with no contractual maturity, such as interest bearing transaction accounts and savings deposits, are reflected in the earliest repricing interval due to contractual arrangements which give management the opportunity to vary the rates paid on these deposits within a thirty day or shorter period. However, we are under no obligation to vary the rates paid on those deposits within any given period. Fixed rate time deposits are reflected at their contractual maturity date.

Interest Rate Sensitivity


(Dollars in thousands)	0 - 3 Months			3 - 12 Months			1 - 5 Years			Over 5 Years			Total
Interest Earning Assets
Securities	$	1,447		$	8,545		$	20,629		$	23,561		$	54,182
Interest-Bearing Balances		1,481			—			—			—			1,481
Loans		24,745			56,847			141,144			36,142			258,878
Federal funds sold		20,876			—			—			—			20,876

Total	$	48,549		$	65,392		$	161,773		$	59,703		$	335,417
Cumulative totals	$	48,549		$	113,941		$	275,714		$	335,417

Interest Bearing Liabilities
Interest checking	$	47,606		$	—		$	—		$	—		$	47,606
Savings		11,442			—			—			—			11,442
Money Market		70,587			—			—			—			70,587
Time Deposits		18,889			90,596			43,962			—			153,447
Short term borrowings		281			—			—			—			281
FHLB Borrowings		2,350			—			15,000			4,000			21,350

Total		151,155			90,596			58,962			4,000			304,713
Cumulative totals		151,155			241,751			300,713			304,713			—

Interest sensitivity gap		(102,606	)		(25,204	)		102,811			55,703			30,704
Cumulative interest sensitivity gap		(102,606	)		(127,810	)		(24,999	)		30,704			—

Cumulative interest sensitivity gap to total interest earning assets		-30.59	%		-38.10	%		-7.45	%		9.15	%

Capital Resources

To enable future growth of the Company, there must be an adequate level of capital. Management reviews the Company’s capital to ensure that the amount, composition and quality of the Company’s assets and liabilities satisfy regulatory requirements, meet or exceed industry standards, and support projected Company growth.

Stockholders’ equity decreased $4.1 million during 2010 due primarily to the net loss for the year of $3.9 million.

Risk Based Capital Analysis

Capital Analysis


	December 31,
(Dollars in thousands)	2010			2009
Tier 1 Capital:
Preferred Stock, net	$	10,087		$	10,019
Common Stock		16,167			14,697
Surplus		15,436			16,856
Retained Deficit		(11,622	)		(7,414	)

Total Tier 1 Capital	$	30,068		$	34,158
Tier 2 Capital:
Allowance for Loan Losses (allowable portion)		3,357			2,862
Total Risk Based Capital	$	33,425		$	37,020

Capital Ratios:
Tier I Risk Based Capital Ratio		11.3	%		13.0	%
Total Risk Based Capital Ratio		12.5	%		14.1	%
Leverage ratio (Tier I capital to average assets)		8.4	%		10.4	%

Financial Instruments with off Balance Sheet Risk and Contractual Obligations and Other Commitments

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

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

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not Required.

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following financial statements are filed as a part of this report:

Financial Statements

Consolidated Balance Sheets, December 31, 2010 and 2009

Consolidated Statements of Operations, Years Ended December 31, 2010 and December 31, 2009

Consolidated Statements of Changes in Stockholders’ Equity, Years Ended December 31, 2010 and December 31, 2009

Consolidated Statements of Cash Flows, Years Ended December 31, 2010 and December 31, 2009

Notes to Consolidated Financial Statements

Report of Independent Registered Public Accounting Firm

CONSOLIDATED BALANCE SHEETS


In Thousands, Except Share and Per Share Data	December 31, 2010			December 31, 2009

*Assets*
Cash and due from banks	$	4,479		$	7,051
Federal funds sold		20,876			19,908
Securities available for sale, at fair value		51,603			46,353
Restricted equity securities		2,579			2,547
Loans, net of allowance for loan losses of $5,228 in 2010 and $2,862 in 2009		258,878			249,807
Property and equipment, net		8,772			8,197
Other real estate owned		2,976			707
Accrued income		1,222			1,099
Prepaid FDIC insurance		984			1,606
Other assets		735			533

Total assets	$	353,104		$	337,808


*Liabilities and Stockholders’ Equity*
Deposits:
Noninterest-bearing	$	17,411		$	20,525
Interest-bearing		283,082			251,124

Total deposits		300,493			271,649
Short term borrowings		281			714
Federal Home Loan Bank borrowings		21,350			30,200
Accrued interest payable		766			1,068
Other liabilities		558			397

Total liabilities		323,448			304,028


Commitments and contingencies		—			—

*Stockholders’ equity:*
Preferred stock, $1,000 par value; 10,000 shares of series A and 374 shares of series B authorized, issued and outstanding at December 31, 2010 and 2009		10,374			10,374
Discount on preferred stock		(287	)		(355	)
Common stock, $5 par value; authorized 10,000,000 shares, issued and outstanding 3,241,547 in 2010 and 2,939,400 in 2009 (includes 8,207 restricted shares in 2010)		16,167			14,697
Surplus		15,436			16,856
Retained deficit		(11,622	)		(7,414	)
Accumulated other comprehensive loss		(412	)		(378	)

Total stockholders’ equity		29,656			33,780

Total liabilities and stockholders’ equity	$	353,104		$	337,808

See Notes to Consolidated Financial Statements

CONSOLIDATED STATEMENTS OF OPERATIONS


In Thousands, Except Share and Per Share Data	2010			2009

*Interest income:*
Loans and fees on loans	$	14,362		$	12,986
Taxable investment securities		1,720			833
Federal funds sold		39			23
Dividends on restricted stock		59			43
Other interest income		6			—

Total interest income		16,186			13,885


*Interest expense:*
Deposits		4,877			5,281
Other borrowed funds		561			603

Total interest expense		5,438			5,884

Net interest income		10,748			8,001


*Provision for loan losses*		6,453			725

Net interest income after provision for loan losses		4,295			7,276


*Noninterest income:*
Service charges on deposit accounts		294			315
Mortgage loan brokerage fees		175			122
Rental income		134			106
Gain on sale of investment securities		—			160
Other income		244			210

Total noninterest income		847			913


*Noninterest expense:*
Salaries and employee benefits		4,549			3,995
Occupancy and equipment expense		1,286			1,185
Advertising and marketing expense		376			303
Professional fees		494			260
Data processing expense		445			364
Bank franchise taxes		203			190
FDIC insurance expense		657			542
Gain on sale of other real estate		(77	)		—
Other expense		1,082			854

Total noninterest expense		9,015			7,693

Net (loss) income before income taxes		(3,873	)		496
Income tax expense		—			—

Net (loss) income	$	(3,873	)	$	496
Dividends accumulated on preferred stock		534			153
Accretion of discount on preferred stock		68			20

Net (loss) income available to common shareholders	$	(4,475	)	$	323

*(Loss) earnings per share, basic and diluted*	$	(1.38	)	$	.10

*Weighted average shares outstanding, basic and diluted*		3,240,220			3,233,340

See Notes to Consolidated Financial Statements

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY


In Thousands, Except Share Data	Preferred Stock		Common Stock		Surplus			Retained Deficit			Discount on Preferred Stock			Accum. Other Comp. Income (Loss)			Total
Balance, December 31, 2008	$	—	$	14,697	$	17,044		$	(7,806	)	$	—		$	563		$	24,498

Preferred Stock issuance at $1,000 par		10,374										(374	)					10,000
Issuance cost on preferred stock						(242	)											(242	)
Preferred stock dividend paid									(85	)								(85	)
Accretion of discount on preferred stock									(19	)		19						—
Net income									496									496
Net change in unrealized gain (loss) on investment securities available for sale															(781	)		(781	)
Reclassification adjustment for gains realized on sale of securities available for sale															(160	)		(160	)

Total comprehensive loss																		(445	)

Stock based compensation						54												54

Balance, December 31, 2009	$	10,374	$	14,697	$	16,856		$	(7,414	)	$	(355	)	$	(378	)	$	33,780


Stock split				1,470		(1,470	)											—
Preferred stock dividend paid									(267	)								(267	)
Accretion of discount on preferred stock									(68	)		68						—
Net loss									(3,873	)								(3,873	)
Net change in unrealized gain (loss) on investment securities available for sale															(34	)		(34	)

Total comprehensive loss																		(3,907	)

Stock based compensation						50												50

Balance, December 31, 2010	$	10,374	$	16,167	$	15,436		$	(11,622	)	$	(287	)	$	(412	)	$	29,656

See Notes to Consolidated Financial Statements

CONSOLIDATED STATEMENTS OF CASH FLOWS


In Thousands	2010			2009
*Cash flows from operating activities:*
Net (loss) income	$	(3,873	)	$	496
Adjustments to reconcile net (loss) income to net cash provided by (used in) operations:
Depreciation and amortization		609			595
Provision for loan losses		6,453			725
Amortization of premium on securities, net		329			36
Gain on sale of other real estate		(77	)		—
Gain on sale of investment securities		—			(160	)
Stock compensation expense		50			54
Changes in assets and liabilities:
Accrued income		(123	)		(334	)
Other assets		421			(1,479	)
Accrued interest payable		(302	)		214
Other liabilities		161			(377	)

Net cash flows provided by (used in) operating activities		3,648			(230	)

*Cash flows from investing activities:*
Net increase in federal funds sold		(968	)		(19,388	)
Purchases of investment securities		(32,774	)		(46,488	)
Sales/maturities of available for sale securities		27,160			8,806
Purchase of restricted equity securities, net		(32	)		(780	)
Net increase in loans		(18,089	)		(43,096	)
Proceeds from sale of other real estate		373			499
Purchases of property and equipment		(1,184	)		(185	)

Net cash flows used in investing activities		(25,514	)		(100,632	)

*Cash flows from financing activities:*
Net (decrease) increase in noninterest-bearing deposits		(3,114	)		7,818
Net increase in interest-bearing deposits		31,958			75,420
Net decrease in short-term borrowings		(433	)		(184	)
Net (decrease) increase in long-term FHLB borrowings		(8,850	)		12,000
Preferred stock dividend payment		(267	)		(85	)
Issuance of preferred stock, net of issuance costs		—			9,758

Net cash flows provided by financing activities		19,294			104,727

Net (decrease) increase in cash and cash equivalents		(2,572	)		3,865
*Cash and cash equivalents, beginning*		7,051			3,186

*Cash and cash equivalents, ending*	$	4,479		$	7,051

*Supplemental disclosure of cash flow information:*
Cash payments for interest	$	5,740		$	5,670

Cash payments for income taxes	$	—		$	—

*Supplemental disclosure of noncash investing activities:*
Unrealized loss on securities available for sale	$	(34	)	$	(941	)

Transfer from loans to other real estate	$	2,565		$	955

See Notes to Consolidated Financial Statements

Note 1. Organization and Summary of Significant Accounting Policies

Organization

On September 4, 2009, Hometown Bankshares Corporation (the “Company”) acquired all outstanding stock of Hometown Bank (the “Bank”) in an exchange for shares of the Company on a one-for-one basis to become a single-bank holding company with the Bank becoming a wholly-owned subsidiary. The Bank was organized and incorporated under the laws of the State of Virginia on November 9, 2004 and commenced operations on November 14, 2005. The Bank currently serves Roanoke City, Virginia, the County of Roanoke, Virginia, the City of Salem, Virginia, Christiansburg, Virginia, and surrounding areas. As a state chartered bank which is a member of the Federal Reserve System, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions, the Federal Deposit Insurance Corporation and the Federal Reserve Board.

Summary of Significant Accounting Policies

The following is a description of the significant accounting and reporting policies the Company follows in preparing and presenting its consolidated financial statements.

Principles of Consolidation

The consolidated financial statements include the accounts of HomeTown Bankshares Corporation and its wholly-owned subsidiary HomeTown Bank. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of other real estate owned, the valuation of deferred tax assets and fair value measurements. Substantially all of the Company’s loan portfolio consists of loans in its market area. Accordingly, the ultimate collectibility of a substantial portion of the Company’s loan portfolio and the recovery of a substantial portion of the carrying amount of foreclosed real estate (as applicable) is susceptible to changes in local market conditions.

Stock Split

On May 18, 2010, the Company declared a stock split, whereby each stockholder received one additional share for each ten shares owned. The shares were distributed on July 19, 2010 to stockholders of record at the close of business on June 18, 2010. All applicable share and per-share amounts in the consolidated financial statements and related disclosures have been retroactively adjusted to reflect this stock split.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and amounts due from correspondent banks. For the purpose of presentation in the consolidated statement of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption “cash and due from banks”.

Securities

Investments in debt and equity securities with readily determinable fair values are classified as either held to maturity, available for sale, or trading, based on management’s intent. Currently all of the Company’s investment securities are classified as available for sale. Available for sale securities are carried at estimated fair value with the corresponding unrealized gains and losses excluded from earnings and reported in other comprehensive income. Gains or losses are recognized in earnings on the trade date using the amortized cost of the specific security sold.

Note 1. Organization and Summary of Significant Accounting Policies, continued

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.

Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) the Company intends to sell the security or (ii) it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is more-likely-than-not that it will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. The Company regularly reviews each investment security for other-than-temporary impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, the best estimate of the present value of cash flows expected to be collected from debt securities, the Company’s intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery.

Restricted Equity Securities

As members of the Federal Reserve Bank (FRB) and the Federal Home Loan Bank of Atlanta (FHLB), the Company is required to maintain certain minimum investments in the capital stock of the FRB and FHLB. The Company’s investment in these securities is recorded at cost, based on the redemption provisions of the FRB and FHLB.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal amount adjusted for any charge-offs, allowance for loan losses and deferred fees or costs on originated loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan.

Interest is accrued and credited to income based on the principal amount outstanding. The accrual of interest on impaired loans for all classes is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest for the current year is reversed. Interest income is subsequently recognized only to the extent cash payments are received. When facts and circumstances indicate the borrower has regained the ability to meet the required payments, the loan is returned to accrual status. Past due status of loans is determined based on contractual terms. The loan portfolio is comprised of the following classes.

•

Residential real estate construction loans carry risks that the home will not be finished according to schedule, will not be finished according to the 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 may be unable to finish the construction project as planned because of financial pressure unrelated to the project.

•

Land acquisition and development loans and commercial construction loans carry risks that the project will not be finished according to schedule, 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. Land acquisition and development loans and commercial construction loans also bear the risk that the developer in the case of land acquisition and development loans or the general contractor in the case of commercial construction loans, may be unable to finish the development or construction project as planned because of financial pressure unrelated to the project.

Note 1. Organization and Summary of Significant Accounting Policies, continued

•

Residential real estate loans carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral.

•

Commercial real estate loans carry risks associated with the successful operation of a business or a real estate project, in addition to other risks associated with the ownership of real estate, because the repayment of these loans may be dependent upon the profitability and cash flows of the business or project.

•

Commercial, industrial and agricultural loans carry risks associated with the successful operation of a business. In addition, there is risk associated with the value of the collateral, it may depreciate over time and cannot be appraised with as much precision.

•

Equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral.

•

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.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

TDRs (Temporary Debt Restructurings) occur when the Company agrees to significantly modify the original terms of a loan due to the deterioration in the financial condition of the borrower. TDRs are considered impaired loans. Upon designation as a TDR, the Company evaluates the borrower’s payment history, past due status and ability to make payments based on the revised terms of the loan. If a loan was accruing prior to being modified as a TDR and if the Company concludes that the borrower is able to make such payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the loan will remain on an accruing status. If a loan was on nonaccrual status at the time of the TDR, the loan will remain on nonaccrual status following the modification and may be returned to accrual status based on a record of making payments as scheduled for a period of six consecutive months. As of December 31, 2010, the Company had $1.9 million of loans classified as TDRs.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Consumer loans are charged off when they become 120 days past due. Non-consumer loans are charged off when the loan becomes 180 days past due unless the loan is well secured and in the process of collection. Borrowers that are in bankruptcy are charged off unless the debt has been reaffirmed and is well secured and recovery is probable. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

Note 1. Organization and Summary of Significant Accounting Policies, continued

The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired, and is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. For collateral dependent loans, an updated appraisal will be ordered if a current one is not on file. Appraisals are performed by independent third-party appraisers with relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions when appropriate. The general component covers non-classified, or performing, loans and those loans classified as doubtful, substandard or special mention that are not impaired. The general component is based on historical loss experience adjusted for qualitative factors, such as current economic conditions, including current home sales and foreclosures, unemployment rates and retail sales. The characteristics of the loan ratings are as follows:

•

Pass rated 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.

•

Special mention loans have 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 is characterized by late payments. The Company’s risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

•

Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Company’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 Company. There is a distinct possibility that the Company 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 Company will be unable to collect all amounts due.

•

Substandard nonaccrual loans have the same characteristics as substandard loans; however, they have a non-accrual classification.

•

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 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.

Loan Fees and Costs

Loan origination and commitment fees and certain direct loan origination costs charged by the Bank are deferred and the net amount amortized as an adjustment of the related loan’s yield. The Bank is amortizing these net amounts over the contractual life of the related loans or, in the case of demand loans, over the estimated life. Net fees related to standby letters of credit are recognized over the commitment period.

Note 1. Organization and Summary of Significant Accounting Policies, continued

Property and Equipment

Land is carried at cost. Buildings, equipment, and leasehold improvements are carried at cost, less accumulated depreciation and amortization. Depreciation is provided over the estimated useful lives of the respective assets on the straight-line basis. Estimated useful lives range from ten to forty years for buildings and from three to ten years for equipment, furniture, and fixtures. Leasehold improvements are amortized over a term which includes the remaining lease term and probable renewal periods on a straight-line basis. Maintenance and repairs are charged to expense as incurred and major improvements are capitalized.

Foreclosed Properties

Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value less anticipated cost to sell at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management, and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in loss on foreclosed real estate. There were no valuation allowances for properties at December 31, 2010 and 2009.

Transfers of Financial Assets

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

Advertising Expense

The Bank expenses advertising costs as they are incurred. For the years ended December 31, 2010 and 2009, advertising expense was $376 thousand and $244 thousand, respectively.

Income Taxes

Deferred income tax assets and liabilities are determined using the liability method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax basis of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being

Note 1. Organization and Summary of Significant Accounting Policies, continued

realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of operations.

Earnings (Loss) per Share

Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period, after giving retroactive effect to stock splits and dividends. Diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.

Comprehensive Income (Loss)

Annual comprehensive income (loss) reflects the change in the Company’s equity during the year arising from transactions and events other than investment by and distributions to stockholders. It consists of net income plus certain other changes in assets and liabilities that are reported as separate components of stockholders’ equity rather than as income or expense. These changes for the Company relate solely to unrealized gains and losses on securities available for sale.

Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted 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.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distress sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation techniques or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Financial Instruments

Credit related financial instruments: In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under line of credit arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.

Stock-Based Compensation Plan

The 2005 Stock Option Plan was approved by shareholders on April 20, 2006, which authorized 550,000 shares of common stock to be used in the granting of incentive options to employees and directors. This is the first stock incentive plan adopted by the Company. Under the plan, the option price cannot be less than the fair market value of the stock on the date granted. An option’s maximum term is ten years from the date of grant. Options granted under the plan may be subject to a vesting schedule.

Note 1. Organization and Summary of Significant Accounting Policies, continued

The Company accounts for the stock option plan in accordance with applicable accounting guidance. Under the fair value recognition provisions of this guidance, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.

Reclassifications

Certain reclassifications have been made to prior periods to conform to current year presentation.

Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (FASB) issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140,” was adopted into the Accounting Standards Codification (Codification) in December 2009 through the issuance of Accounting Standards Update (ASU) 2009-16. The new standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. ASU 2009-16 was effective for transfers on or after January 1, 2010. The adoption of the new guidance did not have a material impact on the Company’s consolidated) financial statements.

In June 2009, the FASB issued new guidance relating to variable interest entities. The new guidance, which was issued as SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” was adopted into the Codification in December 2009. The objective of the guidance is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS No. 167 was effective as of January 1, 2010. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In October 2009, the FASB issued ASU 2009-15, “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing.” ASU 2009-15 amends Subtopic 470-20 to expand accounting and reporting guidance for own-share lending arrangements issued in contemplation of convertible debt issuance. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009 and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued ASU 2010-04, “Accounting for Various Topics – Technical Corrections to SEC Paragraphs.” ASU 2010-04 makes technical corrections to existing Securities and Exchange Commission (SEC) guidance including the following topics: accounting for subsequent investments, termination of an interest rate swap, issuance of financial statements - subsequent events, use of residual method to value acquired assets other than goodwill, adjustments in assets and liabilities for holding gains and losses, and selections of discount rate used for measuring defined benefit obligation. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued 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 February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements.” ASU 2010-09 addresses both the interaction of the requirements of Topic 855 with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provisions related to subsequent events. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. ASU 2010-09 was effective immediately. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

Note 1. Organization and Summary of Significant Accounting Policies, continued

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

On September 15, 2010, the SEC issued Release No. 33-9142, “Internal Control Over Financial Reporting In Exchange Act Periodic Reports of Non-Accelerated Filers.” This release issued a final rule adopting amendments to its rules and forms to conform them to Section 404(c) of the Sarbanes-Oxley Act of 2002 (SOX), as added by Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act. SOX Section 404(c) provides that Section 404(b) shall not apply with respect to any audit report prepared for an issuer that is neither an accelerated filer nor a large accelerated filer as defined in Rule 12b-2 under the Securities Exchange Act of 1934. Release No. 33-9142 was effective September 21, 2010.

On September 17, 2010, the SEC issued Release No. 33-9144, “Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management’s Discussion and Analysis.” This interpretive release is intended to improve discussion of liquidity and capital resources in Management’s Discussion and Analysis of Financial Condition and Results of Operations in order to facilitate understanding by investors of the liquidity and funding risks facing the registrant. This release was issued in conjunction with a proposed rule, “Short-Term Borrowings Disclosures,” that would require public companies to disclose additional information to investors about their short-term borrowing arrangements. Release No. 33-9144 was effective on September 28, 2010.

In January 2011, the FASB issued ASU 2011-01, “Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20.” The amendments in this ASU temporarily delay the effective date of the disclosures about troubled debt restructurings in ASU 2010-20 for public entities. The delay is intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011.

In December 2010, the FASB issued ASU 2010-29, “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 is not expected to have a material impact on the Company’s consolidated financial statements.

The SEC has issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting,” which requires companies to submit financial statements in XBRL (extensible business reporting language) 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.

Note 2. Investment Securities

The amortized cost and fair value of securities available for sale are as follows:


	December 31, 2010
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
(Dollars In Thousands)	Cost		Gains		Losses			Value
U. S. Government agency securities	$	23,632	$	210	$	(497	)	$	23,345
Mortgage-backed securities		26,343		52		(75	)		26,320
Municipal securities		2,040		—		(102	)		1,938

	$	52,015	$	262	$	(674	)	$	51,603


	December 31, 2009
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
(Dollars In Thousands)	Cost		Gains		Losses			Value
U. S. Government agency securities	$	21,444	$	71	$	(203	)	$	21,312
Mortgage-backed securities		25,287		—		(246	)		25,041

	$	46,731	$	71	$	(449	)	$	46,353

At December 31, 2010, the Company does not consider any bond in an unrealized loss position to be other than temporarily impaired.

U.S. Government and federal agency securities. The unrealized losses on fifteen of the Company’s investments in obligations of the U.S. government were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2010.

Mortgage-backed securities. The unrealized losses in nine of the Company’s investments in government-sponsored entity mortgage-backed securities were caused by interest rate increases. The Company purchased those investments at a discount relative to their face amount, and the contractual cash flows of those securities would not be settled at a price less than the amortized cost bases of the Company’s investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2010.

Municipal securities. The unrealized losses on the Company’s seven investments in obligations of municipal securities were caused by interest rate increases. All municipal securities are investment grade. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2010.

Note 2. Investment Securities, continued

The following tables demonstrate the unrealized loss position of securities available for sale at December 31, 2010 and 2009.


	December 31, 2010
	Less than 12 months					12 months or more				Total
(Dollars In Thousands)	Estimated Fair		Unrealized			Estimated Fair		Unrealized		Estimated Fair		Unrealized
(Dollars In Thousands)	Value		Loss			Value		Loss		Value		Loss
U. S. Government agency securities	$	14,833	$	(497	)	$	—	$	—	$	14,833	$	(497	)
Mortgage-backed securities		16,086		(75	)		—		—		16,086		(75	)
Municipal securities		1,686		(102	)		—		—		1,686		(102	)

	$	32,605	$	(674	)	$	—	$	—	$	32,605	$	(674	)


	December 31, 2009
	Less than 12 months					12 months or more				Total
(Dollars In Thousands)	Estimated Fair		Unrealized			Estimated Fair		Unrealized		Estimated Fair		Unrealized
(Dollars In Thousands)	Value		Loss			Value		Loss		Value		Loss
U. S. Government agency securities	$	18,277	$	(203	)	$	—	$	—	$	18,277	$	(203	)
Mortgage-backed securities		25,041		(246	)		—		—		25,041		(246	)

	$	43,318	$	(449	)	$	—	$	—	$	43,318	$	(449	)

The amortized cost and estimated fair value of securities at December 31, 2010, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to prepay obligations with or without call or prepayment penalties.


(Dollars In Thousands)	Amortized		Estimated Fair
(Dollars In Thousands)	Cost		Value
Less than one year	$	—	$	—
Over one through five years		1,000		1,012
Over five through ten years		15,872		15,846
Greater than 10 years		35,143		34,745

	$	52,015	$	51,603

Proceeds from the maturities and the calls of securities available for sale in 2010 and 2009 were $27.2 million and $8.8 million, respectively. The Company had no sales of securities in 2010, but realized $160 thousand in gains on sales of its available for sale securities for the period ended December 31, 2009. Total pledged securities had a fair market value of $15.7 million at December 31, 2010. Securities having a fair market value of $6.4 million were pledged to secure public deposits, while securities pledged to secure Federal Home Loan Bank borrowings totaled $7.8 million. $1.5 million in securities were pledged for other purposes at December 31, 2010.

The primary purpose of the investment portfolio is to generate income, diversify earning assets, and meet liquidity needs of the Company through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The Company monitors the portfolio, which is subject to liquidity needs, market rate changes, and

Note 2. Investment Securities, continued

credit risk changes, to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business or entity behind the instrument. The primary cause of unrealized losses is the decline in the prices of the bonds as interest rates have risen.

Note 3. Loans Receivable

The major classifications of loans in the consolidated balance sheets at December 31, 2010 and 2009 were as follows:


	December 31,
(Dollars In Thousands)	2010			2009
Construction:
Residential	$	7,608		$	7,664
Land acquisition, development & commercial		28,981			38,493
Real Estate:
Residential		55,381			45,456
Commercial		109,674			102,401
Commercial, industrial & agricultural		39,204			38,845
Equity lines		20,121			16,023
Consumer		3,137			3,787

	$	264,106		$	252,669

Less allowance for loan losses		(5,228	)		(2,862	)

Loans, net	$	258,878		$	249,807

The past due and non accrual status of loans as of December 31, 2010 was as follows:


(Dollars In Thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		Nonaccrual Loans
Construction:
Residential	$	—	$	—	$	224	$	224	$	7,384	$	7,608	$	224
Land acquisition, development & commercial		960		429		2,166		3,555		25,426		28,981		2,166
Real Estate:										—
Residential		261		5,016		875		6,152		49,229		55,381		875

Commercial		—		—		—		—		109,674		109,674
Commercial, industrial & agricultural		—		—		419		419		38,785		39,204		419
Equity lines		202		132		—		334		19,787		20,121		—
Consumer		2		—		—		2		3,135		3,137		—

Total	$	1,425	$	5,577	$	3,684	$	10,686	$	253,420	$	264,106	$	3,684

There were no loans past due ninety days or more and still accruing interest at December 31. 2010, at December 31, 2009 $553 thousand of loans were past due ninety or more days and still accruing interest.

Note 3. Loans Receivable, continued

Impaired loans, which include TDRs of $1.9 million and the related allowance at December 31, 2010 were as follows:


(Dollars In Thousands)	Recorded Investment in Loans		Unpaid Principal Balance		Related Allowance		Average Balance Total Loans		Interest Income Recognized
Construction:
Residential	$	2,007	$	2,007	$	—	$	1,250	$	36
Land acquisition, development & commercial		7,893		9,229		1,065		7,349		239
Real Estate:
Residential		7,210		7,210		175		6,903		192

Commercial		9,302		9,302		282		6,322		273

Commercial, industrial & agricultural		428		428		—		960		17
Equity lines		—		—		—		49		—
Consumer		—		—		—		—		—

Total	$	26,840	$	28,176	$	1,522	$	22,833	$	757

The balance of impaired loans was $20.8 million at December 31, 2009, for which there were specific valuation allowances of $538 thousand. The average balance of impaired loans for 2009 was $7.1 million.

Note 4. Allowance for Loan Losses

Changes in the allowance for loan losses were as follows:


	December 31,
(Dollars In Thousands)	2010			2009

Balance at the beginning of the year	$	2,862		$	2,862
Provision charged to operations		6,453			725
Recoveries of loans charged off		77			9
Loans charged off		(4,164	)		(734	)

Balance at the end of the year	$	5,228		$	2,862

Note 4. Allowance for Loan Losses, continued

The following table presents, as of December 31, 2010, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans and loans by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment).

Allowance for loan losses:


	Construction				Real Estate
	Residential		Land acquisition, development & commercial		Residential		Commercial		Commercial, industrial & agricultural		Equity lines		Consumer		Total
Ending balance	$	121	$	1,802	$	785	$	1,556	$	702	$	222	$	40	$	5,228

Ending balance: Individually evaluated for impairment	$	—	$	1,065	$	175	$	282	$	—	$	—	$	—	$	1,522


Ending balance: Collectively evaluated for impairment	$	121	$	737	$	610	$	1,274	$	702	$	222	$	40	$	3,706


Loans:
Ending balance	$	7,608	$	28,981	$	55,381	$	109,674	$	39,204	$	20,121	$	3,137	$	264,106

Ending balance: Individually evaluated for impairment	$	2,007	$	7,893	$	7,210	$	9,302	$	428	$	—	$	—	$	26,840


Ending balance: Collectively evaluated for impairment	$	5,601	$	21,088	$	48,171	$	100,372	$	38,776	$	20,121	$	3,137	$	237,266

Note 4. Allowance for Loan Losses, continued

Loans by credit quality indicators as of December 31, 2010 were as follows:


(Dollars In Thousands)	Pass		Special Mention		Substandard		Substandard Nonaccrual		Total
Construction:
Residential	$	5,250	$	350	$	1,784	$	224	$	7,608
Land acquisition, development & commercial		18,564		2,524		5,727		2,166		28,981
Real Estate:

Residential		47,782		223		6,501		875		55,381

Commercial		94,965		5,152		9,557				109,674

Commercial, industrial & agricultural		37,239		35		1,511		419		39,204
Equity lines		20,121		—		—		—		20,121
Consumer		3,059		—		78		—		3,137

Total	$	226,980	$	8,284	$	25,158	$	3,684	$	264,106

At December 31, 2010, the Company does not have any loans classified as Doubtful or Loss.

Note 5. Property and Equipment

The major components of property and equipment at December 31, 2010 and 2009 were as follows:


(Dollars In Thousands)	2010		2009
Land	$	2,749	$	1,817
Buildings and improvements		3,694		3,688
Leasehold improvements		2,377		2,374
Furniture and equipment		1,901		1,737
Software		311		297
Construction in process		60		—

Property and equipment, total		11,092		9,913
Less accumulated depreciation and amortization		2,320		1,716

Property and equipment, net	$	8,772	$	8,197

Depreciation and amortization expense was $609 thousand and $595 thousand for the years ended December 31, 2010 and 2009, respectively.

Leases

The Company currently leases its main office under a non-cancelable lease agreement. The lease expires December 15, 2015 and provides an option to extend the lease for two additional five-year periods. Terms of the agreement provide for an annual rental increase based on a published inflation index, not to exceed three percent over the rent for the immediately preceding lease year. Minimum annual payments until expiration at December 15, 2015 are $161,040. The Bank currently leases a branch location under a non-cancelable lease agreement. Terms of the agreement provide for an annual rental increase based on a published inflation index, not to exceed three percent over the rent for the immediately preceding lease year. The lease expires on July 31, 2016 and provides an option to extend the lease for two additional five-year periods. Minimum annual payments until expiration at July 31, 2016 are $98,688. The Company currently leases another branch location along with additional office space under non-cancelable lease agreements. Terms of the agreements provide for a rental increase of ten percent upon renewal of

Note 5. Property and Equipment, continued

the leases. The leases expire on April 30, 2013 and provide an option to extend the leases for one additional five-year period. Minimum annual payments until expiration at April 30, 2013 are $19,584. At June 1, 2010, the Company entered into another lease agreement in expectation of opening a branch in Salem, VA. Under the terms of the non-cancelable lease, minimum annual payments until expiration at June 1, 2011 are $101,250. At each anniversary date, the lease payments will be subject to an adjustment based on the Consumer Price Index for All Urban Consumers. The Company also has an option to extend the lease for four additional five-year periods.

Rent expense for the year ended December 31, 2010 and 2009 was $330 thousand and $292 thousand, respectively.

Note 6. Deposits

The aggregate amount of time deposits in denominations of one hundred thousand dollars or more at December 31, 2010 and 2009 was $74.6 million and $117.6 million, respectively. At December 31, 2010, the scheduled maturities of time deposits are as follows:


(Dollars in Thousands)	2010
2011	$	109,458
2012		33,440
2013		7,232
2014		1,711
2015		1,579

Total	$	153,420

The Company obtains certain deposits through the efforts of third-party deposit brokers. At December 31, 2010 and 2009, brokered deposits totaled $37.8 million and $47.0 million, respectively, and were included in interest-bearing deposits on the consolidated balance sheets.

Note 7. Short Term Borrowings

Short term borrowings consist of the following at December 31, 2010 and 2009:


(Dollars In Thousands)	2010			2009
Securities sold under agreements to repurchase	$	281		$	714


Weighted average interest rate		0.89	%		0.91	%

Short term borrowings consist of securities sold under agreements to repurchase, which are secured transactions with customers and generally mature the day following the day sold. Short-term borrowings may also include Federal funds purchased, which are unsecured overnight borrowings from other financial institutions. At December 31, 2010, the Bank had established $19 million in federal funds lines of credit with no balance outstanding.

Note 8. Federal Home Loan Bank Borrowings

The Company has outstanding long-term debt with the Federal Home Loan Bank of Atlanta in the amount of $21.4 million and $30.2 million as of December 31, 2010 and 2009, respectively. The long-term debt at December 31, 2010 is comprised of one convertible advance in the amount of $3.0 million, one convertible advance in the amount of $4.0 million, one fixed rate advance in the amount of $2.4 million, one fixed rate advance in the amount of $12 million. The Federal Home Loan Bank of Atlanta has the option to convert the convertible advances on the conversion dates below, and on any quarterly interest payment date thereafter, with at least two business days notice. If called, the advance will be converted into a 3-month London Interbank Offered Rate (LIBOR) based adjustable rate credit.

Note 8. Federal Home Loan Bank Borrowings, continued

At December 31, 2010 and 2009, borrowings from the Federal Home Loan Bank of Atlanta were as follows:


(Dollars In Thousands)
Advance Date	Maturity Date	Conversion Date	Current Rate			2010		2009

May 18, 2007	May 18, 2012	February 18, 2011		4.49	%	$	3,000	$	3,000
September 7, 2007	September 7, 2017	March 7, 2011		3.69	%		4,000		4,000
May 17, 2009	May 17, 2011			0.47	%		2,350		11,200
October 19, 2009	October 19, 2012			1.97	%		12,000		12,000

						$	21,350	$	30,200

The Company had collateral pledged on these borrowings at December 31, 2010 including real estate loans totaling $43.8 million, investment securities totaling $7.8 million, and Federal Home Loan Bank stock with a book value of $1.7 million.

Note 9. Fair Value Measurements

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

Level 1- Valuation is based on quoted prices in active markets for identical assets and liabilities.

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

Level 3- Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

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

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

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

Note 9. Fair Value Measurements, continued

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

The following tables presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 and 2009:


			Carrying value at December 31, 2010
(Dollars In Thousands) Description	Balance as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U. S. Government agency securities	$	23,345		$	23,345
Mortgaged-backed securities		26,320			26,320
Municipal securities		1,938			1,938
Derivative assets		301			301
Liabilities:
Derivative liabilities	$	301		$	301

			Carrying value at December 31, 2009
(Dollars In Thousands) Description	Balance as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U. S. Government agency securities	$	21,312		$	22,345
Mortgaged-backed securities		25,041			26,320
Derivative assets		274			274
Liabilities:
Derivative liabilities	$	274		$	274

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

Note 9. Fair Value Measurements, continued

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

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

Other Real Estate Owned (OREO): Foreclosed assets are adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair market value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the OREO as nonrecurring Level 2. When the appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the OREO as nonrecurring Level 3.

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


			Carrying value at December 31, 2010
(Dollars In Thousands) Description	Balance as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired Loans, net of valuation allowance	$	4,951		$	211	$	4,740
Other real estate owned	$	2,976		$	2,976

			Carrying value at December 31, 2009
(Dollars In Thousands) Description	Balance as of December 31, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired Loans, net of valuation allowance	$	4,144		$	1,391	$	2,753
Other real estate owned	$	707		$	707

Note 9. Fair Value Measurements, continued

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Cash and due from banks: The carrying amounts reported in the balance sheet for cash and due from banks approximate their fair values.

Federal funds sold: Federal funds sold consist of overnight loans to other financial institutions and mature within one to three days. At December 31, 2010 and 2009, management believes the carrying value of federal funds sold approximates estimated market value.

Available-for-sale securities: Fair values for securities, excluding restricted equity securities, are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

Deposit liabilities: The fair values disclosed for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date. The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of deposit to a schedule of aggregated contractual maturities on such time deposits.

Short term borrowings: Short term borrowings consist of overnight borrowings and mature within one to three days. At December 31, 2010 and 2009, management believes the carrying value of securities sold under agreements to repurchase approximates estimated market value.

FHLB borrowings: The fair values for long term borrowings are estimated using a discounted cash flow calculation that applies interest rates currently being offered on long term borrowings to the contractual maturities on such long term borrowings.

Accrued interest: The carrying amount of accrued interest receivable and payable approximates fair value.

Off-balance sheet financial instruments: The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements. At December 31, 2010 and 2009, the fair value of loan commitments and standby letters of credit were deemed to be immaterial.

The carrying amounts and approximate fair values of the Bank’s financial instruments are as follows at December 31, 2010 and 2009.


	2010				2009
	Carrying		Approximate		Carrying		Approximate
(Dollars in Thousands)	Amounts		Fair Values		Amounts		Fair Values
*Financial assets*
Cash and due from banks	$	4,479	$	4,479	$	7,051	$	7,051
Federal funds sold		20,876		20,876		19,908		19,908
Securities available-for-sale		51,603		51,603		46,353		46,353
Loans, net		258,878		256,127		249,807		249,398
Accrued income		1,222		1,222		1,099		1,099
Derivative assets		301		301		274		274
*Financial liabilities*
Total deposits		300,493		301,233		271,649		272,056
Short term borrowings		281		281		714		714
FHLB borrowings		21,350		22,246		30,200		31,375
Accrued interest payable		766		766		1,068		1,068
Derivative liabilities		301		301		274		274

Note 10. (Loss) Earnings per Share

The following table details the computation of basic and diluted (loss) earnings per share for the years ended December 31, 2010 and 2009.

In Thousands, Except Share and per share data.


	2010			2009
Net (loss) income available to common shareholders	$	(4,475	)	$	323


Weighted average common shares outstanding		3,240,220			3,233,340


Weighted average common shares outstanding, diluted		3,240,220			3,233,340


Basic and diluted (loss) earnings per share	$	(1.38	)	$	0.10

At December 31, 2010 and 2009, stock options to purchase 492,360 and 495,000 shares, respectively, were outstanding. These options were not included in the calculation of diluted weighted average shares as their impact would be anti-dilutive. All share and per share information has been restated for the 2010 stock split for the periods presented.

Note 11. Stock Based Compensation

The Company has a 2005 Stock Option Plan (the Plan) pursuant to which the Board of Directors may grant stock options to directors, officers and employees. Under the fair value recognition provisions of relevant accounting guidance, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.

The Company uses the Black-Scholes option pricing model to determine the fair value of stock options. The fair value of the stock based payment awards is affected by the price of our stock and a number of financial assumptions and variables. These variables include the risk free interest rate, expected dividend rate, expected stock price volatility and the expected life of the options. No options were granted in the year ended December 31, 2010. The following table shows the assumptions for the Black-Scholes model used in determining the fair value of options granted for the year ending December 31, 2009. Options were restated for the 2010 stock split.


	2009

Expected dividend yield		0.75	%
Risk-free interest rate		1.87	%
Expected life of options (in years)		6
Expected volatility of stock price		43	%

The expected volatility in 2009 is based on the Company’s stock price during the previous year. The risk-free interest rate is the implied yield available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of the options granted. The expected life is based on the average of the contractual life and vesting schedule for the options granted. The dividend yield assumption is based on expected dividend payouts.

Note 11. Stock Based Compensation, continued

A summary of option activity under the 2005 stock option plan during the year ended December 31, 2010 is as follows:


				Weighted				Weighted
				Average		Aggregate		Average
	Options			Exercise		Intrinsic		Contractual
	Outstanding			Price		Value (1)		Term

Balance at December 31, 2009		495,000		$	10.21
Granted		—			—
Exercised		—			—
Forfeited		(2,640	)		10.00

Balance at December 31, 2010		492,360		$	10.21	$	—		5.48 years

Exercisable at December 31, 2010		467,793		$	10.09	$	—		5.35 years

(1)

The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on December 31, 2010.

The Company recorded stock based compensation expense of $50 thousand and $54 thousand for the years ended December 31, 2010 and 2009, respectively. At December 31, 2010, the total compensation cost related to nonvested options was $14 thousand. This expense will be recognized over a weighted average life of .49 years.

In 2009, the Board of Directors authorized 132,000 shares of common stock for issuance under the Restricted Stock Plan. The plan provides for restricted stock awards to key employees. Restricted shares awarded to employees generally vest over a five year period and compensation expense is charged to income ratably over the vesting period and was $8 in 2010. Compensation is accounted for using the fair market value of the Company’s common stock on the date the restricted shares are awarded. The weighted-average grant date fair value of restricted stock granted in 2010 was $7.16, no restricted stock grants were awarded in 2009.

As of December 31, 2010, there was $45 of total unrecognized compensation cost related to restricted stock granted under the Plan. The cost is expected to be recognized through 2014. A summary of the activity for restricted stock awards for the periods indicated is presented below:


	2010
			Weighted-
			Average
			Grant Date
	Shares		Fair Value
Nonvested at beginning of year		—		—
Granted		8,207	$	7.16
Vested		—		—
Cancelled		—		—

Nonvested at end of year		8,207	$	7.16

Note 12. Employee Benefit Plans Defined Contribution Plan

The Company adopted a profit sharing plan pursuant to Section 401(k) of the Internal Revenue Code. The plan covers substantially all employees. Participants may contribute a percentage of compensation, subject to a maximum allowed under the Code. The Company makes non-discretionary matching contributions of 100% of the employee’s deferral up to 3% of compensation and matches 50% of the employee’s next 3% deferral. In addition, the Company may make additional contributions at the discretion of the Board of Directors. The Company’s matching contributions were $133 thousand and $122 thousand for the years ended December 31, 2010 and 2009, respectively.

Note 13. Income Taxes

The Company files income tax returns in the U.S. federal jurisdiction and the Commonwealth of Virginia. With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2007. The Company has operating loss carryforwards of $7.6 million for federal income tax purposes that may be used to offset future taxable income. If not previously utilized, the federal loss carryforward will begin to expire in 2025.

The current and deferred components of income tax expense for the periods ended December 31, 2010 and 2009 are as follows:


(Dollars In Thousands)	2010			2009
Current tax expense	$	—		$	—
Deferred tax expense (benefit)		(1,276	)		150
Deferred tax asset valuation allowance change		1,276			(150	)

	$	—		$	—

Deferred Income Tax Analysis

The significant components of net deferred tax assets at December 31, 2010 and 2009 are summarized as follows:


(Dollars In Thousands)	2010			2009
Deferred tax assets
Net operating losses	$	2,570		$	1,647
Pre-opening expenses		158			175
Allowance for loan losses		1,330			833
Stock based compensation		236			236
Other		45			7

Deferred tax asset		4,339			2,898


Deferred tax liabilities
Depreciation		298			202
Accretion of bond discount		15			14
Deferred loan fees		461			401

Deferred tax liability		774			617

Net Deferred tax asset		3,566			2,281

Valuation allowance		(3,566	)		(2,281	)

	$	—		$	—

Note 14. Commitments and Contingencies

Litigation

In the normal course of business the Company may be involved in various legal proceedings. The Company was not involved in any litigation for the year ended December 31, 2010.

Financial Instruments with Off-balance-sheet Risk

The Company is party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, credit risk in excess of the amount recognized in the balance sheet.

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

A summary of the Company’s commitments at December 31, 2010 and 2009 is as follows (dollars in thousands):


(Dollars in Thousands)	2010		2009

Commitments to extend credit	$	14,228	$	22,100
Unfunded commitments under lines of credit		22,509		8,285
Standby letters of credit		1,183		2,297

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

Unfunded commitments under commercial lines-of-credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines-of-credit are uncollateralized and usually do not contain a specified maturity date and ultimately may not be drawn upon to the total extent to which the Company is committed.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Company deems necessary.

The Company is required to maintain certain required reserve balances with the Federal Reserve Bank. At December 31, 2010 and 2009, these reserve balances amounted to $1.2 million and $475 thousand, respectively.

The Company from time to time may have cash and cash equivalents on deposit with financial institutions that exceed federally insured limits.

Note 14. Commitments and Contingencies, continued

Financial Derivatives

Financial Derivatives are reported at fair value in other assets and other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as hedges, the gain or loss is recognized in current earnings. In 2008, the Company entered into interest rate swaps to facilitate customer transactions in connection with their financing needs. Upon entering into swaps with the borrowers to meet their financing needs, the Company entered into offsetting positions with counterparties to minimize risk to the Company. These back-to-back swaps qualify as derivatives, but are not designated as hedging instruments. Interest rate swap contracts involve the risk of dealing with borrowers and counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument contract is positive, this generally indicates that the counterparty or customer owes the Company, and results in credit risk to the Company. When the fair value of a derivative instrument contract is negative, the Company owes the customer or counterparty and therefore, has no risk.

A summary of the Company’s interest rate swaps is as follows (dollars in thousands):


	December 31, 2010
(Dollars in Thousands)	Notional Amount			Estimated Fair Value
Interest rate swap agreements:
Pay fixed / receive variable swaps	$	(2,924	)	$	(301	)
Pay variable / receive fixed swaps		2,924			301

Total	$	—		$	—

Note 15. Regulatory Restrictions

Dividends

The Company, as a Virginia banking corporation, may pay dividends only out of its retained earnings. However, regulatory authorities may limit payment of dividends by any company when it is determined that such a limitation is in the public interest and is necessary to ensure financial soundness of the Company. At December 31, 2010 there are no retained earnings available from which to pay dividends.

Capital Requirements

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

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets, as all those terms are defined in the applicable regulations. As of December 31, 2010, management believes the Company and the Bank met all capital adequacy requirements to which they are subject.

As of December 31, 2010, the most recent notification from the Federal Deposit Insurance Corporation, the Bank met the criteria to be considered well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since the notification that management believes have changed the Bank’s category.

Note 15. Regulatory Restrictions, continued

The Company’s and the Bank’s actual capital amounts and ratios are also presented in the following table.


	Actual					Minimum Capital Requirement					Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2010
Total Capital (to Risk-Weighted Assets)
Consolidated	$	33,425		12.50	%	$	21,345		8.00	%		N/A		N/A
HomeTown Bank	$	31,092		11.70	%	$	21,345		8.00	%	$	26,681		10.00	%
Tier I Capital (to Risk-Weighted Assets)
Consolidated	$	30,068		11.30	%	$	10,672		4.00	%		N/A		N/A
HomeTown Bank	$	27,735		10.40	%	$	10,672		4.00	%	$	16,008		6.00	%
Tier I Capital (to Average Assets)
Consolidated	$	30,068		8.40	%	$	14,255		4.00	%		N/A		N/A
HomeTown Bank	$	27,735		7.80	%	$	14,255		4.00	%	$	17,819		5.00	%

	Actual					Minimum Capital Requirement					Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2009
Total Capital (to Risk-Weighted Assets)
Consolidated	$	37,019		14.10	%	$	21,004		8.00	%		N/A		N/A
HomeTown Bank	$	31,846		12.10	%	$	21,003		8.00	%	$	26,254		10.00	%
Tier I Capital (to Risk-Weighted Assets)
Consolidated	$	34,157		13.00	%	$	10,502		4.00	%		N/A		N/A
HomeTown Bank	$	28,984		11.00	%	$	10,501		4.00	%	$	15,752		6.00	%
Tier I Capital (to Average Assets)
Consolidated	$	34,157		10.40	%	$	13,105		4.00	%		N/A		N/A
HomeTown Bank	$	28,984		8.90	%	$	13,100		4.00	%	$	16,375		5.00	%

Note 16. Transactions with Related Parties

The Company has entered into transactions with its directors, significant shareholders and their affiliates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. Aggregate loan transactions with related parties were as follows:


(Dollars in Thousands)	2010			2009

Balance, beginning	$	10,539		$	10,141
New loans		1,072			3,971
Repayments		(2,140	)		(3,573	)

Balance, ending	$	9,471		$	10,539

Note 17. Capital Transaction

The Department of the Treasury created the Troubled Asset Relief Program Capital Purchase Program in 2008 to make capital available to certain U.S. financial institutions. Under this program, the Treasury would purchase preferred stock with an initial cumulative dividend rate of 5% and receive warrants to purchase additional preferred stock with a cumulative dividend rate of 9%. Participating financial institutions were required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program.

On September 18, 2009, as part of the Capital Purchase Program, the Company entered into a Letter Agreement and Securities Purchase Agreement with the Treasury, pursuant to which the Company sold (i) 10,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, $1,000 par value per share and (ii) a warrant (the “Warrant”) to purchase 374 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, $1,000 par value per share, at an initial exercise price of $.01 per share. The Warrant was exercised immediately. The discount will be accreted up to the $374,000 over five years.

The Preferred Stock qualifies as Tier 1 capital and the Series A pays cumulative dividends at a rate of 5% per annum for the first five years, and thereafter at a rate of 9% per annum. The Series B pays cumulative dividends at a rate of 9% per annum. Due to the net loss incurred in 2010, the Company is prohibited from paying dividends on the preferred stock. Dividends in arrears totaled $267 thousand at December 31, 2010.

Note 18. Condensed Parent Company Financial Information

Financial information pertaining only to HomeTown Bankshares Corporation follows. The parent company was formed on September 4, 2009.

CONDENSED BALANCE SHEETS


In Thousands	December 31, 2010		December 31, 2009

*Assets*
Cash and due from banks	$	2,334	$	5,172
Investment in bank subsidiary		27,322		28,607
Other assets		—		1

Total assets	$	29,656	$	33,780


*Liabilities and Stockholders’ Equity*
Total liabilities	$	—	$	—

*Stockholders’ equity:*
Total stockholders’ equity		29,656		33,780

Total liabilities and stockholders’ equity	$	29,656	$	33,780

CONDENSED STATEMENTS OF OPERATIONS


In Thousands	For the year ended December 31, 2010			Period from September 4, 2009 To December 31, 2009

*Income*
Undistributed earnings (loss) of subsidiary	$	(3,800	)	$	496
*Expenses*		(73	)		—

*Net Income (Loss)*	$	(3,873	)	$	496

Note 18. Condensed Parent Company Financial Information, continued

CONDENSED STATEMENTS OF CASH FLOWS


In Thousands	For the year ended December 31, 2010			Period from September 4, 2009 To December 31, 2009
*Cash flows from operating activities:*
Net income (loss)	$	(3,873	)	$	496
Equity in undistributed net (income) loss of subsidiary bank		3,800			(496	)
Decrease (increase) in other assets		2			(1	)

Net cash flows used in operating activities	$	(71	)	$	(1	)


*Cash flows from investing activities:*
Capital contribution to bank subsidiary	$	(2,500	)	$	(4,500	)

Net cash flows used in investing activities	$	(2,500	)	$	(4,500	)


*Cash flows from financing activities:*
Issuance of preferred stock net of issuance costs	$	—		$	9,758
Preferred dividend payment		(267	)		(85	)

Net cash flows (used in) provided by financing activities	$	(267	)	$	9,673


Net (decrease) increase in cash and cash equivalents	$	(2,838	)	$	5,172

*Cash and cash equivalents, beginning*		5,172			—

*Cash and cash equivalents, ending*	$	2,334		$	5,172

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

HomeTown Bankshares Corporation

Roanoke, Virginia

We have audited the accompanying consolidated balance sheets of HomeTown Bankshares Corporation and subsidiary as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HomeTown Bankshares Corporation and subsidiary as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

LOGO

Winchester, Virginia

March 31, 2011

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

ITEM 9A.

CONTROLS AND PROCEDURES

As of the end of the period covered by this report, our management, including our Chief Executive Officer and Chief Financial Officer, reviewed and evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 15d-15. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Bank that is required to be included in our periodic filings with the Securities and Exchange Commission. There have been no significant changes in our internal controls or, to management’s knowledge, in other factors that could significantly affect those internal controls subsequent to the date we carried out our evaluation, and there has been no corrective actions with respect to significant deficiencies or material weaknesses.

MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

HomeTown Bankshares Corporation’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. HomeTown Bankshares Corporation’s internal control over financial reporting is designed 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.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of HomeTown Bankshares’s internal control over financial reporting as of December 31, 2010. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on this assessment, management believes that, as of December 31, 2010, HomeTown Bankshares’s internal control over financial reporting was effective.

This annual report does not include an attestation report of HomeTown Bankshares’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by HomeTown Bankshares’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit filers to provide only management’s report in this annual report.

ITEM 9B.

OTHER INFORMATION

None

PART III

ITEM 10.

DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE.

Pursuant to General Instruction G(3) of Form 10-K, the information required to be disclosed in this item 10 is contained in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders and is incorporated herein by reference.

ITEM 11.

EXECUTIVE COMPENSATION.

Pursuant to General Instruction G(3) of Form 10-K, the information required to be disclosed in this item 11 is contained in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders and is incorporated herein by reference.

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

Pursuant to General Instruction G(3) of Form 10-K, the information required to be disclosed in this item 12 is contained in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders and is incorporated herein by reference.

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

Pursuant to General Instruction G(3) of Form 10-K, the information required to be disclosed in this item 13 is contained in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders and is incorporated herein by reference.

ITEM 14.

PRINCIPAL ACCOUNTING FEES AND SERVICES.

Pursuant to General Instruction G(3) of Form 10-K, the information required to be disclosed in this item 14 is contained in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders and is incorporated herein by reference.

PART IV

ITEM 15.

EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

Financial Statements:

Consolidated Balance Sheets as of December 31, 2010 and 2009

Consolidated Statements of Operations for the Years Ended December 31, 2010 and 2009

Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2010 and 2009

Consolidated Statements of Cash Flows for the Years Ended December 31, 2010 and 2009

Report of Independent Registered Public Accounting Firm


Exhibit Number

3.1		Certificate of Amendment and Articles of Amendment for the Series A Preferred Stock, incorporated herein by reference to Exhibit 3.1 to Form 8-K filed September 24, 2009.

3.2		Certificate of Amendment and Articles of Amendment for the Series B Preferred Stock, incorporated herein by reference to Exhibit 3.1 to Form 8-K filed September 24, 2009.

4.1		Form of Certificate for the Series A Preferred Stock, incorporated herein by reference to Exhibit 4.1 to Form 8-K filed September 24, 2009.

4.2		Form of Certificate for the Series B Preferred Stock, incorporated herein by reference to Exhibit 4.2 to Form 8-K filed September 24, 2009.

10.2*		Employment Agreement dated March 1, 2006 between HomeTown Bank and S. K. Still, incorporated herein by reference to Exhibit 10.2 to Form 10QSB for the quarter ended March 31, 2006.

10.3*		Employment Agreement dated March 1, 2006 between HomeTown Bank and W. C. Moses, incorporated herein by reference to Exhibit 10.3 to Form 10QSB for the quarter ended March 31, 2006.



10.4		HomeTown Bank 2005 Stock Option Plan, incorporated herein by reference to Exhibit 10.4 to Form 10QSB for the quarter ended June 30, 2006.

10.5		Real estate purchase contract, incorporated herein by reference to Exhibit 10.5 to Form 10QSB for the quarter ended June 30, 2006.

10.6*		Employment Agreement dated May 1, 2006 between HomeTown Bank and C. W. Maness, Jr., incorporated herein by reference to Exhibit 10.4 to Form 10QSB for the quarter ended June 30, 2006.

10.7		Lease agreement, incorporated herein by reference to Exhibit 10.7 to form 10QSB for the quarter ended September 30, 2006.

10.8		Hometown Bankshares Corporation Restricted Stock Plan, Incorporated herein by reference to Exhibit 10.1 to Form 8-K filed September 16, 2010.

10.9		Letter Agreement, including Schedule A, and Securities Purchase Agreement, dated September 18, 2009, between HomeTown Bankshares Corporation and United States Department of the Treasury, with respect to the issuance and sale of the Series A Preferred Stock and Series B Preferred Stock, incorporated herein by reference to Exhibit 10.1 to Form 8-K filed September 24, 2009.

10.10		Form of Compensation Modification Agreement and Waiver, executed by Senior Executive Officers of HomeTown Bankshares Corporation , incorporated herein by reference to Exhibit 10.2 to Form 8-K filed September 24, 2009.

31.1		Certification of Chief Executive of Officer (302 Certification).

31.2		Certification of Chief Financial Officer (302 Certification).

32		Certification pursuant to 18 U.S.C. Section 1350 (906 Certification).

99.1		TARP Chief Executive Officer Certification

99.2		TARP Chief Financial Officer Certification

*	Denotes management contract

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.


	HOMETOWN BANKSHARES CORPORATION

Date: March 31, 2011	By:	/S/ SUSAN K. STILL
		Susan K. Still President Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.


Signature	Title	Date

/S/ SUSAN K. STILL Susan K. Still	Director, President, and Chief Executive Officer (principal executive officer)	March 31, 2011

/S/ GEORGE B. CARTLEDGE, JR. George B. Cartledge, Jr.	Director	March 31, 2011

/S/ WARNER DALHOUSE Warner Dalhouse	Director	March 31, 2011

/S/ VICTOR F. FOTI Victor F. Foti	Director	March 31, 2011

/S/ DANIEL D. HAMRICK Daniel D. Hamrick	Director	March 31, 2011

/S/ EDWARD G. MURPHY, JR. Edward G. Murphy, Jr. MD	Director	March 31, 2011

/S/ WILLIAM R. RAKES William R. Rakes	Director	March 31, 2011

/S/ JAMES M. TURNER, JR. James M. Turner, Jr.	Director	March 31, 2011

/S/ CHARLES W. MANESS, JR. Charles W. Maness, Jr.	Chief Financial Officer (principal accounting and financial officer)	March 31, 2011

INDEX TO EXHIBITS


Exhibit Number		Description

		Material Contracts

3.1		Certificate of Amendment and Articles of Amendment for the Series A Preferred Stock, incorporated herein by reference to Exhibit 3.1 to Form 8-K filed September 24, 2009.

3.2		Certificate of Amendment and Articles of Amendment for the Series B Preferred Stock, incorporated herein by reference to Exhibit 3.1 to Form 8-K filed September 24, 2009.

4.1		Form of Certificate for the Series A Preferred Stock, incorporated herein by reference to Exhibit 4.1 to Form 8-K filed September 24, 2009.

4.2		Form of Certificate for the Series B Preferred Stock, incorporated herein by reference to Exhibit 4.2 to Form 8-K filed September 24, 2009.

10.2*		Employment Agreement dated March 1, 2006 between HomeTown Bank and S. K. Still, incorporated herein by reference to Exhibit 10.2 to Form 10QSB for the quarter ended March 31, 2006.

10.3*		Employment Agreement dated March 1, 2006 between HomeTown Bank and W. C. Moses, incorporated herein by reference to Exhibit 10.3 to Form 10QSB for the quarter ended March 31, 2006.

10.4		HomeTown Bank 2005 Stock Option Plan, incorporated herein by reference to Exhibit 10.4 to Form 10QSB for the quarter ended June 30, 2006.

10.5		Real estate purchase contract, incorporated herein by reference to Exhibit 10.5 to Form 10QSB for the quarter ended June 30, 2006.

10.6*		Employment Agreement dated May 1, 2006 between HomeTown Bank and C. W. Maness, Jr., incorporated herein by reference to Exhibit 10.4 to Form 10QSB for the quarter ended June 30, 2006.

10.7		Lease agreement, incorporated herein by reference to Exhibit 10.7 to form 10QSB for the quarter ended September 30, 2006.

10.8		Hometown Bankshares Corporation Restricted Stock Plan, Incorporated herein by reference to Exhibit 10.1 to Form 8-K filed September 16, 2010.

10.9		Letter Agreement, including Schedule A, and Securities Purchase Agreement, dated September 18, 2009, between HomeTown Bankshares Corporation and United States Department of the Treasury, with respect to the issuance and sale of the Series A Preferred Stock and Series B Preferred Stock, incorporated herein by reference to Exhibit 10.1 to Form 8-K filed September 24, 2009.

10.10		Form of Compensation Modification Agreement and Waiver, executed by Senior Executive Officers of HomeTown Bankshares Corporation , incorporated herein by reference to Exhibit 10.2 to Form 8-K filed September 24, 2009.

31.1		Certification of Chief Executive of Officer (302 Certification).

31.2		Certification of Chief Financial Officer (302 Certification).

32		Certification pursuant to 18 U.S.C. Section 1350 (906 Certification).

99.1		TARP Chief Executive Officer Certification

99.2		TARP Chief Financial Officer Certification

*	Denotes management contract

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